El Pollo Loco Holdings, Inc.

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco Third Quarter 2021 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode, and the lines will be open for your questions following the presentation. Please note that this conference is being recorded today, November 4th, 2021. And now I would like to turn the conference over to Larry Roberts, Interim Chief Executive Officer and Chief Financial Officer.

Thank you, Operator, and good afternoon. By now, everyone should have access to our third quarter 2021 earnings release. If not, it can be found at www.apoyoloco.com in the investor relations section. Before we begin our formal remarks, I need to remind everyone that our discussion today will include forward-looking statements, including statements related to the impact of the COVID-19 pandemic on our business and strategic actions we are taking in response, as well as our marketing initiatives, cash flow expectations, capital expenditure plans, and plans for new store openings, 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 conditions. We expect to file our 10-Q for the third quarter of 2021 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. Before I go into the quarterly results, I'd like to quickly touch on the recent announcement of our CEO transition. On behalf of everyone at El Pollo Loco, I would like to thank Bernard Okoka for his valuable contributions to the company. As you know, during Bernard's tenure as CEO, our team developed a culture predicated on servant-led leadership, which we continue to draw throughout our organization. In addition, under his leadership, we developed our LAMX brand positioning, accelerated our digital penetration through our delivery, loyalty, and mobile ordering platforms, and simplified our operations. These initiatives have positioned the company for success over the coming years. With this transition, I look forward to continuing to build upon these accomplishments and working with our management team, franchisees, and the board to fully capitalize on the growth opportunities ahead. With that, let me share our third quarter results and discuss our course forward. We are thrilled to see the continuation of our strong sales performance during the third quarter as we posted a 9.3% increase in system-wide comparable restaurant sales resulting in a two-year system-wide comparable sales growth of 11.9%. This momentum has continued into the fourth quarter with system-wide comparable sales growth as of October 27th of 8.4%. During the third quarter, system average weekly unit volumes again exceeded $40,000 and nine DMAs achieved record sales. These measures point to the strength of our business coming out of the pandemic. Further, our restaurant contribution margin was 20.4%, which includes a $3.2 million employee retention payroll tax credit, and pro forma earnings per share for the quarter was 27 cents. Our strong top-line performance was partly driven by solid marketing and insightful advertising during the quarter as we promoted our $5 fire grill combo offerings. Instead of relying on introducing new products, This particular promotion took advantage of our consumer insights to effectively target an older Gen Z, younger millennial demographic. The tagline value yourself has proven to resonate very well with this particular demographic group as they seek higher quality value meal options. This promotion was followed closely by new double chicken nachos that were introduced in early September. This past Monday, We continued to build on our authentic roots with a Day of the Dead promotion that featured two free loaves of pan de muerto bread with every family meal. We also issued a new set of gift cards highlighting the holiday, which helped more than double gift card sales versus the same period in 2020. On Tuesday, we kicked off the holidays with our Blessed Togetherness marketing campaign, which taps into the desire for families and friends to reconnect with each other over the holidays, especially in light of the challenges posed by the COVID pandemic over the past 20 months. The campaign features new tamale bowls, chicken pozole, and Mexican hot chocolate. These traditional holiday products, along with the new packaging and point-of-sale graphics, will help create a festive environment at our restaurants and have historically driven strong sales in previous years. Our delivery and loyalty programs continue to grow as e-commerce sales averaged over 12% of total sales during our last marketing module, which is up over two percentage points from the beginning of the year. E-commerce will only continue to grow as we continue to invest in these sales channels, including the addition of two new management positions to oversee our off-premise and CRM platforms. We are also finalizing discussions to partner with a third party to enhance our CRM and consumer data platform capabilities, which we expect to be implemented by early 2022. As we've consistently highlighted, we are excited about the progress we've made in our e-commerce business and believe that we've only just begun tapping into its full potential to build customer loyalty and drive sales. We also believe that e-commerce is critical to casting a wider net in order to attract younger consumers to Apoyo Loco. While we are excited about the sales driving initiatives we have in place, I would now like to turn our attention to one of the biggest near-term challenges that we are experiencing along with the rest of the restaurant industry. The challenges of recruiting and labor retention have impacted our restaurants