Fiesta Restaurant Group, Inc.
Q1 2016 Earnings Call Transcript

Published: 10 May 2016

[Operator:]

Greetings and welcome to the Fiesta Restaurant Group First Quarter 2016 Earnings Conference Call. I would now like to turn the conference over to your host, Ms. Lynn Schweinfurth, Senior Vice President and Chief Financial Officer. Thank you. You may begin.

[Lynn S. Schweinfurth:]

Thank you. Good afternoon and thank you for joining our call. Our first quarter 2016 earnings release was issued after the market close today. If you've not already seen it, it can be found on our website, www.frgi.com, under the Investor Relations section. Before we begin, I must remind everyone that our call today will include statements that are not based on historical information. These forward-looking statements include, without limitation, statements regarding our future financial position and results of operations, business strategies, 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 we 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 our SEC filings. Please note that during today's conference call, we will discuss certain non-GAAP financial measures, which we believe can be useful in evaluating our 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 our earnings release. Now, I would like to turn the call over to Tim Taft, President and Chief Executive Officer.

[Timothy P. Taft:]

Thank you, Lynn, and good afternoon, everyone. Let me first speak to the quarterly results. We had anticipated a challenging start to the year, given the record comparable restaurant sales lap for Pollo Tropical, along with negative impact of planned cannibalization, although macroeconomic pressures proved to be more onerous for both brands, more so than we expected. So, we believe the fundamentals of our business are intact and we continue to focus on the long-term growth strategy and execution. Additionally, we believe, we will meet the 2016 operating targets we provided in our press release this afternoon. Pollo Tropical's comparable restaurant sales were flat, as the 0.1% increase in comparable guest traffic was offset by a 0.1% decrease in average check. Also embedded in this result was a 2% estimated cannibalization that negatively impacted traffic. The year-ago comparison was 6.4% and on a three year basis comp sales are up 12.7%. While the brand had solid sales performance in January and February, we experienced softness in March, especially in Dallas and Huston, where we do not have any media support. Additionally, we believe that the slowdown in the oil industry has increasingly affected both our restaurant brands especially at Houston. In April, comparable restaurant sales came in flat at Pollo, importantly, while the month started in negative territory, similar to what we had seen in March, we saw positive momentum sequentially through the month with the last week coming in at 2.6% positive. In April, we promoted a new product at Pollo chicken skewers or chicken pinchos, which proved so popular we had to increase our supply of product to keep up with demand. We estimate Easter positively impacting the fiscal month by 0.6%. With that background, let me go through two key aspects of the Pollo Tropical strategy

[Lynn S. Schweinfurth:]

