Q3 2023 El Pollo Loco Holdings Inc Earnings Call
Participants
Ira M. Fils; CFO; El Pollo Loco Holdings, Inc.
Maria Hollandsworth; COO; El Pollo Loco Holdings, Inc.
William R. Floyd; Independent Chairman; El Pollo Loco Holdings, Inc.
Jake Rowland Bartlett; VP; Truist Securities, Inc., Research Division
Zachary James Riddle; Research Analyst; William Blair & Company L.L.C., Research Division
Presentation
Operator
Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco Third Quarter 2023 Earnings Conference Call. (Operator Instructions) 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 M. 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. 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.
William R. 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 M. 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.
Question and Answer Session
Operator
(Operator Instructions) Our first question comes from Jake Bartlett with Truth Securities.
Jake Rowland Bartlett
Great. I appreciate it. My first one is big picture. And Bill, I'm not sure if you can answer part of this and Maria, obviously. The question is, what do you think needs to change? You talked about kind of really your strategic focus going forward versus what we've seen over the last year or 2, what do you think is going to be the most different over the next coming year or 2?
William R. Floyd
Well, let me respond to that, and Maria can certainly jump in on it. One of the things in my prepared remarks was the word acceleration. And we have been a company for quite a while that has been essentially a regionally-based company primarily in Southern California. And that is a strong area for us and will continue to be. But the Board strategically is looking at really growth and becoming a national brand. We think there is a huge unlock potential with El Pollo Loco, and we intend to grow, accelerate our growth, as I said. And that is really, I guess, if you want to call it a change, we are just looking at how do we take this brand, whether it's in where we currently reside or in other new markets, how do we accelerate our growth. We think there's just a great untapped opportunity that we intend to take advantage of.
Maria Hollandsworth
Jake, thanks for the question. We have great food and people love it. We appeal to everyone from families and adults and kids, and we have a business model that makes sense. What we do need to do is continue to develop our relationships with our newer franchisees in addition to the existing ones and also cultivate those relationships. We want to make sure we have a strong infrastructure behind our franchise growth story. But what I'm really excited about growth is I have experience in my past life on this. So I'm really looking forward to that opportunity of really driving our growth to become a national brand.
Jake Rowland Bartlett
Got it. No, that all makes sense. And I think the last quarter, the update was, I think you had 51 development commitments. Your stores in newer markets had been doing well or doing fairly well and you're getting interest from new franchisees. What do you think the kind of the 1 or 2 factors that have held back that growth that you think you can fix? And I've been around -- a lot of us have been around the story since 2014 when you were trying to kind of expand nationally and that was the goal then. Certainly, a lot has changed and you've made a lot of improvements. But what do you think at this point is holding you back? What are the kind of the 1 or 2 things that you think you need to change or improve to really start to ignite the growth that you're hoping for?
William R. Floyd
Well, I think there are a couple of things, rather than thinking about holding us back, it's what are we going to do to grow. And frankly, one of the key components of our strategy, we have -- as Maria said, we have a great franchise base, and we intend to -- acceleration, if you will, is a commitment of resources to grow in the franchise area. We perhaps had not committed as much in that area in the past, and that's changing. And we are going to also be exploring additional marketing resources to grow that business. And again, we are going to be -- first of all, we have to have a good story for new franchisees, what is the why. And as I said to you, we have a unique product that is very different than any other chicken concept. And we may have not told that story as effectively in the past as we have. As you may be aware, we just hired a new Chief Marketing Officer, and I happen to think we've got a team in place today, that is going to allow us to fulfill what we're looking at. So those are the changes that I'm certainly thinking about from a Board perspective. Maria?
Maria Hollandsworth
Yes. I totally agree with you, Bill. Like I said earlier, Jake, we are building that infrastructure that will support our franchise growth.
