Fiesta Restaurant Group, Inc.
Q2 2015 Earnings Call Transcript

Published: 31 Jul 2015

[Operator:]

Greetings and welcome to the Fiesta Restaurant Group Second Quarter 2015 Earnings Conference Call. I would now turn the conference over to your host today Ms. Lynn Schweinfurth, Senior Vice President and Chief Financial Officer. Thank you. You may now begin.

[Lynn S. Schweinfurth:]

Thank you. Good afternoon and thank you for joining our call. Our second quarter 2015 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 may include statements that are not based on historical information. These forward-looking statements include, without limitation, statements regarding our financial position in the future 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 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 our results prepared in accordance with GAAP and a reconciliation to comparable GAAP measures is available in our earnings release. Now I'd like to turn the call over to Tim Taft, President and Chief Executive Officer.

[Timothy P. Taft:]

Thanks, Lynn, and good afternoon, everyone. The Fiesta team has once again delivered exceptional performance and positioned us for what we believe will be another great year of operational and financial progress. Through their hard work and dedication, we've extended our track record of generating stronger year-over-year results in each quarter since the May 2012 spin-off. In the four years that I've served as CEO of this company, I've always been proud of what this team has accomplished. And this was certainly the case in the second quarter as well. Revenues grew by 11.5% as we benefited from combination of 21 net company-owned restaurant openings as well as comparable restaurant sales increases at both brands. Double-digit top-line growth flowed through the P&L and resulted in restaurant-level profitability improvement and ultimately EPS growth of 20%. I'd like to point out that growth and our bottom line came on the heels of a 67% EPS gain in the same period last year, a remarkable result. We've achieved strong top-line results by remaining focused on strategically advancing Pollo Tropical development in new and emerging markets as well as through purposeful cannibalization. In South Florida, cannibalization relieves some operational stress from high-volume restaurants, provides a better experience for our staff and our customers, while at the same time expands our total market share. In addition, cannibalization is not only happening in South Florida locations. Because this is not a typical growth story, we have been infilling and therefore cannibalizing most every market in which we operate. Of the more than 50 restaurants we've built in the last four years, more than a third have cannibalized existing restaurants in the trade area. This has negatively impacted same-store sales and transaction by over one percentage point in 2014 and is projected to do the same in 2015 as we purposely build out existing markets. Now let's dive a little deeper into that performance of our two brands. Pollo Tropical comparable restaurants sales grew 4.3% during the second quarter and 11% on a two-year basis, extending its track record of positive gains to 23 consecutive quarters. As disclosed in our earnings release, Pollo Tropical comp store traffic fell slightly. We believe this was the result of customers making discretionary spending adjustments earlier in the year related to affordable health care enrollment and related premium payments. You may recall, we discussed this issue on our first quarter conference call. We compared the current environment to that of early 2013 when payroll taxes increased and IRS refund checks were delayed when we saw guests pull back for restaurant occasions for a few months, but resumed their prior spending habits after this adjustment period. We are seeing a similar pattern this year as transaction growth improved at the end of second quarter and again in July. Through this past Sunday, July month to-date comparable traffic grew 1.2%, resulting in comp sales of 6.4%. Turning to Taco Cabana, the brand is certainly on an upward trajectory with positive sales momentum. Comparable restaurant sales grew 5.6% during the second quarter, which included 1% in guest count growth. On a two-year basis, comparable restaurant sales were 8.4% positive. The brand has now achieved positive sales gains for six consecutive quarters and 19 of the past 20 quarters. July month-to-date, Taco Cabana has generated transaction growth of 1.3%, resulting in comp sales growth of 7.1%. In addition to positive traffic which we attribute to improved operational execution and advertising effectiveness, pricing and our new menu boards continued to drive higher sales mix. With Taco Cabana's remodeling program all but complete, we are turning our attention to rebuilding the limited-time offer or LTO pipeline under the leadership of our new Executive Chef at Taco Cabana, Andy Dismore. We believe LTOs are essential in keeping the brand fresh and innovative in guests' minds and to sustaining consistent transaction growth. Turning to supplier partnerships. I want to highlight that we recently extended our multi-year product and marketing agreement with The Coca-Cola Company. You may recall about 18 months ago, we consolidated all of our fountain beverage