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spk02: Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco Second Quarter 2022 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, August 4th, 2022. And now I would like to turn the conference over to Ira Filz, Chief Financial Officer. Thank you. You may begin.
spk01: Thank you, Operator, and good afternoon. By now, everyone has access to our second quarter 2022 earnings release. If not, it can be found at www.lpoyoloco.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 impacts of the COVID pandemic and macroeconomic environment 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 condition. We expect to file our 10-Q for the second 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 considered in isolation or as a substitute for results prepared in accordance with GAAP, and Reconciliation's two comparable GAAP measures are available in our earnings release. Now, I would like to turn it over to Larry Roberts, our Chief Executive Officer.
spk04: Thank you, Ira. And good afternoon, everyone. Let me start by welcoming Ira to the Apoyo Local family. As many of you know, he's a well-rounded and accomplished executive with a strong 20 plus year track record of leadership and experience in the restaurant industry. I look forward to as many contributions as we execute on our strategic priorities in 2022 and beyond. Turning to our second quarter results, System-wide comparable restaurant sales increased 7.5%, including a 2.9% increase at company-owned stores and a 10.6% increase at franchise locations, helped in part by the success of our shredded beef birria limited-time offer. Labor and commodity inflation continued to persist during the second quarter, pressuring our store-level margins. Nevertheless, our team continued to do a nice job managing our business, resulting in pro forma diluted earnings per share of 21 cents. We believe efforts toward improving our brand differentiation and awareness were a key driver of our sales growth during the second quarter. As I noted on our last call, our shredded beef berry promotion, which ran from mid-March to early June, performed exceptionally well, aided by our new social media-centric marketing approach. With its success, we will be evaluating whether beef can be a permanent item on our menu. At the very least, we know that we have an exceptional, limited-time promotion that will be on the calendar for years to come. To build upon this excitement, we launched our Tristata promotion in early June by utilizing a similar marketing approach as with Beef Birria. This includes creating a new and unique content across the major social media channels with a special emphasis on TikTok, all of which is allowing us to send targeted messages to various user groups, particularly our younger consumer base. To date, the response to our tostada promotion has been outstanding. We have achieved record levels of tostada sales during promotion with our tostada mix averaging almost 18% since the start of the module. This is 400 basis points higher than our peak to solid mix last year. Despite the success of our recent promotions, we did see some softening in customer traffic starting in mid-June, mostly during our dinner day part. Quarter-to-date system same-store sales through July 27th increased 2.4%. We believe the softness at dinner is a combination of consumers pulling back due to economic uncertainties and a lack of value advertising for our dinner day part. We have not advertised family meals since December of 2021. With this in mind, we will be utilizing both TV and social media channels in the near term to promote more value-oriented messaging, starting with our family feast promotion, which includes eight pieces of chicken and a family-sized salad, two large sides, and churros for $24. Additionally, starting in August, we will advertise our fire-grilled value menu with a price point starting at $5. These meals include an entree with a choice of either a chicken and cheese quesadilla, original pollo bowl, classic chicken burrito, or tacos al carbon and comes with chips and a drink. To be clear, Neither the $24 family feast nor the $5 value menu are discount offerings, but rather they highlight our strong value proposition in what could be a challenging consumer environment. As we progress through the balance of year, we will continue to work on additional means of providing great value to our consumers without compromising our margins. While dealing with this challenging operating environment, we remain focused on executing our strategic priorities that are designed to strengthen our average unit volumes, improve our profitability, and in time, accelerate our store growth. Our marketing will continue to focus on those attributes that differentiate El Pollo Loco, including our flame-grilled chicken and freshly prepared food. As we've noted, social media would be a key medium for our messaging, and along those lines, we recently hired a vice president of digital marketing, to coordinate our digital and social media efforts. Accordingly, we are getting ready to completely revamp our mobile app and website, which we expect to complete in early 2023. This investment will enable us to significantly upgrade and unify the consumer experience on our website and app, as well as greatly enhance our loyalty program. In addition, as part of our strategy to become more relevant to younger consumers, we launched our Abuela Approved TikTok campaign in July. This campaign uses a series of short videos to tap into the growing popularity of abuelas or grandmothers. Napoleon Local recognizes that the generational gap is narrowing and there is a unique bond between grandparent and grandchild. In fact, the number of Americans living in a