El Pollo Loco Holdings, Inc. Q4 FY2023 Earnings Call

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco Fourth Quarter 2023 Earnings Conference Call. At this time, all participants have been placed in listen-only mode, and lines will be open for your questions following the presentation. Please note that this conference is being recorded today, March 7, 2024. And now I would like to turn the conference over to Ira Fils, the company's Chief Financial Officer. Please go ahead, sir.

Thank you, operator, and good afternoon. By now, everyone should have access to our fourth quarter 2023 earnings release. If not, it can be found at www.elpolloloco.com in the Investor Relations section. Before we begin our formal remarks, I need to remind everyone that our discussions today will include forward-looking statements, including statements related to our growth opportunities, strategic and operational 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 a more detailed discussion of the risks that could impact our future operating results and financial condition. We expect to file our 10-K for 2023 tomorrow and would encourage you to review that document at your earliest convenience. During today's call, we will discuss non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP, and reconciliations to comparable GAAP measures are available in our earnings release, which is available in the Investor Relations section of our website. With respect to the restaurant contribution margin outlook we will be providing on today's call, please note that we have not provided a reconciliation to the most directly comparable forward-looking 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 Interim CEO, President and COO, Maria Hollandsworth.

Thank you, Ira, and good afternoon, everyone. During the fourth quarter, we continued to make great progress in reemphasizing what makes our brand unique, our one-of-a-kind, better-for-you grilled chicken offering. As we go forward, we aim to lean into this differentiating strength through our marketing and product development, both to drive our top line growth and help us achieve the immense potential we have ahead of us. To that end, our organization is aligned around five key operational pillars. The first operational pillar, attract, hire and retain top talent, demonstrates our belief that success in the restaurant industry is highly correlated with employee engagement. This includes building a compelling employer brand with strategies aligned with our values as well as creating a culture of accountability and recognition while fostering a positive and inclusive environment. Our second operational pillar, being known for our famous fire-grilled chicken, prioritizes our focus on our key differentiators, including our fire-grilled chicken, flavors from Mexico and better-for-you positioning consistently and frequently. In late December, we reintroduced Double Pollo Fit Bowls to help make New Year resolution planning easier and more convenient. Packed with double the protein, the double Pollo Fit Bowls are a filling and nutritious choice for those craving a delicious flavorful meal. Since launch, we have seen great reception with guests typically skewing female and a little higher income. Starting in February, we began the promotion of our current tostada platform alongside the introduction of a seasonal shrimp tostada and shrimp taco available for Lent. Additionally, guests can substitute shrimp for chicken or shrimp to any on-tray for a small upcharge. We're excited to emphasize our better-for-you chicken offerings while providing a relevant seafood option during this time of year. Additionally, in late December, we launched a new menu board designed to make it easier for our guests to not only navigate our menu but also help them find new items and platforms. In addition to new items like the chicken avocado stuffed quesadilla, we also introduced chips and Queso Blanco, new Aguas Frescas flavors, and the crunchy shredded chicken taco as new add-on items. The new menu board has received positive customer feedback for appearing more modern and premium. Over time, we will continue to evolve our menu to drive more add-on items and provide everyday value for our customers. We are also making progress with our relaunched catering program that we rolled out in late September. During the fourth quarter, we expanded our marketing support on digital and social to include messaging for key catering moments to keep El Pollo Loco top of mind as a great option for group occasions. We were encouraged to see sequential improvement in catering sales from the third quarter. With a new catering menu that provides a broader offering beyond our chicken on the bone, we still believe our catering channel mix has the opportunity to