El Pollo Loco Holdings Inc

NASDAQ:LOCO

Earnings Call Transcript 2024-Q1

[Operator]

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco First Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded today, May 2, 2024.And now I would like to turn the conference over to Ira Fils, the company's Chief Financial Officer. Please go ahead.

[Ira Fils, executive]

Thank you, operator, and good afternoon. By now, everyone should have access to our first quarter 2024 earnings release. If not, it can be found at www.elpolloloco.com in the Investor Relations section.Before we begin our formal remarks, I need to remind everyone that our discussions today will include forward-looking statements, including statements related to our growth opportunities, strategic operating initiatives, expectations regarding sales and margins, potential changes to our product platforms, capital expenditure plans, expectations regarding kiosk rollouts, the ability of our franchisees to drive growth, expectations regarding commodity and wage inflation, remodel plans and our 2024 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 the year ended 2023 previously filed as well as our Form 10-Q for the first quarter to be filed 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 first quarter of '24 tomorrow. We 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 a substitute for results prepared in accordance with GAAP, and reconciliations to comparable GAAP measures are available in our earnings release. which is available in the Investor Relations section of our website.With respect to the restaurant contribution margin outlook we will be providing on today's call, please note that we have not provided a reconciliation to the most directly comparable forward-looking GAAP financial measure because without unreasonable efforts, we are unable to predict with reasonable certainty the amount of or timing of non-GAAP adjustments that are used to calculate income from operations and company-operated restaurant revenue on a forward-looking basis.Now I would like to turn it over to our CEO, Liz Williams.

[Elizabeth Williams, executive]

