El Pollo Loco Holdings, Inc. (NASDAQ:LOCO) Q3 2023 Earnings Call Transcript

El Pollo Loco Holdings, Inc. (NASDAQ:LOCO) Q3 2023 Earnings Call Transcript November 2, 2023

El Pollo Loco Holdings, Inc. beats earnings expectations. Reported EPS is $0.19, expectations were $0.18.

Operator: Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco Third Quarter 2023 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode and the line will be open for your questions following the presentation. Please note that this conference is being recorded today, November 2, 2023. And now I would like to turn the conference over to Ira Fils, the company's Chief Financial Officer. Please go ahead.

Ira Fils: Thank you, operator, and good afternoon. By now, everyone should have access to our third quarter 2023 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 discussions today will include forward-looking statements, including statements related to our growth opportunities, strategic and operational initiatives, expectations regarding sales and margins, potential changes to our product platforms, capital expenditure plans, expectations regarding kiosk rollouts, the ability of our franchisees to drive growth, expectations regarding commodity and wage inflation, remodel and expansion plans and our 2023 guidance, among others.

A busy restaurant kitchen with a chef carefully plating a meal.

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 currently expect. We refer you to our recent SEC filings, including our Form 10-K 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 third quarter of 2023 tomorrow, and we would 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, which is available in the Investor Relations section of our website.

With respect to the restaurant contribution margin outlook, we will be providing on today's call, please note that we have not provided a reconciliation to the most directly comparable forward-looking GAAP financial measure because without unreasonable efforts, we are unable to predict with reasonable certainty the amount of or timing of non-GAAP adjustments that are used to calculate income from operations and company-operated restaurant revenue on a forward-looking basis. Now I would like to turn it over to Bill Floyd, our Chairman of the Board.

Bill Floyd: Thank you, Ira. As we position the company for growth going into the new year, the Board of Directors has been assessing the best way to support the execution and acceleration of El Pollo Loco's long-term strategy. In doing so, the Board has named Maria Hollandsworth, our Chief Operating Officer, to the additional role of Interim Chief Executive Officer, replacing Larry Roberts. This change will be effective at the end of the day tomorrow. In light of Maria's new incoming role, she is joining us on today's call, and I'm pleased you'll be able to hear from her directly on our strategic initiatives. Larry was an important part of our El Pollo Loco's history as a public company thus far from serving as our CFO during our initial public offering in 2014 to leading the company as our CEO for the past 2 years.

On behalf of the Board, I want to thank Larry for his valuable leadership and contributions to the company over the past 10 years. Now let me be abundantly clear for everyone on this call. It is the Board's belief that El Pollo Loco has a tremendous opportunity to create value for all its stakeholders. In order to capitalize on this opportunity, we believe the company should remain focused on what makes us unique, our flame-grilled chicken, while continuing to improve our profitability through the implementation of technology, such as kiosks and our ongoing process optimization efforts. Finally, we will accelerate unit growth, expanding into new markets to realize the immense potential of the El Pollo Loco brand. The Board firmly believes in our strategic direction, and we are excited to accelerate the pace in which we will achieve it.

The Board has engaged a nationally recognized executive search firm to help identify our next CEO to lead the company forward. The Board will consider both internal and external candidates to ensure we find the right person with the necessary skills and experience to ensure that we capitalize on our opportunity. As I mentioned earlier, to help ensure a smooth transition, our current COO, Maria Hollandsworth, will assume the additional role of Interim President and CEO until a new CEO is identified. Maria has been in the restaurant industry for approximately 30 years with extensive experience driving operations for multiple franchised quick-service brands. Maria understands our customers, our franchisees and our people, making her well-suited to step into this role.

Maria will be supported by the rest of our world-class leadership team and our engaged and experienced Board of Directors. I look forward to working more closely with Maria to capture the immense opportunity ahead of us. With that, I turn it over to our incoming Interim President and CEO, Maria Hollandsworth. Maria?

Maria Hollandsworth: Thanks, Bill. I'm pleased to be named Interim President and CEO of El Pollo Loco and look forward to working closely with the Board and our senior leadership team to continue to drive our strong brand forward. Before I turn the call over to Ira to go over the financials, let me first update you on our revenue growth initiatives, including our refocus on chicken and the rollout of catering, our profitability improvement initiatives driven by the implementation of new technology and provide an update on our development strategy, including our recent refranchising transactions. The opportunity for this brand is simple, to make El Pollo Loco an operational powerhouse, where our customers fall in love with our one-of-a-kind flame-grilled chicken.

