El Pollo Loco Holdings, Inc. (NASDAQ:LOCO) Q1 2023 Earnings Call Transcript May 7, 2023

Operator: Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco First Quarter 2023 Earnings Conference Call. Please note that this conference call is being recorded today, May 4, 2023. And now I would like to turn the conference over to your host, 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 first 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 strategic pillars and strategic initiatives, our operational plans, marketing and new product initiatives, cash flow expectations, capital expenditure plans, remodel plans, expected new store openings and franchise partnerships 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 formal 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 2023 tomorrow and 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 non-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 our President and CEO, Larry Roberts.

Larry Roberts: Thanks, Ira, and good afternoon, everyone. We are encouraged by the start to 2023 as we achieved positive system comparable restaurant sales growth of 0.8% during the first quarter despite unprecedented California weather, which we believe impacted comparable restaurant sales by 2 to 4 percentage points and lapping last year’s highly successful Beef Birria promotion. The increase included a 3.8% increase at company-owned and a 1% decrease at franchise restaurants. Our focus on restaurant-level operating controls was instrumental in driving a year-over-year 470 basis point improvement in restaurant level margins to 15%, which enabled us to deliver adjusted earnings per share of $0.14. This was achieved while customer service metrics continued to reach new highs.

On the development front, we recently signed 3 franchise development agreements for an incremental 26 new restaurants in 3 new markets, which are Northern Colorado, New Mexico and El Paso, Texas. In addition, the franchise restaurant opened last November in the Denver area continues to perform very well with sales averaging over $70,000 per week, which highlights the success we can have as we expand into new markets. One further note is that in April, we implemented a reorganization of our support center to reduce G&A spend and reallocate resources to operation services and marketing. We believe that this reorganization will result in continued improvement of restaurant operations and better execution of our brand strategies, both of which will build sales over the long term.

Let me now talk about the progress we’ve made against several of our key strategic pillars. As mentioned on our last earnings call, earlier this year, we hired a new creative agency, Organic to help us build awareness and drive our brand differentiation, which we call own . As part of the marketing strategy, we are bringing a new look and energy to our advertising across all media channels. We believe that this approach will resonate with both moms and families while also attracting younger consumers. Our new approach debuted with the double chicken tostada limited time offer that began in late February and featured both beef and chicken options. Despite being our third consecutive year promoting this product, tostada sales achieved a record high mix of over 19% during the promotion.

Post promotion, tostada continued to mix at around 15% of sales, which is up from 13.5% pre-promotion and represents our highest selling non-chicken on-the-bone menu item. To add some additional context to the success of Tostada, just 2 years ago, they represented 8.5% of our sales mix. By consistently promoting a very differentiated product, we’ve nearly doubled their sales mix in just 2 years. In late April, we brought back shredded beef Birria as a limited time offer for the second year running. Similar to last year, our guests can experience this menu item in a variety of entrees, including crunchy tacos, grilled Burritos and overstuffed quesadilla which can be dipped into a Mexican-inspired consummate. While it will be difficult to match last year’s record performance, we believe that beef Birria will drive frequency and attract new customers to El pollo loco while also providing additional feedback as we assess beef as a permanent menu item.

As part of our brand evolution, we continue to evaluate our menu approach with a menu board test that is currently in process. Through the menu board test, we are looking to achieve 2 things: first, make it easier for consumers to understand and navigate our menu; and second, identify new menu IMs and platforms that will resonate with consumers and build sales over the long term. Many items we are testing include new add-on snacks, stuff quesadilla, hardshell tacos, beef and new beverages. Depending on the test results, we expect to roll out a revised menu and menu board in the fall. In addition to the menu board test, we’ve developed several catering concepts that we will be screening with consumers with the goal of launching a revamped catering program later this year.

The program will offer more options for customers versus our current focus on chicken on the bone. We believe providing variety is more in line with the way consumers eating groups today, especially in offices. Today, catering sales represent approximately 1% of our total system sales. The right program and focus, we believe catering has potential to be a significant sales layer for our restaurants. To further drive our strategy of attracting young consumers in early May, we launched our revamped app and loyalty program. These upgrades make it easier for customers to order food and the loyalty program provides additional options for engagement and tiers of food redemptions. To help promote the new loyalty program, we are creating Pollo millionaires.

Once a day for 30 days, we are rewarding an existing or new loyalty member with 1 million reward points. The new app has been well received with a 4.5 star rating, while sign-ups for our loyalty program have roughly doubled versus prior trends. We expect that both the app and loyalty program will only get better as we continue to update them and make them even more engaging for our customers. Shifting to operations. In the first quarter, we continued to make significant progress against our strategic pillar of delivering essential service profitably. 97% of our restaurants are now fully staffed and crew member turnover during the first quarter was under 100%, which we believe is significantly below our competitors. The low turnover reflects our continued efforts to build a recognition culture and create a great work environment for our employees.

