Fiesta Restaurant Group, Inc.
Q2 2017 Earnings Call Transcript

Published: 7 Aug 2017

[Operator:]

Good afternoon and welcome to the Fiesta Restaurant Group Second 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 a question. Now, I'd like to turn the call over to Mr. Raphael Gross, Managing Director at ICR. Please go ahead, Raphael.

[Raphael Gross:]

Thank you and good afternoon, everyone. Fiesta Restaurant Group's second 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 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 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 President and Chief Executive Officer, Rich Stockinger; Senior Vice President and Chief Operating Officer, Danny Meisenheimer; and Senior Vice President and Chief Financial Officer, Lynn Schweinfurth. 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. Our second quarter financial results reflect industry-wide weakness, and the impact of our planned reduction in media, as we put in place key elements of our Strategic Renewal Plan that we believe will fundamentally improve the guest experience and induce trial and increase frequency, creating value for our shareholders. We laid out the significant progress we are making in our press release that was issued issue today. Our team is energized by the level of investment and focus being made across the organization to deliver a brand promise that will delight our guests and build upon an already strong affinity for our brands, especially in our core markets where we are focusing our efforts first. And while it's still early, we believe the rejuvenation of our brands is in process. Leading indicators that demonstrate positive momentum among others, include qualitative guests and employee feedback, reduced customer complaints, increased complements and improve guest metrics and social media scores. To summarize the timeline, after I joined the company at the end of February, I worked with a team to develop the Plan. In April, we launch the Plan starting with Pollo first and then Taco about a month later. Additionally, we suspended broadcast media where possible, while we began working in earnest to put in place key initiatives. Now, that many of the food quality improvements are being implemented, we are making considerable progress on hospitality and on the restaurant environment. We are beginning to reintroduce media to our markets. We introduced media at the end of June for Pollo and we're seeing improvements in our sales trajectory. We will relaunch our Pollo brand in mid-October and our Taco brand shortly thereafter with new creative advertising campaigns that Danny will further touch on. We continue to ensure that we are managing our business with financial discipline, including ensuring we will generate attractive investment returns and we're being rigorous in utilizing research and analysis to assist us in making business decisions. In addition, as we noted in our press release, we're in the process of refinancing our revolving credit facility, which expires late next year. Once completed, we will refine our plans to allocate capital, including considering the implementation of a share repurchase plan. During and after the relaunch of both brands, we will continue to make progress establishing platforms for growth for the future, including new restaurant prototypes that meet or exceed our return requirements, emerging market growth strategies and systems and processes to build delivery, catering, online ordering and loyalty platforms. In closing, we remain confident that our actions will fundamentally improve our core business models, improving sales and profitability trends as we enter 2018. I would like to thank our 12,000 employees and our partners for their passion in the development and implementation of the Plan. With that, I'd like to turn the call over to Danny.

[Danny K. Meisenheimer:]