commitments under the Coco-Cola umbrella with an initial agreement that was expected to run until 2019. This amended deal solidifies our partnership with Coca-Cola until approximately 2024. And as part of the agreement, Coca-Cola is providing funding for equipment to ensure that we are pouring the highest quality products along with marketing support. Our R&D and supply chain teams continue to focus on opportunities to reduce our chicken cost. As we've stated on previous occasions, there has been a contraction of chicken supplies for smaller whole birds that we use for our Pollo chicken platters and sandwiches, causing relative cost increases substantially this year over last. Current initiatives are centered around offering more dark meat, chicken options and purchasing larger chickens for dice chicken meats while ensuring we are delivering high-quality products. We currently expect to have these initiatives rolled out by the end of the year. Now let me address some of the key questions investors have recently raised as it relates to our business. First let me touch on the macro environment. I already mentioned the temporary headwind that we believe impacted transaction growth at Pollo Tropical beginning in February, which has since dissipated given our improved performance during the latter part of the second quarter and into July. Next, the impact of avian flu. In general, avian flu has not had serious impact on our operations mainly because the flu has reduced the supply of egg layers and not broilers. Taco Cabana had some impact due to the national egg shortage, but we are mitigating those cost implications through price increases on breakfast items and shifting sales mix towards non-egg breakfast offerings. We have also been able to secure adequate supply to meet the demand for breakfast unlike some competitors that have reduced breakfast hours. Turning to state of Texas economy. The business environment and consumer spending patterns on our Texas markets continue to be healthy. Lower oil prices in recent months have not negatively impacted our performance as Texas has a growing and diversified business environment in the markets in which we operate. Economic metrics continue to be stronger than that of the overall national economy. Next, our remodeling and reimaging efforts. We have recently completed all of our planned Taco Cabana remodels, while our Pollo Tropical reimage program has shifted into high gear. We have started reimaging two of our restaurants in Orlando market and will complete the majority of the market by October. During the third quarter, we are planning on reimaging two restaurants in Nashville that were built a few years back under the old prototype. We are doing so because we will shortly have two Big Blue restaurants open in Nashville and we want to have a consistent brand image when we turn on the broadcast media. With four stores open in the market, we'll have the scale to be media-efficient and will begin advertising in the coming months. Finally, we are currently testing our acceptance of our Big Blue prototype in South Florida, having recently completed the reimaging of one of our busiest and most high-profile restaurants in Miami. Our guest reaction has been overwhelmingly positive. This gives us confidence that we're on the right track to make Pollo Tropical even more competitive than the segment. Now let's talk about off-premise business, which includes online ordering, catering to go and drive-thru. Since its introduction, Pollo Tropical's mobile app and online ordering platform has successfully helped the brand better connect with guests and made ordering and payment more convenient. With this knowledge under our belt, we are currently piloting a similar app for Taco Cabana along with online ordering. We plan to have this fully rolled out at Taco Cabana by mid-2016. As part of our commitment to off-premise business development, we've identified an internal director to oversee this key area of growth. Willie Romeo will be responsible for driving profitable growth and quality execution of all Taco Cabana and Poll Tropical meal occasions that occur outside the four walls of our restaurants. Willie not only possesses experience in overseeing high-quality restaurant operations, but has proven himself to be an effective, innovative and results-oriented business leader. Finally, let me update you on our new restaurant development progress. We have opened a total of 13 restaurants for the first half of the year. During the second quarter, we opened up two Pollo Tropical restaurants in Florida and four in Texas. We also opened up one Taco Cabana in Texas. It's worth noting that we are expecting our largest number of restaurant openings in a single quarter this quarter, one Taco Cabana and 15 Pollo Tropical restaurants. We had previously targeted between 28 and 32 openings this year and are now raising our range to 32 to 34 restaurants. All but two openings will be Pollo Tropical restaurants. Of the Pollo Tropical openings, 13 will be in Texas, six will be in Atlanta, two will be in Tennessee and the balance will be in Florida. We've also made considerable progress on our development pipeline for 2016 and beyond. To ensure that we are opening restaurants that will successfully grow in the years to come, we continue to focus and invest in our most valuable asset