system-wide, but especially our company-owned restaurants. We believe that this issue is a primary driver of the performance gap between franchise and company restaurants during the third quarter. with 12.6% comp growth for our franchise restaurants versus 4.8% comp growth in our company-owned restaurants. While there may be a number of reasons for the sales performance gap, fundamentally, we believe that our franchisees have done a better job adapting to the realities of the new labor market than we have in our company-owned restaurants. During the third quarter, the number of restaurants impacted by labor availability challenges increased, and we've had to reduce offering hours and or service modes and a number of company-owned restaurants. This is negatively impacting our company-owned comparable restaurant sales by four to six percentage points. Addressing this issue is our number one business objective. To that end, we are maniacally focused on employee recruiting and, more importantly, retention. With regards to recruiting, in addition to ensuring that the wages we offer are competitive, we have increased resources to resurface more candidates and process applications faster, and are assisting our area leaders and restaurant managers to proactively recruit team members in their respective trade areas. To further improve our labor retention, we have increased our training budget to better onboard new employees, and we are launching Employee Appreciation Month in November, which will include an employee engagement survey to better understand what's on the minds of our team members. Most importantly, we are increasing our efforts to create a familiar culture in each and every one of our restaurants by increasing employee recognition and continuing to develop servant-led leaders. Lastly, in addition to staffing our restaurants, our other top priority is to further simplify our operations in an effort to make our team members' jobs easier to execute and more rewarding. As highlighted previously, we have made good progress on this, but we must do more if we are going to continue to retain employees and deliver great service to our customers. This will include a system-wide initiative that will include both franchise and company operators. Together, we will implement short- and long-term initiatives that we believe can significantly simplify our operations further. Several of these have already been implemented, including removing certain product offerings and packaging options from our restaurants beginning last Tuesday. We believe these efforts are critical given the staffing challenges that plague our industry. I have two other topics I'd like to briefly touch on. we have not been immune to the global supply chain challenges facing our industry and many others. Ensuring supply to our restaurants continues to be challenging. However, it is now primarily isolated to packaging. Our teams have done an outstanding job managing this difficulty, and we have not suffered any significant disruptions to the business. We will continue to closely monitor all aspects of our supply chain for challenges as they arise. Second, we signed our second four-restaurant development agreement for Denver with an existing franchisee. This further highlights the strength of our concept and the confidence our franchisees have in its success in new markets. Despite the current challenges, as we look forward to the end of the year, into 2022, we could not be more excited about our brand position today and the growth opportunity we have ahead of us. Let me assure you that our strategy has not changed. We will continue to focus on our acceleration agenda to build on the momentum in our core business for rapid and successful growth over the next three years. This roadmap is built upon the following four key pillars. First, expand the brand by growing in new geographies in an asset-light fashion. Second, support the brand by building the right organization for asset-light growth. Third, evolve the brand through digital innovation and expand frictionless convenience for our customers, no matter how they choose to interact with us. And lastly, focus the brand on our most valuable core equities and exaggerate them to the point where we really stand out in terms of what makes us so special and unique. With that, let me now review our third quarter financial results in greater detail. For the third quarter ended September 29th, 2021, total revenue increased 4.3%, to $115.7 million compared to $111 million in the third quarter of 2020. Company-operated restaurant revenue increased 2.8% to $100 million from $97.3 million in the same period last year. The increase in company-operated restaurant sales was primarily due to a 4.8% increase in company-operated comparable restaurant sales an increase of $0.9 million in non-comparable restaurant sales, and an increase of $0.4 million from restaurants that were temporarily closed due to the pandemic during last year's third quarter. The increase in company-operated comparable restaurant sales was comprised of a 3.5% increase in average check and a 1.2% improvement in transactions. During the third quarter, our gross pricing increase versus 2020 was 5.2%. As I mentioned earlier, our sales momentum has continued into the fourth quarter. Through October 27th, fourth quarter system-wide comparable restaurant sales increased 8.4%, consisting of a 2.1% increase at company-owned restaurants and a 12.9% increase at franchise restaurants, while two-year system-wide comparable restaurant sales were up 8.5%. Franchise revenue was $8.9 million