Portillo's Inc. Q2 FY2023 Earnings Call

Greetings, and welcome to the Portillo's Second Quarter 2023 Earnings Conference Call. All participants are currently in a listen-only mode. This conference is being recorded. It is now my pleasure to introduce your host, Barbara Noverini, Portillo's Director of Investor Relations. Thank you. Please go ahead.

Thank you, operator. Good morning, everyone, and welcome to our fiscal second quarter 2023 earnings call. You can read through the results we announced this morning in our earnings press release and supplemental presentation at investors.portillos.com. With me on the call today is Michael Osanloo, President and Chief Executive Officer; and Michelle Hook, Chief Financial Officer. Let's begin with a reminder that any commentary made during this call about our future financial results and business conditions constitute forward-looking statements, which are based on management's current business and market expectations and are not guarantees of future performance. We do not undertake to update these forward-looking statements unless required by law. Our annual report on Form 10-K and our Form 10-Q, both include discussions of risk factors that may cause our actual results to vary materially from these forward-looking statements. Today's earnings call should not be considered as an alternative to GAAP measures. We direct you to the materials we released this morning for the reconciliations of these non-GAAP measures to the most comparable GAAP measures. Finally, after we deliver our prepared remarks, we will open the lines for your questions. Now let me turn the call over to Michael Osanloo, President and Chief Executive Officer.

Thank you, Barb, and good morning, everyone. We're pleased to have you join us for our second quarter 2023 earnings call. I'm proud to announce that we achieved another quarter of double-digit growth in both revenue and restaurant-level EBITDA, demonstrating the strength of our brand. Total sales grew by 12.3%, and we achieved restaurant-level margins of 25.3%. This level of profitability was achieved even as we opened six new restaurants since Q2 of 2022. Michelle will provide more detail on our financial performance shortly. First, I want to highlight the key factors driving our momentum. We're excited about our class of 22 restaurants and their significant contribution to our financial results. Although it’s still early, this group has exceeded our expectations. We've discussed The Colony frequently, and year-to-date, it has generated over $8.5 million in sales. This figure represents year-to-date results, not an annualized amount, and it's bringing joy to many Texans. Tucson and Gilbert are already demonstrating average weekly sales on par with our established Arizona restaurants, and Schererville, Indiana is performing well with Chicago-like average unit volumes. To maintain this positive trajectory, we prioritize quality and execution to ensure exceptional experiences for both our team members and guests. New restaurants typically have lower margins at the outset due to our investment in resources to ensure excellent performance. However, it’s encouraging that the margin impact from the class of 22 has been less severe than we anticipated, reflecting both their operational strength and their top-line sales performance. This leads me to my next point: our core business's strength grants us the ability to grow. In the second quarter, same-restaurant sales rose by 5.9%. Michelle will break down this performance for you soon. In an economic climate that has been unpredictable, we achieved mid-single-digit comps against our long-term growth target of low single digits. Our restaurants are fully staffed, and we empower our team members to focus on providing a great guest experience through high-quality food in a welcoming