multi-generational household with three or more generations has nearly quadrupled over the past decade. Our content featuring Abuela is about acknowledging these dynamics and spreading joy and wisdom with a heavy dose of relatability. To date, the videos have been viewed over 3.5 million times on TikTok. Over time, we expect campaigns like Abuela Approved to attract younger consumers to our brand. Shifting to restaurant operations, which is another of our strategic priorities, We believe we have made significant progress during the quarter with regard to staffing, retention, processes, and routines at all operational levels. Beginning with staffing, applicant flow has increased significantly, and while a handful of our restaurants remain challenged, our overall staffing levels have improved tremendously. This combined with improved turnover has resulted in over 95% of company-owned restaurants being able to operate all channels at all hours every day. We've also made significant improvements in our four-wall execution, as demonstrated by the reduction of total drive-through times by approximately one minute and significant improvements across multiple consumer metrics. For example, our last visit excellence scores have improved by over 10 percentage points in company-operated restaurants since the first quarter of this year, and they're at the highest levels we've achieved since 2019. We believe these operational improvements enhance our consumer proposition and drive higher sales over time. Lastly, we continue to work on projects to simplify our restaurant operations. Since the launch of this initiative, we have implemented a number of changes that have reduced complexity as well as the labor hours required to complete various tasks. These include menu deletions, de-stemmed serrano peppers, pre-chopped cilantro, and revised tortilla packing procedures. In addition to these, we are testing a handful of initiatives, several of which we expect to implement in the near term, that could significantly reduce labor hours required in our back of house. These include new food processors for salsa, the use of soap tanks for cleaning grills, dishwashers, avocado slicers, and simplified onboarding procedures for new employees. These and other projects are part of a longer-term effort to streamline the daily work performed by employees, thereby improving their engagement and enhancing guest satisfaction through better execution in our restaurants. While our efforts to promote brand awareness and improve restaurant operations are key strategic initiatives, we believe it's equally important for Apoyo Loco to ingrain the right company culture. We've made significant progress in our restaurants, creating a servant-led leadership culture predicated on recognition while still maintaining accountability. This is clearly evident by the recognition boards we have in all of our restaurants, postings on Workplace by Facebook, and the engagement we are seeing amongst our teams. While these efforts will continue at our restaurants, we are also working to create a restaurant mindset within the support center. We want all support center employees to have a greater appreciation for the work our team members do to serve our customers. With that in mind, all new Support Center employees are now required to work two days in our restaurants as part of our onboarding process. In addition, all vice presidents and above are now required to spend one day per quarter visiting restaurants with either a senior company operator or a franchisee. And in August, we will be relaunching Day of Pollo, where all Support Center employees will work in a restaurant to show support for our restaurant team members. Finally, our support center employees will be given WOW pins to recognize team members who provide exceptional service when they visit one of our restaurants, either company operated or franchised. We believe these and additional initiatives will improve overall employee satisfaction, which will translate into a better experience for our customers. On the franchising front, I am very pleased that we recently signed a development agreement with a new franchisee for the Seattle area and are finalizing an agreement for Chico Redding, California and Southern Oregon. These, along with the opening of our first restaurant in Denver, scheduled for September, demonstrate that we are making progress in our efforts to develop in new markets with franchisees. In addition to these signings, we are in discussions with a number of other franchise candidates, which we hope to conclude with new development agreements over the balance of the year. As part of our franchising strategy, we are striving to put our restaurants in the hands of strong operators, and one way to accomplish that is to focus on expanded development opportunities with current franchise partners. To that end, one of our current franchisees with 12 restaurants in Phoenix and California has recently teamed up with a former company operator to purchase five restaurants in San Antonio and two restaurants in Louisiana from other franchisees. Both transactions include new development agreements six new restaurants in San Antonio, and four in Louisiana. In closing, while we are not immune to the softening trends the industry is seeing in the third quarter to date, we continue to make meaningful and tangible progress in our strategic initiatives, which will ultimately position the Apollo Local brand to better capture the opportunities ahead of us. I'd also like to thank our team members and franchise partners for their passion, commitment, and dedication to making this brand and this family truly special. With that, let me turn the call over to Ira for a more detailed discussion of our second quarter financial results.