[Lynn S. Schweinfurth:]

Thank you, Tim. I too am very pleased with our second quarter results. From a top-line standpoint, Taco's strong trajectory of sales continues and Pollo comp sales have recovered from some softening that began in February. The pacing of new restaurant development continues to improve as we effectively build out our non-core markets quickly to reach and leverage media efficiency and pursue our fill-in strategy in core markets. The operating teams are effectively managing operating costs, while the organization continues to prudently invest in all areas that will allow us to meet both our near-term and long-term growth goals. Let me begin with a summary of our financial results for the period, after which I will review some updates to our full-year outlook. We grew total revenues by 11.5% to $171.9 million in the second quarter as we benefited from new company-owned restaurant openings over the past year and solid comparable restaurant sales growth at both brands. Pollo generated comparable restaurant sales growth of 4.3%, consisting of 4.5% increase in average check, which was slightly offset by 0.2% decrease in comparable guest traffic due to reasons that Tim described earlier. Average check was driven by menu price increases that positively impacted restaurant sales by 5.4%, partially offset by higher discounts and lower sales mix due to fewer family meals and side items. Our fill-in strategy that Tim has addressed resulted in sales cannibalization negatively impacting comp sales by approximately 1.1% during the quarter. Taco generated comparable restaurant sales growth of 5.6%, which consisted of a 4.6% increase in average check and 1% growth in comparable guest traffic. Average check was driven by menu price increases that positively impacted restaurant sales by 2.9% and a positive change in sales mix due to the implementation of new menu boards in February. These strong results were generated despite a negative influence of weather primarily in June due to tropical storm Bill. As a reminder, the new menu boards at Taco eliminated combo meals. While guests can still order an off-menu combo meal, we continue to see our guests ordering more plates and adding side items such as drinks or chips and queso to their order. This change produced incremental sales mix and profitability over the prior year. In addition to opening seven restaurants, we closed two Taco restaurants as planned at lease expiration. Net enterprise restaurants increased by 21 or 8% to 299. Both brands expanded their restaurant margins during the quarter as restaurant level EBITDA as a percentage of restaurant sales improved 130 basis points to 23.4%. This improvement was due to favorable cost of sales, labor, rent and preopening costs that were partially offset by higher depreciation and amortization expenses. In dollar terms, restaurant level EBITDA rose 18.3% to $40.1 million. Consolidated adjusted EBITDA increased 20.8% to $27 million and improved 120 basis points as a percentage of revenues to 15.7%. Cost of sales improved as a percentage of restaurant sales by 20 basis points primarily due to the benefit of price increases, a shift in sales mix to more profitable menu items due to Taco Cabana's new menu board, and effective supply chain initiative. These benefits more than offset commodity cost increases. Restaurant wages and related costs improved as a percentage of restaurant sales by 80 basis points as sales growth at both brands and favorable medical costs more than offset labor costs at new elevated Pollo restaurant. Pre-opening costs were consistent at $1.2 million in the second quarter of 2015, with seven company-owned restaurant openings in both this year and last year's second quarter. As a reminder, expenses for future restaurant openings are typically incurred beginning four to six months prior to opening. D&A expenses increased $1.5 million compared to last year to $13.6 million, primarily due to ongoing human capital investments related to manager training to support our expansion of Pollo restaurants and investments made in our infrastructure to support our growth strategies. Depreciation and amortization increased $1.8 million to $7.4 million in the second quarter of 2015 due to new company-owned restaurant openings over the past year. Interest expense decreased by $0.2 million to $0.4 million in the second quarter compared to the prior year period primarily due to lower borrowing rates. Our weighted average effective interest rate at the end of the quarter was 1.8%. We recognized other income of $142,000, primarily from business interruption insurance proceeds for a Pollo location that would temporarily closed due to a fire. Our annual effective income tax rate for 2015 is estimated at 38.3%, consistent with the prior year period, and it seems that the Work Opportunity Tax Credit is not reenacted in 2015. Net income increased to $11.2 million in the second quarter of 2015, or EPS of $0.42 as compared to net income of $9.3 million in the prior year period, or EPS of $0.35. This amounted to 20% EPS growth compared to the same quarter in 2014. And as Tim mentioned, this growth was on top of a 67% EPS growth in the same quarter last year. Of the 67% EPS growth we experienced last year, about 25% was related to our refinancing completed in late 2013 with the majority of the growth being generated by operations. Turning to brand margins; consolidated restaurant level EBITDA margins improved in the second quarter by 130 basis points as a result of larger expansion at both brands. Pollo's margins expanded by 20 basis points despite continued pressure from rising chicken costs and more importantly while adding new elevated restaurants to its footprint. Taco's margin expanded by 220 basis points, as the brand continues to do an extraordinary job controlling costs and flowing dollars to the bottom line. At quarter end we had a cash balance of $5.5 million, and after reserving $5.5 million for letters of credit, we had $73.5 million of borrowing capacity under our senior credit facility. We continue to be in compliance with all related covenants. Next, let me touch on financial expectations for 2015. Recall that 2015 is a 53-week fiscal year. For purposes of calculating the flow through on incremental sales attributable to the 53rd week, we allocate most expenses on a weekly basis with the exception of rent and approximately two thirds of our G&A expenses. For the full year 2015 we are reaffirming all of our previously disclosed operating targets with the exception of two. The two exceptions are