Thank you, Ira, and good afternoon, everyone. I am thrilled to be speaking with you today on my first call as El Pollo Loco's new CEO. Since I joined El Pollo Loco at the beginning of March this year, I have been busy immersing myself in the business from working the opening and closing shifts in our restaurants to marinating chicken and working the drive-thru line. I've enjoyed spending time with team members and also our franchise partners as I've gained a comprehensive understanding of our operations.The more I become ingrained in our culture, the deeper my belief is that we have a truly unique brand with significant opportunities ahead of us. What attracted me to joining El Pollo Loco and what I believe to be the strength of our brand is our delicious, freshly prepared, high-quality food and dedicated team members.My first few months at El Pollo Loco have only confirmed my excitement. Our food is cherished by our guests for taste, freshness and quality. Our signature product, our fire-grilled citrus-marinated chicken is prepared fresh daily in our restaurants for our customers. We are one of the few in the quick service restaurant category that can offer portable, craveable burritos and tacos alongside healthier options like Tostada Salads and Pollo Bowls, next to our original chicken meal.In fact, consumer research showed that El Pollo Loco leads the quick service segment in our fresh, high-quality, healthy option offerings. This is an incredible equity in our world today and was clearly demonstrated by the success of our Double Tostada LTO during the first quarter. Overall, I believe we have a tremendous opportunity to take this beloved brand to another level.In order to achieve that potential, I have focused the organization around 5 strategic pillars: first, a brand that wins to be the flavorful, affordable, better-for-you chicken leader; second, a hospitality mindset, showing up consistently and with a hospitality mindset; third, digital first, become a digital-first business in service of improving the customer experience; fourth, deliver winning unit economics; and fifth, drive unit growth again with national expansion.So let's start with our first pillar, brand that wins. To broaden our reach with new customers, we need to sharpen our brand positioning by leaning heavily into key differentiators, our citrus-marinated fire-grilled chicken with our craveable flavors from Mexico and a menu of better-for-you offerings. El Pollo Loco sits at the intersection of chicken and Mexican, 2 of the fastest-growing categories.Over the next few months, we will focus on how we drive awareness that El Pollo Loco is the flavorful, affordable, better-for-you chicken brand. We are beloved for our high quality of ingredients, for our freshness and ability to customize all for a good value and with the convenience of fast service, oftentimes through a drive-thru. We need to spend more time communicating these messages to an expanded consumer base across traditional and digital channels.We are also focused on simultaneously bringing thoughtful innovation and affordable options back to the brand. Bottom line, we have an incredible opportunity to position the brand for consistent, long-term traffic gains.Next, our second pillar, hospitality mindset. With any great brand, people are our greatest assets, and I am so impressed with the quality and commitment of our team members in our restaurants, and the positive inclusive culture we have built. As we revisit some of our standards, we are working closely with our operators and franchise partners to raise the bar and further our culture of accountability.Ultimately, our goal is to deliver speed and consistency in our operations. This starts with clear systems, process, tools and best-in-class training program. We know we have an opportunity for simplification and to continue to focus on priority labor initiatives to drive speed and to make the team member jobs easier, which will also enhance customer service.One example is the rollout of new equipment that will simplify the preparation of our freshly made salsa in the restaurant. Another example is the rollout of kiosks that enable customers to order more efficiently. I am excited with the focus and investment we are making in these 2 and other productivity areas and look forward to sharing more in the future.Quick, efficient and consistent operations are critical to driving increased frequency and traffic gains. I am confident these initiatives will help us balance the rising labor costs while also keeping a focus on preparing quality food and enhancing our overall guest experience.Digital first is our next strategic pillar, unlocking a frictionless experience in our restaurants to further differentiate our brand and reach customers for whom convenience and value are key decision factors. We have made several investments in consumer-facing technology, including our loyalty program, Loco Rewards, digital ordering through our website and mobile app and our integrated delivery through third-party.We are also investing heavily in our digital experience from digital menu boards to order confirmation boards and now with the seamless adoption of our kiosks by our guests. When combined with the cash machine, our test restaurants have consistently been able to serve our guests more efficiently with less labor, especially at peak traffic period.I'm pleased to say that we remain on track to complete the rollout of kiosks to all our company-owned restaurants later this summer, and our franchise partners are actively deploying these units as well. We are also exploring new digital technologies in the drive-thru that enhance the customer experience and further automate ordering. We look forward to sharing more in upcoming calls as our test gets underway.Next, our fourth strategic pillar is deliver winning unit economics to further improve our restaurant profitability. Nothing replaces a strong business model and the flywheels that generates with growing the business and driving development. El Pollo Loco has historically had higher store-level margins, and we are focused on getting back in that range.In addition to the focus we have with labor productivity, we are closely reviewing everything from COGS to R&M, utilities and other controllable expenses. While still early in the process, we have identified several areas of improvements. But more importantly, we are doing this methodically to ensure it does not impact our high-quality food or the guest experience.Because we are still very early in the process, we have refrained from fully incorporating the potential savings into the margin outlook, that Ira will provide. But as we have greater insight into the timing and size of the potential savings, you can expect we will update future outlook accordingly.Finally, we are pleased that the modernization of our store base through thoughtful remodeling is also showing improved sales and positive returns. In addition to welcoming our customers with an updated brand image, we are in the process of incorporating feedback from the recent remodels and further value engineering before full rollout. We remain optimistic about the continued remodeling plan for both company-owned and franchise restaurants.This leads to our last strategic pillar, driving unit growth. Partnering with world-class franchisees is key to our accelerated growth plan. I have been so impressed by the quality of our franchise system. The passion they have for the El Pollo Loco brand and the collaborative partnership that has been built over many years. Building on the work that has been done over the last few months, I would like to share our focus going forward.Our first focus is to complete the work on updating our restaurant design and lowering build costs. Our current prototype cost about $2.2 million to build. Simply put, that is too expensive to drive consistent, long-term franchise growth. To remedy this, we are currently in the process of working with multiple partners to value engineer and reduce the cost of our prototype, while also making sure the image of the restaurant conveys our future brand image.We also recently launched a new development incentive for all of our franchise partners. We are excited about the combination of reducing the build cost, improving the unit level margins with our winning economic focus, together with a meaningful development incentive. Coupled with strong sales growth, we believe this formula will reinvigorate the pipeline over time.Finally, we are also thoughtfully evaluating our market entry strategy and existing market growth plans in addition to elevating our franchise recruitment process and support for new and existing franchise partners. We have recently reorganized to provide a higher level of support and continue to resource franchise operations. These initiatives, combined with more marketing and operational focus on new markets, will help ensure as new markets open, we have more success.There is still significant work ahead of us, but I firmly believe that El Pollo Loco should be and will be a national brand over time. That said, we need to get the right building blocks in place to ensure our long-term success.Let me conclude by saying, I am optimistic about the future of El Pollo Loco and what we can accomplish with the team. I want to thank our over 4,300 team members and our franchise partners for their hard work and dedication every day. I'm thrilled to work alongside you, and I look forward to nurturing our special culture and unlocking El Pollo Loco's long-term potential.With that, let me turn the call over to Ira for a more detailed discussion of our first quarter financial results.