Thank you, Rich. There is a renewed passion within our team to uphold high standards and reestablish ourselves as a best in-class operator. There is much to be excited about as we put in place our many action items that we believe are resonating with guest. As Rich touched on, we will relaunch both brands in the coming months with new creative advertising campaigns that we believe will be impactful and help to induce trial and increase frequency as guest experience the quality improvements in our restaurants. These campaigns will be part of comprehensive marketing strategy that includes brand building messaging through mediums including broadcast, point purchase, out-of-house billboards, digital and social media. At both Pollo and Taco, we're planning to resume Spanish television and outdoor billboards in core markets. Through these communication platforms, we will convey our updated positioning and reinforce our brand equities across all consumer touch points. We recently received top line brand and guest research, which we believe validates key initiatives underway as part of the Plan, including opportunities to address cleanliness, restaurant maintenance, and food quality. By the end of August, we expect to complete detailed qualitative and quantitative brand and guest research to further apply to our business. In addition, a pricing elasticity analysis by restaurant is underway that will assist us in identifying where we can potentially add price to mitigate the investments being made in our restaurants and to help guide our menu and promotional initiatives as we move forward. Operationally, we are changing the culture to truly embrace our food quality, hospitality and restaurant environment standards. We have improved almost 90% of each brand menu with food and ingredient enhancements, including removing artificial preservatives. In addition to utilizing clean and fresh ingredients, we're in the process of vertically integrating our chicken supply chain at Pollo. This will allow us to control the feed and breed of the chickens that we purchase and serve in our restaurants. In addition to quality improvements, we believe these enhancements may provide us a way to further differentiate our brand, especially in markets outside of core. Pre-shift meetings now include food sampling to ensure our team members know and love our food, and are familiar with current product promotions. Regional chefs are being put in place to ensure adherence to high quality operating and food safety standards. New labor models are being tested at each brand to enhance hospitality, deliver consistent high quality food, and ensure speed of service and accuracy. Video menu boards will be rolled out in core markets by our relaunch dates and through the balance of the system by year-end. Not only will there be enhanced presentation of our menu and an ability to transition day-part menus and to systematically implement price changes, but they also provide us another vehicle to use for promotions and brand building. We plan to use these video monitors to show our products being freshly prepared in our kitchens throughout the day. Updated cleanliness checklists have been rolled out to ensure that a clean and safe restaurant is top of mind, and being addressed with frequency throughout the day. We will spend up to $26 million on capital this year, addressing deferred maintenance needs to start restaurants. Lastly, we are in the process of rolling out a new preventative maintenance program to improve the longevity and the atmosphere at our restaurants. Turning to development, we opened three company-owned Pollo Tropical restaurants in Florida, and two company-owned Taco Cabana restaurants in Texas during the second quarter. In total, we expect to open nine Pollo Tropical restaurants and six Taco Cabana restaurants in 2017, including one conversion of a former Pollo restaurant. Year-to-date, we have opened six Pollo Tropical and three Taco Cabana restaurants. We will continue our remodeling program at Pollo this year addressing nine restaurants in South Florida. These are complete front-of-house and back-of-house initiatives. Three of the projects nearing completion. We also completed the previously announced closure of 30 Pollo Tropical restaurants in Texas, Nashville, Tennessee and Atlanta, Georgia in April, and in July we closed four Taco Cabana restaurants. The Taco Cabana closures address restaurants that were nearing the end of their lease terms and restaurants where the trade area had moved away or they were site limitations where it did not make sense financially to remain open. Overall the team is extremely motivated by and proud of the changes taking shape in our restaurants. We believe the Plan will lead to a bright future for our guest, our team members and our shareholders. With that, let me turn the call over to Lynn to discuss our financial results.

[Lynn S. Schweinfurth:]