Along these lines, last week, we completed the rollout of our revamped onboarding program, which greatly simplifies and improves the experience of new employees joining our restaurant teams. As a result of these efforts, during the first quarter, we continue to see improvements in our company and franchise restaurant service metrics, including drive-through times, social media ratings and customer complaints. As we continue to improve customer service across the system, we are also making significant progress, better managing labor and food costs at company-operated restaurants, which is showing up in our operating margins. Labor efficiencies and food waste are well controlled, and we have significantly reduced overtime pay and meal brake penalties.

In addition to restaurant level cost management, project teams are working against additional margin-enhancing opportunities, which we expect to deliver results as we head into 2024. With regards to our efforts to simplify operations, the rollout of – so tanks will be completed in May for company restaurants and later this summer for franchisees. We also continue to make good progress in simplifying sauce preparation and we’ll be installing dishwashers and restaurants that have space available. One especially promising initiative is self-ordering kiosks, which are now installed in 10 company-owned restaurants. Based on results so far in which we are seeing good average check growth, we are expanding the test to 10 more company-owned restaurants and a number of franchisees will be installing them over the next several months.

Provided we continue to see positive results, we expect to accelerate the program later this year. With that, let’s discuss our last driver, accelerating development. As highlighted earlier, we recently signed 3 additional franchise development agreements with 2 new franchisees to open a total of 26 new restaurants over the next several years in 3 new markets. Combined with previously signed agreements, we now have franchise development activities underway in 12 states. While we made exciting progress in our franchise development efforts, our team continues to work on securing new agreements, and we look forward to announcing additional partnerships as the year progresses. In closing, we remain excited by the opportunities ahead for El Pollo Loco with improved operations, aided by a familiar culture, initiatives in place that will further differentiate our brand, drive awareness for younger consumers and build sales layers and renewed efforts to attract high-quality franchisees to the El Pollo Loco system, we believe that we are positioning ourselves for sales and profit growth.

I’d like to close by thanking each member of our familia, including all of our team members and franchisees for the work they do each and every day to make El Pollo Loco a truly special brand. With that, let me turn the call over to Ira for a more detailed discussion of our first quarter financial results.

Ira Fils: Thank you, Larry, and good afternoon, everyone. For the first quarter ended March 29, 2023, total revenue increased 4.1% to $114.5 million compared to $110 million in the first quarter of 2022. Company-operated restaurant revenue increased 4.2% to $97.9 million from $94 million in the same period last year. The increase in company-operated restaurant sales was primarily driven by a 3.8% increase in company-operated comparable restaurant sales. The increase in company-operated comparable restaurant sales was comprised of a 6.3% increase in average check size, partially offset by a 2.4% decrease in transactions. During the first quarter, our effective menu price increase versus 2022 was approximately 11%. As we look ahead, we believe system-wide comparable sales will be flat to down 2% for the second quarter as we lap our extremely successful beef Birria promotion last year.

Franchise revenue was $9.7 million during the first quarter compared to $9.3 million in the prior year period. The increase was driven by the opening of 9 new franchise restaurants opened during or subsequent to the first quarter of 2022 and revenue generated from 3 company-owned restaurants sold to an existing franchisee during the fourth quarter of 2022 and 1 in the first quarter of 2023. This was partially offset by a franchise comparable restaurant sales decline of 1%. Turning to expenses. Food and paper costs as a percentage of company restaurant sales decreased 200 basis points year-over-year to 27.5% due to higher menu prices, partially offset by increased commodity costs. Commodity inflation during the first quarter was approximately 4% and did moderate substantially from 16% during the fourth quarter of 2022.

We now expect commodity inflation to decelerate to between 2% and 3% for 2023. Labor and related expenses as a percentage of company restaurant sales decreased 260 basis points year-over-year to 32.2% due to lower COVID-19-related sick pay, lower overtime expense, lower workers’ compensation expense and the impact of higher menu prices, partially offset by higher wage rates. Labor inflation during the first quarter was a little over 4%. We expect wage inflation of 4% to 5% for 2023. Occupancy and other operating expenses as a percentage of company restaurant sales was flat year-over-year at 25.4%, primarily due to higher repairs and maintenance expenses as well as higher occupancy-related expenses being offset by higher menu prices. Our restaurant contribution margin for the first quarter was 15% compared to 10.3% in the year ago period.

