Portillo's Inc. Q3 FY2021 Earnings Call

Good day ladies and gentlemen, and thank you for standing by. Welcome to Portillo’s Third Quarter 2021 Earnings Conference Call. At this time all participants have been placed in a listen-only mode. Please note that this conference is being recorded today, November 18, 2021. I would now like to turn the call over to your host, Mr. Fitzhugh Taylor, Managing Director at ICR. Thank you, you may begin.

Thank you, Rob. And good morning, everyone. With me on the call today is Michael Osanloo, President and Chief Executive Officer of Portillo's, Michelle Hook, the Company's Chief Financial Officer. Before we begin our formal remarks, let me remind everyone that part of our discussion today will include forward-looking statements. These statements are not guarantees of future performance and should not be unduly relied upon. We do not undertake to update these forward-looking statements unless required by law. And we refer you to today's earnings release in our SEC filings for a more detailed discussion of the risks that could impact Portillo's future operating results and financial condition. Our remarks also include non-GAAP financial measures such as adjusted EBITDA, and restaurant level adjusted EBITDA; we direct you to our earnings release issued this morning, which is available on our website for reconciliations of these non-GAAP measures to their most comparable GAAP measures. Any non-GAAP financial measures should not be considered as an alternative to GAAP measures, such as net income or operating income, or any other GAAP measure of our liquidity or financial position. Finally, after we deliver our prepared remarks, we will open the lines for your questions. Let me now turn the call over to Michael Osanloo. Michael?

Thank you, Fitzhugh. And good morning, everyone. We appreciate you all joining us for what is our inaugural quarterly earnings call as a public company. It's an incredibly exciting time for Portillo's. We are so proud of the successful completion of our IPO and we're pleased with our performance so far this year, which is reflected in the continuing improvement in guest traffic as our business is evolving into a new normal. Our teams continue to pivot in a smart, efficient way to serve our loyal guests in a safe environment. I couldn't be more pleased with our performance led by our amazing teams and their ability to successfully adjust and continue to improve. And importantly, they're doing all this while living our values of family, greatness, energy, and fun. Before I let Michelle review the quarter results in more detail. Since this is our first earnings call since our IPO, I want to take a few minutes to talk about Portillo's and just share what makes our brand so special. Our story began in 1963 when Dick Portillo invested $1,100 in a trailer in Villa Park, Illinois. The dog house, as he called it, sold hot dogs, fries, and tamales. A few years later, Dick opened his first freestanding restaurant and named it Portillo's. And that was just the beginning of this great American success story. After gradual expansion over multiple decades, Berkshire Partners acquired Portillo's in 2014 and has since accelerated our growth, adding 29 restaurants across six additional states. Most people think of Portillo's as a Chicago institution, but the reality is we've burst our seams to become a national brand, with 68 restaurants today, soon to be 69 across nine states. Even as we've grown, we've maintained that iconic status with our fans who are truly obsessed. We do this with our unique menu of unrivaled Chicago street food and all American favorites that has something craveable for everyone. We've got Italian beef sandwiches, Chicago style hot dogs, char grilled third pound burgers, fresh made salads, and much more, all at a remarkable price point. In addition to this amazing menu, I also want to stress Portillo's operational excellence across numerous order channels. We've been multichannel since before it was even a thing. While other brands have been chasing this, especially since the outset of the pandemic, this is what Portillo's has done from early on in our history. Just to give you an idea of our business, both pre-pandemic and now, our annual drive-thru sales represented $3.4 million per restaurant in 2019 and $4.9 million in the 12-months ending Q3 2021. That's just our drive-through. Our dine-in sales represented $4.4 million per restaurant in 2019 and $2.1 million in the 12-months ending Q3 2021. Although dine-in has decreased because of the pandemic, traffic remains healthy. That's in part because our restaurants are beautiful, and they're engaging. They're thoughtfully designed to handle incredible volume while still providing a memorable and differentiated experience, with each having its own locally inspired decor. And then there's delivery. We started delivery in 2017 and it accounted for about $500,000 per restaurant in 2019 and nearly $900,000 in the 12-months ending Q3 2021. Our other channels are also growing; we cater literally tons and tons of food in convenient formats that fit any occasion. I already mentioned that our fans are obsessed; people love catering Portillo's for their gatherings and events. We also have a really strong direct-shipping business that not only gives us sales but provides key insights into where there's latent demand for our business. This multichannel approach allows us to achieve best-in-class unit economics, including the highest average unit volumes in the fast casual space and adjusted EBITDA margins that put us in an elite class of restaurants. We are committed to continuing to be a world-class multichannel restaurant brand, with incredible sales from all of our channels. Switching to development. By the end of Q4, we will have added two new restaurants to the portfolio, opening location number 68 in the Indianapolis market in the City of Westfield, and location number 69 opening in about two weeks in Madison, Wisconsin. Both new locations demonstrate our strategy to open new restaurants outside of our core Chicagoland market. The Westfield location on the north side of Indy adds to an already strong presence as our fourth restaurant in Indianapolis and the seventh in the state. And the new Madison location will be a second entry to Madison, and the fourth in the state. Each of these serves a separate and distinct trade area. With these two, we will have added five new restaurants in 2021, including two new markets having opened our first which includes Orlando, Florida, and Sterling Heights, Michigan. As we move into next year and beyond, we're excited about our massive whitespace opportunity. As we've previously stated in our IPO filings with the SEC, there's potential for over 600 Portillo's restaurants throughout the country. This is obviously a long-term growth number and we plan to expand at about 10% growth annually. Our current plan is to open seven restaurants in 2022, and we're targeting to expand our presence in Florida, Arizona, Indiana, and Michigan, as well as an initial expansion into Texas. This strategy allows us to tap into our two-pronged approach to expansion; first, continuing to expand our presence in our core market across the Midwest, and second, targeting national markets across the Sunbelt for opportunistic growth. One specific new location plan for '22 that I want to highlight is what we're calling a Portillo's pickup, which will be located in Joliet, Illinois. Unlike our other restaurants, this off-premise-only spot features a smaller footprint than the traditional Portillo's and it will not have a dining room. Instead, it'll feature three drive-through lanes as well as a pickup area catering and delivery. This is the first prototype and if successful, gives us a great option to fill in mature markets. Finally, as we grow our unit count, we continue to be focused on our talent pipeline. We will continue to invest in our training programs, develop leaders and live our values of family, greatness, energy, and fun each and every day. All of these efforts are reflected and drive our financial performance. With that, I'm going to turn it over to Michelle to cover more details about our financial results.