spk01: Thank you, Larry, and good afternoon, everyone. Let me start by saying I am very excited to join the El Pollo Loco team, and thank you for welcoming me into the familia. Turning to the financials, for the second quarter ended June 29, 2022, Total revenue increased 1.7% to $124.1 million compared to $122 million in the second quarter of 2021. Company-operated restaurant revenue decreased 0.5% to $106.5 million from $107 million in the same period last year. The decrease in company-operated restaurant sales was primarily due to a $2.7 million decrease due to the sale of eight company-owned restaurants to a franchisee during 2021 and 1 million from restaurants closed during the past year. This decrease was partially offset by a 2.9% increase in company-operated comparable restaurant sales and 0.3 million in non-comparable restaurant sales. The increase in company operated comparable restaurant sales was comprised of an 8% increase in average check and a 4.7% decrease. During the second quarter, our effective price increase versus 2021 was 9%. Based on current economic conditions and consumer sentiment, We continue to expect approximately 9% pricing for the full year, inclusive of a 2% to 3% price increase we will be taking in mid-August. Looking ahead, third quarter to date through July 27th, system-wide comparable restaurant sales increased 2.4%, consisting of a 0.4% increase at company-owned restaurants, and a 5.5% increase at franchise restaurants, all of which reflects the traffic softness that Larry alluded to earlier. Franchise revenue was $10.1 million during the second quarter compared to $8.4 million in the prior year period. This increase was driven by a franchise comparable restaurant sales increase of 10.6% as well as the opening of five new franchise restaurants opened during or subsequent to the second quarter of 2021 and revenue generated from eight company-owned restaurants sold to an existing franchisee during 2021. This was partially offset by the closure of three franchise restaurants during the same period. Turning to expenses, food and paper costs as a percentage of company restaurant sales increased 370 basis points year over year to 29.8% due to increased commodity costs and investments in new packaging, partially offset by higher menu prices. Commodity inflation during the second quarter was approximately 21%. We continue to see significant commodity inflation and currently expect it to be approximately 24% in the third quarter. Although still elevated, we expect commodity inflation to peak in the third quarter before easing in the fourth quarter. We anticipate full year 2022 food cost inflation to be approximately 20%. Labor and related expenses as a percentage of company restaurant sales increased 150 basis points year over year to 31% due to higher wage inflation, overtime costs, and other labor-related costs, partially offset by lower workers' compensation expense. Based on the continuing labor pressure that we're experiencing, we are expecting wage inflation of 8% to 9% for the full year. During the second quarter, we incurred approximately $300,000 of COVID-related expenses, including leave of absence and overtime pay. Occupancy and other operating expenses as a percentage of company restaurant sales increased 60 basis points to 24.3% due to higher utility costs and marketplace delivery fees. Our restaurant contribution margin for the quarter was 15% compared to 20.8% in the prior year. We expect margins to be under further pressure in the third quarter as a result of softer sales and elevated inflation. General and administrative expenses decreased to 9.7 million from 10.5 million in the year-ago period, primarily due to a decrease in management bonus expense. As a percentage of total revenues, G&A decreased approximately 80 basis points to 7.8%. We recorded a provision for income taxes of 3.1 million in the second quarter of 2022 for an effective tax rate of 30%. This compares to a provision for income taxes of 3.4 million and an effective tax rate of 27.8% in the prior year second quarter. We reported gap net income of 7.1 million or 20 cents per diluted share in the second quarter compared to gap net income of 8.8 million or 24 cents per diluted share in the prior year period. Pro forma net income for the second quarter was 7.6 million or 21 cents per diluted share compared to pro forma net income of 10.7 million or $0.29 per diluted share in the second quarter of last year. For a reconciliation of pro forma net income and earnings per share to the comparable gap figures, please refer to our earnings release. Turning to liquidity. During the second quarter, as of June 27, 2022, we had $40 million of debt outstanding and $34.3 million in cash and cash equivalent. In late July, we refinanced our $150 million credit facility, extending the term out five years to July of 2027. On July 29th, we made a $20 million repayment to the credit facility, and our outstanding balance as of August 4th was reduced to $20 million. 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 three to six company-owned restaurants and six to ten franchise restaurants, the remodeling of 10 to 15 company-operated restaurants and 20 to 30 franchise restaurants, capital spending of $20 to $25 million and a pro forma income tax rate of 26.5%. This concludes our prepared remarks. We'd like to thank you, and we are now happy to answer any questions that you may have. Operator, please open the line for questions.
