Fiesta Restaurant Group, Inc.
Q2 2016 Earnings Call Transcript

Published: 4 Aug 2016

[Operator:]

Greetings, and welcome to the Fiesta Restaurant Group Second 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.

[Lynn S. Schweinfurth:]

Thank you. Good afternoon, and thank you for joining our call. Our second quarter 2016 earnings release was issued after the market closed 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 of 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. As an introduction to my comments this afternoon allow me to frame the narrative so that the facts that follow are made clear, and you, or audience, understands our current and future direction. Five years ago we did not have a single restaurant outside of Florida and the only successful unit outside of Miami, Palm Beach and Broward County's was a new unit in a new market

[Lynn S. Schweinfurth:]

Thank you, Tim. As we shared on our earnings call last quarter, we had anticipated that the second quarter was going to be a tough period for our business, but results proved to be even more challenging than we had initially thought. As a result of how we have fared year-to-date, we have adjusted some of our annual guidelines, which I will detail shortly. But first, let's discuss the second quarter itself. For the second quarter we grew total revenues by 5.6% to $181.5 million through sales contributions from the net new 37 company-owned restaurant openings over the past year which offset declines in comparable restaurant sales at both brands. Pollo comparable restaurant sales decreased 1.4% which included a 2.6% decrease in comparable guest traffic and a 1.2% increase in average check. Sales cannibalization from new restaurants on existing restaurants negatively impacted comparable restaurant transaction growth by approximately 2%. Average check was primarily driven by menu price increases that positively impacted restaurant sales by 1%. On a two-year basis, quarterly comparable restaurant sales grew 2.9%. Average weekly sales at new Pollo restaurants have similarly trended lower, particularly in emerging markets, due to the consumer environment, cannibalization and low brand awareness. However, where we introduced broadcast media we are seeing promising results, as Tim has already outlined. In July, comp store sales at Pollo were down 1.8%. This compares to a prior-year comp month of 6.4% in 2015. In the second quarter Taco comparable restaurant sales decreased 3.8% and resulted from a 5.5% decrease in comparable guest traffic, partially offset by a 1.7% increase in average check. Weather negatively affected comp transactions by approximately 1%, while menu price increases positively impacted restaurant sales by 2.4%. On a two-year basis, quarterly comparable restaurant sales grew 1.8%. In July, comp store sales at Taco were down 5.8%. This compares to a prior-year comp month of 7.1% in 2015. In terms of quarterly expense and cost drivers, please refer to our earnings release which provides explanations for each P&L line item on a consolidated basis. Unfortunately, with negative comparable sales at both brands this quarter, sales deleverage negatively impacted profitability at both brands across fixed and semi-fixed operating costs. Net income decreased $2.3 million to $8.9 million, or $0.33 per diluted share, compared to net income of $11.2 million, or $0.42 per diluted share in the prior year period. Second quarter adjusted net income decreased $2 million to $9.2 million, or $0.34 per diluted share with the bulk of the adjustments related to relocation and severance costs for transitioning the Pollo headquarters to Texas. Consolidated restaurant-level EBITDA margins decreased in the second quarter by 190 basis points primarily due to margin contraction at both Pollo and Taco. Pollo's margin decreased 340 basis points as favorable commodity costs were not sufficient to offset higher labor, rent, advertising and other restaurant operating expenses. Similarly, Taco's margins decreased by 60 basis points due to the same reasons. At quarter-end we had a cash balance of $4.8 million and after reserving $5.2 million for letters of credit, we had $76.9 million of borrowing capacity under our senior credit facility. We continue to be in compliance with all related covenants. As a reminder we disclose 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. We plan to publish our 10-Q document today similar to what we have done in the past to give investors as much information as possible as quickly as possible. Turning to our 2016 outlook, we will continue to provide a limited updated set of operating targets for the year. These do not include any impact or costs related to the potential separation transaction or the severance and relocation costs we called out this quarter. Based on our current results to-date, we are revising our comparable restaurant sales growth projection for the year at Pollo, which is now expected to be down 1% to up 1%, while Taco is now expected to be down 3% to down 1%. We had previously projected comparable restaurant sales growth of low single-digits at both brands. We also are estimating that year-over-year AUVs will decline at Pollo in the back half of 2016 similar to the first half of this year. This is the result of adding new restaurants to our store base in emerging markets that carry lower initial sales volumes and the impact of the current macro environment. We now expect EBITDA margin expansion at Taco will only partially offset margin contraction at Pollo, resulting in consolidated restaurant EBITDA contraction for the full year. As a reminder, 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 items. We have also lowered the range for general and administrative expenses to $54 million to $57 million. This is primarily due to lower expected incentive-based compensation expenses. We are reaffirming other operating targets for fiscal 2016 that are laid out in our press release issued today. On a positive note, we are very encouraged with the progress we have made towards planning future restaurant prototypes, menu boards, sales mix and staffing models that we believe will deliver improved results as we look out to 2017 and beyond. In closing, while the first half of 2016 proved even more challenging than what we expected earlier this year, we continue to expect a benefit from easy comparisons in the second half of the year, a declining impact of cannibalization at Pollo, as well as the impact of initiatives that Tim articulated earlier. Additionally, we took pricing of 90 basis points at Pollo in early July that we tested before implementing system-wide. With that, let's open the line for questions.

