El Pollo Loco Holdings, Inc. (NASDAQ:LOCO) Q3 2022 Results Conference Call November 3, 2022 4:30 PM ET
Company Participants
Ira Fils – CFO
Larry Roberts – CEO
Maria Hollandsworth – COO
Conference Call Participants
Jack Corrigan – Truist Securities
David Tarantino – Baird
Operator
Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco Third Quarter 2022 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded today, November 3, 2022.
And now I’d like to turn the conference over to Ira Fils, the company’s Chief Financial Officer.
Ira Fils
Thank you, operator, and good afternoon. By now, everyone should have access to our third quarter 2022 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 the impact of the COVID pandemic and macro environment on the business as well as our marketing and new product initiatives, cash flow expectations, capital expenditure plans, remodel plans for new store openings and expected income tax rate 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 2022 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 included 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.
Now I’d like to turn it over to Larry Roberts, Chief Executive Officer.
Larry Roberts
Thanks, Ira, and good afternoon, everyone.
Before we get into the quarter, let me start by welcoming our new Chief Operating Officer, Maria Hollandsworth, to El Pollo Loco family. As you may have seen from our press release, Maria joins us from Dunkin’, where she was Regional Vice President of Operations. Prior to Dunkin’, Maria spent over 20 years with Jack in the Box in numerous operating roles, including her most recent position as Vice President, Strategic Initiatives and Operations Services. With the recent addition of Ira Fils as CFO and now Maria, I believe we have an outstanding leadership team that will provide the necessary skills and expertise to drive the continued expansion of El Pollo Loco.
I’d also like to highlight that over the last 12 months, our system-wide sales exceeded $1 billion. This is a great accomplishment for El Pollo Loco and highlight the affinity people have for our brand and the huge growth opportunities we have ahead of us. Finally, as many of you have probably seen, on October 11, we announced a declaration of a $1.50 special dividend and authorization to repurchase up to $20 million of our common stock. These programs underscore the strength of our balance sheet, and more importantly, the confidence we have in our business going forward.
Turning to the third quarter. We’re pleased with our continued top line momentum with system-wide comparable restaurant sales growth of 3.8%, including a 3.4% increase at company-owned restaurants and a 4.1% increase at franchise locations. Trends we saw towards the end of the second quarter continued into the third quarter, including the healthy growth of our lunch business year-over-year. I’m also pleased to add that our fourth quarter has started similarly to the third with system-wide same-store sales through October 26, increasing approximately 3.5%, including a 5.4% increase at company-owned restaurants and a 2.2% increase at franchise locations.
Store level margins during the third quarter continued to be pressured by wage, commodity and utilities inflation, however, staffing levels improved throughout the quarter, and our company-operated restaurant teams made good progress managing their businesses, resulting in pro forma earnings per share of $0.14. We were very pleased with our Tostada promotion, which ran until mid-August. During several weeks of the promotion, Tostada achieved an 18% menu mix, which was 400 basis points higher than their previous peak, and they continue to make that over 14%, which is 200 basis points higher than their pre-promotion mix.
During the balance of the third quarter, we focused on value, marketing a family feast at $24 and a revised fire-grill combo meals starting at $5. We believe these value offers are critical to attracting more value-conscious consumers. Looking ahead to November and the balance of the year, we are very excited about our next promotion, Overstuffed Quesadillas, which includes a beef option that builds on the success of Beef Birria earlier this year. We believe this promotion will be highly appealing to younger consumers and a great fit for enhanced efforts in digital and social media with a particular focus on the use of TikTok. We’ll also continue to promote our $24 family fees, which delivers great value for family and group gatherings.
Looking ahead to next year, our 2023 marketing calendar will expand to 6 promotion modules from 5 this year. As a result of investments made in our product development process, these promotions will include introduction of several new products that we believe will resonate with both new and existing consumers. More excitingly, we believe that several of these products have the potential to be permanent menu items that will broaden our appeal and drive increased frequency among current customers.
Shifting to restaurant operations, I couldn’t be more pleased with the progress we have made in our company operations. As I have previously noted, our franchise partners have operated at very high levels throughout the last 3 years. After making this a key priority, service our company-operated restaurants have dramatically improved over the past 6 months. Virtually all of our company-operated restaurants now operate full hours across all channels daily. While overtime staffing is still required in a number of locations, we expect to continue its downward trend given the applicant flow and our intensive focus on hiring and training.
In addition to improved staffing levels, our focus on drive-through times, last visit excellence scores and leadership training for Area Leaders is delivering outstanding results in company-operated restaurants. Drive-through times have continued to improve and now the fastest they have been in almost 2 years. In addition to the hard work and dedication of our team members, our last visit excellence scores have improved by over 25 percentage points since March to the highest level they have ever been. More importantly, as our drive-through times and last excellence scores have improved, so have all our other key operating metrics, including our value scores, social media ratings and customer complaints.