spk02: Thank you. Ladies and gentlemen, at this time, we will be conducting a question and answer session. If you'd like to ask a question, you may press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 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 key. Our first question comes from the line of Jake Bartlett with Truist. Please proceed with your question.
spk03: Great. Thanks for taking the question. You know, my first question was really on the trajectory of sales and You mentioned deceleration in mid-June. We've been hearing from others kind of a mid-May when gas prices were high, COVID cases were spiking. So I want to just dig into kind of the mid-June commentary. It's a little bit different. And I'm wondering whether that has to do with kind of the benefit of the beef birria ending, I think, in early, the promotion ending in early June. Just help us understand kind of the trajectory of of the same source sales. And then I had a follow-up question to that.
spk04: Yeah. Thanks, Jake. I think you kind of hit on one of the things I think that delayed the softness we were seeing. Again, as we look through Q2, got off to a very strong start with beef birria, contingency, good momentum with that product. And so for us, we really didn't, see a noticeable, I'll say, softening, especially relative to our internal forecast, until that mid-June timeframe. And that's when we really started to see a softening in the dinner business as being what we thought was the primary driver of that softness. So I do think the beef birria promotion may have been something that delayed the onset of the softness in our business, because birria was selling both at lunch and dinner. Uh, it, it, you know, it skewed more lunch, but it was still a pretty big dinner product. So it wasn't until that was winding down. And then, um, you know, we saw the sauce as a dinner that, uh, led to the softening that we highlighted around mid June.
spk03: Got it. And then, you know, my, my next question is just on the consumer and, you know, how you're positioned. Um, you know, maybe if you could remind us what your kind of, you know, average income consumer is, um, it may be confirmed that the weakness that you saw was really, you know, specifically from that lower income consumer that, that seems to be feeling the most pressure right now. And I guess all related to that question, you know, just bigger picture, how you feel, you know, El Pollo Loco is positioned if this current situation worsens. How do you feel about your value positioning now versus, you know, the great recession? I don't have the data going back that far, but maybe you could help me, um, I understand how you did then, but how it might be different now. That would be helpful.