[Operator:]

Thank you. At this time, we will be conducting a question-and-answer session. Our first question is from Alex Slagle from Jefferies. Please go ahead.

[Alexander Russell Slagle:]

Hey. Thank you. Couple questions. One on the July trends. Is there any measurable impact from the July 4 shift in the comps?

[Lynn S. Schweinfurth:]

Yes. There's a little bit. We started the July comp month with July 4. So we didn't have the lead-in for the weekend preceding July 4 compared to the prior year. And so that does have a little bit of a negative impact on the monthly results.

[Alexander Russell Slagle:]

Okay. And then if you could provide a little bit more color on what you've seen in Texas and how things have changed recently with regard to the consumer spending trends you've seen, maybe internal weekly data and anything else anecdotally you've seen?

[Timothy P. Taft:]

Well, Alex, it clearly begins with Houston. And Houston has really been hammered hard over the last three months compared to the rest of – what was expected, it was a delayed reaction to the oil issues. Last year, Houston was one of our better-performing restaurants and markets, and this year it's one of – clearly it's our worst. Well, first of all, in July there wasn't any media that was run in July. August we started off with, as we've mentioned, the $4.99 and promotional $0.99 tacos. And in fact, we've seen some really dynamic encouragement from the various markets. Dallas is looking much better. Houston has all but cut their negatives in half. So we are seeing other parts of the state that are starting to respond, too. So August is a good start.

[Alexander Russell Slagle:]

Okay. And then on Pollo and the labor outlook, I think at some point you'd maybe talked to labor being up 100 basis points in 2016. Maybe you could talk to how that outlook's changed given the comp change?

[Lynn S. Schweinfurth:]

Yes. I would say the outlook is a little bit larger in terms of the margin contraction on the labor line item, probably 120 basis points or a little bit greater year-over-year based on a 52-week 2015 comparison.

[Alexander Russell Slagle:]

Okay. Thank you.

[Operator:]

Our next question is from Jeff Farmer from Wells Fargo.

[Jeff D. Farmer:]

Thanks. You did touch on it briefly, but what are your cost control opportunities across both concepts? And do the Q2 results reflect any benefit whatsoever from pursuing any of those opportunities?