Thank you, Tim. Overall, quarterly performance was below our expectations due to a few key items. The first was the decline in comparable sales at both brands in March, which more than offset better than expected performance year-to-date through February. However, the decline in March transactions was fairly consistent with industry trends experienced in Florida and Texas as measured by published industry benchmarks. Our 53rd week 2015 fiscal year resulted in a later start to fiscal 2016. The benefit of not having New Year's in Q1 this year compared to last year offset the timing of Easter that fell in Q1 this year compared to Q2 last year. Additionally, favorable weather positively impacted Taco in Q1 by an estimated 1% to 1.5%. Average weekly sales at new Pollo restaurants have trended lower, particularly in emerging markets due to the consumer environment, cannibalization and low brand awareness. However, when we introduced broadcast media, we are seeing promising results, as Tim has outlined. We have a number of initiatives that we believe will help to build sales through the year at both brands that Tim has already touched on. We believe these initiatives along with the easier prior-year comparisons, additional pricing, and a declining impact of cannibalization at Pollo through the year will allow us to meet at least low single-digit comparable sales at both brands in 2016. Turning to margins. In addition to the impact of lower sales volumes on margins, there are a few key opportunities to improve profitability at new Pollo restaurants. As an example, there are additional managers in training in restaurants that will ultimately be deployed to new restaurants when opened later in the year. Our initial flagship locations in emerging markets have higher rent expense, particularly in Texas where demand is high for attractive retail location. We are also focused on achieving targeted operating costs sooner after opening new restaurants. As a result of these pressures, we are now planning to take additional price at Pollo in the middle of the year of at least 50 basis points. This is incremental to the 1% price increase taken in early February. For Taco, we are still considering whether or not we will take price mid-year. Without a mid-year pricing increase, we estimate pricing to impact Taco 2016 full year comps by 1.8%. We expect the cost of sales as a percent of restaurant sales to be more favorable in the first quarter given our supply chain initiatives, including new chicken specifications and favorable cost year-over-year for key commodities. However, we are experiencing some operating inefficiencies at both brands as our restaurant managers are utilizing a new inventory management system that was rolled out late last year that we believe will improve food cost management in the medium and long term, but is having a negative short-term impact. In addition, at Pollo, we experienced some yield challenges around our Latin shrimp promotion that we have already concluded. Importantly, we have identified additional savings we expect in the balance of the year and therefore expect cost of sales as a percent of restaurant sales to improve through the year to meet or exceed our annual 2016 targets affirmed in our press release today. Consolidated restaurant level EBITDA margins decreased in the first quarter by 140 basis points due to margin contraction at Pollo. Pollo's margin decreased by 340 basis points as favorable commodity costs were not sufficient to offset higher labor, rent, advertising and other restaurant operating expenses. On the other hand, Taco's margin improved by 70 basis points as the brand experienced sales leverage and lower cost of sale. We currently expect restaurant EBITDA margin expansion at Taco will more than offset some margin contraction at Pollo in 2016, resulting in consolidated restaurant EBITDA expansion for the full year. Please note that we expect the restaurant EBITDA margin will be negatively impacted 20 basis points to 30 basis points simply based on having an extra week of sales leverage in fiscal 2015, as fixed costs are embedded in labor, other operating and rent expense line item. At quarter-end, we had a cash balance of $4.1 million and after reserving $5.2 million for letters of credit, we had $73.9 million of borrowing capacity under our senior credit facility. We continue to be in compliance with all related covenants. As a reminder, we disclosed a great deal of brand specific financial and operating performance in our quarterly earnings release tables and in our SEC filings. This information includes brand specific comp and non-comp restaurant average unit volumes and income statement line item details and variance explanations. Next, I would like to refer to the update of our financial expectations for fiscal year 2016 laid out in our press release. The targets that changed include the following

[Operator:]

Thank you, ladies and gentlemen. Our first question comes from the line of Will Slabaugh from Stephens, Inc. Please go ahead.

[Will Slabaugh:]

Yeah. Thank you. I wanted to ask a clarifying question first. So on Pollo, I believe you said you're positive 2.6% the last week or two. I just wanted to clarify that and then if you would be willing to give the April comp there at Pollo?

[Lynn S. Schweinfurth:]

Okay. The April comps we did give in our opening comments and they did sequentially improve through the month and ended with the last week being a positive 2.6%.

[Will Slabaugh:]

Okay. So we should just assume it's somewhere between 0% and 2.6% for the full month?

[Lynn S. Schweinfurth:]

Yes.

[Will Slabaugh:]

Fair enough. Okay. Just clarifying that. Okay. And then as far as the unit growth guidance goes, are you intentionally letting some of those 2016 sour slide into 2017 just to maybe lessen that fairly dramatic cannibalization that we've been seeing or would you consider that reduction to be equally or even more externally forced and you'd rather have kept the previous range?

[Lynn S. Schweinfurth:]

I think it was situational to a great extent in terms of our development pipeline and a few situations, in particular, with the restaurants we pushed out into early 2016. Some of that also included the fact that we were nearing more of a holiday time period and we prefer to open up the restaurants outside of that window. So a couple of different things were going on and therefore the restaurants pushed into 2017. And then to go back to your earlier question, well, if I may, we did report that April comp store sales for Pollo were flat in April. But the trajectory started in the negative territory and then grew throughout the – through the month of April ending at 2.6% in the last week. In addition, just as a reminder, because of our late fiscal calendar beginning, the April fiscal month ended on May 1.

