3 Critical Takeaways From the Zoe's Kitchen Q1 Earnings Report

By Andy Gould Markets Fool.com

Heading into Zoe's Kitchen's (NYSE: ZOES) first-quarter earnings report, investors were hoping that the the Mediterranean fast-casual restaurant chain had learned its lesson about setting expectations too high after reducing guidance on two separate occasions in 2016.

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Instead, the company suffered its worst quarter of comparable-restaurant sales as a public company and was forced to drastically reduce its forward guidance once again, sending shares plummeting as the market reevaluates Zoe's growth prospects.

Data by YCharts.

No way to spin it -- comps were downright awful

Zoe's comparable-restaurant sales began to look shaky in the second half of 2016, dropping from a steady, multi-year range of 4%-plus down to 2.4% in the third quarter and just 0.7% in the fourth. This phenomenon wasn't unique to Zoe's, as the "restaurant recession" saw several chains struggle with low customer traffic. The one silver lining was that comps were still in positive territory, and Zoe's was guiding for 1% to 2% comps growth in 2017.

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However, for the first quarter, the metric actuallydecreased 3.3%, the weakest quarter since its IPO. This was fueled by a 4.6% decrease in traffic and partially offset by a 1.3% price increase. Even compared to restaurant industry averages -- comps declines of 1.6% and traffic declines of 3.6% -- Zoe's results are worrisome, bringing into question how well its Mediterranean concept is resonating with consumers in a sea of proliferating fast-casual choices.

Image source: Zoe's Kitchen.

CEO Kevin Miles said similar traffic trends have extended so far into the second quarter, causing the company to once again lower its guidance for the third time in four quarters. Zoe's now expects full-year comparable-restaurant sales to come in between flat and down 3%. That's a pretty severe drop from previous guidance of 1% to 2% growth, and the rather wide range seems to reinforce that management doesn't have a great handle on how the rest of the year is going to unfold. To be fair, it might also indicate that management is determined not to under-deliver again and is simply setting the bar extremely low.

Margins are headed lower, too

Zoe's posted healthy restaurant-level profit margins in 2016 of 20%. But those margins are coming under pressure as Zoe's continues to aggressively open new stores that, on average, ring up lower average sales and are less efficient during their first couple years of operation.

In the first quarter, restaurant-level margin decreased 210 basis points to 19.9%, driven mostly by higher labor and store-level operating costs, particularly at newer restaurants.

Forecasting lower profitability for the rest of 2017, the company also lowered its guidance for full-year restaurant-level margin to between 18.3% and 19%, down from a range of 19% to 19.3%. Given that Zoe's also lowered comps and overall revenue guidance, this is hardly surprising, but it's it's another sign that Zoe's is suffering from the wrong kind of momentum.

Full speed ahead with expansion ... for now

From 2014 to 2016, Zoe's doubled its store count to more than 200 restaurants. Long-term plans include reaching the 400-store mark by the end of 2020, with an eventual goal of 1,600 units.

Zoe's opened 10 new restaurants in the first quarter. Asked whether the company will slow its expansion plans if comps continue to decline, management reaffirmed its full-year 2017 guidance for 38 to 40 new openings, which represents about 19% annual store growth. While Zoe's trudges through this period of weak comps, this level of expansion will help compensate by providing a steady lift to the top line.

But that's cold comfort for investors now questioning whether Zoe's longer-term growth plans are realistic given the last several quarters of disappointing comps. Management unveiled a few initiatives designed to boost revenue last quarter, including new menu items, more targeted marketing, and a strong push into delivery service. And this quarter, Zoe's announced additional technology investments designed to improve its online ordering and mobile app experiences.

While these efforts may pay off in the long run, for the moment, the company doesn't seem to have any quick answers for how to reverse its worsening traffic trends.

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Andy Gould owns shares of Zoe's Kitchen. Andy Gould has the following options: short January 2018 $30 puts on Zoe's Kitchen and long January 2018 $30 calls on Zoe's Kitchen. The Motley Fool owns shares of and recommends Zoe's Kitchen. The Motley Fool has a disclosure policy.