[Operator:]

Thank you. At this time we'll be conducting a question-and-answer session. Our first question comes from Nicole Miller from Piper Jaffray.

[Nicole M. Miller Regan:]

Thank you. Good afternoon. I just had two quick ones. First on the top line as it relates to development, are you encouraged as you increased the guidance for openings this year, can we use that as a run rate into next year or is it just simply a pull forward of stores that would have opened at the beginning of next year and there might not be an acceleration going forward? How can we think about that?

[Lynn S. Schweinfurth:]

Nicole, I would say you can use it as a run rate as you move forward. As we can pull restaurants into 2015, we can also pull more restaurants into 2016 as a result of increased acceleration.

[Nicole M. Miller Regan:]

Okay. And then just a second one also on the top line, but as it relates to menu, beverage platforms and innovations have been something that contributed. How has the incident rate changed or improved and what kind of room lift you have on beverage platforms?

[Timothy P. Taft:]

Well, I think that traditionally for both brands, Nicole we skew a little bit low in terms of percentages of sales for drinks. That's why this new deal with Coca-Cola is so important. I think a big opportunity that we have not only in marketing, but also pouring a more quality drink, something that this new contract allows for new equipment and a more consistent and quality drink throughout the system, but I think that still in next year you'll see more programs dedicated specifically to increasing drink itself.

[Nicole M. Miller Regan:]

Thank you.

[Operator:]

Thank you. Our next question comes from Alex Slagle from Jefferies.

[Alexander Russell Slagle:]

Hey, thank you. Congrats guys. Similar question on the development and just pick your brain a little bit more on what changed, in your view. Is it the people, pipeline that you've been working on? Is that really the key driver of the decision to increase the development?

[Timothy P. Taft:]

I think it's a combination Alex, not the least of which is that the availability of high quality sites continued to be very robust. Certainly, having new training stores in Texas is helping that. It's still going to be a scramble as we continue to build more restaurants between now and the end of the year. But our goal clearly is to increase and ramp up the number of restaurants that we build on a go-forward basis. And I think this is – as we get processes in place, we'll learn exactly what the challenges are in new markets, that that's going to bode well for us and help us when we move into other cities as well.

[Alexander Russell Slagle:]

Okay. And any initial thoughts on what in your 2016 development pipeline -- I mean what percentage roughly might be in Texas for Pollo?

[Timothy P. Taft:]

I think the fair number is probably half. I think that's a number that we've been going with.

[Lynn S. Schweinfurth:]

Yeah, I mean, we will be focused of course on all our existing markets, so especially Atlanta, Florida, of course and Texas. And Texas and Florida being a material portion.

[Alexander Russell Slagle:]

All right. Thank you.

[Operator:]

Thank you. Our next question comes from Jeff Farmer from Wells Fargo.