during the third quarter, compared to $7.8 million in the prior year period. This increase was driven by a franchise comparable restaurant sales increase of 12.6%, as well as the opening of one new franchise restaurant during or subsequent to the third quarter of 2020, and revenue generated from eight company-owned restaurants sold to an existing franchisee during the quarter. This was partially offset by the closure of two franchise restaurants during the same period. Turning to expenses. Food and paper costs as a percentage of company restaurant sales increased 110 basis points to 26.7% as higher menu prices were more than offset by increased commodity costs, investments in new packaging, and higher usage of salsa and beverages as a result of reopening dining rooms. We expect commodity cost pressures to continue and now expect full-year inflation to be around 3% compared to our prior guidance of 2%. Labor and related expenses as a percentage of company restaurant sales decreased 180 basis points year over year to 27.8% as higher wage inflation, overtime costs, and training expenses, along with increased labor hours due to increased transactions, were more than offset by higher menu prices and a $3.2 million employee retention credit, which was recorded as an offset to payroll tax expense classified as part of labor and related expenses. While we put steps in place to manage labor, we continue to expect labor cost pressure for the remainder of 2021 as a result of 5% to 5.5% wage inflation, which is raised from our prior guidance of 4.5% to 5%, and continued investments in recruiting, training, and retaining restaurant team members that I mentioned earlier. Occupancy and other operating expenses as a percentage of company restaurant sales increased 60 basis points to 25.1% due to higher utility costs, rents, and marketplace delivery fees. These were partially offset by higher sales revenue. During the third quarter of 2020, we received an insurance reimbursement of $2 million. Our restaurant contribution margin for the quarter was 20.4%, and 17.2% after adjusting for the $3.2 million employee retention payroll tax credit. General and administrative expenses decreased slightly to $9.4 million from $9.8 million in the year-ago period due to a $1.3 million decrease in labor-related costs, primarily related to a decrease in estimated management bonus expense. This was partially offset by higher recruiting fees, outside services, as well as an increase in legal and professional expenses. As a percentage of total revenues, G&A decreased approximately 30 basis points to 8.5% as a result of the decreased labor costs and higher revenues versus last year. We recorded a provision for income taxes of $3.7 million in the third quarter of 2021, for an effective tax rate of 26.5%. This compares to a provision for income taxes of $1.6 million and an effective tax rate of 14.2% in the prior year third quarter. We reported gap net income of $10.2 million, or $0.28 per diluted share, in the third quarter compared to gap net income of $9.9 million, or $0.28 per diluted share, in the prior year period. Pro forma net income for the quarter was $10 million, or 27 cents per diluted share, compared to pro forma net income of $9.9 million, or 28 cents 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 gap measures, please refer to our earnings release. With that, let me quickly review our development plan. During the third quarter, there were no company or franchise restaurants opened. However, we successfully completed five company and two franchise remodels using our new LAMEX design. Looking ahead, due to permitting and equipment delivery delays, we now expect to open two to three company-owned restaurants and one to three new franchise restaurants for 2021. As a result of new unit and remodel delays, we now expect our capital spending for 2021 to be in the range of $15 to $20 million. As we mentioned on our last call, we concluded the sale of our eight company-owned restaurants in Sacramento to an existing franchisee during the third quarter. As a reminder, this transaction included an agreement to build three additional restaurants in the market. In addition, along with a four-unit development agreement mentioned earlier for Denver, we concluded three agreements for an additional six restaurants in various territories in California during the third quarter. Turning to liquidity during the third quarter, we did not pay down any debt, and as of September 29th, 2021, we had $40 million of debt outstanding and $24.7 million in cash and cash equivalents. Lastly, due to the uncertainty surrounding the COVID-19 pandemic, the company is not providing a financial outlook for the year ending December 29th However, we are updating the following limited guidance for fiscal 2021. The opening of two to three company-owned restaurants and one to three franchise restaurants. The remodeling of 10 company-owned restaurants and 10 franchise restaurants. Accelerating commodity, labor, and utility costs for further pressure margins in the fourth quarter of 2021 relative to the third quarter of 2021. And pro forma income tax rate of 26.5%. This concludes our prepared remarks. I'd like to thank you again for joining us on the call today. I'm now happy to answer any questions that you may have.

Ladies and gentlemen, we will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. and a confirmation tone will indicate that your line is in the queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pull for questions. Our first question is from Andy Barish with Jefferies. Please proceed.