grow to approximately 5% of sales over time. To further accelerate the growth of catering, we are aligning marketing resources to focus on menu innovation, driving awareness, and overall customer experience. Our third pillar, digital-centric in service of improving the customer experience, includes investing in consumer-facing technology to further differentiate our brand and reach customers for whom convenience and value are key decision factors. This includes our loyalty program, digital ordering through our website and mobile app, and our integrated delivery through a third-party service. This also includes the ability for our consumers to order on kiosks. We have been thrilled by the seamless adoption by our guests. Additionally, when coupled with a cash machine, our test restaurants have been able to allow for a more efficient servicing of our guests with less labor, especially at peak traffic periods. To that end, we remain on track to complete the rollout to all of our company-owned restaurants by mid-2024. Our fourth operational pillar is driving consistency in operations execution with the hospitality mindset through a focus on brand standards. Delivering a consistent experience across the brand starts with having the right playbook. In the quarter, we launched an updated operations manual, inclusive of a hospitality module specific to digital ordering and kiosks, and subsequent training to ensure that we have a consistent customer experience. We also believe that we can drive additional consistency through simplification and labor efficiencies, and we have several initiatives in place to drive that consistent experience and reduce or optimize labor in our restaurants. In addition to the kiosks, which I previously discussed, another labor-saving initiative comes from our salsa offering, which we divided in two phases. Late last year, we completed the simplification of our salsa lineup by introducing our salsa fresca offering and reducing our salsa count from two to one. With that behind us, our next phase is to roll out our new salsa processing equipment, which will further drive consistency of our products while also improving labor efficiency as the new equipment is both easier to use and easier to clean. We are on track to roll out the salsa equipment to all our company restaurants by mid-2024 and to franchisees by the end of the year. Lastly, we continue to test other labor-saving initiatives and look for operational efficiencies as we thoughtfully enhance our operating model. We are also aggressively exploring all areas of the P&L from COGS to R&M, utilities, and other controllable expenses. We are leveraging third-party data and really scrutinizing all costs to help offset expected incremental labor costs from upcoming legislative changes. We are doing this carefully to ensure the El Pollo Loco experience is best-in-class for our customers and consistent across our entire system. Our fifth operational pillar is to build back the fundamentals of winning economics and partner with world-class franchisees to prepare for accelerated growth. I am excited about the work we have done with our franchisees in the past few months in this area. We have put support back into franchise recruitment, new restaurant and market openings with better training materials and best practice sharing. This will ensure operational excellence as new markets open and as we grow in markets where El Pollo Loco is relatively newer and less well known to consumers. We are also very focused on improving our development capabilities from helping franchisees with better site selection to significantly cost-engineering our new builds for company and franchise units. We know that if we get the economic model right with lower build costs, combined with higher sales volumes and store level margins, the development flywheel will get going. We have initiatives in place in all of these areas and look forward to sharing more details in the quarters to come. In addition, we are excited to announce an acceleration in our remodeling efforts for both the company-owned and franchise systems to continue to enhance our restaurants and provide our customers with a more modern dining experience. We currently expect to remodel 15 to 20 company restaurants and 40 to 50 franchise restaurants in 2024. In closing, I would like to thank our El Pollo Loco team members and our franchisees for the hard work they put in every day to make this brand great. It is an exciting time to be at El Pollo Loco, and I'm thrilled to be working alongside Liz Williams, our new CEO, who starts on March 11 and the rest of the management team as we unlock our brand's long-term potential. With that, let me turn the call over to Ira for a more detailed discussion of our fourth quarter financial results.