[Will Slabaugh:]

Okay. Got it. Sorry, I missed that. And then lastly just wondered if you could touch on labor. You mentioned that was up at Pollo I believe 70 basis points to show for the company. Wondering if you could talk just a little bit more about sort of the outlook for labor at Pollo, why it did increase sort of a flat same-store sales number like it did and sort of your outlook for the rest of the year?

[Lynn S. Schweinfurth:]

Yeah. The outlook for the rest of the year for Pollo is consistent with what we reported last month. So we believe that the labor line item will be pressured by about 100 basis points this year compared to last year. Some of the pressures we are seeing currently which we do expect to continue for a short period of time include; having extra managers in restaurants where we'll deploy those managers to new restaurants when they open later in the year. And then we're continuing to focus on trying to get to more efficient operating margins sooner in the new restaurants.

[Will Slabaugh:]

Got it. Thanks, Lynn.

[Operator:]

Thank you. Our next question comes from the line of Alex Slagle from Jefferies. Please go ahead.

[Alexander Russell Slagle:]

Hey, thanks. I was wondering if you could remind us again of the cadence of the same-store sales through the quarter for Pollo. I recall the comp that compares by ease (24

[Lynn S. Schweinfurth:]

Yeah. So the first month of the quarter we were at a 0.6% positive transaction at Pollo and a 0.8% positive transaction at Taco with same-store sales coming in at a negative 0.9% at Pollo and a positive 3.4% at Taco. And then the performance improved in the month of February for both brands, and as I think we mentioned earlier in the call, our February year-to-date numbers were better than our expectations. However, March came in negative at both brands beyond the Easter timeframe, which surprised us, and was very consistent with some of the industry benchmarks we look at, in particular, Knapp-Track and Black Box.

[Alexander Russell Slagle:]

Okay. Thank you. And then, just remind us what the promotional line up in the first quarter and quarter to-date second quarter is this year versus last year, maybe for Pollo?

[Lynn S. Schweinfurth:]

Sure.

[Timothy P. Taft:]

I think one of the big differences is that, we had a year ago starting last Wednesday, we had a direct mail drop going into Mother's Day. So that was pretty impactful over the last week or so.

[Lynn S. Schweinfurth:]

And then the actual product promotions, if that was also what you wanted us to address, this year it included our Chicken Spinach wraps in the beginning part of the quarter and then the shrimp fest in the middle part of the quarter, and then in April, we started promoting a new product that Tim mentioned earlier, pinchos or their chicken skewers, and the mix associated with that promotion was very well received by the guests. And then in the prior year, we offered the Tropical Lite menu, another shrimp promotion. I think it was the Shrimp Wrap promotion, and a Create Your Own TropiChops promotion. And then in April, it was the Tangy Pineapple Wrap combo promotion.

[Alexander Russell Slagle:]

Okay. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Jeff Farmer from Wells Fargo. Please go ahead.

[Jeff D. Farmer:]

Thanks. It looks like Pollo's Q1 average unit volume fell about 9%. I'm just curious how we should be thinking about the magnitude of that decline over the balance of 2016?

[Lynn S. Schweinfurth:]

Well, that's a good question, Jeff. We haven't really talked about much of a revenue expectation for the year. I will say our expectation of 10% plus from a long-term standpoint is probably higher than what we'll see this year. And we believe this year sales will only grow in the future. So it's going to be a little bit of an inflection year as it relates to sales.

[Jeff D. Farmer:]

Okay. So just to try to take a stab at this again, so does that seem fairly representative to you, that down 9%? I think it was something close to 10.5% decline in Q4.

[Lynn S. Schweinfurth:]

It depends what you're comparing.

[Jeff D. Farmer:]

Okay. I'll move on to the next one then. You did touch on this with Will, so excluding the 80 basis points of COGS favorability that Pollo saw in Q1, looks like your restaurant level margin would have been down something close to 400 basis points. Again, similar dynamic, I'm just trying to get a sense as to what that deleverage will look like over the balance of the year, whether or not that 400 basis points is a good proxy for what we should be looking at over the balance of the year, excluding cost of goods sold?