For the second quarter, we expect our restaurant contribution margin to be between 16.5% and 17.5%. For the full year 2023, we now expect our restaurant contribution margin to be in the 15% to 17% range. General and administrative expenses increased 80 basis points year-over-year to 9.8% of total revenue. The increase for the quarter is due to higher labor-related expenses, primarily higher incentive compensation. In addition, we incurred one-time expenses related to the recent share distribution. As we go through 2023, we are actively working on identifying ways to improve efficiency in our business. To that end, we are now in the process of reallocating resources to further support restaurant operations and future sales growth, as Larry mentioned previously.

As a result, we will incur approximately $1.1 million in one-time restructuring-related costs during the second quarter. Such will result in an approximately $1 million reduction in our overall G&A spend for the balance of the year as resources are reallocated. During the first quarter, we recorded a provision for income taxes of $2 million for an effective tax rate of 28.4%. This compares to a provision for income taxes of $0.9 million and effective tax rate of 30% in the prior year first quarter. We reported GAAP net income of $4.9 million or $0.13 per diluted share in the first quarter compared to GAAP net income of $2.1 million or $0.06 per diluted share in the prior year period. Adjusted net income for the quarter was $4.9 million or $0.14 per diluted share compared to adjusted net income of $2.6 million or $0.07 per diluted share in the first quarter of last year.

Please refer to our earnings release for a reconciliation of non-GAAP measures. During the first quarter, we remodeled seven company-operated restaurants and seven franchise restaurants. We continue to expect to remodel 10 to 15 company-operated locations and 20 to 30 franchise locations in 2023. In regards to new restaurant development, we now expect three to five company openings and six to nine franchise openings as permitting and other development delays have pushed store openings originally planned for the back half of 2023 into 2024. Turning to liquidity, as of March 29, 2023, we had $58 million of debt outstanding and $4.8 million in cash and cash equivalents. We also paid down $8 million on our 2022 revolver during the first quarter.

Subsequent to the end of the quarter, we borrowed an additional $2 million. And as of May 4, 2023, our outstanding borrowings were $60 million. During the quarter, we repurchased 552,000 shares for approximately $6.2 million. As of March 29, 2023, we had approximately $13.8 million remaining on our current share repurchase program. Subsequent to the end of the quarter, through April 28th, we repurchased an additional 453,000 shares for approximately $4.1 million. Finally, based on our results to-date, we would like to provide the following update to our 2023 guidance, the opening of three to five company-owned restaurants and six to nine franchised restaurants, remodeling of 10 to 15 company-owned and 20 to 30 franchise restaurants, capital spending of $25 million to $29 million.

G&A expenses are now expected to be from $42 million and $45 million, inclusive of approximately $1.4 million in one-time costs related to the reorganization and the recent share distribution and an adjusted income tax rate of 26.5% to 27.5%. This concludes our prepared remarks. We would 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.

Q&A Session

Operator: First question is from Jake Bartlett from Truist Securities. Please go ahead.

Jake Bartlett: Well, thank you so much for taking the question. Larry or Ira, my first is on the guidance for the second quarter and kind of also what you reported in the first. And you mentioned a weather impact of 2% to 4%. First question is, how do you know what’s weather and what’s not, meaning, how confident are you that that’s what’s driven the lower same-store sales in the first quarter than otherwise. When we hear from other companies that they are not highlighting California as being particularly weak, and so I am just trying to reconcile that with your commentary on the weather.

Larry Roberts: Yes, Jake. So, the way we measure that is we actually take a look at those days in which we had rain versus those that we did not and then we look at the comp sales gap between the two. And so what we see is on a rainy day, we will see somewhere around 6 to 8 percentage points drop in sales relative to a non-rainy day. And so that’s where we come in with it. We don’t look at weather cold days versus warm days, it’s really strictly rain days versus non-rain days. And the one thing I would highlight is, I think one reason why perhaps we see weather more heavily impact us is that if you go into a El Pollo Loco restaurant for lunch time, you see a lot of workers in our restaurants getting their chicken on a bone meals and things.

And so clearly, on a rainy day, many of them are not working. They are generally working on lawns, on roofs, painting houses and those things. So, maybe that’s the reason why we see a heavier impact in some other concepts. But that’s the way we measure it. Rain days with non-rand days and see what that gap is, and that’s how we estimate what the weather impact is.

Jake Bartlett: Got it. Appreciate that. And another question kind of building on just a question of underlying trends for you, are you seeing any shifts in how your different consumer cohorts are behaving, meaning any incremental pressure on the lower end consumer, your family consumer. I am trying to really just figure out how – just understand better how you are positioned for the current macro environment.

