Earnings Transcript for FRGI - Q2 Fiscal Year 2021

Operator: Good day and welcome to the Fiesta Restaurant Group Second Quarter 2021 Earnings Conference Call. All participants will be in listen only mode. After today's presentation there will be an opportunity to ask questions. Please note today's event is being recorded. I'd now like to turn the conference over to Raphael Gross with ICR. Please go ahead sir.

Raphael Gross: Thank you, operator. Fiesta Restaurant Group’s second quarter 2021 earnings release was issued after the market closed today. If you have not already accessed it, it can be found on the company’s website, www.frgi.com, under the Investor Relations section. Before we begin, I’d like to inform you that during the call today, the company will make various statements that are not based on historical information. These forward-looking statements include, without limitation, statements regarding the company’s future financial position and results of operations, business strategy, budget, projected costs and plans, and objectives of management for future operations. Actual outcomes and results may differ materially unless is expressed or forecasted in such forward-looking statements, and the company can give no assurance that such forward-looking statements will prove to be correct. Important factors that could cause actual results to differ materially from those expressed or implied by the forward-looking statements can be found in the company’s SEC filings. Please note that during today’s conference call, certain non-GAAP financial measures will be discussed, which the company believes can be useful in evaluating its performance. Any discussion of such information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP and a reconciliation to comparable GAAP measures is available in the company’s earnings release. On the call with me today are President and Chief Executive Officer, Rich Stockinger; and Chief Financial Officer, Dirk Montgomery. And now, I’d like to turn the call over to Rich.