spk04: Sure. Yeah, so when we look at our consumer base, we have roughly somewhere around 45% of consumers. I think consumers are actually households. So 45% of our consumers live in households with income of $50,000 or less. So somewhat similar to QSRs, but certainly highlights that we have a good portion of our consumer base that would be called a lower income consumer. consumer base. And so, again, I think that's one of the reasons why we think we saw the drop off of dinner, not necessarily because of our pricing at dinner. It's just, you know, dinner eating out is a big ticket item. And so we think our consumers, especially lower income consumers, have pulled back on that. You know, the other thing I highlight, again, I mentioned it on the opening remarks, is, you know, we haven't advertised family meals and certainly have price point at family meals since the beginning of the year. Really, end of last year was the last time we did that. So I think not being out there with a message around family meals and a price point around family meals was also a contributor to the value piece. Now, looking forward, like I highlighted in the call, we're going to do the $24 family feast. We're working on the combo meal starting at $5. So we see those as great avenues to highlight the value that that we provide. The other piece on the value equation that we've made huge progress on, and we actually see it in some of the consumer data that we're pulling, is as we've really improved our company operations, we've seen the value metrics improve. So it's not just the experience metrics that consumers come back with, it's when we look at the value scores, We're seeing they're actually improving fairly significantly on the company side, which, of course, then drives the entire system. So part of the value equation is to continue making that progress in operations that we've made and keep getting better and better because, in the end, that is a key component of value to consumers. Now, the differences between now and the Great Recession – Yeah, they're huge. I mean, if you go back to where Apoyo Local was back in 2009, 2010, the entree side of the business was a much bigger part, was a smaller part of the business. A lot of value things didn't even exist. So since that time, we've really upgraded and enhanced, and a bigger part of our business comes from the entree side of the business, the burritos, tostadas, salads, and those things. And those are... value offerings that we have that we didn't have back then. So I do think, you know, it's going to be a situation at least over the next several quarters where we're going to have to continue developing ways to reach out to those really value conscious, value conscious, they're really price conscious consumers with really strong price points that not only will drive transactions, but, you know, maintain the margins. And I think we have a lot of levers to do that with. And we're continuing to dig through other things. We've got research going on right now that will be done over the next couple weeks that hopefully will also get us even more targeted on things we can do to really drive that value equation for our consumers.
spk03: Great. That's really helpful. And then my other question was on your food costs and the inflation that you're seeing. And if I heard correctly, it went from 21% in the second quarter to, you expect, 24% in the third. In my notes, I believe back in January, you talked about having 80% of your chicken prices locked in, for instance. So what are the big moving pieces that have driven the inflation so much higher and continues to drive it higher? I think when I look at the spot markets for a lot of these commodities, I'm seeing items coming off their peaks. So that's one question. And then as you look into 2023, you know, it looks like you could have a pretty material deflation as you left this incredible inflation that you're seeing now. You know, is there any reason to think that wouldn't be the case? And maybe as you think about that 80% of the chicken that was locked in at the beginning of the year, was that a price that's lower than the spot price now? I mean, you have kind of visibility in that chicken piece to make us feel like, you know, maybe you could see some material deflation next year.
spk04: Yeah, Jake, first of all, I mean, just to, and I'm sorry if I confused you on a previous call, when we were talking about what was locked in is that 80% of our chicken on a bone was locked in. Right. So probably somewhere around 30% or so of our chicken business is a non chicken on a bone, you know, it's boneless breast, boneless thigh meat. And those were always floating. So we had a portion of chicken on a bone that was floating. And then we had all of our non chicken on a bone that was floating. So that, That's why you see higher inflation on the chicken as we move through because, you know, those pieces were not locked in. You know, having said that, you know, we are right now starting to see some movement on some of these things. And it's really week to week. I mean, it is – really week to week around, you know, seeing some improvement around, it's still on chicken, the boneless chicken especially, but just recently starting to see some around, you know, avocados, some of the produce, some of the other things that we're starting to see. I just, you know, we haven't banked on it yet, but we are starting to see a little improvement there. And again, we really do expect to start seeing some more of that in the fourth quarter and And then going into next year, I think it's very difficult to predict in this current economic situation for sure what's going to happen next year. But we certainly would expect commodity inflation to be quite a bit less than this year. Could we get to deflation? I'm not sure. I think chicken on the bone will be the variable that we determine that. because we do have chicken on the bone, the 80% that is locked in, at pretty favorable costs relative to market costs right now. But again, these markets are moving very, very fast, so we will see as we enter into our chicken on the bone negotiations, which is starting right about now or in a couple weeks, to see where we come out on that. If we get favorable chicken on the bone pricing as we head into next year, then there certainly would be potential for deflation.
spk03: Great. I appreciate it. Thank you so much.
spk02: Our next question comes from the line of David Tarantino with Robert W. Baird. Please proceed with your question.