I couldn’t be prouder of our company-operated restaurant teams and restaurant leaders who have worked incredibly hard to improve their operations as well as our franchise operators who have consistently delivered exceptional service through very challenging times. In conjunction with the improvements we made in our 4-wall operations, we continued our efforts to simplify our restaurant operations during the quarter and are now very close to implementing several significant initiatives geared towards reducing operational complexity and improving product quality. These include the use of soap tanks to clean broilers and grill filters, revised on-boarding processes that will cut the number of hours spent hiring and training new employees and new source of making equipment that will further improve product quality and reduce preparation and cleaning time. We expect these to roll out to our system during the fourth quarter, enabling our team members to execute their daily duties more consistently and efficiently, thereby delivering an enhanced test experience.
Turning to development. We opened 2 new company-owned and 4 new franchise restaurants during the quarter. In addition, we remodeled 4 company and 2 franchise restaurants. We are pleased to have recently finalized a 5-unit development agreement for Chico Redding, California and Southern Oregon that we spoke to last quarter. To date, we have signed 4 development agreements for a total of 17 restaurants, and we continue to have discussions with those existing and new franchisees to develop El Pollo Loco units in new markets. Our investments in franchise recruiting are clearly paying off as we continue to see a high level of interest from prospective partners, which gives us confidence in our expansion strategy and expect new unit growth to increase to 14 to 20 new restaurants in 2023.
In closing, as we look ahead, the work we were doing this last year has us excited about 2023. First, our company-operated restaurant operations have improved significantly from where they were last year. With continued focus, they will improve even further in the entire El Pollo Loco system will be providing service at very high levels as we enter the new year. Second, utilizing our improved development process, we have a strong and exciting marketing calendar that includes new products, several of which could be permanent menu items capable of driving incremental traffic.
Third, we continue to invest in and enhance our loyalty, digital and social media platforms. We will also be revamping our mobile app and website, which will enable a relaunch of our loyalty program with a brand-new customer experience towards the end of the first quarter of 2023. And lastly, our franchisee recruiting program continues to gain traction, and we look forward to bringing new partners into the El Pollo Loco family and introducing our great food to more cities across United States.
While it’s very difficult to predict the future economic environment, we remain confident that the work we are doing this year is setting El Pollo Loco up for future growth and success. I’d like to thank our team members and franchise partners the work they do every day to make El Pollo Loco an exceptional brands.
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, Larry, and good afternoon, everyone. For the third quarter ended September 28, 2022 total revenue increased 3.6% to $119.9 million compared to $115.7 million in the third quarter of 2021. Company-operated restaurant revenue increased 3.2% to $103.2 million from $100 million in the same period last year. The increase in company-operated restaurant sales was primarily driven by a 3.4% increase in company-operated comparable restaurant sales. The increase in company-operated comparable restaurant sales was comprised of a 7.5% increase in average check size, partially offset by a 4.1% decrease in transactions.
During the third quarter, our effective price increase versus 2021 was a little over 10%. Based on current economic conditions and consumer sentiment and including an additional 2.5% price increase in November, we continue to expect approximately 10% pricing for the full year. Looking ahead, fourth quarter-to-date through October 26, system-wide comparable restaurant sales increased 3.5%, consisting of a 5.4% increase at company-owned restaurants and a 2.2% increase at franchise restaurants.
For the same time period, our 2-year system-wide comparable restaurant sales were up 11.1%, further demonstrating the positive momentum we are experiencing to date. Franchise revenue was $9.5 million during the third quarter compared to $8.9 million in the prior year period. This increase was driven by a franchise comparable restaurant sales increase of 4.1% as well as the opening of 9 new franchise restaurants opened during or subsequent to the third quarter of 2021 and revenue generated from 8 company-owned restaurants sold to an existing franchisee during the third quarter of 2021. This was partially offset by the closure of 2 franchise restaurants during or subsequent to the third quarter of 2021.
Turning to expenses. Food and paper costs as a percentage of company restaurant sales increased 250 basis points year-over-year to 29.2% due to increased commodity costs, partially offset by higher menu prices. Commodity inflation during the third quarter was approximately 23%. Although still elevated, we expect commodity inflation to ease to 15% to 16% in the fourth quarter. We anticipate full year 2022 inflation to be approximately 20%. Labor and related expenses as a percentage of company restaurant sales increased 450 basis points year-over-year to 32.3%.