[Lynn S. Schweinfurth:]

I would say Q2 probably did not reflect most of the opportunities we've been addressing. Many of what we put in place were effectively in place at the beginning of July. The categories certainly include the two biggest expense line items, cost of sales and cost of labor. We've made some good progress in terms of labor and looking at our matrix and improving the efficiency in terms of how we schedule labor in our restaurants without negatively impacting the guest experience. The other thing we are putting in place in the next week is the new menu board that we think will help sales mix and help cost of sales and related profitability. So that's going to go in place as a test initially, but it will have forward-looking implications, we hope, based on everything we've modeled out up to this point. You didn't ask about new restaurant prototypes, but I'll throw this in in the context of certainly a great deal of focus and energy with a sense of urgency at the company around, improving the new restaurant model and the result. So in addition to top line and expense areas of focus, we've also designed restaurant prototypes at each of the two brands that are much lower in cost and should produce returns sooner even at lower sales volumes.

[Jeff D. Farmer:]

Okay. And you guys made at least a handful of comments about the environment out there and what's going on. But just in terms of thinking about how the aggressive, let's call it, value-based marketing by not just fast casual but a lot of those quick service players just across the board in terms of the $10 and under check, how has all that aggressive value-based marketing activity played out on your traffic, in your opinion?

[Timothy P. Taft:]

I would say that it's had a direct impact on our business. Any time you have a value messaging and it's not just QSR, as you mentioned. It's casual, even white linen is discounting. And so there is a certain segment of our population that is drawn to that. I will say that in the earlier part of the year both of the brands were really focusing their messaging around the brand and brand building and explaining to people the concepts. And then with the increase of competitive activity with pricing, we really went back to hitting that a lot harder. And I think that we're seeing it certainly in August and we've seen it in other markets along the way that that's the right thing that we have to do during this time. Now I will say it's really not a huge departure from us because our message is, for Pollo, has always been around a value proposition. Now our LTOs are really reflecting a price point that we feel is competitive.

[Jeff D. Farmer:]

Okay. And then, Lynn, I'm going to take one stab at this. I'm not sure if you're going to provide color, but on the last call you did point to EPS growth, obviously, with the Q2 results, the updated guidance, especially at the restaurant level, EBITDA line, and July same-store sales trends. Any color on how we should be thinking about the magnitude of a potential EPS decline in 2016 versus 2015?

[Lynn S. Schweinfurth:]

Well, because of the second quarter results, we are now expecting a decline in EPS this year compared to next year. And just recall that 2015 we had that 53rd week, which is a $0.07 impact. So I'll just leave it at that.

[Jeff D. Farmer:]

Okay. Thank you.

[Operator:]

Our next question is from Will Slabaugh from Stephens.

[Will Slabaugh:]

Yes. Thank you. Wanted to ask you about capital allocation, if I could. And wondering if you could frame for us your thoughts around continuing to build stores at a fairly aggressive pace now, and one could argue that the stock isn't receiving the credit for it, versus taking a short break while you refine the smaller, cheaper prototypes that you spoke about earlier, repurchasing shares in the meantime that should be worth a lot more down the road once the execution here does improve. So curious on how you battle those back and forth. And then if there's any indication on what unit growth for 2017 might look like.

[Timothy P. Taft:]

Will, I'll start with the latter half of that question. What we mentioned in our comments that 2017 you'll see us build the preponderance of our restaurants in markets that are already media efficient, so that will include Atlanta and Florida markets, as well as San Antonio; one in Houston and couple in Dallas that we committed to, and those have been committed for quite a while. But we recognize that because of the supply and demand that it's best for us to pursue Texas in a manner that is to get more awareness, to get the fundamentals just getting people accustomed to what the brand is all about. And we can do that with everything with the exception of TV. So you'll see every promotional item come to bear in Dallas and Houston next year. Everything but TV in Dallas. San Antonio will be complemented with media. But you'll see us next year give a break to the Dallas market, allow it to grow organically and the volume that we've committed to will be in other markets outside of Texas.