Thank you, Danny. In addition to industry weakness that continues to impact our Florida and Texas markets, our suspension of media and the curtailment of discounting for several months at both brands further negatively impacted our results. Comparable restaurant sales at Pollo decreased 7.7% compared to a 1.4% decrease in the second quarter last year. This year's decline included a 10% decrease in comparable restaurant transactions, partially offset by a 2.3% increase in average check, of which 2.1% was driven by menu price increases. As noted in our earnings press release, Black Box reported declining comparable restaurant transactions of 5.8% for the fast casual segment in Florida. Pollo comparable restaurant transactions in Florida declined 9.5% and were approximately 370 basis points below this benchmark. Our July comparable restaurant sales and transactions at Pollo through July 30 declined by 6.4% and 8.4% respectively, which reflects the sequential improvement relative to the second quarter. At Pollo, we have been off-air since early April, but resumed media in late June, promoting our $12.99 family meal. During July, weekly sequential sales improved from negative 6.6% to negative 5.2%. Turning to Taco Cabana, comparable restaurant sales in the second quarter declined 4.7% compared to a 3.8% decrease in the second quarter last year. This year's decline included a 4.5% decrease in comparable restaurant transactions and a 0.2% decrease in average check. The average check was negatively impacted by sales mix, partially offset by menu price increases that positively impacted restaurant sales by 2%. We believe guests are managing their checks to offset the elimination of our $4.99 meal deal. Black Box reported declining comparable restaurant transactions at 6% for the fast casual segment in Texas. Comparable restaurant transactions at Taco declined 4.5% or approximately 150 basis points better than this benchmark. July comparable restaurant sales and transactions through July 30 for Taco declined by 8.9% and 9.5% respectively. We believe the suspension of television media at the beginning of May, one month later than Pollo due to certain committed spending and the reduction in discounting is negatively impacting sequential performance. In terms of our key restaurant level line items, we have highlighted our year-over-year variance explanations at the consolidated levels in the press release. Our 10-Q that will be issued this afternoon provides variance explanations by P&L line item for each of the two brands. We also use restaurant level adjusted EBITDA as a supplemental measure to evaluate the performance and profitability of our restaurants in the aggregate, which is defined as adjusted EBITDA, excluding franchise royalty revenues and fees, pre-opening costs, and general and administrative expenses, including corporate level general and administrative expenses. At Pollo, second quarter restaurant level adjusted EBITDA increased by $0.8 million. Restaurant level EBITDA was positively impacted by reduced advertising expense of $1.7 million, lower cost of sales and the closure of 30 unprofitable restaurants, partially offset by a decline in restaurant sales of $7.5 million. At Taco, second quarter restaurant level adjusted EBITDA declined by $2.6 million. Restaurant level EBITDA was negatively impacted by a decline in restaurant sales of $1.3 million, higher restaurant wages and related expenses and higher operating expenses, partially offset by lower advertising expenses of $1 million. Please refer to our earnings release and 10-Q for all related non-GAAP reconciliation table. Now, let's quickly go over charges recognized in the second quarter. General and administrative expenses increased $4.9 million, compared to the prior year period or an increase of 320 basis points as a percentage of total revenue. As we called out in our press release, general and administrative expenses in the second quarter were negatively impacted primarily by board and shareholder matter costs of $3.1 million and Plan restructuring costs and retention bonuses of $1.9 million or 290 basis points as a percentage of total revenue. We recognized additional impairment and other lease charges of $10.8 million, primarily related to lease charges for Pollo Tropical restaurants that closed in the second quarter, impairment charges for three closed Pollo Tropical restaurants as a result of a decision not to convert the locations to Taco Cabana restaurants and impairment charges with respect to four Taco Cabana restaurants that we closed early in the third quarter. We expect that the cash impact of these lease and other charges in 2017 will be approximately $3 million assuming ongoing lease, tax, utility and other obligations. The 30 closed Pollo Tropical restaurants contributed approximately $7.8 million in restaurant sales and $5 million in restaurant level operating losses to income from operations, including $1.4 million of depreciation expense for the six months ended July 2, 2017. Adjusted net income was $8.1 million or $0.30 per diluted share compared to adjusted net income of $9.3 million or $0.35 per diluted share in the prior year period. Rich as our new CEO is using the adjusted EBITDA measure for the purpose of assessing performance and allocating resources to segments. The adjusted EBITDA measure includes adjustments for significant items that management believes are related to strategic change and/or are not related to the ongoing operation of our restaurants, in addition to stock-based compensation, impairment and other lease charges and other expense income. During the quarter, consolidated adjusted EBITDA declined 4% to $24.1 million, driven by lower comparable restaurant sales and higher general and administrative costs, partially offset by lower advertising expense and pre-opening costs. Shortly after the end of the second quarter, we closed four Taco Cabana restaurants that contributed approximately $2.1 million in restaurant sales and $0.4 million in restaurant level operating losses to income from operations for the six months ended July 2, 2017. Annual capital expenditures are estimated to be $60 million to $70 million, including $22 million to $25 million for development of new restaurants, $22 million to $26 million for ongoing and deferred capital maintenance, $14 million to $16 million for other corporate projects, such as IT and systems projects and indoor video menu boards and approximately $2 million to $3 million for remodeling costs. We have a clear mission and a highly detailed roadmap and we are taking all the necessary actions to strengthen our business to create meaningful shareholder value. We appreciate your time, and now Rich, Danny and I would be happy to answer any of your questions.

[Operator:]

Thank you. We will now be conducting a question-and-answer session. Our first question is from Will Slabaugh of Stephens. Please go ahead.

[Will Slabaugh:]

Yeah. Thanks. One of the reference to research that you mentioned you just got back on the brand. You talked about a few leading indicators improving. What's happening that's causing these leading indicators to improve, what are the guests citing more specifically? And then also is there a reasonable lag time that we might think about until we see some sort of improvement from those?

[Richard C. Stockinger:]

Okay. I'll take the first, and I'll let Danny jump on it afterwards, it's Rich. Well, the number one thing had to do with cleaning the restaurants number one, which was in the AU (20

[Danny K. Meisenheimer:]

Yeah. To add to that, Rich. From a lag time standpoint, we're seeing so many things that are underway already at Taco Cabana and at Pollo in terms of the cleanliness that Rich talked about the investment in the facilities, the programs that we've introduced and retrained and recertified across the system has taken place and is still taking place today for both brands. And in addition to that from a food standpoint, as Rich mentioned, the new products improved ingredients are well underway and that will continue throughout the balance of the year with a larger emphasis now and in the coming weeks.