[Ira Fils, executive]

Thank you, Liz, and good afternoon, everyone. For the first quarter ended March 27, 2024, total revenue increased 1.4% to $116.2 million compared to $114.5 million in the first quarter of 2023. Company-operated restaurant revenue decreased 0.7% to $97.2 million from $97.9 million in the same period last year.The decrease in company-operated restaurant sales was primarily driven by a $5 million decrease in revenue from the refranchising of 18 company-operated restaurants to existing franchisees in prior quarters offset by a 3.8% increase in company-operated comparable restaurant sales and additional sales from restaurants open during or subsequent to the first quarter of 2023.The increase and comparable restaurant sales included a 2.6% increase in average check size and an approximately 1.2% increase in transactions. During the first quarter, our effective price increase versus 2023 was 6.7%. Franchise revenue increased 17.3% to $11.3 million during the first quarter, driven by a 5.9% increase in franchise comparable restaurant sales as well as 3 new franchise restaurant openings during or subsequent to the first quarter of 2023 and the 18 refranchise restaurants I've just mentioned earlier.Looking ahead, second quarter to date through April 24, 2024, system-wide comparable store sales increased 5.3%, consisting of a 3.7% increase in company-operated restaurants and a 6.3% increase in franchise restaurants. As Liz mentioned, we're pleased with the reception by consumers of our double Tostada promotion to start the second quarter and the benefit to our quarter-to-date results.Turning to expenses. Food and paper costs as a percentage of company restaurant sales decreased 110 basis points year-over-year to 26.4% due to higher menu prices. During the quarter, we experienced slight commodity inflation of approximately 2.5%. We continue to expect commodity inflation to be approximately 3% for the full year 2024.Labor and related expenses as a percentage of company restaurant sales decreased 70 basis points year-over-year to 31.5%. Higher menu prices and better operating efficiencies were partially offset by wage rate increases during the quarter. Labor inflation during the first quarter was a little over 4%, and we expect wage inflation between 12% to 14% for the full year 2024, driven by the California minimum wage increase to $20 an hour for QSR restaurants on April 1, 2024.Occupancy and other operating expenses as a percentage of company restaurant sales decreased 80 basis points year-over-year to 24.6%, primarily due to the leverage gained on the same-store sales increase, combined with the sale of lower volume restaurants to existing franchisees in the prior year.Our restaurant contribution margin for the first quarter was 17.6% compared to 15% in the year ago period. For the full year 2024, we expect our restaurant contribution margin to be in the 15.5% to 16.5% range, including the second quarter in the 16.5% to 17.5% range.As we move into 2024, we are pleased with the progress we are making in our labor improvement initiatives. And as Liz mentioned earlier, we're continuing to focus on identifying additional savings and efficiencies across the P&L as we look to continue to improve restaurant level margins.General and administrative expenses increased 50 basis points year-over-year to 10.3% of total revenue. The increase for the quarter was primarily due to restructuring costs related to certain positions in the organization and executive transition costs.During the first quarter, we recorded a provision for income taxes of $2.2 million for an effective tax rate of 27.1%. This compares to a provision for income taxes of $2 million and an effective tax rate of 28.4% in the prior year period. We reported GAAP net income of $5.9 million or $0.19 per diluted share in the first quarter compared to GAAP net income of $4.9 million or $0.13 per diluted share in the prior year period.Adjusted net income for the quarter was $6.8 million or $0.22 per diluted share compared to adjusted net income of $4.9 million or $0.14 per diluted share in the first quarter of last year. Please refer to our earnings release for a reconciliation of non-GAAP measures.In regards to [indiscernible] remodels, during the first quarter we completed 3 company-operated restaurant remodels and 11 franchise restaurant remodels.Turning to liquidity. During the first quarter, we paid down $4 million on our revolver. And as of March 27, 2024, we had $80 million of debt outstanding and $9.1 million in cash and cash equivalents. Subsequent to the end of the quarter, we paid down an additional $5 million on our revolver, resulting in $75 million of debt outstanding as of May 2, 2024.Additionally, during the first quarter, we repurchased 136,400 shares of stock for approximately $1.2 million, leaving about $6.2 million remaining under our current share repurchase authorization as of March 27, 2024.Finally, based on our results to date, we would like to provide the following guidance for 2024. The opening of 2 company-owned restaurants and 5 to 7 franchise restaurants; capital spending of $25 million to $28 million; G&A expenses of $45 million to $47 million, excluding onetime costs and an adjusted income tax rate of 27% to 28%.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.