Thank you, Maria, and good afternoon, everyone. For the fourth quarter ended December 27, 2023, total revenue decreased 3.2% to $112.2 million compared to $115.9 million in the fourth quarter of 2022. Company-operated restaurant revenue decreased 5.7% to $94 million from $99.6 million in the same period last year. The decrease in company-operated restaurant sales was primarily driven by a $5.8 million decrease in revenue from the refranchising of 80 company-operated restaurants to existing franchisees in prior quarters, as well as a 0.2% decrease in company-operated restaurant sales. This was partially offset by additional sales from restaurants opened during or subsequent to the fourth quarter of 2022. The decrease in comparable restaurant sales included a 0.4% decrease in average check size, offset by a 0.2% increase in transactions. During the fourth quarter, our effective price increase versus 2022 was approximately 6%. For 2024, we expect our pricing to be in the mid- to high single digits to help offset the impact of the April 1 California minimum wage increase. Franchise revenue increased 17% to $11 million during the fourth quarter, driven by a 1.6% increase in franchise comparable restaurant sales as well as five new franchise restaurant openings during or subsequent to the fourth quarter of 2022 and 18 refranchise restaurants I've mentioned earlier. Looking ahead, from the 2024 first quarter to date through February 28, system-wide comparable store sales increased 3.8%, consisting of a 2.2% increase in company-operated restaurants and a 4.7% increase in franchise restaurants. We are excited about the sales momentum in the business as we move past some of the underlying weather impact experienced in Q1 and feel we have created a strong marketing plan and calendar for the remainder of the year. Turning to expenses. Food and paper costs as a percentage of company restaurant sales decreased 140 basis points year-over-year to 26.9% due to higher menu prices. During the quarter, we experienced slight commodity inflation of approximately 0.7%. We expect commodity inflation to be approximately 3% for the full year 2024. Labor and related expenses as a percentage of company restaurant sales increased 40 basis points year-over-year to 32.3%. Higher menu pricing and improved labor management was more than offset by wage increases and higher workers' compensation expense during the quarter. Labor inflation during the fourth quarter was 3.6%, and we expect wage inflation between 12% and 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 increased 20 basis points year-over-year to 25.2% primarily due to higher repairs and maintenance and insurance costs, partially offset by lower utilities expense. Our restaurant contribution margin for the fourth quarter was 15.8% compared to 14.7% in the year-ago period. For both the full year '24 and the first quarter of 2024, we expect our restaurant contribution margin to be in the 15% to 16% range. As we move into 2024, we are pleased with the progress we are making in our labor improvement initiatives and we are focusing on identifying additional savings and efficiencies across the P&L as we continue to improve restaurant level margins. General and administrative expenses increased to 110 basis points year-over-year to 9.4% of total revenue. The increase for the quarter was primarily due to executive transition costs and increased other G&A expenses. During the fourth quarter, we recorded a provision for income taxes of $1.7 million for an effective tax rate of 27.7%. This compares to a provision for income taxes of $2.3 million and an effective tax rate of 26.4% in the prior year period. We reported GAAP net income of $4.4 million or $0.14 per diluted share in the fourth quarter compared to GAAP net income of $6.5 million or $0.18 per diluted share in the prior year period. Adjusted net income for the fourth quarter was $5.2 million or $0.16 per diluted share compared to adjusted net income of $6 million or $0.16 per diluted share in the fourth quarter of last year. Please refer to our earnings release for a reconciliation of non-GAAP measures. Turning to unit development. During the fourth quarter, we opened one company-operated restaurant in Las Vegas and two franchised restaurants, one in Denver and one in Utah, bringing the total to two company and three franchise openings for 2023. As we look to 2024, we are currently planning to remodel 15 to 20 company-owned restaurants and between 40 and 50 franchise restaurants. Turning to liquidity. As of December 27, 2023, we had $84 million of debt outstanding and $7.3 million in cash and cash equivalents. After the end of the quarter, the company paid down $3 million on the revolver and as of March 7, 2024, there was $81 million of debt outstanding. As we mentioned on our last call, on October 31, 2023, our Board of Directors approved a new share repurchase program with an authorization to purchase up to $20 million of common stock through March 31, 2025. Following our repurchase of approximately $12.6 million in December, we have $7.4 million remaining under our authorization. Finally, based on our results to date, we would like to provide the following guidance for 2024, the opening of two company-owned restaurants and five to seven franchise restaurants. Capital spending of between $25 million and $28 million and G&A expenses of between $45 million and $47 million, which includes management incentive compensation expense at 100% of target and approximately $4.5 million in stock compensation expense and an adjusted income tax 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.