[Jeff D. Farmer:]

Great. Thank you. Just given the 15 Pollo unit openings you guys guided to for Q3. That comes with a lot of margin inefficiencies theoretically just from that concentrated rate of development. So looking at again just Pollo specifically and the restaurant level margin, is it fair to expect that you guys might see some restaurant level margin pressure either sequentially or year-over-year into Q3?

[Lynn S. Schweinfurth:]

Yeah, I think that is fair, Jeff, and thank you for raising the question. I think where we're going to see more pressure is likely on the wage line item. But I think from a cost of sales, we should be about where we thought we'd be. But part of that is as a result of some improvements we've seen in some of our commodity costs, in particular cheese and taco meat, but the other offset to those improvements has been eggs as we've been talking about publicly. So while we were able to take some price to help offset that impact, there will be a little bit of an impact of cost of sales. So again, all of those moving pieces will work together to get to about where we were from a forecast standpoint previously on cost of sales, but wages and the labor line item will likely be impacted related to the number of openings.

[Jeff D. Farmer:]

Okay. And then admittedly early, but when Texas based Pollo unit openings -- I think you're going to begin to see some of these guys enter the comp base late 2015, early 2016, again, acknowledging that's it's early, but right now based on what you know, would you expect them to enter the comparable store base as a headwind or a tailwind to that consolidated same store sales number?

[Lynn S. Schweinfurth:]

Well, I think at this point and some of this will be determined based on the timing of our advertising and when those stores go into the comp base, but we believe it will be a little bit of a tailwind on the comp sales.

[Jeff D. Farmer:]

Okay. Then just final question, somewhat related. You just mentioned advertising and I might have missed this, but in terms of just advertising expense as a percent of sales in 2015, obviously I saw what happened in the first half of the year, but for full year 2015 is there an expectation you put out there?

[Timothy P. Taft:]

I think that we haven't put it out there, but I think that we pretty much hinted on a continuing basis is that our percentage of sales from marketing's going to remain the same. That's something though that we're looking at on 2016 and beyond, but stay tuned.

[Jeff D. Farmer:]

Okay. Thank you, guys.

[Lynn S. Schweinfurth:]

Thanks, Jeff.

[Operator:]

Thank you. Our next question comes from Will Slabaugh from Stephens Inc.

[Will Slabaugh:]

Yeah, thanks. Just, wondering if you could talk a little bit more about the Pollo remodels. It sounds like you're pretty pleased with what you've seen so far. So I'm just curious if there is any anything that we should take from that in terms of the rate at which you want push through this new image across the system. And then if secondarily there is a targeted sales lift range that you'd be willing to share at this point.

[Timothy P. Taft:]

Well, Will, I think that we are excited and you're right

[Will Slabaugh:]

Got it. That's helpful. And moving back over to commodity inflation if I could, as far as the small birds go and you mentioned that's going to continue to be a headwind for you and you're mitigating that in various ways. I'm curious just for that particular piece of poultry, if you're expecting that to continue to rise into next year. What's the expectation that you're hearing out there in the marketplace for small birds at least as far out as people are willing to project?

[Timothy P. Taft:]

Well I think originally folks thought that there would be a decrease in 2016. I think that's still up in the air. We're not counting on the small bird going down in price with any material effect, but I think that we'll have some information hopefully for you by the end of the year in terms of what our mitigation exercises are marrying for us.

[Will Slabaugh:]

Got it. And just last one for me. I wonder if you could talk about the new markets and kind of what you've been seeing as you opened up some new restaurants and as the awareness rises, so thinking beyond Texas, Nashville, Jacksonville, Atlanta, et cetera what you've been seeing there and then as you talk about layering in the media, what that typical lift has been in the past as you take a market that hasn't had media, at least broadcast media and all of a sudden it comes on air?