In the third quarter of 2021, under the CARES Act, the company recognized a $3.2 million employee retention credit, which drove 320 of the 450 year-over-year basis point increase. The remainder of their increase was due to higher wage inflation, overtime costs and other labor-related costs, partially offset by lower workers’ compensation expense. We continue to expect wage inflation of about 8% for the full year. During the third quarter, we incurred approximately $440,000 of COVID related expenses.
Occupancy and other operating expenses has a percentage of company restaurant sales increased 100 basis points to 26.1% due to higher utility costs, repairs and maintenance expense and marketplace delivery fees. Our restaurant contribution margin for the quarter was 12.4% compared to 20.4% in the prior year. We expect Q4 restaurant margins to rebound somewhat from Q3 but still be below prior year levels as a result of the high commodity and wage inflation. As we look into 2023, we believe commodity inflation will be between 3% and 5% and wage inflation will be between 4% and 6%.
General and administrative expenses increased to $9.9 million from $9.4 million, an increase of $0.5 million or 5.3%. As a percentage of total revenues, G&A increased approximately 10 basis points to 8.2% of total revenue. We recorded a provision for income taxes of $1.8 million in the third quarter of 2022 for an effective tax rate of 26.2%. This compares to a provision for income taxes of $3.7 million, an effective tax rate of 26.4% in the prior year third quarter. We reported GAAP net income of $5 million or $0.14 per diluted share in the third quarter compared to GAAP net income of $10.2 million or $0.28 per diluted share in the prior year period.
Pro forma net income for the quarter was $5 million or $0.14 per diluted share compared to pro forma net income of $10 million or $0.27 per diluted share in the third quarter of last year. For a reconciliation of pro forma net income and earnings per share to the comparable GAAP figures, please refer to our earnings release.
Turning to liquidity. As of September 28, 2022, we had $20 million of debt outstanding and $19.3 million in cash and cash equivalents. Subsequent to the end of the third quarter on October 11, our Board of Directors declared a special dividend of $1.50 per share payable on November 9 to shareholders of record as of the close of business on October 24. The payment of the dividend will be funded by a combination of a drawdown on our revolver, combined with cash on hand.
On November 3, we borrowed an additional $46 million to fund the special dividend. Outstanding borrower — borrowings as of November 3, 2022, were $66 million with cash on hand, expected to be approximately $10 million after the payment of the special dividend. In addition, our Board of Directors approved a new share repurchase program with authorization to purchase up to $20 million of dollars of shares terminating on March 28, 2024.
Lastly, due to the uncertainty surrounding the COVID-19 pandemic and current economic conditions, we won’t be providing a full financial outlook for the year ending December 28, 2022. However, we are providing the following limited guidance for fiscal 2022. The opening of 4 company-owned restaurants and 7 to 9 franchise restaurants, the remodeling of 6 company-operated restaurants and 20 to 25 franchise restaurants. Capital spending of $19 million to $22 million and a pro forma income tax rate of 26.5%.
This concludes our prepared remarks. We’d like to thank you again for joining us on the call today, and we are 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 the line of Jake Bartlett with Truist Securities.
Jack Corrigan
This is actually Jack Corrigan for Jake. First, I just wanted to ask about restaurant level margins and your commodity guidance of 3% to 5% for ‘23. What level of visibility for that 3% to 5% guidance, how much do you have locks now? And we’re seeing chicken prices down in the 40% range right now. So can you remind us how much you had locked in 2022? Just so as we’re seeing the spot prices of those are actually tracking what we might be seeing in your commodity inflation or deflation.
Ira Fils
Yes. Jack, this is Ira. So we are in the process of booking for next year, probably book, and we’re very close to that. We’re booking about 75% of our chicken will be booked, our chicken buy will be booked for next year. So we have some pretty good visibility into the — our commodity guidance for next year.
Larry Roberts
Yes. And Jack, I’ll just add to that. You’re seeing in chicken markets is the drop-off in chicken prices, certainly, we’re seeing that a lot on the boneless, the boneless side and boneless breast. And then the chicken and the bone that we purchased a little less so, and we are seeing an increase in that year-over-year from what we booked this past year.
Jack Corrigan
Great. That’s really helpful. I had a similar question from wage inflation. I mean 4% to 6% for next year. And then you mentioned some productivity things that you’re putting in place [Technical Difficulty] the on-boarding process, [new sauce] making equipment. So how much do you expect those things in your pricing to offset that wage inflation? Or are those more customer-facing processes?
Larry Roberts
Yes. So I think overall, on the wage inflation, I mean, bear in mind, none of this includes the AB 257, which we now believe won’t even — it’s probably unlikely can take effect next year, if it does, it will be late in the year. So again, we have pretty good visibility into the actual wage inflation in terms of what we’re anticipating in the current environment.