Thank you, Michael. Before we discuss our third quarter results, let me briefly recap our recent IPO. On October 25, following the end of the quarter, we completed our IPO by issuing approximately 23.3 million shares, including approximately 3 million shares sold to our underwriters as part of the over-allotment option at an offering price of $20 per share. We received net proceeds of approximately $429.9 million after underwriting discounts and commissions and estimated offering expenses, which we used, along with cash on hand, to 1 repaying the redeemable preferred equity in full, including the redemption premium, all totaling $221.7 million; 2 repay all of the outstanding borrowings under the second lien credit agreement, including prepayment penalties, all totaling $158.1 million, and 3, purchasing LLC units or shares of Class A common stock from certain pre-IPO LLC members for $57 million. Also, in connection with the IPO in the fourth quarter, each option under the 2014 equity incentive plan that was outstanding, whether vested or unvested, was substituted for an option to purchase a number of shares of Class A common stock under the 2021 equity incentive plan, and the option holders received a cash payment in respect of their options, whether vested or unvested, in an aggregate amount of approximately $6.3 million. In addition, as a result of modifications to the terms of certain pre-IPO performance vesting awards, we will record a compensation expense based on the fair value of the modified awards. We will expect to recognize a cash compensation expense of approximately $1.3 million and a non-cash compensation expense of approximately $23.3 million each in the fourth quarter. Now turning to our results for the third quarter, revenues were $138 million, reflecting an increase of $18.3 million, or 15.3%, compared to the third quarter of 2020. This was driven by a 6.8% increase in our same-restaurant sales, combined with the opening of two new restaurants in the fourth quarter of 2020 and three new restaurants opened in the first three quarters of 2021. The same-restaurant sales increase of 6.8% was primarily driven by a 7.9% increase in average check, partially offset by a decrease in our traffic. Our higher average check was due to increases in our menu prices, the mix of items sold, and more items per order. The decrease in traffic reflected continued pressure from COVID, as we have fewer people dining in our restaurants versus pre-pandemic levels. This was partially offset by more people going through our drive-thru channels. While all dining rooms were opened during the third quarter, we continue to be subject to local mask mandates for indoor dining in many of our locations. We aim to continue to provide exceptional service to our loyal guests in a safe environment for both our team members and guests. Now returning to our cost of goods sold, the cost of goods sold excluding depreciation and amortization as a percentage of revenues increased to 32.1% from 30.6% last year, primarily due to an increase in commodity prices, specifically beef. This was offset by an increase in our average check. We, along with others in the industry, continue to navigate through disruption in our supply chain, and we continue to work hard to maintain inventory. When it comes to supply chain, we're confident in both our distribution partners and suppliers. We have outstanding relationships that we believe will allow us to continue to procure products needed and we feel extremely confident in our distribution strategy. Moving on to labor, labor as a percentage of revenues increased to 26.8% from 24.3% last year, primarily due to an increase in hourly rates, investments made in training costs, and discretionary bonuses. All these costs were partially offset by an increase in our average check. As you are all aware, the labor market is extremely tight right now and everybody is competing for talent. We've made a substantial investment in team member pay in the second quarter as part of an ongoing enhancement to our pay, benefits, training, and talent development. And we are seeing the impacts flow through in third quarter labor expenses, as our average hourly rates are up nearly 20% quarter-over-quarter. While the current labor market challenges have hindered our ability to be fully staffed, our restaurants have not had to limit service channels or hours of operation. And we are proud of our committed team members that service our guests each and every day. We remain committed to investing in our Portillo's family and as a result, would expect elevated year-over-year labor costs to continue in the near future. Even with increases in food and labor costs, we continue to produce strong margin results when you look at both the restaurant-level margins and the adjusted EBITDA margins within the quarter. Now, turning to our other operating expenses, those expenses increased $2.5 million or 19.5%, which was primarily due to the opening of five new restaurants since the third quarter of 2020. In addition to incremental costs for cleaning and utilities, as dining capacity has expanded since the third quarter of last year. All of this was combined with an increase in our direct marketing expenses, as well as repair and maintenance costs. Looking at our occupancy costs, those decreased as a percent of sales, primarily due to the year-over-year sales increase previously described and as inclusive of the opening of the five new restaurants since the third quarter of 2020. When you look at our restaurant-level adjusted EBITDA, that metric decreased 1.1% to $34.2 million, largely a result of the impact of commodity and labor inflation. We did not take any incremental pricing during the third quarter, and have increased certain prices to reflect an approximately 3% price increase in the early part of the fourth quarter, to combat both the commodity and labor headwinds we're seeing. Our G&A expenses as a percentage of revenues increased to 8.5% from 8.1% versus last year's third quarter, primarily due to higher wages, resulting from annual rate increases, filling open positions, higher training program costs for future restaurant leadership, and higher costs associated with becoming a publicly traded company. When you roll all of this off, it led to adjusted EBITDA of $24.2 million, versus a prior year of $26.4 million, a decrease of 8.4%. Now from a balance sheet perspective, as I previously mentioned, we use the proceeds from our IPO along with cash on hand to repay the redeemable preferred equity in full, repay outstanding borrowings on our Second Lien Credit Agreement, and purchase LLC units or shares of Class A common stock from certain pre-IPO numbers. After making those payments, our cash-on-hand today is over $40 million and remains healthy. Additionally, our debt has decreased by $155 million and the full balance of redeemable preferred equity has been extinguished in connection with the completion of our IPO. With that, that concludes our financial results. I'll now turn it over to Michael for closing remarks.