Rich Stockinger: Thank you, Rafe. I’d first like to thank all of the investors and other participants on the call today for their continued support. I’ll be covering two topics today a business update including an overview of second quarter results and an update on the status of our 2021 strategic priorities. Patty Lopez-Calleja, our Chief Experience Officer will provide a digital platform initiatives update, followed by Dirk wrapping up with the financial update. The most important event for the quarter was the announcement of the Taco divestiture on July 1st. Additional details regarding the transactions are referenced in our Form 8-K filed on July 7th. We made the strategic decision to sell Taco Cabana business to allow our leadership team to focus completely on accelerating Pollo growth. And we are very excited about the tremendous expansion opportunities we have for the Pollo Tropical business. We expect to close the divestiture transaction in the third quarter. Concurrent with the Taco Cabana divestiture, we are planning to use the sale proceeds to fully pay off our term loan balance. As a result, we will be a debt free after the transaction close and believe the cash balance as of the end of the second quarter of 2021 of $69.9 million will be materially unchanged subsequent to the close. Those funds will be used in part for focused investments to accelerate Pollo Tropical growth. I want to take a moment to thank the Taco Cabana team for their passion, effort and success as we position that brand for growth over the last four years. We wish you all the best of luck and we will miss all of you. Regarding second quarter results we were pleased with Pollo Tropical performance with comparable restaurant sales improving to very close to 2019 levels with very strong margin results. Beginning in April we began to experience hourly staffing challenges through the workforce availability that had an increasingly negative impact on sales through the remainder of the quarter. We have taken a number of steps to improve recruiting and retention of our hourly workforce and staffing levels improved slightly in July compared to the second quarter. Despite that the labor staffing challenges Pollo Tropical July comparable sales versus 2019 were slightly favorable compared to June comparable sales versus 2019 after adjusting for the July 4th holiday differences. We continued our strong margin performance in the second quarter with 2021 income from continuing operations of $2.7 million and income from continuing operations before income taxes of $1.8 million compared to a loss for both measures in the second quarter of 2020. Continuing operations adjusted EBITDA a non GAAP measure was $9.1 million or 10% of total revenues compared to $2.6 million and 4.2% of revenue in the second quarter of 2020. Pollo Tropical grew restaurant level adjusted EBITDA margin a non-GAAP measure from 16.3% in the second quarter of 2020 to 20.4% in the second quarter of 2021 In addition, our total cash balance continued to grow reaching $69.9 million at the end of the second quarter. Dirk will provide additional details regarding the second quarter results and our outlook for the remainder of 2021 as part of his prepared comments. On our first quarter earnings call we noted that we had begun to experience staffing availability issues and identified action plans we were taking to address those challenges, including raising the minimum hourly team member pay rate, providing special incentives for managers, and streamlining the recruiting process. Despite those efforts staff availability issues intensified in the second quarter and had an increasingly negative impact on sales throughout the quarter. In an effort to maintain service we implemented operation simplification measures and where necessary reduced operating hours, temporarily closed dining rooms and postponed delivery and online ordering to allow our teams to focus on drive-through and counter takeout sales. As a result, total operating hours for the quarter across all channels were approximately 4% lower than our normal operating hours, a significant reduction in open hours of operation compared to the first quarter of 2021 and the fourth quarter of 2020. Staffing levels have gradually improved each month from a low point in April but are still below optimal levels overall. We are implementing additional tactics to improve staffing levels which include the following. We are continuing the additional $1 per hour increase for the hourly operations personnel through August and are in the process of completing unit level benchmarking of wage rates by position to ensure our wage rates are competitive based on evolving market conditions. We are evaluating better tailoring our benefits platform to the unique needs of our employee base. We continue to challenge our recruiting resources and processes including the addition of additional resources dedicated to specific geographies that are currently experiencing greater issues as well as sign on bonuses for hourly and management new hires. To increase retention, we are also upgrading our new team member onboarding process. We believe that we can offset the cost impact of increased wage rates through selective price increases while still maintaining attractive value perceptions with our customers. This is based on internal research and research conducted by our outside pricing analytics consultants. Over the last three years, we believe that our brands have taken lower price increases than our peer group. In April, we increased prices by 3% at Pollo Tropical and plan to evaluate additional pricing actions as needed later this year in response to the cost pressures. COVID cases in state of Florida have been on the rise since late June which is a concern for both health safety and staff availability. As we have since the beginning of the pandemic, we will continue to put our team member and guests safety first and are following CDC guidelines to require all Pollo Tropical employees and entering our restaurants to wear masks regardless of vaccination status. Now I'd like to provide an update on our strategic priorities. As I mentioned in the fourth quarter, our strategic priorities are as follows. Concentrate on accelerating growth in non dine in channels and improving the guest experience across all channels to better enable our customers to enjoy our brands wherever and whenever they choose. Enhance our digital platform and make improvements in ease of use and speed of service for all premise including an enhanced digital drive through experience curbside geo fencing technology enhancements to improve speed and customization of the consumer experience and continued improvements in our loyalty platform that drive incremental sales from loyalty members. And three continue refining the Pollo Tropical brand essence in preparation for expansion in existing and new markets. We made good progress growing non dine in channels during the second quarter. At Pollo Tropical we generated second quarter 2021 drive thru growth of 18% compared to the second quarter of 2020 and delivering an online channel growth of at least 80% in those channels compared to the second quarter of 2020. We continued our ongoing brand positioning research in the second quarter which we believe will allow us to develop a more focused and effective strategy for our digital platform remodels and brand expansion. That work will continue in the remainder of 2021. Over the second quarter we continue to make investments to enhance our digital platform and improve the customer experience and those efforts will continue through the remainder of 2021. Patty will provide additional details on our digital platform plans and progress in a moment. Finally we made very good progress on our third strategic priority which is to continue refining the Pollo Tropical brand essence in preparation for expansion again in existing and new markets for both company owned and franchise locations. We are currently testing key restaurant design and operating platform improvements in remodels and we’ll continue to do so the remainder of 2021. Our first remodel was completed during the second quarter at the Western location and initial customer feedback on the new design has been very positive. Design enhancements reflect preliminary research results on brand image and also incorporate guest behavior learnings from COVID and include the following changes, updated color schemes, fewer dining room seats, optimized make lines to improve speed of service, and enhance mobile pickup capabilities. In summary, we are pleased with our sales and margin results for the quarter and believe that our sales run rate would have been at or above 2019 levels if not for the staffing issues we encounter. The Taco Cabana divestiture will allow us to create a more effective, efficient and focused organization, applying appropriate resources to accelerate delivery of the exciting growth potential we have in our Pollo Tropical brand. This will include our efforts to drive an upgraded customer experience across all service channels continuing to invest in expanding our growing digital platform and finalizing our new unit expansion target for 2022. Now Patty will provide a bit more color on our digital platform strategies and progress. Patty?