[Operator]

[Operator Instructions] The first question we have comes from Todd Brooks of The Benchmark Company.

[Todd Brooks, analyst]

Welcome, Liz, and this release is a really nice way to kick things off. So congrats.

[Elizabeth Williams, executive]

Thank you. I agree.

[Todd Brooks, analyst]

If you go and look at the restaurant-level operating margin, you parsed a couple of things out that were drivers. You talked about higher menu prices, but you also talked about operating efficiencies. If we can look at the year-over-year increase at 260 basis points, how much are attributable to each bucket? And can you walk through the timing of pricing that you took relative to the minimum wage increase that kicked in at the beginning of April?

[Ira Fils, executive]

Yes. So Todd, a couple of things there. We -- if you roll back a little bit, we had taken price a little in preparation for minimum wage happening in April. We had taken some price back in December, and then we took additional price in -- at the end of February to really help -- that was a big part of what helped drive the operating margin improvement. The other thing is we had -- we really had good sales. I mean when you're comping up sales, we got some great leverage on the P&L.And then third, we did start some of the initiatives, the biggest one really being as we started looking at the better way to process our salsa, started a little earlier in the quarter as well. So it was a combination of all those things, as well as just kind of overall general better management of labor schedules. As we're really -- let's face it, we're really focused -- as we're looking forward into April 1, really focused on making sure we're running efficient labor.

[Elizabeth Williams, executive]

And just to look at that, I'd say it's really been an all-hands-on-deck focus across the operating team, but then all of the supporting functions. And so as we look forward, not just stopping with the improvements that we found, but also starting to look at every single line item within the P&L as well.

[Todd Brooks, analyst]

Fantastic. And then one more, and I'll jump back in queue. If you listen to other calls, there's a lot of talk about varying performance across different income cohorts. I know you've got a geographic concentration and a really good handle on your different income cohorts. Just how variable was the performance across household incomes? And what were you seeing in maybe your lowest couple of cohorts as far as trends during the quarter?

[Elizabeth Williams, executive]

Yes. Because we serve really well across cohorts, we weren't -- we didn't have an outsized effect by any of them. And we really do -- our menu has so much on it for different folks. So we have the value at the lower end, although we do see that we need to have even more value. So that's something we're working on. But then we have also -- you can get something better for you, healthy, the salad, the bowls that -- those ticket items are more expensive. So those are the $10-plus items.Although the family meals are a great example of a really good value. Although it is a high-price ticket, you're feeding lots of people with that. So again, that really spans against all the different demographics as well. So it was one of those things where I don't -- unlike maybe some other brands, I don't think we were as negatively affected by some of the trends that you're seeing. That said, we really have to stay on top of value. And like I keep saying, we're focused on it.

[Operator]

The next question we have is from Andy Barish of Jefferies.

[Andrew Barish, analyst]

Liz, welcome. I guess, I just would love to hear your impressions. I know it's not the first 100 days yet, but appreciate you laying out the strategic pillars. Just what's kind of surprised you positively, maybe an area where you kind of discovered there needs to be a little bit more work as well?

[Elizabeth Williams, executive]

Yes. I would say positively I have been blown away by just the quality and then how that quality is translating into consumers' perceptions of El Pollo Loco. When you look at the consumer research, we get so much credit for having such delicious, healthy, high quality, really great ingredients and consumers play that back to us, which is -- in QSR, that is unique. So I'm really excited by that.I think there's a huge opportunity to talk more with our consumers about customization. We really are a brand where you can customize. So I think there's huge opportunities there. But we truly have food that people feel good eating. And so I think that's just been a place that we're excited to lean into more. Also pleasantly surprised by our -- just how strong our operations are.When I look at the quality of the team members, when I dug into our turnover, we have some of the lowest turnover rates that I've seen in years. And I really just attribute -- is attributed, I think, to our culture and also our strong franchise partners as well as our corporate operations team, just a great culture. So I'm excited about all that, and I still see a ton of opportunity across the business overall.