Thank you, Michelle. We've talked a lot about Portillo's growth. Across the landscape of fast casual and quick service restaurant chains, Portillo's really is a standout when it comes to unit economics. But there's one major component that makes our brand so special. It is our people-centric, values-driven culture. Our purpose is central to everything that we do. And we use our values of family, greatness, energy, and fun as our guiding principles. We care for and invest in our team members, and they in turn care for and invest in Portillo's. For example, when Portillo's completed its IPO last month, we awarded all restaurant managers one-time restricted stock unit grants. We know our over 500 managers work hard every single day, and I am proud that we take care of our leaders. By nurturing our connections as a family of team members, our teams are most motivated to work even harder for one another and to take amazing care of our guests. It's palpable to our guests; it's why they're obsessed. They aren't just coming to Portillo's for the craveable food at a fantastic price point; they're coming for the experience, and that's an experience that translates across the country. Thank you. Operator, back to you.

That concludes our formal remarks. As always, thank you for your interest in Portillo's. Our first question comes from Andy Barish with Jefferies. Please proceed with your question.

Hey, good morning, guys. Just a quick question, I'm trying to sort of conceptualize the near-term margin challenges and how much we should be looking at third quarter being a base, or do you expect some near-term pressures as the industry has been talking about, and then sort of seeing things reach more of an equilibrium as you move through '22. Just trying to get a sense of some near-term color on the margins there?