[Lynn S. Schweinfurth:]

Well, let me just clarify hopefully what I tried to communicate earlier and that is, we are expecting some contraction at Pollo this year compared to last year, not in a huge amount, especially once you incorporate the cost of sales savings we'll experience this year. But then, that contraction will be more than offset by the Taco margins this year to result in a consolidated restaurant EBITDA margin expansion in 2016.

[Jeff D. Farmer:]

Okay. And then just final one to sort of segue from what you just said there and you did touch on this a little bit in the prepared remarks. But, 80 basis points of COGS favorability at Pollo in Q1, just in the context of seeing 180 basis points over the full year, how should we think about that in Q2, Q3, Q4? Is there a quarter that's going to see some outsized level of favorability and others are going to see smaller, how should we think about getting to 180 for the full year versus 80 basis points

[Lynn S. Schweinfurth:]

Yeah. We should see a sequential improvement in Q2 and then another sequential improvement in Q3 and then it might be roughly the same, if not a little bit less than the fourth quarter.

[Jeff D. Farmer:]

Okay. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Joshua Long from Piper Jaffray. Please go ahead.

[Joshua C. Long:]

Great. Thank you. Wanted to see if we might be able to dig into some of the pressure you're seeing in – you called out Houston in particular. I was just curious if you'd be able to share any sort of trends you're seeing at the restaurant level in terms of maybe mix shifts or if it's really just purely driven by traffic? And then also curious on what the opportunities are to maybe look at Houston as an investment spending market. You've talked about the opportunity to maybe go in and pre-spend some marketing dollars to kind of help ramp up certain markets before you reach the media efficiency level. I didn't know if that was an opportunity in some of these other markets in Texas.

[Timothy P. Taft:]

Well, first of all, Josh, the first part of the question was in Houston especially there has been – it was just about a month ago I suppose that the media came out and said that there was a little bit of a ripple, which later became a wobble, because of the industry segment. Lots of other segments are looking up in the state of Texas. It wasn't until this past quarter where Texas fell from being the number one job state. But in Houston in particular, first of all, we have less than 10 restaurants at the end of the year – well, I think we'll have less than eight – around eight restaurants or less than eight restaurants in Houston by the end of the year. So we're not talking about a considerable number. I think the big driver is cannibalization, as we've been talking about, but in – the fact of putting money in Houston probably wouldn't make all that much sense. A market like Atlanta where we're going on air in July, which is earlier than we anticipated, the fact that we went on in San Antonio early and we're seeing some good impact there because we've got some pretty good penetration there. And then there is a possibility, given the success of San Antonio looking at a market like Dallas where that's got some scale that by the end of the year will have around 15 restaurants in DFW, so that might be a possibility. But again to recap, Houston, not a whole lot of restaurants, some cannibalization, awareness obviously is an issue and the market has been impacted. But overall, the opportunity to – at the end of this year, we will have essentially two markets that are not on air, so we've obviously come a long way in that regard in the last two years.

[Joshua C. Long:]

Absolutely, I appreciate that color, Tim. As we think about the opportunities around some of the off-premise and online initiatives that you mentioned does sound pretty exciting. Was curious on the loyalty program if that's something that you've really built up in-house, or if that's more of a partnership with third-party vendors? And then secondarily, on your catering and group ordering, just curious what you learned about that in test and what kind of initiatives or items you put in place to help make sure that that's a smooth rollout? We've talked about maybe building up some extra capacity in your most dense markets in terms of usage. So just curious on how we should be thinking about the rollout of that, so it doesn't necessarily disrupt the restaurant level operations as we go through the year. Granted it's going to be a small piece of the business, but just curious what your early thoughts are there.

[Timothy P. Taft:]

I think that with the loyalty program, that's something that we've been working on and with another provider. The catering, the online, those are growing organically, so we won't really put a whole lot of weight or media or push them because we do want operations to get accustomed to that pace of increase. So, as a percentage of sales, it might be a small number, but it continues to grow week after week, not only the loyalty program but also our third-party provider for that we've been testing in San Antonio is going very well. And we anticipate rolling that out to other markets. Again, it's one of those things to your point and it's a good one. We want to make sure that these growth items are incremental, at the same time, we want to make sure that they grow organically. So we're not bringing operations to their knees because obviously they're running some pretty significant numbers now. So to-date what we've found is higher check average. We found people excited about the opportunity for a third-party provider. Internally, we're excited about the marketing for the loyalty program because it's going to make our communication a lot smarter and a lot more targeted and therefore a lot more efficient.