To get there, we will continue to implement processes and technologies to ensure our product is consistent and available across our system in every restaurant every day. Our chicken is known for being flame grilled, but our marination is truly special and delivers the flavor that our customers crave. I have implemented a semiannual marination calibration to ensure our customers get the same great tasting chicken, no matter what location they visit, day or night. We're also currently in test with enhanced holding equipment, which we expect to complete by mid-February, and we'll provide an update on the next earnings call. With this equipment, we are hoping to improve both availability, especially in shoulder periods, as well as consistency of both temperature and taste.

Additionally, in late September, we rolled out our revamped catering program. We believe that catering has the opportunity to be up to 5% of our sales relative to approximately 1% today. And this revamp is the first step in addressing the significant opportunity ahead of us. Our revamp program includes a new catering menu that provides more options for our customers with a broader offering beyond our chicken on the bone. While it is still early, we're happy with the traction we've seen thus far and remain excited about our opportunity to do even more. We also have a significant opportunity to improve our profitability through process and technology enhancements. The restaurant industry faces new challenges daily. And given our geographic mix, especially for our company-owned restaurants, we need to grow sales, leverage technologies better, to become more efficient and to help offset some expected incremental costs we anticipate from upcoming legislation changes.

More importantly, these initiatives will help ensure the El Pollo Loco experience is consistent across our entire system. In recent weeks, we have expanded our kiosk test to approximately 20 company-owned restaurants in addition to several franchise restaurants. To date, our test results have been very encouraging, resulting in reduced restaurant-level labor hours per day. Additionally, the adoption by consumers has been terrific and more seamless than we originally envisioned. We are excited to announce that we will be rolling out kiosk store system as quickly as possible. That said, our current gating factor is the procurement of the associated cash machine. We will update you on our progress next quarter. We are also rolling out new salsa processing equipment, which will drive consistency of our products while also driving labor efficiency as the new equipment is both easier to use and easier to clean.

We expect to complete the rollout of this new equipment to company restaurants by mid-2024, with franchisees complete by end of 2024. In addition, we are simplifying our salsa lineup by introducing our salsa fresca offering and reducing our salsa count from 2 to 1. We also continue to test additional initiatives such as automated dishwasher, among others. To summarize, new and innovative technologies and equipment provide us with substantial opportunity to become more efficient in the coming quarters and year. Finally, let me touch on our development strategy. Subsequent to the end of the quarter, we opened our second restaurant in Denver with our second franchisee in the market. We are pleased to report that both of our Denver restaurants are performing very well, highlighting the strength of the brand and the success that it is possible as we expand in new markets.

We also refranchised 17 company-operated restaurants to current franchise partners, including 9 restaurants in Houston, Texas, 7 restaurants in California and 1 restaurant in Utah. While this does not represent a change in our strategy, we're pleased to be able to opportunistically transfer these units into the hands of our strong franchise partners who will leverage their local market knowledge to further drive the growth of El Pollo Loco in each market. Our franchisees' excitement to acquire these restaurants showcases our franchise partners' belief in the significant opportunity ahead for the El Pollo Loco brand. In closing, I want to thank Bill and the Board of Directors for entrusting me to lead this unique brand, the El Pollo Loco team members for showing up every day and being what makes this company truly special.

I also would like to thank the investment community for your continued interest and support of El Pollo Loco. With that, let me turn the call over to Ira for a more detailed discussion of our third quarter financial results.

Ira Fils: Thank you, Maria, and good afternoon, everyone. For the third quarter ended September 27, 2023, total revenue increased 0.4% to $120.4 million compared to $119.9 million in the third quarter of 2022. Company-operated restaurant revenue decreased 0.5% to $102.7 million from $103.2 million in the same period last year. The decrease in company-operated restaurant sales was primarily driven by a $1.6 million decrease in revenue from the refranchising of 4 company-operated restaurants to existing franchisees in prior quarters as well as a $200,000 decrease in revenue recognized for our loyalty points program. This was partially offset by additional sales from restaurants opened during or subsequent to the third quarter of 2022 as well as 0.3% increase in company-operated comparable restaurant sales.