Yes, first, nice to hear from you, Andy, hope you're doing well. Before I turn over to Michelle, there's one thing that I think I don't want anyone to gloss over. Is that in Q3, we kind of took the full brunt of all of the commodity and wage inflation, and there was no pricing to mitigate some of that. So keep in mind, we took pricing at the very beginning of Q4. And obviously, we think that that will mitigate some of the margin pressure. But I'll let Michelle expand.

Yes, Andy. I think when you look at the pressures we're seeing in the back half of this year, we expect them to continue into the fourth quarter. And when we think about '22, as well, I don't think we see an end in sight in terms of commodity inflation. But to Michael's point, I think I mentioned the pricing action we took at the beginning of Q4, which was around 3% pricing, and we will continue to evaluate that as we look into '22 based on what that outlook continues to look like. And we'll make decisions on if we need to look at adjusting pricing further. But we know that the healthy way to grow this business is through transaction growth. But we'll continue to evaluate both those key lines of food and labor and see if we need to again adjust price as we move into '22.

And just as a follow-up on pricing. When is your typical kind of annual price increase? And how do you look at that, as you mentioned, over the next few months or so?

Yes. What we like to do, Andy, as part of our strategy is typically to be price laggards versus the rest of the industry. We carefully evaluate what the rest of fast casual and QSR is doing, and we try to make sure that we maintain an exceptionally strong value proposition. But we also feel that we have very, very sharp price points, and we have some pricing power at our disposal. We evaluate it on an ongoing basis. I don't think we live in a typical environment right now when it comes to commodity inflation. So we're treating this year as somewhat idiosyncratic, and we're looking at pricing constantly. And we're evaluating where we need to be, we're evaluating where the rest of the market is, and we're evaluating what the consumer’s appetite is.

Okay, very helpful. Thank you.

Thanks, Andy.

Our next question is from John Glass with Morgan Stanley. Please proceed with your question.

Hi, good morning. Hey, Michael, you gave some color around the drive-thru performance pre-COVID and post-COVID in the dining business. If you look through the first three quarters of 2021, how is the dining improved? And what I'm trying to get out is, is as dine-in doesn't improve, are you seeing any diminution in the drive-thru sales? Or do you think you can hold those? And you think about volumes in the future? Is that a possible state where you've got the diamond back that those elevated drive-thru levels remain relatively constant?

Yes. Great to hear from you, John, hope you're well. It's an interesting dynamic, as I think, our drive-dining used to be low 50% of our mix. And right now, it's about 32% of our mix, and it's been slow in coming back. I think there's two factors to that. I think one is that dine-in in general across America has been a little bit slow in rebounding with COVID. But also, our restaurants in Chicago, which are still under a mask mandate, have been even more affected by that. Now, the good news is that our drive-thru traffic actually remains incredibly strong and resilient. And so as our dining has slowly eked back up towards mix, it has not negatively affected our drive-thru channel. I don't know where this will stabilize; I think that there's a lot of opportunity for us, but it would be foolish of me to make a guess on how much of it is incremental versus how much of it is shifting.

Thank you for that. Can you talk about you mentioned Texas as a next year event? When you think the timing of that is, what's the city you've selected? Why did you select that city? Or was it maybe just location-based, not necessarily seam-based? How did you think about Texas?

I can't share the specific city right now, but we are extremely excited about the location we have chosen. I can't wait to discuss it with everyone because I believe this will be a flagship restaurant and a strong performer for us. This will be our first venture into Texas, and we aim for it to be a big success. It is set to open in the fourth quarter, and I will share the exact location when I can to generate excitement. Unfortunately, I can't disclose the specific city at this moment.

Got it. Thank you.

Our next question comes from Dennis Geiger with UBS. Please proceed with your question.

Great. Good morning. And thanks, folks. First, just wondering if you could share or maybe remind folks sort of what you're seeing in the most recently opened stores in some of the newer markets, Michael, perhaps highlighting though the performance of those stores on comp or profitability or other metrics relative to the rest of the system? Or just any kind of commentary you could share on how you've been feeling about those new stores in those newer markets?

Yes, I'll tell you, qualitatively, we're thrilled with them. We think that as a class, the five restaurants that we have, actually six now that we've opened up are all meeting or beating our expectations, so we feel exceptionally good about them. There's a nuance to other than just the financials; what I really love is that we opened these restaurants up 100% with values-based hires, right? We hired people who represented our values of family, greatness, energy, fun. And the experience that they are providing our guests from the get-go is exceptionally good. And so from a qualitative perspective, that thrills the heck out of me; that's setting up a restaurant for long-term success, taking great care of our teams, and great care of our guests. And Michelle can highlight for you the financials.