[Richard C. Stockinger:]

And in addition to the metrics, as mentioned by Lynn, in the month of July, we saw a sequential improvement in sales as a result of doing the $12.99 original family meal promotion, and we've seen a positive result and feedback from our guests.

[Will Slabaugh:]

Got you. And on the comp trajectory, is it possible to disaggregate the comp decline that you saw, and assign a portion of that to the lack of marketing? I know, you just had some marketing on in July, so I know that may not be a perfect run rate, but is there a way to think about the comp impact, I guess from just not having marketing on at either brand?

[Lynn S. Schweinfurth:]

Well, the July comps that I did cite on the call in my opening comments did include some marketing at Pollo . So, I think you can attribute some of the sequential improvement to marketing. But frankly, we started to see improvements even before the marketing was back on air, so again some of those leading indicators, some of the positive guest feedbacks we've received, we believe are starting to positively impact the trajectory of the business.

[Will Slabaugh:]

Thank you.

[Richard C. Stockinger:]

Next caller?

[Operator:]

Thank you. The next question is from Jeff Farmer of Wells Fargo. Please go ahead.

[Jeff D. Farmer:]

Thank you. You did touch on it, but where are you in terms of pulling back on discounting at both concepts? And then guess what I mean by that, is there potentially more reduction of discounting to come?

[Richard C. Stockinger:]

We are now at around 2.5% of the discounts, and that's primarily to our military and our first responders. There is no plans in the future to do any discounting as we've done in the past. We're going up against and Taco as an example, where it can range from 6% to 8% on any given week, in terms of promotion and discount. So, we are not going any lower than that. We think it's very, very important to not only our brands, our business, but from a community perspective to continue the military as well as our first responders to continue give them the discounts that we have.

[Jeff D. Farmer:]

Okay. And then just to clarify on the $4.99 meal, just from a value offering, so not discount, but from a value offering perspective, it sounds like you pulled that. But as you move forward, any plan to potentially pullback maybe a higher price point value offering?

[Danny K. Meisenheimer:]

Yes, there is. The idea of moving away from $4.99, there were factors behind that. But really, it's about creating that value in the market with the enhanced product offerings that we have at a very fair and reasonable price and return. So you will see us move away from that, but you will also see us do so in a very reasonable way, fair to the guest and also fair to the bottom-line.

[Jeff D. Farmer:]

And just one more on the labor model test, I'm just curious. Ultimately, what does this mean to staffing levels and what potentially could that mean to labor costs as a percent of revenue or however you want to look at labor costs moving forward?

[Lynn S. Schweinfurth:]

Well, certainly, the rationale behind the labor test is to put the appropriate amount of staffing in the restaurant, so that we're delivering a great guest experience, that should increase frequency and traffic over time. So those two things work together. There will be an incremental increase we believe, but we believe it's pretty manageable with pricing, but we should see the benefits of a better experience and the top line growth related to that.

[Jeff D. Farmer:]

Okay. Thank you.

[Operator:]

Thank you. The next question is from Nick Setyan, Wedbush. Please go ahead.

[Nick Setyan:]

Hi. One of the things you guys held in the press release is the refined positioning of Pollo Tropical. I mean, what exactly does that mean relative to what the positioning of Pollo Tropical has been historically?

[Richard C. Stockinger:]

Sure. I'll take that one first. Well that has to do with in some of our emerging markets where the Pollo Tropical brand has not been accepted in the local market, there is a reason why we kept six restaurants in South Texas to use it kind of as a beachhead. It's not much different than what we just announced at one of our competitors, which is fine, El Pollo Loco in terms of putting different types of menu items on that are more geared towards the local environment, things like tortillas as El Pollo Loco is doing, in Texas things like removing the black beans and the yuca and the plantains and putting on more items that are more familiar with the local people, corn, corn soufflés in Atlanta and Georgia and doing different type of beans, and we're going to do any beans instead of black beans in Texas. So, we're in the process of redoing the menu, looking at different alternatives, but we're also going to be using our outside vendor and partner when we do the elasticity and the TURF analysis to make sure whatever we're putting on which is around the chicken, everything is going to be bound the 24-hour marinated chicken. And the fact that we now have vertical integration, we think we have a better product than anybody in the market.

[Nick Setyan:]

And can you elaborate a little bit more on the vertical integration as well? I mean, to what extent are we vertically integrated? Are we actually going to have farms raising chickens?