environment at a good price. This dedication has allowed us to maintain multiyear highs in important guest experience metrics such as service speed, accuracy, overall satisfaction, and value perception. These metrics become even more essential when consumers are cautious about spending, as guests tend to be more selective where they choose to spend their money during tighter economic times. We believe that providing a consistently excellent experience for our team members, which in turn enhances the experience for guests, positions us well to succeed amid economic fluctuations. Lastly, in this quarter, we observed an ongoing improvement in restaurant-level margins. We have implemented two strategic initiatives to sustain this progress. First, we are actively managing our exposure to commodity prices, securing rates when advantageous while allowing the remaining prices to fluctuate. We expect some margin benefits from the unlocked portions of our commodity basket as inflation continues to ease. Second, we are pursuing labor efficiencies throughout the system, demonstrated by our Kitchen 23 initiative. We have completed a third of our planned Kitchen 23 conversions this year, which involve quick and low-cost remodels of older restaurants in the Chicagoland area. These remodels include relocating salad bowls, introducing grab-and-go retail displays, and implementing self-service fountain drinks. These updates are creating genuine operational efficiencies and helping us achieve our margin improvement goals for 2023. However, Kitchen 23 is not solely focused on cost savings; we are also seeing increased beverage and product sales from improved merchandising, and the restaurants are visually enhanced. This initiative is performing as we anticipated, and more restaurants will receive these updates in ongoing renovations and in new builds for the class of 23. It's important to note that Q2 is usually our highest margin quarter seasonally, but we have some margin pressures ahead. We have recently enacted our annual wage increases, and the second half of the year will see a significant number of new restaurant openings. Nevertheless, we are committed to improving margins year-over-year for the entirety of 2023. Now, let’s discuss the new restaurants slated for the class of 23. As a reminder, we've announced plans to open three new locations in the Dallas-Fort Worth area, three in Chicagoland—including our second Portillo's pickup in Rosemont, Illinois, one in Arizona, and one in Central Florida. Most of the class of 23 will be located in the Sunbelt as we continue to expand in markets to achieve efficient scale. For instance, Queen Creek in Arizona represents our sixth location in the Phoenix metropolitan area. We recently announced Clermont, which further develops the Central Florida market. Expanding in the DFW market remains a key priority, and we are actively constructing in Allen and Arlington, which we will showcase during Development Day on September 19. We will also be adding one more location in Fort Worth to complete the class of 23. These eight restaurants are currently in progress, and we are pleased with this momentum. We plan to open two restaurants in Q3 and the remaining ones in Q4. Additionally, we have a ninth restaurant in the 2023 pipeline, but we intend to pace its opening into the first quarter of 2024, as operating conditions are not ideal for new openings during our busiest seasonal period. This strategy proved successful for us with The Colony earlier this year. Overall, we are navigating an uncertain economic landscape while achieving profitable growth and successfully launching new restaurants. Our core performance is strong, enabling us to reinvest our cash flow to drive further growth, and importantly, all of our growth is self-funded. Now, I will turn it over to Michelle.

