El Pollo Loco Holdings (LOCO) Q1 2019 Earnings Call Transcript

El Pollo Loco Holdings (LOCO -0.36%)
Q1 2019 Earnings Call
May. 02, 2019, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings and welcome to El Pollo Loco first-quarter 2019 earnings conference call. [Operator Instructions.] Please note this conference is being recorded. I will now turn the conference over to your host today, Larry Roberts, chief financial officer. Please proceed.

Larry Roberts -- Chief Financial Officer

Thank you, operator, and good afternoon. By now everyone should have access to our first-quarter 2019 earnings release. If not, it can be found at www.elpolloloco.com in the Investor Relations section. Before we begin our formal remarks, I need to remind everyone that our discussion today will include forward-looking statements.

These forward-looking statements are not guarantees of future performance, and therefore you should not put undue reliance on them. These statements are also subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. We expect to file our 10-Q for the first quarter of 2019 tomorrow, and we encourage you to review that document at your earliest convenience.

During today's call, we will discuss non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP, and reconciliations to comparable GAAP measures are available in our earnings release. I'd like to now turn the call over to President and Chief Executive Officer Bernard Acoca.

Bernard Acoca -- President and Chief Executive Officer

Thanks, Larry. Good afternoon, everyone, and thank you all for joining us today. We are pleased with our results in the first quarter, which continue to be driven by the execution of our transformation agenda. For the quarter we achieved 2.4% systemwide comparable restaurant sales growth and pro forma EPS of $0.15.

This marks the third quarter in a row of positive systemwide comparable sales growth since our transformation agenda was implemented. These results were achieved despite adverse weather conditions in California, where 80% of our restaurants are located. Restaurant contribution margin was 17.7%, which reflected the sales headwinds and higher labor costs we expected. Looking forward to the second quarter, we believe that our new Queso Fresco Tostadas and Overstuffed Quesadilla promotions, which historically have been strong, limited-time offers, will help us regain traffic momentum.

In addition, we have gone back to advertising a $20 price point on family meals, which we had stopped advertising in February. Over the longer term, we remain focused on executing our transformation agenda, which as you know consists of four key strategies: one, developing a people-first culture by investing in and growing our talent; two, differentiating the brand by accentuating our strengths and building upon them; three, simplifying operations, thereby making it easier to be an employee and franchisee; and four, growing the business responsibly and profitably for the long term. I'd like to now update you on some of our key accomplishments over the past two months supporting these strategies. As I discussed, we believe that culture is the foundation for all great companies.

It is therefore critical that we continue to invest in and develop our talent. With the goal of creating a people-first culture, we have set out to drive a performance-based culture with heart. This was embodied in the first quarter by our extremely successful inaugural employee appreciation month, a four-week program designed to celebrate, invest in and thank our greatest asset, our employees. We started the program in week one by focusing on employee recognition, including the launch of our dedicated service awards celebrating our long-term employees.

During week two, we invested in our employees' professional development and personal well-being. Week three showcased our employees' unique talents and tapped into their creativity to help us come up with our next great new products. And finally, week four focused on volunteerism and giving back to the communities we serve, culminating in a huge community service event in east Los Angeles on April 1, Cesar Chavez day, a day intended to commemorate his legacy by giving back to those in need. During that event, over 500 employees, franchisees and customers worked side by side to beautify Theodore Roosevelt High School in East Los Angeles.

This week of volunteerism also included events in Phoenix, Las Vegas, Dallas and Houston, where 5,000 meals were served to feed the hungry. We believe this focus on our employees is starting to bear fruit, as evidenced by our Q1 2019 turnover rate. As compared to our full year 2018 results, we saw an 8-percentage-point improvement in general manager turnover, which came in at 17%, and a 21-percentage-point improvement for crew members, which came in at 115%. Our management and crew turnover continue to be well below industry averages, which we believe can be further improved upon in our commitment to become an employer of choice in the industry.