[Lynn S. Schweinfurth:]

And just on capital allocation, we have ongoing discussions about how we want to spend our capital now and on a go-forward basis. And we do believe our new restaurant prototype of 2017 will provide much better results than what we've seen, certainly as a result of some of our top line challenges around cannibalization and brand awareness, particularly in the emerging markets. But we do believe we've got a business model that can justify capital spending next year. Now what we've also said in the past is we were never intending to keep a 20% growth rate in terms of new restaurant growth at Pollo, which we've done in the last two years. We really want to get to a growth rate that is more sustainable on a go-forward basis and a focus on opening great successful new restaurants. And so next year we will take our percentage growth down to what we think is more of a sustainable level, in the low double-digit to mid double-digit area, and then at the same time with our new smaller Taco Cabana restaurant, we will start to increase its development. It's not going to be a huge increase, but anywhere between 5 to 10 restaurants in 2017.

[Will Slabaugh:]

Okay. And just to clarify, you said that the 2017 new Pollo's will be the smaller, cheaper prototype?

[Lynn S. Schweinfurth:]

As soon as we can put them in place, there have been projects already in process with permits and other commitments that we can't necessarily vary from, but where we can we are going to put in the smaller prototype.

[Will Slabaugh:]

Thank you.

[Operator:]

Our next question is from Brian Vaccaro from Raymond James.

[Brian M. Vaccaro:]

Thanks, and good evening. Just a couple of quick clarifications. Lynn, you talked about some labor and food cost savings initiatives, just wanted to clarify, those are all related to Pollo Tropical, is that correct?

[Lynn S. Schweinfurth:]

The ones I did comment about were, but that is not to say that we aren't going after other opportunities at Taco Cabana as well.

[Brian M. Vaccaro:]

Okay, all right. Just wanted to clarify that. And then, I just want to also clarify, so Pollo Tropical you said next year you expect unit growth to be in the low to mid double-digits, and then in addition to that 5 maybe 10 Tacos next year, did I hear that correctly?

[Lynn S. Schweinfurth:]

Yeah, between 5 and 10.

[Brian M. Vaccaro:]

Between 5 and 10. Okay. All right. And then, if I could, back to the Pollo comps in the quarter, can you give some color on the regional trends, what you saw, South Florida, non-South Florida, and specifically speak to how comps responded to the incremental ad spend in some of those markets as you pulsed it on and off?

[Timothy P. Taft:]

Yeah, Brian, the big three down in Broward, Dade, and Palm Beach, which represent over 50%, those as an aggregate were up during the quarter, so extremely high volumes and still positive on top of that. In other markets where we had a good deal of competitive intrusion – or not competitive intrusion, I'm sorry, but cannibalization, adding some restaurants, we had some flattening out a little bit. I will say, though, that Tampa and Orlando are responding well and I think it's important to note too that – and Atlanta, by the way, is a market that is coming around. We mentioned some of the sales increases that we're seeing once we went on air there and in San Antonio. But I think it's important to note, that we as a company are really putting our eggs next year in the basket of fishing where the fish are biting, so you'll see us next year again in those markets where we're already media efficient. I think again – and Orlando is a very good example of it.

[Lynn S. Schweinfurth:]

Well, one clarification. So I think as Tim was talking about the results in South Florida with media, absolutely we were performing at positive comp store sales. And, in fact, the gap between some of our industry benchmarks was almost 3% in terms of comparable transactions. Where we started to fall off and go into negative territory resulting in negative comps for the quarter were after the media went away. So we're not seeing the longer tails we've seen in the past. And it's something that we've been trying to address in terms of our go-forward strategy, from a media standpoint.

[Brian M. Vaccaro:]

Okay. And then in terms of media efficiency, and I wanted to ask about Dallas specifically, I think the plan was to perhaps turn on media support sometime in the second half of 2016. Is that still the plan?

[Timothy P. Taft:]

No. I think what we plan on doing is beginning next year we will have all kinds of media, with the exception of TV, beginning the first part of next year.

[Brian M. Vaccaro:]

Okay. And how about Houston? Would that be sometime early mid-2017 as well perhaps? Or maybe a little later?