Yes, and Dennis, this was outlined in the S-1 as well. So when you look at the five restaurants that we've opened since third quarter 2020, they're performing above our expectations. So typically, what our expectations are in year one for a new restaurant would be around averaging $6.4 million AUVs. The restaurants, the five that I mentioned that we opened since the third quarter, are performing roughly 35% above that metric. So to Michael's point, we're extremely proud of the performance. Most of those restaurants are outside of our Chicagoland market. So our flagship restaurant in Michigan and Sterling Heights, a restaurant near Arizona, and Glendale, and then our first restaurant in Orlando, Florida. So we're proud about that performance and the fact that they're, like I mentioned, roughly 35% above what we were targeting in that year AUV.

Great, thank you. And then just a second question, just as it relates to supply chain, labor shortages, etc. Any thought there with respect to impacting openings over the next 12 months or so? It doesn't sound like, and I think, Michelle, you spoke to the strength of your relationships. But just curious if there's anything to note there as it relates to challenges opening stores over the next 12 months, or any impact on build costs, etc.? Thank you.

There was a lot in that second question of yours, Dennis. Let me break down some of the different parts. We recently opened in Westfield, Indiana, and we're set to open in two weeks in West Madison, Wisconsin. We are currently training those teams. I’m hopeful because we were pleasantly surprised by how easy it was to attract talent and hire for both locations. We are opening these restaurants fully staffed. It’s uncertain if this is a sign that the labor market is improving, but we are pleased with our capability to open these restaurants fully staffed, train the staff, and start operations. While there are some supply chain challenges, they are not negatively impacting our business or our operations. We are experiencing occasional spikes in costs that then return to normal, along with other fluctuations. The next six to nine months will require us to be very agile and responsive to these supply chain dynamics. Regarding labor, we will continue our approach, which is to offer a unique opportunity for individuals, hire based on values, and provide a lifetime of opportunity if they choose that path. I know you are aware, Dennis, but we do not pay minimum wage at any of our restaurants. We are significantly above minimum wage nationwide because we genuinely believe that our people are the foundation of our business, and we take good care of our teams.

Great. Thanks, guys. And congrats.

Thank you, Dennis.

Our next question comes from Nicole Miller with Piper Sandler. Please proceed with your question.

Thank you. Good morning. Labor costs are challenging, but if you flip it around and think about efficiency, how is labor efficiency? I think you measure that by items sold per labor hour?

Yes. First of all, hi, Nicole, nice to hear from you. You are absolutely right. It's something we take great pride in. I don't know if everyone is aware, but during the pandemic year, we did not lay off anyone; instead, we invested in our workforce. As a result, we experienced a significant increase in labor efficiency in 2020, measured by items per labor hour. While 2020 was an incredible year, I must admit that our team worked a bit too hard. The good news is that the investments we've made in our people, the support we've shown them, and the cross-training initiatives led to about a 10% improvement in items per labor hour in 2021 compared to 2019. This enhanced efficiency is definitely helping to alleviate some of the cost pressures, as our team members are working incredibly diligently. We believe that this learning experience from the COVID year will continue to benefit our team, our investors, and our organization for many years ahead.

And can you just run through where you stood on a debt-to-EBITDA ratio at the end of the quarter? And why you're comfortable with that level? And ideally, does the ratio taper as EBITDA increases? Or would you be proactively paying down debt?

Yes, Nicole, I'll comment on our post-debt structure, which after we paid off the Second Lien, the $155 million, we're roughly around a 3.5 times debt-to-EBITDA ratio. And so our expectation is, is that as we continue to grow that EBITDA line, we're naturally going to delever, but the capital structure is in a stronger position post-IPO at the end of the quarter that ratio is obviously higher, just given that the payoff of the Second Lien occurred post-Q3 as part of the IPO proceeds.

Alright, thank you so much, and good luck.

Thanks, Nicole.

Our next question is from an analyst with Bank of America. Please proceed with your question.

Hi, thank you. I have a question about labor. And then just a quick follow up on the pricing comment. The labor investments you've made were partially offset by you said lower staffing levels but also increased productivity as you were just discussing. I guess, can you talk about the extent to which not having as much staff as you would like might have hindered top line? I know you said you didn't have to close restaurants. But presumably, your lines were longer and perhaps you lost some sales from that perspective. So any insights you might have on whether that actually affected your sales? And also to the extent that there's more productivity, can you just remind me, is that some of the technology that you've invested in? Or what's been driving that in terms of systems?