In terms of the efficiency initiatives that we put in place, I mean, a lot of those are really just going to be freeing up labor to focus on the customer. We’ll be evaluating whether we think any of those are things that we can actually start pulling some labor out. I think there might be some potential there. But right now, certainly, some of them we’ve done so far is really just freeing things up. And then as we look at these, we’ll evaluate whether we think we can actually reduce labor hours in a restaurant at all, but that’s to be determined.
And then certainly, on the pricing side, we’ll be carrying pricing above inflation heading into the Q1 and really — especially the first part of the year, and then we’ll be evaluating what levels of pricing we think we can take and whether or not we can be taking anything I would call catch-up pricing, which kind of catches you up to the pricing shortfall we’ve had over the last year or 2 years with this rapid inflation.
Jack Corrigan
Great. And just to clarify, my math is a 10% pricing for the full year that would get you to about 12.5% in the fourth quarter. Am I doing that correctly?
Ira Fils
No, I think you’re on the high side there, Jack. We’re a little north of 10% also in the fourth quarter.
Jack Corrigan
Okay. And just how would that — assuming you didn’t take any more pricing after November increase, how would that roll through the quarters next year? Through pricing?
Ira Fils
Yes, yes. As you carry off into the first quarter of next year, you’ll be again about $10.5-ish or so through the first quarter. That will start to step down and actually into part of the second quarter, and it should start to step down as we get into the June time frame to — if we did nothing else into the 7% range. And then really the balance of the year will depend upon how we decide upon taken, as Larry mentioned, some additional pricing as we look back in the back half of the year.
Operator
[Operator Instructions] Our next question comes from the line of David Tarantino with Baird.
David Tarantino
Larry or Ira, I wanted to ask another question just about margin structure. And my question is what is the path to getting back to the margins that you are accustomed to delivering. I think, Larry, you referenced maybe a catch-up amount of pricing. Is there a strategy that you have to — if inflation doesn’t come down to try to kind of return margins to the levels you’ve had historically?
Larry Roberts
Yes, David, I’ll talk and I’ll let Ira chime in. I mean, first of all, a big focal point right now is we continue to be higher and over time. Over time, it’s gotten a lot better from where we were, but it’s still certainly higher than we were pre pandemic. And so a huge focus on getting overtime down as being one of the margin drivers. And quite frankly, just getting — we can get rid of COVID, I mean that continues to cost somewhere around $0.5 million a quarter on COVID costs, which is probably something that’s fairly unique to California in terms of the legislation that we have to comply with.
A highlight on some of the ops efficiency measures. Again, some of that is just going to be, I’ll call it, redeployed labor. But I think there are some things we’re working on that may enable us to perhaps reduce some of the labor costs that way. And then I’d also say on the supply chain side, where we’re looking at some things from a sourcing perspective that should help us save costs in addition to the dip to lower commodity costs, looking to change whether it’s changing vendors on things or looking at some of the items we source, we think there could be opportunities there also to improve margins.
So you can find those with, like I said, the potential opportunity next year to maybe you’re able to take some catch-up pricing. We think that will be the margin drivers for next year to get us back up to those levels that we’re more accustomed than being at. Anything else, Iran?
Ira Fils
No, I think you hit the hot points. I think just — I mean, we feel like we have pretty good visibility into our commodity inflation for next year. And so that gives us confidence that we will likely be able to take a little bit of pricing above the level of inflation next year, which will help improve margins next year to more to where they’ve been. And then just structurally, the things Larry talked about in regards to overtime and some of the COVID-related pay that we were required to make is going to be a little bit of a tailwind for us next year.
Larry Roberts
And then last one. And hopefully, utility inflation won’t be like it has been. I mean, gas prices, it’s hard to believe they’re going to get up from where they’ve been.
David Tarantino
Understood. I guess the follow-up is how are you and your franchisees looking at kind of the 4-wall profitability equation when you’re making decisions on building new units. It’s nice to see the projected step-up next year on openings. But I guess, are you penciling in higher margins in the future? Is that how you’re penciling out these deals? Or I guess, how do you think about it?
Larry Roberts
Yes. No, we’re penciling that there will be a return to much better margins than what we’re seeing this past year. Yes. So when we’re looking at this, we’re looking at kind of getting back to margin levels where we’ve been in the past.
Operator
We have reached the end of our question-and-answer session. I’d like to turn the call back over to Mr. Roberts for any closing remarks.
Larry Roberts
Yes, I’d just like to thank everybody for joining the call today. I hope to hear that we feel very good about where the business is now and really excited about next year. And so thanks again for joining. And since we want to talk again until next year I wish everybody a great holiday season and look forward to talking with you again next year. Thanks, everybody.
Operator
Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.
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