[Timothy P. Taft:]

Well, let me start with the second one. We have in the past in Atlanta, because we have admitted that Atlanta is going to be a tough market and we don't think that we're going to be media efficient until probably around 2017, so early 2017. So with that said, we have in the past though spent money as if it was media efficient in the Atlanta market and the results were – you need to get the media efficient as quickly as possible, because it does make a big impact. At Nashville, we now have our third restaurant open in Nashville and he Nashville market is performing very-very well. We have our fourth one that's going to open up within the next two months. So you'll see us in Nashville media efficient by the end of this year and we'll be on air. To your second question in the Dallas market, for all intents and purposes, Dallas, San Antonio and Houston, we haven't really spent any media dollars of note. What we plan on doing is that it's – and it's a fine kind of balancing act that you walk in between building rooftops without driving topline awareness via media and cannibalizing by adding additional rooftops. Thus far we haven't had to spend any money as I mentioned and I think that you'll see as our growth percentage, as our numbers increase, that you'll see us start to go into radio and television and that certainly will be a part of the mix for 2016.

[Will Slabaugh:]

Thanks Tim.

[Timothy P. Taft:]

Thank you, Will.

[Operator:]

Thank you. We have time for one last question. Our last question comes from Nick Setyan from Wedbush Securities.

[Nick Setyan:]

A great quarter. Especially, I just want to focus on the margins real quick. The labor leverage at Pollo and I think that's beyond everyone's expectations. I mean, can that – can we read that as the newer openings are actually ramping to efficiency quicker that you previously thought they would?

[Lynn S. Schweinfurth:]

Nick, I think that might be premature. We did have a great quarter. We had fewer openings than we'll have for instance in the third quarter. We did have a favorable impact associated with the medical accrual that we adjusted for during the quarter so that was a positive, but that's not to take away from the Pollo team really doing a great job in terms of controlling margins.

[Nick Setyan:]

Exactly. Got it. We've talked about some of the efficiency initiatives particularly in South Florida where we can drive some throughput. Is remodeling going to be part of that as well? Are there opportunities to maybe drive some further throughout or they're just going to have external remodeling?

[Timothy P. Taft:]

Well, I will tell you one of the greatest things that has happened is that the experience from remodeling number nine down in Miami, Nick, that when we were forced to for about a three day period to run everything through the drive-thru, our dining rooms were closed as we put new floors down. What it forced us to do is really look at throughput and look at efficiency and manpower and where it was deployed inside the kitchen. We were running in excess of 600 cars a day through the drive-thru which is an extraordinary number. And so with that we're learning what it's going to take and what the opportunities are for future restaurants and I think too perhaps it could impact design and product flow, but I still believe that in South Florida we're reaping the benefits of some of the efficiency in cutting out some of the products that we had as part of our menu a year ago. But I think what's certainly evident is that the traffic and topline sales are positively going to be impacted by these remodels.

[Nick Setyan:]

Got it. And on Taco, we just did over 20% margins here. I think that's a record going back as far as I think I have the data, but how are you thinking about the unit growth in terms of Taco?

[Timothy P. Taft:]

Well, I'll tell you, Taco is making a strong case for itself for additional development. I think that versus where we were and that team and that brand was three years ago that it's really got our attention. And we're looking at not only the opportunities inside of Texas, but elsewhere and I think that probably what you'll see us doing is looking further at Taco Cabana and further refining what opportunities we have to make that more efficient. But you're absolutely right,. I'm glad that you pointed it out. The performance in this past quarter was an absolutely brilliant job by Todd and his team.

[Nick Setyan:]

Okay, and just one quick modeling question. Then what do we think about pricing at Taco in Q3 and Q4 and I guess at Pollo as well?

[Lynn S. Schweinfurth:]

Well, at this point we have not committed to take any more pricing through the balance of the year but once we make a determination we will certainly share that timing when it's appropriate.

[Nick Setyan:]

Okay. So as of now, assuming no incremental pricing, is that still 2.8% in Q3 and Q4 for Taco?

[Lynn S. Schweinfurth:]

That's fair. Yes, absolutely and then for Pollo they are running over 5% currently, but then that will drop down when we lap the early to mid November price that they took last year.

[Nick Setyan:]

And it drops down to about mid-2% if I'm correct?

[Lynn S. Schweinfurth:]

Maybe a little bit higher than that. No. I think that's a fair comment, sorry.

[Nick Setyan:]

Okay. Thanks so much guys.

[Timothy P. Taft:]

Thanks, Nick.

[Operator:]

Thank you. This concludes the Q&A portion and our conference call for today. Thank you for your participation. You may now disconnect.