Furthermore, we've continued to strengthen our team with the addition of the third new member to the El Pollo Loco leadership team in the last 12 months, Chief Operating Officer Miguel Lozano. Miguel returned to El Pollo Loco in April after spending 23 years at Starbucks, where he most recently led operations for 780 stores in southern California, one of Starbucks's top-performing regions. Prior to Starbucks, he spent six years at El Pollo Loco, starting as a restaurant general manager before working his way up to area leader and eventually becoming a franchisee. He and his family successfully owned and operated an El Pollo Loco restaurant in La Habra, California for seven years.

We're thrilled to have Miguel back in the El Pollo Loco family. Miguel is the consummate servant leader who has proven he knows how to achieve results through others by building strong teams. I know he will play a key role in formulating organizational strategy, creating memorable customer experiences we can be proud of and ultimately driving brand growth and profitability. In addition, we recently hired a vice president of digital marketing, Brian Wallunas, who started last week and comes to us from Coca-Cola, where he was director of marketing technology.

Prior to Coke, Brian held digital strategy positions at Arby's and Domino's. This is a critical hire as we look to make our local rewards loyalty program a bigger part of how we go to market and migrate more of our advertising media mix to digital channels. Brian will be tasked with growing our loyalty, digital and social media channels to not only drive brand affinity, but also incremental sales opportunities as we expand and deepen our efforts in e-commerce and delivery. Our second strategy involves accentuating and building upon our brand strengths in order to differentiate the brand and enlist our values as a source of competitive advantage.

As we highlighted on our last call, we initiated a brand relaunch in early March and have now completed the systemwide rollout of our new logo, advertising campaign, Feed the Flame tag line, menu boards and point-of-purchase materials. We plan to introduce a new mobile app and e-commerce site in the third quarter, with new packaging and uniforms to follow later in the year. This brand relaunch highlights the craft, hard work and love behind what we do, with a strong focus on both our signature flame-grilled chicken and our Better for You LA Mex cuisine, which appeals to our Hispanic and general market consumers alike. Our third strategy is to simplify operations for our employees and franchisees.

A key focus of this goal has been the reduction of back-of-house complexity to free up capacity in order to deliver a better customer experience. On this front we have successfully implemented our simplified menu across the system, which eliminated approximately 20% of lower-mixing, lower-margin menu items. In addition, we have rolled out a new back-of-house management system to approximately 90 restaurants and expect to complete the implementation by the end of this year. This system should streamline our operations and is expected to free up at least one hour per day for our restaurant general managers.

Moreover, we are currently testing several new procedures and equipment that will further reduce back-of-house complexity. These include new cooking procedures, marinating processes and holding cabinets. Everything we do in our kitchens is being reevaluated in order to make things easier for our team members and franchisees. We're convinced that improved operations can significantly enhance our employees' ability to provide better food and service to our guests, all while having the added benefit of lowering turnover and increasing retention, which is particularly important in today's tight labor environment.

This final strategy for our transformation agenda is growing our business profitably and responsibly for the long term. We are setting the foundation for new market expansion and continue to target a 2020 date for entry into one or two new markets. We recently hired Chute Gerdeman, an internationally recognized design firm, to help us develop our restaurant of the future. Development of this new prototype, which will incorporate our new brand visual expression and a more simplified back-of-house operating platform, is expected to be completed by the fall.

We firmly believe that our work to streamline our menu and simplify our operations platform will facilitate success as we expand to new markets. As part of our strategy to grow responsibly and profitably, after the end of the quarter we sold four company-operated restaurants in the East Bay area and agreed in principle to sell seven company-operated restaurants in Phoenix to two franchisees. We're excited to put these restaurants into the hands of strong-performing franchisees, and both transactions include development agreements to ensure continued growth in these markets. The sale of Phoenix is expected to close in the second quarter.