[Joshua C. Long:]

Great. That's helpful. And then last one for me. In terms of the new inventory management and sort of the hiccup that you saw during the quarter, I was just curious if you had a sense as to when that learning curve or that growing pain would kind of taper off? Is that something that you're largely through, or if that's something that still is getting worked on? And then secondarily, was the yield problem you mentioned in terms of the Lenten offer, was that related to the inventory management system as well, or was that just more of a temporal item at the restaurant given that promotion?

[Timothy P. Taft:]

Two things. The shrimp was a real simple – we sold a ton of them. We had a – it was really an inventory. We thought we're supposed to get a certain number of per pound and we got a fewer per pound, which we're putting a larger shrimp on the product, which caused a yield problem. That was part of the issue. Something obviously that it's a short window in and out, and so the damage was done. Our inventory management issue, I think we've been pretty much doing it the same way for a very long time. Last October, as you know, we rolled out that program and it takes a while for the teams to get used to it. As we indicated, I think it's more of a short-term issue. There is no doubt that it's going to save us money in the long term and will provide greater clarity on our inventory. But it's a short-term issue that getting the team accustomed to a new process and it just took a while. I think it's more of a blip than anything else.

[Joshua C. Long:]

Okay. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Brian Vaccaro from Raymond James. Please go ahead.

[Brian M. Vaccaro:]

Thanks and good afternoon. I wanted to start out on the Pollo Tropical comps, and ask about the year-on-year increase in advertising spend during the first quarter. I guess, if you just think about the year-on-year increase by month, was it fairly even through the quarter or was there a particular period where the impact was greatest or less as you looked at the individual months?

[Timothy P. Taft:]

Well, I think that if you take a look at the first quarter by month, it's pretty evenly spread and the incremental media was essentially in three markets, and that was in Dade, Broward and Palm Beach, and maybe a little bit more on a comparative basis in Nashville. But pretty evenly spread, I think, really starting in mid to late January.

[Brian M. Vaccaro:]

Okay. And, I guess, shifting gears a bit. In context of the more intense competitive environment, are you seeing a larger impact on your lunch or dinner daypart at Pollo? And maybe share sort of how you're thinking tactically at Pollo regarding some menu innovation, et cetera, from a value perspective to respond to the environment?

[Timothy P. Taft:]

Well, there is no doubt that everybody is getting into discounting. And as we've mentioned pretty consistently, that it's fast-food to white linen, everybody is discounting. Because that's someplace that we've always been, we don't really feel the need to respond any differently. I think we're always been a value proposition, we continue to offer that, we still get very, very high scores for it. But we're not – I think that one of the things that you mentioned is product innovation, and the idea of pinchos is a new item for us which is completely different than what we've ever done before. And the response, as we mentioned, has been very, very favorable. Pollo Tropical, like Taco Cabana, as we've mentioned in the past, over the last couple of years has been a little bit more ops friendly in that we haven't been doing new product innovation, that is over, beginning in 2016. So I think on a go forward basis, you'll see more product innovation coupled with our ongoing price value that's been so attractive.

[Brian M. Vaccaro:]

Okay. And switching over to Taco Cabana, if you could just comment also on the daypart trends there, and is there a particular daypart that you've seen some sequential deterioration in in the month of April that you can provide some color on? Thank you.

[Timothy P. Taft:]

Nothing in particular. I think it's just pretty much across the board. I think the one daypart that continues to grow is breakfast (40

[Brian M. Vaccaro:]

Okay, all right. And then just one quick model question if I could, Lynn? The other OpEx line at Pollo in the quarter was up a fair amount more than I'd have expected? Anything unusual or one time in nature there, or is that just a product of rolling in the lower new unit volumes?