Thank you for your question. We see several factors at play with our labor algorithm. Firstly, we are slightly understaffed compared to our ideal levels, about 10% less staffed throughout the third quarter. Secondly, our productivity has improved compared to historical levels during that same period. Lastly, our hourly wage in the third quarter was significantly higher than it was in the previous year. These three elements are interconnected. You are correct that being understaffed negatively impacts the guest experience and slows down service, such as drive-thrus and lines. It is reasonable to conclude that better staffing leads to improved performance, which encourages repeat visits from guests. We intend to fully staff our locations as opportunities arise because we believe that well-staffed restaurants perform better and that there is potential for growth in that area. I completely agree with your perspective on this issue.

Great, thank you. And then just on pricing, I know you talked about being really cognizant of your customer and thoughtful about it. I'd like to think about going forward, though, should I be thinking about kind of stable trends? You added some price, maybe you give some of that back in traffic. If I think about kind of the two-year, I know there are all kinds of puts in takes, but as I think about elasticity, is the right way to sort of see it as just sort of a one-to-one traffic price trade-off, or do you think you have the ability to take price and again hold more of that traffic? So we might actually see an acceleration in comp.

It's a remarkable business in that our pricing does not have the same elasticity effect as seen in other restaurant or consumer businesses. We have more inelastic demand than many might expect. A lot of the pricing is incremental. However, we need to be careful and smart about how we price. Our business is healthy when it drives transaction growth, which is hugely important to us; we want more people coming through our restaurant. Pricing is an important lever to address idiosyncratic cost increases, such as the unusual fluctuations in commodities and labor markets over the last year, which necessitate some pricing adjustments. But a healthy business is focused on driving transaction growth. The positive aspect is that we have a strong value price proposition. Our pricing is positioned after most fast casual QSRs, which means we appear favorable across the elasticity effect. We will continue to manage our value proposition while covering idiosyncratic cost increases in commodity and labor.

Thank you.

Our next question is from Alton Stump with Loop Capital. Please proceed with your question.

Great, thank you. Good morning. I just wanted to ask, investment in five was talked about a target of 25% cash on cash return by year three, but you've clearly outperformed that with your openings or last couple of years even amidst the pandemic outbreak. So it appears to be being a bit conservative, or is there some reason why we should see cash on cash returns going forward below what you have been able to do over the last couple of years?

It's great to hear from you, Alton. I have to say, your comment makes me a bit wary. We're cautiously optimistic that the performance from our recent openings aligns with our expectations for the future. As a management and leadership team, we're focusing on building restaurants that we believe have significant potential and minimal risks. That's our hope and expectation, but I wouldn't advise you to rely on it completely. Does that sound reasonable?

Yes, no, absolutely. That definitely makes sense. Thank you for that. And then just as my follow-up. It's kind of to think about building outside of which call your Chicago RAM market, of course, Indiana, Michigan, etc. If I assume that probably the average costs of those is a bit lower than your existing builds that you've done in your core market as an AUV is, of course, a bit lower was still awfully industry-leading of course, but kind of how the average returns in your core versus non-core markets are trending?

Yes, there's so much noise in that. I mean, it's a great question. The problem is, there's so much noise in answering that question. Because, yes, historically, Chicago was more expensive to build, no doubt about that. But if I'm comparing historical Chicago build to the cost today to build outside Chicago, it's kind of a wash because everything has gotten so much more expensive. So what we're spending today to build is probably what we would have spent in Chicago a couple of years ago to build. So that's why there's noise. But your intuition that as we go to places like Florida and Texas, and Arizona and Michigan and Indiana, fundamentally, the cost to build is less than it is in a dense Chicago market. And so there's a good argument to be made that we can perform from a cash return standpoint really, really well outside Chicago.

Great, thanks so much Michael. I hop back in the queue.

You bet. Nice to talk to you.

Our next question is from David Tarantino with Baird, please proceed with your question.

Hi, good morning. My first questions about staffing levels. Michael, I think you mentioned this third quarter, you're 10% below where you'd ideally like to be. And my question is, whether you're starting to see progress on narrowing that gap in the fourth quarter, and whether you've set any goals internally on getting back to fully staffed by a certain timeframe.