In summary, we remain excited about our transformation agenda and by the results we've achieved. We believe our momentum continue to accelerate as our transformation agenda gains traction, and I look forward to updating you on our progress on future calls as we continue to elevate the El Pollo Loco brand. Before I turn the call over, I would like to thank all of our employees and franchisee partners for making these results possible. Your passion, commitment and dedication are what make this brand and this family truly special.

I'll now hand the call over to Larry to review our first-quarter results in detail.

Larry Roberts -- Chief Financial Officer

Thanks, Bernard. Before we get into our first-quarter results, I'd first like to touch on our store base. During the first quarter the company closed two restaurants, while franchisees opened two new restaurants, both in California. Looking ahead, we continue to expect to open three to four company-operated restaurants along with three to five franchise restaurants in 2019.

As for remodels, the company completed one vision remodel in the first quarter and franchisees completed an additional three. For 2019, we continue to expect to complete 10 to 15 company remodels and expect our franchise partners to complete another 10 to 15. Now on to our financial results. For the first quarter ended March 27, 2019, total revenue increased 3% to $109 million from $105.8 million in the first quarter of 2018.

The growth was largely the result of the increase in company-operated restaurant sales, which increased 2.7% in the quarter to $97.2 million. Company-operated restaurant sales growth was driven by a 1.5% increase in company-operated comparable restaurant sales as well as by the contribution from 8 new restaurants opened during and subsequent to the first quarter of 2018, partially offset by nine restaurant closures during the same period. The increase in company-operated comparable restaurant sales was comprised of a 4.6% increase in average check, inclusive of 3% effective pricing and a 3.1% decrease in transactions. Franchise revenue increased 5.5% in the first quarter to $6.4 million compared to $6.1 million in the prior year period.

The increase was largely driven by a 3.2% increase in franchise comparable restaurant sales as well as by the contribution of the 11 new franchise restaurants opened during and subsequent to the first quarter of 2018, partially offset by three restaurant closures during the same period. Turning to expenses. Food and paper costs as a percentage of company restaurant sales decreased 90 basis points year over year to 27.9%. The improvement was predominantly due to higher menu prices and favorable sales mix.

Looking ahead, we continue to expect commodity inflation of 1% to 2% in 2019. Labor and related expenses as a percentage of company restaurant sales increased 110 basis points year over year to 30.4%. The increase in labor expenses was due primarily to higher hourly wages in California, especially Los Angeles, and higher worker's compensation expense, partially offset by increased menu prices. We continue to expect labor inflation of about 6% in 2019.

Occupancy and other operating expenses as a percentage of company restaurant sales increased 70 basis points year over year to 23.9%. The increase was primarily due to increases in occupancy, utilities and repair and maintenance costs, partially offset by higher pricing. General and administrative expenses decreased by $1.9 million year over year to $11.3 million. Included in G&A are $2.1 million of legal expenses associated with a securities litigation as compared to $3.7 million in securities litigation costs in the first quarter of 2018.

Excluding the costs associated with the securities litigation and CEO transition costs, G&A expenses in the first quarter of 2019 increased approximately $320,000 year over year to 8.4% of total revenue, which is flat versus the prior year. The dollar increase in G&A expenses resulted primarily from a higher bonus accrual. Depreciation and amortization expense increased to $4.8 million from $4.2 million in the first quarter of last year. The increase was primarily due to new restaurant openings and remodels completed during and after the first quarter of 2018, partially offset by restaurants closed or impaired during the same time period.

As a percentage of company revenue, depreciation and amortization increased 40 basis points year over year. During the quarter we recorded a $4.1 million loss on assets held for sale as the result of the sale of four restaurants in the East Bay area to an existing franchisee, which was completed after the end of the quarter, and an agreement in principle to sell seven restaurants in Phoenix to another franchisee. We recorded a provision for income taxes of $349,000 in the first quarter of 2019 for an effective tax rate of 27.7%. This compares to a provision for income taxes of $1.9 million and an effective tax rate of 43.5% in the prior-year first quarter.