Great. Thank you, Michael. In Q2, we saw strong top-line revenue growth. Revenues were $169.2 million, reflecting an increase of $18.6 million or 12.3% compared to the second quarter of 2022. This increase in revenues was primarily due to the opening of new restaurants in 2022 and 2023 and an increase in our same-restaurant sales. Same-restaurant sales increased 5.9% during the second quarter, which was attributable to an increase in average check of 7.1% and a 1.2% decrease in transactions. The higher average check was driven by an approximate 9.9% increase in menu prices, partially offset by a change in mix. We are experiencing expected cannibalization from some of our recently opened restaurants. We estimate the impact this quarter to be approximately 60 to 80 basis points. As we build more locally in Illinois this year, we do expect some additional cannibalization to occur. The incrementality of the new restaurant revenue and margin is very attractive and well worth the short-term cannibalization. Total revenues are in line with our expectations, and we remain committed to delivering on our long-term growth algorithm of high single to low double-digit revenue growth. Food, beverage, and packaging costs as a percentage of revenues decreased to 33.2% in the second quarter of 2023 from 34.4% in the second quarter of 2022. This was primarily due to an increase in our revenue and lower third-party delivery commissions, partially offset by a 5.5% increase in commodity prices. We continue to expect that overall commodity inflation will ease in the back half of the year and estimate mid-single-digit commodity inflation for the full year. We have locked in pricing on 64% of our commodity basket for the remainder of fiscal 2023. Labor as a percentage of revenues increased to 25.5% in the second quarter of 2023 from 25.2% in the second quarter of 2022. This increase was primarily driven by incremental investments in our team members, including hourly rate increases, variable-based compensation, and higher labor utilization quarter-over-quarter, partially offset by the increase in our revenue. Hourly labor rates were up 4.7% in the second quarter of 2023 and up 6.5% year-to-date versus the prior year period. In the third quarter, we did make additional wage investments in our team members and remain committed to providing a compelling compensation and benefits package. We currently estimate mid-single-digit labor inflation for the full fiscal year. Other operating expenses increased $3.7 million or 24.1% in the second quarter of 2023. This was primarily due to higher credit card fees as our transition to cashless drive-thrus drove an increase in credit card transactions year-over-year, as well as an increase in repair and maintenance expenses, higher insurance and utilities expenses, and the opening of new restaurants. Occupancy expenses increased $0.9 million or 11.6%, primarily driven by the opening of new restaurants in 2022 and 2023. As a percentage of revenues, net occupancy expenses were flat to the second quarter of 2022. Restaurant-level adjusted EBITDA increased 11.3% to $42.7 million in the second quarter of 2023 from $38.4 million in the second quarter of 2022. Restaurant-level adjusted EBITDA margins were 25.3% in the second quarter of 2023 compared to 25.5% in the second quarter of 2022. Restaurant-level adjusted EBITDA margin continued to improve since the fourth quarter of 2022. This improvement is on top of opening four new restaurants in the first two quarters of 2023, which all have a lower margin profile at the start. Our strategic pricing actions have been a very large factor in this margin improvement, combined with our continued focus on the guest experience and operational efficiencies. We do anticipate restaurant-level adjusted EBITDA margins to be pressured by the aforementioned wage investments and our planned new restaurant openings in the back half of 2023. On pricing, as a reminder, we have taken two pricing actions this year. In January, we increased menu prices by approximately 2%. At the beginning of May, we increased menu prices by approximately 3%. These increases continue to combat inflationary cost pressures and progress towards our goal to improve restaurant-level adjusted EBITDA margins for fiscal 2023. We still believe we have pricing power we can use if necessary. We will continue to monitor the current environment and remain flexible and strategic in our pricing approach moving forward. Our focus remains providing a great value for our guests. Our G&A expenses increased $4.2 million to 11.6% in the second quarter of 2023 from 10.3% in the second quarter of 2022. This increase was primarily driven by higher variable-based compensation, an increase in wages and related costs, and higher professional and licensing fees. We are currently estimating to be at the high end of our targeted $72 million to $77 million range for the full fiscal year. Preopening expenses decreased $0.1 million to 0.2% in the second quarter of 2023 from 0.3% in the second quarter of 2022. The decrease was due to the timing and geographic location of activities related to our planned new restaurant openings. All of this led to adjusted EBITDA of $29.2 million in the second quarter of 2023 versus $27.6 million in the second quarter of 2022, an increase of 5.8%. Below the EBITDA line, interest expense was $6.5 million in the second quarter of 2023, an increase of $0.4 million from the second quarter of 2022. This increase was primarily driven by the year-over-year rising interest rate environment, partially offset by the improved lending terms associated with our 2023 term loan and revolver facility. As of the end of Q2, the effective interest rate on the term loan was 8.2%. In the third quarter, we paid down $5 million on our revolver and currently have $5 million of outstanding borrowings against our $100 million revolver facility. Income tax expense was $1.5 million in the second quarter of 2023, a decrease of $0.8 million from the second quarter of 2022. Our effective tax rate for the quarter was 13.5% versus 17.9% in the second quarter of 2022. Our effective tax rate decreased versus the second quarter of 2022, primarily driven by the recording of net operating loss carryforwards, partially offset by an increase in Class A equity ownership, which increases our share of taxable income or loss. We ended the quarter with $22.5 million in cash. Our growth will continue to be self-funded by our operating cash flows and our available cash. We remain committed to delivering healthy top-line and bottom-line growth in 2023 and beyond. Thank you for your time. And with that, I'll turn it back to Michael.