A great question, David. What I would guide you towards is that, the two new restaurants that we just opened up in Westfield, Indiana, and will open in two weeks in Madison, Wisconsin, those two restaurants are fully staffed. And we are all like got our fingers and toes crossed. We're pleasantly surprised and we're hoping that that's an indication of staffing in general. We are staffing up across the system in general. For us, the holidays are really a big deal. We do a ton of catering. We have a lot of seasonal staff, a lot of kids who've gone off to college and come back and want to grab a few hours. And so we are seeing some staffing improvement. But I'm not ready to declare victory or even I'm just not ready to declare that yet. I think there are certainly positives. I would say there's more positive signs than negative signs. But in no way do we feel confident to declare victory on labor.

Got it. Thanks for that. And then I had a question about how you're thinking about prototype design on a long-term basis. I mean, you've seen a very big change in the mix in your business. And I realized that may not have fully settled out yet. But to the extent you have a lot less dine-in business going forward and more drive-through and digital and delivery business, how you thinking about changing how the prototype is designed? And is there an opportunity to optimize the cost of the box when you're building out new units? So any thoughts on that would be great.

It's a great question, and I'm excited to talk about one of my favorite topics. We are focusing on where the market is heading, specifically towards a larger portion of our sales being off-premise rather than on-premise. The prototypes we are developing, including those in Glendale, Orlando, Addison, Kimball in Chicago, and Sterling Heights, are designed to enhance off-premise sales. You'll notice that these restaurants have less formal dining space, with smaller dining rooms. We're also incorporating outdoor patio areas that are highly desirable and flexible for guests. We're being intentional about creating a dedicated entrance and vestibule for third-party delivery and special access formats for off-premise orders. We have made significant improvements to our curbside pick-up system, ensuring efficiency by placing a racking system near parking spots for quick access. Additionally, in Joliet, we are developing a drive-thru only concept. At West Madison, we have introduced a third drive-thru lane, which we are considering naming a fast pass lane. This lane is designed for customers who order via the app or prefer a curbside experience, allowing them to stay in their cars while their food is brought to them. Overall, we are fully committed to aligning our efforts with consumer preferences, as more customers desire off-premise options and the need for in-restaurant dining decreases. This is reflected in the design of all our new prototypes.

Great. Thanks for the context.

You bet, David. Nice to talk to you.

Our next question is from Chris O'Cull with Stifel. Please proceed with your question.

Yes, thanks. Good morning, guys. Now that we're in mid-November, I wanted to ask about catering and large group orders. I know the holidays typically provide or bring a sizable volume. So I was just curious what kind of visibility you have at this point into how that shaping up for the year and then I had a follow-up.

Yes. The ecommerce and catering business is performing exceptionally well for us in the fourth quarter. Many may not realize that Christmas Eve is our busiest day of the year, and it requires all hands on deck. Team members from the restaurant support center help at our locations because catering is significant for us, especially in the Chicago area on Christmas Eve. Our ecommerce business also sees a substantial increase during this time. While I can't provide specific forward-looking guidance, I can say that the last few weeks have shown remarkable strength in our catering business, with significantly positive comparisons to last year. I'm hesitant to share exact figures as I don't want to set expectations, but we feel very positive about our catering performance right now. We're cautiously optimistic and believe we will see a nice improvement compared to last year.

Great. And then can you speak a little bit more about the third order ahead drive-through lanes that's being tested? I'm just wondering how that's being received by consumers. And if you think that's a format, or I guess a design change that you'd look to implement going forward?

Yes, just to be precise, I'm sorry, if I misspoke. But it's going to be in West Madison, which opens in two weeks. So it's anybody's guess as to how it will be received by consumers? I honestly think it's going to be received really well because more and more consumers are asking for restaurant companies to be flexible in how the consumer interacts with you. And there's all kinds of almost micro channels. There's like a need for somebody who wants, if you're a mom with three screaming kids in the back, you don't want to wait in line; you've ordered ahead on the app, and you've paid, you just want to pick up your food. We have made that super easy and we're going to see how that performs in West Madison, and we'll see how that performs in Joliet when we open that up in the first quarter of '22. I think it's a very, very important learning for us. Because, if consumers continue to ask for and require these sort of nuances in how you engage with them, I think the restaurant companies that respond to that and can acquiesce to that kind of consumer demand are going to be in a better position, and I think that's us. I think we as I said in my opening remarks, we were multichannel before it was a thing. We're always going to be super responsive to what the consumer wants and how they want to interact with us. And if there's a way of making that third lane work institutionally, then heck yeah, we'll do that.

Makes sense? Thanks, guys.

Thank you.

Our next question is from Gregory Francfort with Guggenheim Securities. Please proceed with your question.

Thank you for the question. I had two just, the first one, just the pricing. I think historically, you guys have taken pricing once per year and this year, you're basically taking it twice. Can you tell me when you evaluate that and when you normally take it just as we think about next year, what might happen? Thanks.