The increase in company-operated comparable restaurant sales included a 1.3% increase in average check size, offset by a 0.9% decrease in transactions. During the third quarter, our effective price increase versus 2022 was a little over 7%. Looking ahead, fourth quarter to date through October 25, system-wide comparable store sales increased 3.2%, consisting of a 2.1% increase in company-operated restaurants and a 3.9% increase in franchise restaurants. Franchise revenue increased 7.5% to $10.3 million during the third quarter, driven by a 1.1% increase in franchise comparable restaurant sales as well as 7 new franchise restaurant openings in prior quarters and the 4 refranchise restaurants I've just mentioned earlier. Turning to expenses. Food and paper costs as a percentage of company restaurant sales decreased 240 basis points year-over-year to 26.8% due to higher menu prices and lower commodity costs.

During the quarter, we experienced commodity deflation of approximately 2%. We expect commodity inflation to be approximately 1% for the full year 2023. Labor and related expenses as a percentage of company restaurant sales held steady year-over-year at 32.2%. Higher menu pricing and improved labor management was offset by wage rate increases and higher workers' compensation expense. Wage inflation during the third quarter was a little over 3%, and we continue to expect wage inflation of about 4% for the full year 2023. Occupancy and other operating expenses as a percentage of company restaurant sales increased 50 basis points year-over-year to 26.6%, primarily due to higher rent, insurance costs and utilities expense. Our restaurant contribution margin for the third quarter was 14.4% compared to 12.4% in the year ago period.

For the full year 2023, based on what we've experienced thus far, we now expect our restaurant contribution margin to be in the 15% to 16% range. General and administrative expenses decreased 60 basis points year-over-year to 7.6% of total revenue. The decrease for the quarter was primarily due to a decrease in estimated management bonus expense, partially offset by higher legal-related costs. As Maria mentioned earlier, towards the end of the third quarter, we completed the sale of 17 company-operated restaurants within California, Utah and Texas, to existing franchisees that resulted in cash proceeds of $7.5 million and a net gain on sale of $4.9 million. During the third quarter, we recorded a provision for income taxes of $3 million for an effective tax rate of 24.4%.

This compares to a provision for income taxes of $1.8 million and an effective tax rate of 26.2% in the prior year period. We reported GAAP net income of $9.2 million or $0.28 per diluted share in the third quarter compared to GAAP net income of $5 million or $0.14 per diluted share in the prior year period. Adjusted net income for the quarter was $6.4 million or $0.19 per diluted share compared to adjusted net income of $5 million or $0.14 per diluted share in the third quarter of last year. Please refer to our earnings release for a reconciliation of non-GAAP measures. Turning to unit development. Subsequent to the end of the third quarter, we opened 1 company-operated restaurant in Las Vegas and the one franchise restaurant in Denver with our second franchisee that Maria mentioned earlier.

In addition, we now expect to complete remodels for 14 to 15 company-owned restaurants and 28 to 32 franchise restaurants. Turning to liquidity. As of September 27, 2023, we had $80 million of debt outstanding and $13.8 million in cash and cash equivalents. After the end of the quarter, the company paid down $9 million on the revolver. And as of November 2, 2023, there was $71 million of debt outstanding. On August 7, we entered into a stock repurchase agreement with FS Equity Partners and FS Affiliates to repurchase an aggregate of 2.5 million shares of company stock at a price equal to the market closing price on August 7 of $10.63 per share for a total purchase price of $26.6 million. Separately, we also repurchased 206,000 shares during the third quarter for a total approximate $1.9 million, which completed our 2022 stock repurchase plan.

During the first 3 quarters of 2023, the company has repurchased a total of 46.6 million in shares. On October 31, 2023, our Board of Directors approved a new share repurchase program with authorization to purchase up to $20 million of common stock through March 28, 2025. Finally, based on our results to date, we would like to provide the following update to our 2023 guidance. The opening of 2 company-owned restaurants and 3 to 4 franchise restaurants; capital spending of $22 million to $24 million, G&A between $41 million and $43 million; and adjusted income tax rate of 26.5% to 27.5%. This concludes our prepared remarks. We'd like to thank you again for joining us on the call today, and we are now happy to answer any questions that you may have.

Operator, please open the line for questions.

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