Jake Rowland Bartlett
Great. Great. And then I just had a near-term question, then I'll pass it on. But the near-term question is the acceleration that you saw in October, certainly encouraging to see. You didn't explicitly state that the cadence of the third quarter, but it looks like you decelerated pretty materially from the initial -- from what you're doing in July. So what do you attribute the improvement to in October? And was -- were the monthly comps in the third quarter may be impacted by weather? I know you had a hurricane amazingly. What are the factors that have driven the trajectory of the business over the last few months?
Ira M. Fils
Yes, I think you're absolutely right. We did see a deceleration as we move through the quarter. And I don't want to lean too hard on the hurricane. It did impact us. But it was only -- I don't want to say it was about 20 basis points for the quarter. That wasn't really what drove the results. I think we got -- as we moved into September, we got into the end of the promotion that we were on. We were on -- we were finishing out the stuffed quesadillas, which as we worked our way through -- or we started out with stuffed quesadillas in October, that's what. We were finishing out the chopped salads as we finished. So we were at the end of a promotion in September versus last year, we had started a new promotion. So it was a little bit of a promotion timing mismatch as we saw September fall off.
And then as we moved into October, we saw a little bit of the opposite. We saw the stuffed quesadilla promotion came on new, and that really helped accelerate comps in October from what we had seen towards the end of Q3. And so we're really excited about that, obviously. And as we move forth, though, into the balance of the year, I just kind of want to remind everybody, so we will have about 2.5% price falling off in November. So we will see that 3%, obviously, moderate a little bit as we move through the balance of the quarter. And we rolled up -- we're rolling over in the back half of this quarter, a very strong end of the year last year.
Jake Rowland Bartlett
Great. I appreciate it. I'll pass it on and maybe jump back in.
Operator
(Operator Instructions) Our next question comes from Sharon Zackfia with William Blair.
Zachary James Riddle
This is Zach Riddle on for Sharon Zackfia. I guess first question that I have is on the kiosks. I know you said rolling out as quickly as possible, and it sounds like the cash machines are kind of what's holding back kind of a faster rollout. I guess, could you guys provide a little bit more details on, I guess, what that looks like, what as quickly as possible looks like? And then also, would you be able to quantify kind of the labor savings that you're seeing with the kiosks versus the restaurant without one?
Ira M. Fils
So I think -- so a lot of it -- you said it exactly right. It's getting the equipment for the cash machine. We're going to start -- first of all, we're very happy, obviously, with our progress with the kiosk so far. The guests, we've seen a lot -- some very good acceptance from the guests. And we have been able to reduce labor in the restaurants, and we're getting a slight increase in check as well. So in all cases, the kiosk has been very beneficial to us. So we'll start -- as we've been ordering equipment, we'll kind of start the rollout, the accelerated pace of the rollout in January, and we should finish it sometime midyear-ish depending upon how soon we get the equipment and how -- when we actually can get this into the restaurants.
Zachary James Riddle
Great. And I guess if I could just add one follow-up. On the catering program, is there anywhere that you're specifically kind of seeing traction in any type of event or gathering that you're seeing good traction with the catering program?
Maria Hollandsworth
So it's really more across the board. We see them whether in like businesses or box, like Home Depots or Auto Parks. However, we do have a great example where we had one franchisee get an order for 17,500 people. And she realized that would be a challenge to reach out to 2 other franchise organizations. And in the end, those orders were fulfilled by 35 restaurants. And the power of catering, the power of building relationships with our clients, that's what it is. That's what it's all about. And because they know we can deliver, these clients come back and keep ordering from us. And that's our goal, is to continue to build those relationships. That's the kind of traction we're seeing out that. We're very encouraged.
Zachary James Riddle
Great. I'll jump back in the queue.
Operator
Ladies and gentlemen, we have reached the end of today's question-and-answer session. I would now like to turn the call back over to management for closing remarks.
Maria Hollandsworth
Thank you, everyone, for joining us today. We appreciate you making time. I also want to thank the entire El Pollo Loco family for their continued support and focus on our strategy. Have a great rest of the day.
Operator
Thanks for your participation. You may disconnect your lines at this time.