We reported GAAP net income of $913,000 or $0.02 per diluted share in the first quarter compared to net income of $2.5 million or $0.06 per diluted share in the prior year period. Pro forma net income for the quarter was $5.9 million as compared to pro forma net income of $6.7 million in the first quarter of last year. Pro forma diluted earnings per share were $0.15 for the first quarter of 2019 compared to $0.17 in the prior year period. For a reconciliation of pro forma net income and earnings per share to the comparable GAAP figures, please refer to our earnings release.

In terms of our liquidity and balance sheet, we had $6.7 million in cash and equivalents as of March 27, 2019, and $71.1 million in debt outstanding. For the foreseeable future, we expect to finance our operations, including new restaurant development and maintenance capital, through cash from operations and borrowing under our credit facility. For 2019, we expect our capital expenditures to total $14 million to $19 million. During the quarter we repurchased 255,554 shares for approximately $3.4 million for an average price of $13.24.

As of March 27, 2019, we had approximately $15.6 million remaining on our current share repurchase program. Subsequent to the end of the quarter, our Board of Directors approved an additional $30 million share repurchase program, which will run from June 27, 2019 to March 25, 2020. Turning to our outlook for 2019. We are maintaining guidance for the full year as follows.

Excluding the impact of potential share repurchases, we expect pro forma diluted net income per share of $0.70 to $0.75. This compares to pro forma diluted net income per share of $0.74 in 2018. Our pro forma net income per share guidance for 2019 is based in part on the following annual assumptions. We expect systemwide comparable restaurant sales growth to be approximately 2% to 4%.

As I noted, we expect to open three to four new company-owned restaurants and expect our franchisees to open three to five new restaurants. We expect restaurant contribution margin of between 18.2% and 18.9%. We expect G&A expenses of between 8.4% and 8.6% of total revenue, excluding legal fees related to the securities class action litigation and reflecting our change in accounting for franchise advertising fees. We expect adjusted EBITDA of between $62 million and $65 million, and we are using a pro forma income tax rate of 26.5%.

This concludes our prepared remarks. I'd like to thank you again for joining us on the call today, and we are now happy to answer any questions you may have.

Questions & Answers:

Operator

Thank you. [Operator instructions] Our first question comes from Matthew DiFrisco with Guggenheim. Please proceed with your question.

Matthew DiFrisco -- Guggenheim Securities -- Analyst

Thank you, Larry and Bernard. Can you just dig in a little bit into the traffic decline there? How much of that potentially, if any, could come from cutting back the menu by about 20%? I realize those probably were the slower velocity, not the most appealing items, or so you were sensitive to that fact. But was there a drag? Some of your competitors have trimmed their menu, optimized their menus, and there's somewhat of a drag on the traffic when that happens. Did you witness any of that?

Bernard Acoca -- President and Chief Executive Officer

No, Matt, we didn't This is something that we tested pretty extensively in Los Angeles for multiple months prior to rolling it out. And when we actually implemented it throughout the system, we saw it play out in our national rollout, or essentially our official rollout we saw in our test rollout. So we didn't see any degradation in transactions driven by the simplification of our menu.

Matthew DiFrisco -- Guggenheim Securities -- Analyst

OK. And then looking at the franchise comp, did they have a similar traffic decline, or were you exposed more to the weather, so -- and could you sort of quantify what the weather may have been?

Bernard Acoca -- President and Chief Executive Officer

Sure. So if we use a system transaction number, which we don't typically report because it's estimated. We put far more reliance on the integrity of the data of our company transactions. But if we go off of the estimated system transaction number, it actually looks better.

It was negative 2.3% system transactions versus the three -- roughly three -- negative 3% we saw on the company side. So the transaction picture looks a little bit better there. And then I'm sorry, I missed the second part of your question. Can you repeat that?

Matthew DiFrisco -- Guggenheim Securities -- Analyst

No, that was pretty much it, and then the weather side of it.