[Timothy P. Taft:]

Well, Houston is a market that it's going to take quite a few restaurants in order to be media efficient. So that's not one we'll talk about radio and direct mail and all the other things that we can bring to bear. But we won't be spending TV, radio in Houston.

[Brian M. Vaccaro:]

Okay. And then just one last one, if I could. On the smaller prototype, you said I think it was 15%, 15% to 20%, lower capital investment. Can you share sort of what the new sales hurdles, targets I should say, sales targets and sort of cash on cash parameters you're thinking about on that smaller prototype?

[Lynn S. Schweinfurth:]

Yeah. I would say the investment cost itself would be in the neighborhood that you indicated and that we mentioned earlier in the call. In terms of the sales volume, we think we can get to a hurdle of 20% or greater in emerging markets at about a $1.7 million, year three sales number. But then additionally, in some of our more mature markets where we see higher sales initially, the returns will be much higher. Higher than the 25% that we hope to get from our mature markets.

[Brian M. Vaccaro:]

Okay. Thank you.

[Operator:]

Our next question is from Nick Setyan from Wedbush Securities.

[Colin Radke:]

Hi. This is Colin Radke on for Nick. I was just wondering if you could maybe provide a bit more detail on what the media plans are in the second half, kind of market-by-market? You mentioned Texas is sort of off the table for the most part. You said the sales kind of dropped off a bit in Florida once you went away from that. I was just wondering if you could provide a little bit more color, and maybe if your thinking has changed at all based on the results you've seen so far?

[Timothy P. Taft:]

Well, first of all, I think when Brian asked the question and it was about increased media, and there is some misconception that although we were spending a good deal more than a year ago, that it would all come in the first half when in fact what we were really doing is spreading that over the year. So as an example, if last year we had 25 weeks, this year we would have 35 weeks, so we would be able to extend a week with TV and/or radio for greater expansion. I think what you'll find is that the strategy is still the same, that in a competitive environment we're going to continue to spend at the increment. Obviously sales are down so the amount that we'll be able to spend on the marketing or advertising will go down, but you'll still see us in those media markets spending to an increased level versus a year ago, and that's across the board. So San Antonio will have its normal set of media exposure, Atlanta is now on board with that. And then the rest of the Florida markets. And then as we mentioned, Dallas next year will have everything but TV, and Houston will have everything, but TV and radio.

[Colin Radke:]

Okay. Thank you. And then just on Pollo, I think in the past you had mentioned maybe more of an emphasis on menu innovation at Pollo this year. I was just – I know that tends to be sort of focused on the higher end of the menu. I was wondering, given what you're seeing in the promotional environment if you're thinking around that has changed at all?

[Timothy P. Taft:]

No, and I'm glad you asked that question, Colin. I think that what you saw in this past quarter with the Pinchos program with Pollo, it was a check builder. So not only did people have that as an entrée, but they also used it to – we used it to add on and build check. So it's that kind of innovation that you'll see going forward, not necessarily to lower the price, but really to give the customer additional choices and additional reasons to visit.

[Colin Radke:]

Okay. And then just a last one from me. I think you'd mentioned using a similar site selection model as when you first started out in Jacksonville. Just wondering if there was any – now that you guys have sort of built out more of these restaurants, if there are any changes to that in terms of your thinking around what types of sites work, what doesn't work, and what types of areas you really want to go into.

[Lynn S. Schweinfurth:]

Well, I appreciate the question because we're actually in at least late stages in terms of updating our analogs, in terms of a model that we use to determine what we think projected sales will be for new sites. And we needed a certain amount of restaurants to be able to be statistically significant in terms of pursuing an updated version. And so that's currently in process. We think we'll have the model completed by let's say early fall that we can apply on a go-forward basis. So thank you for the question. Something we're proactively trying to refine as we move forward.

[Colin Radke:]

Okay. Thank you very much.

[Operator:]

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. We are out of time for today's call. Fiesta Restaurant Group thanks you for your time and your participation. You may disconnect your lines at this time, and have a good evening.