spk00: Hi. Good afternoon. A couple of questions related to the margins, and then I've got one on unit development as well. So first on the margin, I think, Ira, you mentioned the potential for increased pressure on the margins in the second half of the year, and I was wondering if you could perhaps elaborate on what your comment was intended to mean. Do you mean that margin on an absolute basis could be less than what we saw in the second quarter, or the year-over-year change is going to be different? I guess anything you can do to maybe help how you're thinking about the margin.
spk04: Yeah, David, I'll jump on that one. Yeah, that commentary was really around what we're seeing in the third quarter with the little deceleration in sales and a higher cost inflation. We would anticipate margins to come in under where we were in Q2. Now, again, that was the outlook for Q3. As we look to Q4, then we would start looking to see margins improving based on lower commodity inflation. the idea that we'll really get the overtime and other labor costs under control. Because, again, I don't want to digress too much, but when we looked at second quarter and even the third quarter, our number one priority has really been around getting the restaurant staff, making the investment we need to do to get applicant flow, hire new people, train new people. Our expectation is as we get into the fourth quarter, those hours will start coming back in line to where we've traditionally been you know, even pre-COVID. So that will be another positive on the margin side as we get into the fourth quarter. And then, again, we'll be looking at the pricing that we take in August here in a couple weeks and potentially looking at another price increase as we move through later in the year. So the expectation would be the third quarter with the highest inflation will probably be, you know, below Q2 in terms of margins. But then we would look to start rebounding and rebound in Q4. on the margin side.
spk00: And Larry, is there a certain long term margin that you think is a reasonable target that you want to get to? I know we've had all this inflation, but you know, let's assume that some of it sticks, I guess. Where do you want to ideally operate longer term?
spk04: Well, I think, as I said in the last call, David, I'm looking to get back, and I was saying, I always like to set rather than a super long-term goal, you know, okay, what would you expect over the next year, year and a half or so, you know, as we get into 2023, and just given the current situation, who knows what's going to happen, but I'd be looking to get into the, you know, call it the higher teens on the margin side, and then go from there to try to get back up to 20% over the longer term.
spk00: Got it. Okay. Thank you for that. And then My question on the unit development, you mentioned, you know, converting some of the pipeline into signed agreements. And I was wondering if you could elaborate on, you know, the scale of those agreements and, you know, what type of, you know, number of units, for example, are sort of in process in some of those contracts.
spk04: Oh, David, I don't want to get too far out in front of ourselves on that. But, you know, the ones that we're progressing through and the people we're talking to, I will tell you, tend to be multi-unit franchisees, you know, fairly good-sized businesses looking to do, I'll call it, you know, size development agreements. So they'll be somewhere, you know, five, ten, maybe more than ten restaurants over a period of time. I'll just highlight a few facts. Because of the investments we've made on the franchising efforts, our applicant flow, or I would call it people who have initiated discussions with us or at least shown an interest, we're above where we were for the full year of 2011. So we've had more inquiries this year so far this year than we did all of last year. And, of course, you know, those are just inquiries, and you have to work your way down to find out, okay, which ones are really viable, and you do a lot of work on that. So with that, though, we have seen a larger number of people in the pipeline that we're talking to that we think are good prospects working through those. And, again, these prospects tend to be, you know, larger, you know, franchise organizations that can step up and do, you know, a number of restaurants, you know, whether it's five, 10 or somewhere in that range. But again, you know, probably the, you know, one of the bigger focuses we've had this year has been on that and feel good about the progress we're making. Great. Thank you very much.
spk02: As a reminder, it is star one to ask a question. There are no further questions at this time. I'd like to hand it back to Larry Roberts for closing remarks.
spk04: Okay. Well, I just want to thank everybody for joining the call today. And, you know, as we highlighted, we have some headwinds we're dealing with in the near term. You know, we feel great about the progress we're making on our strategic initiatives. And, you know, we're very, very excited about the prospects for Apoyo Loco, you know, as we move through the balance of this year and into next year. So, again, thank everybody for joining us.
spk02: Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.
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