Bernard Acoca -- President and Chief Executive Officer

Yes. It's hard to really attribute the impact in terms of assigning a specific number to it. But our best estimates in terms of the data that we were able to triangulate there tells us that it was about a little bit more over a point in comp impact, perhaps slightly above a point in terms of the weather impact on our business over the quarter.

Matthew DiFrisco -- Guggenheim Securities -- Analyst

OK. And then my last question. What, if any, is there a benefit to the margins from the selling of the -- the refranchising of the company-owned stores in Arizona and San Francisco? Does that improve your mix of company-owned stores going forward?

Larry Roberts -- Chief Financial Officer

Yes, it does. Selling the East Bay and Phoenix will both be accretive to margins.

Matthew DiFrisco -- Guggenheim Securities -- Analyst

Is that factored into your -- or is it to be determined later? Maybe that 18.2% to 18.9%, does that have an opportunity to be higher?

Bernard Acoca -- President and Chief Executive Officer

Well, at this point, Matt, yes, I took a look at that and just thought this early in the year and given other variables during the year that we may hit up against, and the impact is not insignificant, but it's not big enough to warrant adjusting the range at this time.

Matthew DiFrisco -- Guggenheim Securities -- Analyst

OK. Thank you so much.

Operator

Our next question comes from David Tarantino with Baird. Please proceed with your question.

David Tarantino -- Baird -- Analyst

Good afternoon. First question's on the sales trends. Last time we talked, you did call out the weather, and it does seem like the weather maybe normalized exiting the quarter and into this quarter. So would you be willing to share kind of what your trends did following the weather issues exiting the quarter and what you're seeing so far in the second quarter?

Bernard Acoca -- President and Chief Executive Officer

Yes. So we entered in or exited April kind of flattish on our sales situation, but that was expected based on what we were rolling over from last year in terms of a very strong tostada promotion. And we expect, now that -- at the beginning of May we kicked off our tostada promotion this year at this time, which is historically our strongest promotion. We have confidence that we are going to pick up momentum as the quarter progresses.

But we knew April was going to be tough, and we've got confidence that, based on what we are currently promoting now, that the momentum will get increasingly stronger.

David Tarantino -- Baird -- Analyst

Got it. Just so I understand, flattish meaning flattish year over year or flat relative to what you reported for Q1?

Bernard Acoca -- President and Chief Executive Officer

Year over year.

David Tarantino -- Baird -- Analyst

OK. Thank you for that. And then a couple of questions on menu simplification. Thank you for the update there.

I guess what are you seeing so far in terms of the operations benefit from having reduced that complexity back of the house? Are you starting to see any improvements on some of the metrics you're tracking on that front?

Bernard Acoca -- President and Chief Executive Officer

I think we've done a few things. Menu simplification was certainly one of them, and as you can recall, we also kind of reduced the number of promotions we were running annually from nine to six, and I think the net impact of all of that has been just better execution against the products that we're serving day in and day out, only because we're not having to train so often on new LTOs and our people can focus on executing much better against a lower number of SKUs. So while it's still early days, of course, this coupled with a bunch of the initiatives we're working on, is really intended to improve our overall operations. I think where we saw it most dramatically, if I was to point to a data reference, is NPD data is data that we look at on a quarterly basis.

And what was really impressive -- although again, early days -- we registered the highest food score that we've seen in over 12 months in the first quarter of 2019. So to put that in perspective, our food scores have always been significantly above QSR by at least almost 10 points. And so we exited, for instance, 2018 with food scores that typically averaged 77 or 76, whereas QSR typically comes in -- average QSR typically comes in around 64 or 65. Q1 2019 food scores came in at 80, so we think that's somewhat indicative of this greater focus against execution that we're placing on op simplification.

David Tarantino -- Baird -- Analyst

Great, that's encouraging. So last question. On the selling of the company units, I just wanted to understand your strategy around that concept. Is this more a couple of one-off transactions, or is this going to be more of a broader theme as we move forward?