[Lynn S. Schweinfurth:]

Well, it's certainly part of that. It was mostly, however, due to real estate taxes and some timing of repair and maintenance expenses. So there was kind of timing issues as it relates to repair and maintenance.

[Brian M. Vaccaro:]

All right. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Nick Setyan from Wedbush Securities. Please go ahead.

[Colin Radke:]

Hi, this is Colin Radke on for Nick. You guys called out San Antonio and Nashville as seeing sales growth after launching media, but it sounds like maybe you're not seeing quite the same response in the more mature markets. Is there anything you've learned in terms of the big three after the incremental media spend there in terms of maybe what's working, what's less effective, and maybe if that has any impact on the rest of the year?

[Timothy P. Taft:]

Well, first of all, I think that what you're seeing system-wide will start globally for the Pollo system, rolling over what was a record first quarter a year ago. So, for us to be flat with that in addition to and considering the 2% of cannibalization that we've been talking about, we started off the quarter at a negative 2% in transactions, But we ended up flat. So, that's very, very positive. As we mentioned, the ones driving that were the highest unit level volumes and that was Palm Beach, Dade and Broward. So the fact that those continued to be stronger than a record quarter a year ago, speaks to the media and it speaks to the new creative campaign. As far as Nashville and San Antonio, we're very bullish. We're excited about the results of what we're experiencing in San Antonio and Nashville, up between 9% and 10% in those new markets. So as we've said, moving in to – every time we've gone on air, we've been anywhere between 8% and 10%. That's been our standard increase. The fact that we have done that again in Nashville and showing that in San Antonio is reason for us to start looking at moving up Atlanta as a market and looking at other markets as well. So we're happy with the results of media.

[Colin Radke:]

Okay. All right. And then, just quickly on the new unit volumes. As you guys are starting to build more of these units away from Florida and into areas that are more impacted by weather or seasonality, to what extent do you think the current new unit volumes especially in Texas that are being impacted by seasonality? Are there any kind of numbers or any kind of color, I guess, that you could help us around that?

[Lynn S. Schweinfurth:]

What I'll tell you is, there is a shifting of having a lot of restaurants in Florida to having restaurants not only in Florida now but in Atlanta, Nashville and Texas. In Texas, the seasonality tends to be a little bit in contrast to the Florida seasonality. So, as we open up new restaurants in these markets outside of Florida, both the fourth quarter and the first quarter are lowest seasonality quarters.

[Colin Radke:]

I would also offer that when you take a look at and consider new restaurant sales, there is new restaurants that are going in every one of our markets. So that's a good number of restaurants in Southwest Florida, in Jacksonville, in Atlanta, in Orlando we opened up – we got two opened in the last year in Nashville. We've got obviously at the end of this year, as I mentioned, we'll have in the last – we'll have 15 open in DFW by the end of the year. So we've got – and 9 to 10 restaurants in San Antonio by the end of the year. So, we've got a lot of new restaurants opening. Very few of them have been – are in the markets where they've already being media efficient. So, you've got a lot of cannibalization going in in markets where you're not all that well known. So, as Lynn mentioned, you start off with going from most of your restaurants being built in Florida to now, a lot of your restaurants being built in markets where you're not that well known and you're not on TV. And then you take a look at where we are, and where we will be in the not too distant future with being on-air in Atlanta for the first time. And now we're in on-air in San Antonio and in Nashville and looking at other markets. The new sales performance should be considerably different moving forward.

[Colin Radke:]

Got it. Okay. That makes sense. Thanks for the clarity there. Just one more on me, and I apologize if I missed it. I heard you call out the weather impact on Taco in that quarter-to-date period. Was there any weather impact on the Pollo comp, quarter-to-date?

[Lynn S. Schweinfurth:]

Not really. In fact both the first quarter and the April fiscal month were 0.2% negative impact of weather, so very little.

[Colin Radke:]

Okay. Thank you very much.

[Operator:]

Thank you. Ladies and gentlemen, we have no further questions in queue at this time. This now concludes our teleconference for today. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.