Patty Lopez-Calleja: Thanks, Rich. The goal of our digital transformation strategy is to provide our guests a convenient and frictionless omni-channel experience. As Rich mentioned in his comments, our digital strategy focuses on experience customization that we believe will drive growth across all channels. We continued to improve the Pollo Tropical current state drive to infrastructure during the second quarter upgrading all units to faster drive-thru payment processing devices that reduce estimated processing speed from 25 seconds to less than 5 seconds per transaction. We want to tech enabled traditional channels to make it easier for guests to interact with our brand, i.e., QR code which is a kiosk in hand, digital drive through experience, while adding new channels like the location services enabled curbside. Pilot testing for an enhanced curbside pickup, customer experience with location enabled geo-sensing technology aimed at improving speed of service and ease of use was conducted late in the first quarter. Due to staffing challenges, we suspended the system wide rollout to maintain service levels in other channels until staffing issues stabilized. Partnering once again with the experienced consultancy firm, Bottle Rocket, the design phase of our enhanced drive through digital platform is complete. We're very excited about the capabilities for improved order accuracy, speed of service, greater levels of personalized marketing and additional opportunities to showcase our unique brand attributes that this platform will enable. In addition to creating a stable and scalable environment, an increased order value, the minimal viable product or MVP targeted for the first phase of the digital drive through transformation will give us more insights into who our guests are and how they use this channel. We hope to begin a pilot this greatly enhanced drive through digital platform in select units later this year. We continue to iterate on what and how we communicate with our loyalty members through our app, leveraging insights to provide more personalized and relevant conversations. We see our mobile applications and the future drive through experience as the core components of our digital platform, which will allow for enhanced innovation going forward. Now Drik will provide the financial update and closing comments.