Bernard Acoca -- President and Chief Executive Officer

So I think in the case of the East Bay and Phoenix, one, we had franchisees that expressed -- very, very strong performing franchisees that we have a long-standing relationship with -- that expressed an interest in those restaurants. And given that we had a much smaller presence relative to our franchisees in those markets, it made sense for us to sell them while also ensuring that we put a development agreement in place so that those markets continue to grow into the foreseeable future. In regards to further refranchising, there's nothing on the horizon right now. Frankly speaking, that's not to say that we wouldn't look at something if something opportunistic presented itself, but there's no immediate plans to do anything else on that front.

David Tarantino -- Baird -- Analyst

Great. Thank you very much.

Operator

[Operator instructions] Our next question comes from Andy Barish with Jefferies. Please proceed with your question.

Andy Barish -- Jefferies -- Analyst

Hey, guys. Thanks. I guess I was wondering if you could just give us a little bit more detail on sort of the traffic and the mix divergence, just promotionally, maybe what was going on, and then going forward, kind of key contributors that you expect to drive both components there.

Larry Roberts -- Chief Financial Officer

Well, obviously, the check, as Bernard highlighted, was the big driver of the comps and where 3% of that was price. That was for the quarter. And then the mix was up, and then really several things that we think led to the mix upside. One was just a little bit lower discounting in our loyalty program.

The other was we promoted a Dinner for Two promotion, which actually drove some mix benefit. And so -- and then there were a couple of other things. So those are some of the drivers of the mix benefit. Balance of the year as it plays out, I don't expect the mix benefit to be as high, mainly because some of those things will come off the table.

We did them in Q1; we won't be doing them the balance of the year. Also, as I look at balance of the year, when you look at some of the promotion we're doing, especially we're probably doing a $5.00 type of promotion like we did last year, those obviously are lower mix drivers but higher transaction drivers than we've had in the first quarter. So against a very strong check driven by mix in the first quarter, I expect to see that mix benefit decline and kind of level out during the balance of the year.

Andy Barish -- Jefferies -- Analyst

Great. And then, Larry, can you give us an update on kind of where -- or Bernard -- where Texas stands today? Kind of the impact on the overall enterprise and sort of the 2019 plans for that market after menu simplification and some other things?

Larry Roberts -- Chief Financial Officer

Yes, really, the story hasn't changed tremendously in terms of the impact. As an impact, again, it continues to be a 130-basis-point margin hit, probably a 20-basis-point or so same-store -- maybe 30-basis-point, 20 to 30 basis point same-store sales drag. The thing I will say is we have seen some improvement in the same-store sales trends in both markets, so we're a long way from being where we need to be, but at least that's somewhat encouraging. We continue to invest in the markets operationally.

We've made investments, and when you look at the ops metrics, Texas and Houston are both among the best we have in our system. We're also just investing in billboards in Dallas, so we continue to do things that move the sales in those markets. So we continue to do what we can to improve the sales results and continue on a long journey of getting the sales up to levels and margins up to levels where long term, it's a viable market for us. But still a lot of work to do, but obviously, they continue to be a drag on our overall results.

Andy Barish -- Jefferies -- Analyst

Thank you, guys.

Operator

Thank you. At this time there are no further questions in queue. I would like to turn the call back over to Mr. Bernard Acoca for closing comments.

Bernard Acoca -- President and Chief Executive Officer

Well, thank you, everyone, for joining us on our quarterly call, and we look forward to speaking to you again in the future. So be well.

Operator

[Operator signoff]

Duration: 34 minutes

Call participants:

Larry Roberts -- Chief Financial Officer

Bernard Acoca -- President and Chief Executive Officer

Matthew DiFrisco -- Guggenheim Securities -- Analyst

David Tarantino -- Baird -- Analyst

Andy Barish -- Jefferies -- Analyst

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