[Andrew Barish, analyst]

Fantastic. Ira, if I could ask, and I don't mean to sort of nitpick on monthly numbers, but it looked like March was very strong, and April is still solid, but softer than the implied March numbers just from what you had given out in the fourth quarter with quarter-to-date through February, I believe. Can you give us a sense of sort of the first month in California? You guys are obviously one of the biggest exposures. Just what's going on with the consumer, how they're trading with these price increases? And where do we expect kind of pricing to be for the rest of the year when all the California increases have now been put in place?

[Ira Fils, executive]

Yes. So we took -- so yes, March was very -- obviously, March was very strong. We had a little -- if you break down Q1 back and forth, there was puts and takes from a weather standpoint across the quarter. And yes, we did get some benefit of that in March. But I think we're pretty happy with what we saw from a same-store sales standpoint in April. We did take a little more price. We -- in addition to what we were already carrying, we took a little over 1% more at the start of April. And our sales have held up pretty well. We're definitely seeing a little more check and transactions have been a little bit pressured since we've done that, but I think in an area that we're very comfortable with.And we do -- we are -- first of all, we're holding to that we believe we're going to carry for pricing for the year, mid- to high single-digits. And if you look across other players in our segment, that's what you're hearing from the other players as well, but we are monitoring that very closely as we move forth around the year.

[Operator]

The next question we have comes from Jake Bartlett of Truist Securities.

[Vincent Sengelmann, analyst]

This is Vincent Sengelmann on for Jake. Liz, welcome, and congrats on a solid first quarter. I guess one question I have is, you laid out steps to kind of put together the building blocks of accelerated development. So just curious how long do you expect that to take?

[Elizabeth Williams, executive]

Thanks for the question. We're just getting into this transformation as it regards to cost, taking cost out of the unit. I know the team was really working on it, but I think we didn't get as far as we needed to get, just quite frankly. And then when you couple that with the fact that our economic model wasn't as strong over the last 12 to 18 months, those are the 2 things you've got to have if franchise partners are going to invest.I feel comfortable that we have a plan on our economic model as we've laid out today, and I think we're headed in the right direction. So now we really have to do the work on the cost engineering of our buildings and do that very quickly. Because we don't want to wait around, we put out an incentive recently that we think is really exciting and that our franchise partners, we heard a lot of positive feedback there, just knowing that the franchise partners can get started, moving forward with development.So a long way of saying we've got a lot of work to do in the next couple of months, and then I think we can give a more clear direction on time line, but really focused on getting the development flywheel going again.

[Vincent Sengelmann, analyst]

That's helpful. And then just shifting gears a bit. We've heard some large QSRs talk about a weakening consumer environment. Promotional activity becoming more competitive. So I'm just kind of curious, you mentioned your strategy around providing value to the consumer. How do you balance that strategy of value versus a premium offering in this context? And how do you think about that in terms of your marketing strategy going forward?

[Elizabeth Williams, executive]

Right. So we really believe that you've got to have everyday value across the menu, first and foremost. So even some of those more expensive items I mentioned, like a Tostada Salad, the consumer has to really feel like they're getting a wonderful, delicious, craveable and filling meal, even though it might be on the upper end of their price band. So that's number one. But then in the sub-$10 price range, we've got to figure out how to continue to innovate there. And that's exactly what we're doing with our Burrito platform as an example.So we have in test right now some updated recipes with our -- we're known for great ingredients. We're known for our delicious burritos, but putting a twist on some of those. We have those in tests at a couple of different price points. So it's constantly looking at testing and learning so that we can launch those later this year.

[Operator]

Ladies and gentlemen, we have reached the end of today's question-and-answer session. I would now like to turn the call back over to Liz Williams for closing remarks. Please go ahead.

[Elizabeth Williams, executive]

Thank you. And I just want to thank everyone again for joining today and your interest in El Pollo Loco. We look forward to talking to you again next quarter. Have a wonderful evening.

[Operator]

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