Dirk Montgomery: Thank you, Patty, and good afternoon, everyone. I'll start by reviewing our second quarter results, then provide you with an update on our outlook for the remainder of 2021. As a reminder, the COVID-19 pandemic began to have a significant impact on Pollo Tropical and Taco Cabana sales trends beginning in the week of March 16, 2020 and created some level of non-comparability of current year results with prior years. As a result, we will be providing commentary this year for many key measures comparing current year results to both 2020 and 2019. Based on the planned divestiture, Taco Cabana’s results excluding corporate overhead costs are presented as discontinued operations in our financial statements. The consolidated results I'll be reviewing today will be mostly focused on continuing operations and on the Pollo Tropical brand. Overall, we were pleased with our second quarter performance in terms of sales accelerating to just slightly below 2019 levels and strong margin performance. Total continuing operations revenues increased 43.7% to $91.2 million in the second quarter of 2021 from $63.4 million in the second quarter of 2020 driven by the comparable restaurant sales increase at Pollo Tropical. As we noted previously, our historic penetration of dine-in sales has been approximately 25% and we made very good progress offsetting the dine-in sales loss to the second quarter of 2021 with strong off-premise and drive-thru sales growth. Our second quarter same-store sales comp trend improved from the first quarter 2021 levels and Pollo Tropical comp trends improving to plus 43.5% for the second quarter compared to the second quarter of 2020 and minus 1.8% compared to the second quarter of 2019. Taco Cabana second quarter same-store comp sales were up 15.6% compared to the second quarter of 2020 and minus 6.7% compared to the second quarter of 2019. As Rich indicated, we believe staffing challenges had a negative impact on sales at both brands. Second quarter 2021 consolidated net loss was $0.1 million or $0.00 per diluted share and included $0.11 per diluted share of negative impact from discontinued operations. Second quarter 2021 income from continuing operations was $2.7 million or $0.11 per diluted share. This compares to a net loss in the second quarter of 2020 of $8.3 million or $0.33 per diluted share including a $0.22 per diluted share negative impact primarily from discontinued operations, impairment charges and closed restaurant rent charges. Second quarter 2020 now loss from continuing operations was $6.6 million or $0.26 per diluted share. On an adjusted basis, second quarter 2021 consolidated net income from continuing operations was $3.4 million or $0.13 per diluted share compared to an adjusted net loss of $3.1 million or $0.12 per diluted share in the second quarter of 2020. Please see the non-GAAP reconciliation table in our earnings release for more details. Continuing operations consolidated adjusted EBITDA a non-GAAP measure more than doubled versus last year to $9.1 million and 10% of revenue in 2021 compared to $2.6 million in 2020 and 4.2% of revenue. Now turning to our individual brands. At Pollo Tropical, second quarter comparable restaurant sales increased 43.5%. The second quarter improvement resulted from a 29.2% increase in comparable restaurant transactions and a 14.3% increase in the net impact of product, channel mix and pricing. The increase in product channel mix and pricing versus 2020 was driven primarily by increases in delivery and drive thru check average and sales channel penetration and menu price increases of 4%. Regarding sales trends by channel, Pollo Tropical dine-in and counter takeout comparable restaurant sales increased to 117% in the second quarter of 2020 to the second quarter of 2021, due primarily to the negative impact in 2021 from COVID. All sales channels experienced sales growth compared to the second quarter of 2020 and growth compared to the first quarter of 2021. During the second quarter of 2021 Pollo generated counter sales growth of 7.2% drive thru growth of 0.6% and delivering online channel growth of 2.9% in those channels compared to the first quarter of 2021. In addition Pollo Tropical second quarter 2021 delivery sales penetration continued to exceed 10% of total sales. Dine in sales penetration in the second quarter of 2021 increased from the first quarter of 2021 to 6% in sales. But it's still below the 2019 penetration levels. We believe staffing challenges resulted in a partial in resulting in partial closures of dining rooms and other channels had a negative impact on sales in the second quarter. As Rich mentioned we are taking actions to improve staffing levels. Turning to the brand profitability for the second quarter Pollo restaurant level adjusted EBITDA margin a non GAAP measure continued to be strong with second quarter restaurant level adjusted EBITDA margins of 20.4% in 2021 compared to 16.3% in 2020 and 23.1% in 2019. As a percentage of restaurant sales Pollo Tropical experienced lower second quarter 2021 costs of sales of 30.4% compared to 32.1% in 2020 due to lower promotions and discounts and price increases partially offset by operating inefficiencies. Restaurant wages as a percentage of net sales increased from 23.9% in the second quarter of 2020 to 24.1% in 2021 driven primarily by higher labor costs due to higher wage rates and overtime due in part to labor shortages, as well as higher incentive bonus partially offset by the impact of higher restaurant sales on other labor costs and lower medical costs. Other restaurant operating expenses as a percentage of sales decreased in the second quarter compared to 2020 due primarily to the impact of higher restaurant sales on utilities and sanitation costs and lower insurance costs partially offset by higher repairs and maintenance costs. Rent in the second quarter increased compared to 2020 due primarily to the impact of sale leaseback transactions and lease renewals at higher rates. At Taco Cabana, second quarter 2021 comparable restaurant sales increased 15.6% versus 2020. The increase in comparable restaurant sales resulted from a 13% increase in comparable restaurant transactions and a 2.6% increase in the net impact of product channel mix and pricing. The increase in product channel mix and pricing was driven primarily by menu price increases of 4.3%. Turning to the brand, second quarter profitability Taco Cabana continued to improve margins and dollar profits in the second quarter compared to the second quarter of 2020. Taco restaurant level adjusted EBITDA margins a non-GAAP measure grew from 12.6% in 2020 to 12.8% in 2021 including the negative impact of Winter Storm Uri related cleanup expenses for repairs and landscaping removal of $0.9 million. The estimated negative impact of the cleanup expenses on Taco Cabana second quarter 2021 adjusted EBITDA margins was minus 140 basis points. Turning now to cash flow related comments. In the second quarter, our cash balance grew from the first quarter balance of $58.8 million to $65.8 million at the end of the second quarter. Net debt on non-GAAP financial measure decreased from $13.5 million at the end of the first quarter to $6.6 million at the end of the second quarter. During the second quarter, we sold one property of a previously closed location for proceeds of $1.3 million. As you may recall, last year we had 16 owned properties that we marketed for outright sale or sale leaseback transactions. Through the end of the second quarter of 2021, we sold all 16 of the properties for gross proceeds in excess of $30 million. Total capital expenditures for the second quarter of 2021 were $6 million, which included $3.2 million for maintenance and $0.4 million for remodeling. For Pollo Tropical, $1.3 million for maintenance and $0.1 million for remodeling and for Taco Cabana $0.9 million for technology and corporate development related expenses. One additional cash benefit we expect over the second half of 2021 or early 2022 is the insurance claim proceeds from the costs associated with Winter Storm Uri. Our claim has been filed and we are awaiting a response from our insurers. Following the close of the Taco divestiture, we expect to have ample cash to fund investments in growth. In addition, our board of directors will be evaluating strategies for increasing shareholder value including potential future stock repurchases. I'll close with a few comments on our outlook for the remainder of 2021. We've made progress on addressing staff availability challenges and we believe we will continue to make improvements addressing those challenges over the remainder of the year, which we believe should have a positive impact on sales trends. Margins will be pressured in the second half of the year due primarily to increasing labor costs. However, we believe that over time we will be able to offset those cost increases with pricing action based on the internal analysis and input from pricing analytic consultants. We are evaluating taking additional pricing action in the second half of the year and believe that we can make those moves and still maintain value perceptions due to a relatively low level of pricing action over the last few years. Commodity food costs are expected to remain roughly stable for the remainder of 2021 based on current supply commitments we have in place for calendar 2021 across key commodities. Regarding G&A, the Taco divestiture will allow us to create a more effective efficient and focused organization and we are working on plans to improve efficiency following the close of the transaction. Finally full year 2021 capital expenditures are expected to be in the range of $25 million to $30 million including approximately $4 million related to Taco Cabana. In closing we believe top line momentum will continue to accelerate the remainder of the year driven by our revenue building strategies and off premise channels investments in our digital platform and improve staffing levels. Our team is now fully focused on the exciting growth opportunities we have at Pollo Tropical. Thank you for listening and we will now open the call up for questions. Operator?