[Richard C. Stockinger:]

We don't have farms. We will have probably four or five. We've gone to each one of them, where we'll be controlling the breed and the feed. Now everybody is antibiotic and hormone free by the time it hits the table. We're working on and we're almost there, where we will be totally antibiotic free and totally hormone free during the entire process from the time the chicken is hatched till the time are grilled.

[Danny K. Meisenheimer:]

From a marketing standpoint that also gives us an opportunity to tell a very unique story, in terms of the quality of the product, the care behind that product and to address so many opportunities, we have to be best in-class that Rich talked about earlier.

[Nick Setyan:]

And what about the core markets? I guess what were some of the learnings as you went through this process in terms of why the core markets have been weak recently and what are some things that you can do to change that around?

[Richard C. Stockinger:]

Sure, I'll start with it. The core markets, I mean first and foremost, the food changes were not positive towards the guest, but might have been positive towards a cost or a bottom-line perspective. Our core market guest is very, very loyal, they'll know if you've increased the portion size, they'll know and they'll let you know, if you've reduced the quality or increased the price. They'll also tell you if you are not maintaining your restaurants properly. We learned that very fast. We learned that – we didn't need the research, but we went out and did the research and it's definitely come true. The other thing that we've learned is getting back and talking to our core customers directly in terms of the Spanish speaking areas going on Spanish TV, in the Spanish speaking areas doing the Spanish billboards, very important and we hear daily from our core markets that things have happened at Pollo, they are happy in the improvements on the food quality and are looking forward to more changes going to Pollo that's going to enhance their experience. They let us know.

[Nick Setyan:]

Thank you very much.

[Operator:]

Thank you. The next question is from Brian Vaccaro of Raymond James. Please go ahead.

[Brian M. Vaccaro:]

Thank you and good evening. Lynn, I just wanted to start with a quick clarification. Can you state again what the impact of the 30 closed units was on the quarter, please?

[Lynn S. Schweinfurth:]

Sure. The sales impact was about $7.8 million. Just bear with me for one second.

[Brian M. Vaccaro:]

Sure.

[Lynn S. Schweinfurth:]

Okay. $7.8 million in restaurant sales, $5 million in restaurant level operating losses to income, which included $1.4 million in depreciation expense.

[Brian M. Vaccaro:]

Okay. So, those operating losses are burdened with D&A?

[Lynn S. Schweinfurth:]

That's correct. And that's the...

[Brian M. Vaccaro:]

Okay.

[Lynn S. Schweinfurth:]

... six month period through July 2.

[Brian M. Vaccaro:]

That's the six month through July, okay. I just wanted to clarify that. Thank you. And I also wanted to ask, in terms of big picturing, a lot of investments that are being made, you also highlighted some cost savings opportunities in the G&A line, but also at the store level. Are you at a point yet, where you can take a step back and sort of big picture net-net the level of investment you think you'll need to make in your business that you have made, but that you'll need to make over the next 6 months, 9 months, 12 months to stabilize it and turn it around?

[Lynn S. Schweinfurth:]

I would say, we aren't all the way to bright in terms of understanding all of the investments we're considering, for instance a lot of the systems and digital strategies we're planning to implement, we're still working on what the projections are related to costs and investments around those initiatives. So, I think as we get further down the year, we'll have more information about all of the incremental investments. But for the investments we've made today, we have certainly projected our expectations and we've looked at forecasting those expectations as we move into 2018.

[Brian M. Vaccaro:]

Okay. And then on the comps if I could, just one last topic quickly for me. In terms of looking at the Pollo Tropical comps, can you give any color on regional differences that are worth noting South Florida versus some of your other large Florida markets?

[Lynn S. Schweinfurth:]

Well, I would say the markets generally have trended in a similar manner, particularly in South Florida. Although, we are seeing improvements in our Broward County area, where we've improved our performance, when we look at relative performance across the market. But again, I think the restaurant base has been greatly impacted by being off-air since April, and now that we're starting to interject with additional marketing and seeing some of the progression as it relates to the experience in the restaurants. We're seeing all of the markets sequentially improve as the general statements.

[Brian M. Vaccaro:]

Okay, thank you.

[Operator:]

Thank you. There are no further questions at this time. I would like to turn the conference back over to management for closing comments.

[Lynn S. Schweinfurth:]

Thank you, everyone for your time on the call today. We appreciate your time and we look forward to speaking with you again next quarter.

[Operator:]

Thank you. Ladies and gentlemen this does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.