The first question we have comes from Jake Bartlett of Truist Securities. Please proceed.

Hey, guys. Thanks for taking the question. This is actually Vince Sengelmann on for Jake. Just firstly, on the development guidance, I think slightly below our expectations for the system openings. Can you kind of frame your expectations for sort of your shift to more remodels? What is kind of holding you back in really accelerating development here?

From a remodel perspective, we have completed 33 franchise locations and 15 company locations, and we are experiencing strong sales momentum from these remodels. This is encouraging the franchisees to speed up their development. We're seeing a mid-single-digit sales increase from the remodels, with an average investment of just under $400,000. This significant return is a key reason we are continuing to focus on remodels. Regarding development, we are actively working to onboard more franchisees into the system. Our current position reflects our strong visibility into openings this year, which informs our guidance for 2024. We are still very much engaged in recruiting and adding more franchisees.

Hi, Vince, it's Maria. I also included that on my prepared speech, I did talk about how we have initiatives in place in all these areas. And you're going to hear more about this. Liz is actually very passionate about development. So you're going to hear more about this in the next quarters to come.

Okay. Great. That's super helpful. And then just shifting gears a bit. Just on your strategy to offset the wage increases in California, can you kind of give us an update? I think at ICR you mentioned that you're looking to your operational initiatives to offset roughly a third to a half of the impact of the wage increases. Where are you on track to meet that goal? Are there any early learnings you're getting from, let's say, testing of the new salsa processing equipment or the kiosks that you're willing to share or any update on timing of the price increases?

In terms of the kiosks, we have discovered that having the cash machine works better when the kiosk is placed on the counter. Our customers quickly learn and adapt, especially when we have multiple kiosks in the restaurants. This insight has significantly improved our efficiency in handling customer orders and has aided our team members in preparing those orders.

We are still waiting for the processors regarding the salsa. We've simplified the process from two salsas to one, and we haven't received any negative feedback from our guests, which makes us optimistic about our direction. The processors are on order, and Maria discussed the kiosks. We're also reviewing our labor management, focusing on streamlining things like in-times and out-times to improve efficiency. So far, the results have been promising, and we plan to implement these changes by April 1, coinciding with the minimum wage increase. We are confident that a portion of the impact from California's minimum wage will be balanced by our labor savings. Additionally, we have started adjusting our pricing slightly. For the year, we anticipate mid to high single-digit increases in pricing, and we will continue to adjust based on the effects of the minimum wage increase and our labor savings. Our primary aim is to maintain our profit margins while considering the potential impact of pricing changes on customer traffic.

So we will continue to look for operational efficiencies with labor all throughout the year. We also know that labor alone is not enough to drive best-in-class margins. So we're also going to do a deep dive into the rest of the P&L and look forward to sharing more of that in the upcoming quarters.

Okay. Great. And then just last one for me. Just an update on the consumer. Could you kind of help us understand your strategy and your messaging around balancing value versus your premium offering and whether you've seen any shift in the consumer environment?

I don't necessarily see a shift in the consumer environment. However, we have noticed that consumers have been under some pressure for a couple of quarters. Our average transaction amount has not increased in line with our pricing. Consumers are managing their spending in a few ways; they're opting for less expensive items and purchasing fewer items per order. We're also observing a decline in family meals. Additionally, there's been an uptick in lunch business, which tends to have a lower average spend, impacting our overall transaction amounts. While it seems that lower-income consumers are feeling some pressure, this trend isn't entirely new as we've been seeing it develop over the past few quarters.

Yeah. And for us, when we rolled out our menu boards last December, we know that our customers are looking for favorable food and also consistent value. And so we are testing ways to offer more value across our menu to meet this consumer demand. So look more for more information on this in the next quarters as well.

Awesome. Thank you very much.

Thanks, Vince.

Thank you.

The next question we have comes from Zach Riddle of William Blair. Please go ahead.

Hi, good afternoon. Just a couple of questions for you guys. I guess first off, so just looking at the P&L, the food and packaging costs seems to have come in a little bit higher than we expected in the fourth quarter. Just wondering kind of what drove that? I mean, was it bone-in chicken, boneless chicken, some other ingredients or something like that? Or just kind of what caused that cost to be a bit higher? And then secondarily, I know you just opened or recently opened your second location in Colorado. And I remember last year, the first location was performing really well right out of the gate. So I was wondering if you guys could give us an update on how the Colorado market in general is doing today and maybe how that second restaurant is performing. Thanks.

I don't believe there was a specific item that caused the unfavorable results related to commodities. There might have been a slight impact from the Carnitas promotion, but overall, our expectations for the basket in Q4 were largely met. On a positive note, we recently opened our second store in Denver, and we are thrilled with the performance of both locations. The first store, which opened over a year ago, continues to do very well, and the second store is exceeding our expectations. We are very excited about the performance of our two stores in Denver.

Great. And I guess, just as a follow-up, how should we think about the cadence and maybe number of LTOs in 2024 versus 2023?

I think in 2024, the pattern will be similar. We are reducing the number of limited-time offers from six to five this year. This is a slight adjustment because we have noticed a positive response to items like the Pollo Fit Bowls and the tostadas, with consumers returning and asking for these items after they are taken off the menu. This is why we have decided to extend the limited-time offers a bit and shift from six to five this year.

Great, thanks. That does it for me for questions.

Thank you. 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 the management team for closing remarks. Please go ahead.

Thanks again, everyone, for your interest in El Pollo Loco, and we look forward to talking to you again next quarter. Have a great evening.

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