Operator: Thank you. We will now begin the question-and-answer session. Today's first question comes from James Rutherford at Stephens Inc. Please go ahead.

James Rutherford: Rich, you noted that you're going to have a nice war chest of cash even after retiring your debt with a Taco sale is complete and that you plan to use that to accelerate Pollo growth. I wanted to follow up on that and ask is that more a reference into investments to drive same store sales like remodels or digital or is this more in reference to unit growth expansion next year or maybe a combination of both?

Rich Stockinger: It's a combination of both. We know we have to do some remodels as every organization does. But we're going to concentrate a large part of that on two things; A growth but also maximizing the channels. And what we can do as it relates to the digital platform of increasing the same-store sales by using that money wisely to help the guests through these other channels besides dining.

James Rutherford: Okay. And then Dirk on the margins. It's nice to see that you're hanging in there 20.4% margin in the second quarter. If I compare that to a couple of years ago 2Q of 2019. The margin is down about 270 basis points. It appears that most of the gap in the variance there is in other restaurant operating expenses. And I would assume a lot of that's from the higher delivery mix. Just kind of correct me if I'm wrong on that, but if that's right. Can you just walk us through and remind us what the margin differential is there and how you might be able to improve the margins on delivery sales over time?

Dirk Montgomery: Sure. So you are correct that the other OpEx increase is driven primarily by delivery commission expenses. In terms of margin run rates on our delivery business, we do look at variable profit margins on that business and we actually do generate a profit. We are evaluating additional price increases with in the DSP channel above and beyond the price increases that we have taken for all the rest of our channels as a way for us to improve margins in that channel. And based on the research that we've done we believe that there is a relatively low sensitivity in that channel to price increases. So we're evaluating that along with the other price changes that Rich mentioned for the back half of the year. So we're evaluating that along with the other price changes that Rich mentioned for the back half of the year.

James Rutherford: Got it. That's helpful. You wouldn't be the first clearly to look at higher delivery prices through that channel given the kind of premium nature of that. And on the labor line toward the end of your prepared remarks you were talking about some margin degradation from ongoing labor pressures in the back half of the year maybe before some of that potential price increase comes into play. Just so we're on the same page. Could you maybe help frame the magnitude of that impact and where you expect restaurant margins to go over the next couple of quarters to the extent that you kind of are able to do that?

Dirk Montgomery: Well it's the two moving pieces that we have right now that actually we have not really fully resolved are number one, the cost input pressure from labor. So as Rich said, we took we took wages up by $1 in the second quarter and that's going to continue through August. And we're benchmarking our wage rates against the competitive set to really determine what – whether that's enough whether we need to do more in the future so that's kind of still work process. But I think we feel relatively comfortable that we're probably going to need to maintain the extra dollar that we added through August. The second piece to that to that question is really pricing. And what we haven't finalized yet is what pricing action we might take in the second half of the year. But in general we feel like the pricing action that we believe that we can take can offset the cost increases that we anticipate from labor costs.

Rich Stockinger: And James it's Rich, the other thing that’s going to impact margin again we have been hurt by the staffing by reducing the operating hours, by shutting off online ordering and the DSPs throughout the second quarter and even as we speak right now. With the staffing with the increase wages and the increase of retention and the increased recoupment efforts that we're making we believe that we're going to be able to bring more people on board or back. That should increase the sales which of course is margins and transactions once in mind is the curbside. We've spent the money. We've got state of the art curbside system, but we can't turn it on because we don't have the staffing.

James Rutherford: Got it. That's very helpful. I'll turn it back to the queue. Thanks.

Operator: Ladies and gentlemen, there are no further questions. So this concludes today's question-and-answer session and today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.