Ira Fils: Yes, Jake. So, I think it’s pretty similar to what we have talked about really, I think in the last couple of quarters where we talked about that we do think we are seeing maybe some pullback from a lower call it, income consumer in two ways. One is around just not spending as much because we have seen a number of items for check drop a bit. And I think you may also be seeing it a little bit in terms of vacant seat. And I think we tend to see it more – a little bit more dinner than we do, say, during the rest of the day. So, we are working on some things to bring more value to the menu. For example, we do now have three different bowls for $5 that are in our restaurants to bring that value. We marked them a little bit for a couple of weeks, and it’s something we may look to bring back and do a little bit more marketing on really to address that value of the conscious consumer.

We have seen a nice pickup in mix on our $5 bowls. So, we do have that, and we are looking at other things in which we look to perhaps bring a little more value to the menu at good profit, at good profit points on those. I mean that’s a great thing about bowls is the food costs are fairly low, so you can actually go pretty aggressive on price points and still deliver good margins on those. So, we are looking at more of those types of things. But again, I don’t think the trends have changed that much from what we have seen really since – I mean really fourth quarter last year. I think we have first started seeing perhaps a little bit pullback from some consumers.

Jake Bartlett: Great. I appreciate it. Thank you so much.

Operator: Thank you. The next question we have is from Andy Barish from Jefferies. Please go ahead.

Andy Barish: Hey. Good afternoon guys. Within the system, sales got a flat to negative 2%, are you still expecting company-owned to be positive? And if you could give us maybe a sense of challenges and lapping Birria as your best promotion, just kind of what – maybe what it’s making now versus the peak of what it makes last year, that may give us a little bit more perspective on things as well?

Larry Roberts: Sure. I will start with the second part of that question. If you looked at Birria last year, I mean it got up to as much as a little over 12% mix and really stayed double-digit mix-wise for about six weeks or seven weeks. So, as we highlighted last year, I mean it was a very unique distinctive product that we came out with and had a huge response from consumers. And so you saw a huge increase. And like we highlighted last year also, we saw record sales weeks last year as a result of the Birria promotion. This year, yes, I am not going to give actual numbers. We are seeing probably a little bit normal to slightly above normal mix in terms of Birria. So and I think it reflects that. And that’s not surprising. We knew that was going to be the case or that certainly would not – or probably would not be as strong as last year, given that last year, brand-new product, nobody else was doing Birria, anything like it.

And this year, just not as exciting news as last year. So, not surprising, that’s mixing lower. It’s more like I said, normal to slightly better than normal in terms of the mix. But we do think it’s bringing in some consumers that normally wouldn’t come to us. And like I said, it’s going to give us a good read on the beef as we continue to look at that as being a possible permanent menu item and we include that beef in our menu test that we are currently doing and looking to expand. So, that’s the second part. And in terms of the trends company franchise, I mean the trends you are seeing currently in terms of the company being a higher same-store sales versus franchise. We expect that to continue certainly through the second quarter.

And again, that just reflects – I think part of that is just a lap year-over-year of the company sales versus franchisees, because franchisees during this timeframe last year were really, really high sales growth. And so there is a lap benefit for company restaurants versus franchisees.

Andy Barish: Got it. And then secondly, I mean I know it’s early on with kiosks and understanding what many see with the higher check. But is there a labor opportunity there and potentially either less folks at the POS, or do you expect some flexibility in terms of maybe being able to reallocate some labor to other parts of the restaurant?

Larry Roberts: Yes. So, as part of the tests that we are doing these kiosks, we are also testing the ability to move labor. And a key part of the test that we are finding is – well, a couple of key things. One is the kiosks need to be at the front counter. You don’t want to have them elsewhere in the restaurant because we are seeing a much bigger response when you are at the front counter. And we are also finding for our customers at least that you want to have cash machines available so they can use cash. Because again, we are finding where we have cash machines, the usage is much higher. But the bottom line is we are seeing good average check growth really across the board. And certainly, in those restaurants with the high kiosk usage, we are going to be testing, reallocating labor and possibly removing labor.

Andy Barish: Got it. Thanks Larry.

Operator: Ladies and gentlemen, I think we have reached the end of today’s question-and-answer session. I would now like to turn the call back over to Mr. Larry Roberts for closing remarks.

Larry Roberts: Well, thanks everybody for joining us today. Again, I can’t tell you how much – we are very excited about the prospects. We have got a lot of great things going on in the business and really looking forward to the balance of the year as we implement these and continue to drive growth in the business. Thanks for joining us.

Operator: Thank you, sir. Ladies and gentlemen that then concludes today’s conference. Thank you for joining us. You may now disconnect your lines.