So, Greg, it's great to hear from you. Over the past couple of years, we've been more flexible with our pricing strategy. We do plan a pricing adjustment in late Q3 or early Q4, which has become our typical annual pattern. However, in recent years, due to certain needs or inflationary pressures, we've also implemented smaller price changes in late spring or early summer. I don't want to commit to a strict timing for pricing adjustments. We assess our pricing on a weekly basis, analyzing competitor data and evaluating the impact of our current pricing. While we won't be adjusting prices that often, understanding the competitive landscape and consumer experiences is crucial. Therefore, it shouldn't be unexpected if we implement a minor price change sometime next year, especially as we monitor commodity costs and labor issues, along with any specific inflationary pockets we might encounter.

Got it? Got it. And then it seems like the two companies investor, the two sort of themes investors most focused on is on that labor, the ability to kind of staff restaurants as well as the price increase. Can you maybe talk about why you think Portillo's has greater pricing power than some of your competitors out there? Is it just the absolute level of check or kind of how you're thinking about why Portillo's is a differentiation on that ability? Thanks.

I think it starts with the fact that the average ticket per person at Portillo's is $9.60. That number is validated and has undergone SEC scrutiny, which makes it a real figure. It’s surprisingly low given the quality and abundance of our food and the experience we provide. This gives us a strong value proposition, which contributes to our strong performance and revenue per unit. We also seem to possess latent pricing power; I've observed our competitors’ pricing strategies and how aggressively they adjust prices. We tend to lag behind in pricing, both in terms of frequency and amount compared to our competition. When we do need to adjust our prices, customers seem willing to accept it, likely because they are already accustomed to rising prices elsewhere.

Thank you.

You bet, Greg. Nice talking to you.

Our next question is from Sharon Zackfia with William Blair. Please proceed with your question.

Hi, it's actually Matt Curtis on for Sharon. I have a question on your menu and evolution. You've recently done a lot of menu simplification while you were private. And I was just wondering about going forward how you think about the menu evolving in terms of new products or specific categories you may be looking to expand?

It's a great question. Yes, we have been simplifying the menu. On average, we removed about 75 items from each restaurant during the pandemic, with some locations removing as many as 150 to 200 items. We have taken out some menu items and significantly improved others. We continuously evaluate our menu to see what sells and what guests like. If something sells but isn't well-received, we work hard to enhance it. For example, we've improved our Caesar salads; we previously had a cold chicken that wasn't very good, and I was embarrassed by it. We've drastically improved the quality of the chicken, making the salad better overall. We've also significantly enhanced the quality of our fish sandwich. Our top priority is to ensure that every item on our menu is outstanding. We're quite stringent in this regard, searching for items that we believe don't meet our quality standards. We either improve them significantly or replace them with something better. A perfect example is our spicy chicken sandwich. We previously had a broiled chicken sandwich on a croissant that didn't meet our expectations, so we removed it and introduced the spicy chicken sandwich, which has been a hit. It has boosted our chicken category by 27% year-over-year, which is fantastic news for our guests. The chicken sandwich is unique because it features a spicy jarred jalapeño sauce, a distinctive element that sets us apart from other restaurant chains. We're not trying to be like everyone else; we want to be Portillo's. This exemplifies our commitment to menu innovation. Our culinary team is also closely examining other items on our menu. I often refer to this process as a Darwinian exercise; the strong eliminate the weak, and that's how we approach our menu.

Okay, great. And then I guess just another question on G&A, obviously, you can have the incremental public company costs for the next little while. And it also sounds like some of your investments in training and things like technology, perhaps are likely to continue. But I'm just wondering if you've talked about the company's ability to leverage G&A that is on an underlying basis going forward?

Yes, it's a good question. And I think when you look at to your point in the future quarters and years to come, we're going to have incremental public company G&A. I also mentioned in my prepared remarks, we're going to have incremental stock-based compensation expense as a result of some of the modifications and changes to our equity incentive plan. And so you're going to see that come through. And once you strip out; I'd say those two big buckets, we do expect to leverage G&A as we move forward, but it's not going to be at the expense of not investing in the training, particularly around the folks that we need to run our restaurants in the future. So we're going to continue to make investments in training our future restaurant leaders. But I can tell you that Michael and I are committed to definitely leveraging that line as we move forward when you when you pull out those two line items.

Okay, terrific. Thanks very much, and congratulations on the IPO.

Thank you.

Thank you.

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.