Thanks, Michelle. Before we open for questions, I'd just like to reiterate how excited I am about our future. Portillo's may be a 60-year-old brand, but we're a growth company with a lot of white space. Still, we know we have to continuously earn the right to grow by delivering to each of our core constituents, our team members, our guests, and our shareholders. Looking through the lens of development, our team members gain valuable career growth as they open new restaurants for Portillo's fans across the country. It's incredibly important to open these restaurants well so that our guests find value in the amazing taste and quality of our food, the vibrant and fun experience at our restaurants, and our great prices. New restaurants that opened well ultimately strengthen our earnings power, which drives shareholder value. And then we get to do it all again over and over, compounding growth. We can't wait to share more on that with you at our Development Day in Dallas on September 19. Thank you. And with that, let's turn to Q&A. Operator, please open the line for questions.

And the first question comes from Sharon Zackfia with William Blair.

I wanted to come back to development. And I know that there is a team working on ways to kind of bring down the cost of the box. Is that anything you can share kind of the progress about, or do we have to wait until September? And then on cannibalization, is that something, Michelle, where we would expect that to ramp as the year goes on, considering the comments you made about Chicagoland? Or is the 60 to 80 basis points kind of a good level to stick out?

Yes. No, good question, Sharon. So I'll start with the question on the new restaurant prototype. So Michael mentioned Kitchen 23. So that's part of the evolution as we move towards what we're calling the restaurant of the future. And so I think in the short term, what Michael said is true, which is we're representing some Chicagoland restaurants. And then the new builds that you'll see as part of the Class of 23 will have elements of the restaurant of the future in those. And so as we've mentioned before, we do expect some efficiencies in those kitchens, both in the short term and as we move forward. And then in terms of restaurants, it's the future, which, again, is that smaller prototype we will share more with you at Development Day. So hold tight for that, and we'll share more with you then. And then from a cannibalization standpoint, I think for this year, that's a pretty good number, Sharon, because as the Chicago restaurants, the three come online as part of the Class of 23, you'll see more of that impact, I think, come later on. And so for right now, the 60 to 80 basis points is a fairly decent number to use in the near term.

And Sharon, on the cannibalization point, let me just reiterate something that I think Michelle mentioned. But it only happens really in the markets where we have some scale and density. So I think Chicagoland and a little bit in Arizona. But it's really smart cannibalization, right? The incrementality of the revenue, the incrementality of that margin is so attractive that it's well worth doing for the short-term little bump on cannibalization.

And the next question comes from the line of Andy Barish with Jefferies.

Just wanted to level set on the commentary around second half margins. If you can give us more color, I know we're expecting a move down from the highest seasonal 2Q levels. But can you contextualize that a little bit more maybe sequentially or year-over-year, Michelle?

Yes, Andy, I don't want to provide margin guidance, but I will say that the comments we made regarding COGS and labor should help you understand our expectations for margins. As Michael mentioned, we view Q2 as the peak for the year, similar to last year. Therefore, I don't anticipate achieving the highs we experienced in Q2. The wage investments we made in Q3 will have a minor impact in that quarter, with the full effects of those increases being felt in Q4 since the increases were implemented in mid-July. Consequently, the primary pressure points will arise from labor costs in the latter half of the year.

Got you. And then just wanted to circle back also on the new restaurant opening inefficiencies, which have been better than expected. Are you doing anything differently in terms of opening the restaurants? Or is it really purely that the top line is exceeding your expectations so you're able to cover some of those extra costs around opening?

Yes, the answer is yes to all of that. The Class of 22 is exceeding our expectations on the top line, and the marginal revenue flows through really well. We've implemented several changes in how we open restaurants and our new NRO processes, which help us reach steady operations more quickly. We are training smarter and more efficiently in a shorter timeframe. We are also pulling resources together more quickly because the teams are more capable of managing the restaurant independently. We have shifted away from large-scale openings to more gradual openings, which allows the team to settle in better. We are careful about activating additional channels until the restaurants are ready. For instance, in Orlando, we did not activate any off-premise channels for a year because the restaurant was performing well and needed time to stabilize. All these factors contribute to an improved margin profile early on.

And the next question comes from the line of Brian Mullan from Piper Sandler.

I was just hoping you could speak to that entree count stats that you've been disclosing, which perhaps I think you said, is a better way to think about traffic. And somewhat related to that, it sounds like from the prepared remarks, you haven't decided yet on price in terms of taking any additional pricing actions towards the balance of the year. But can you just speak to the primary considerations that are front and center in your minds right now as you do weigh any decision?

Yes, the entree count is getting very close to the combination of mix and transactions, both of which are around negative three-plus percent. As our channel shifting stabilizes, it’s likely we will focus more on the transaction mix component, as that represents the cleanest number now that we have a more standardized and stable transaction mix. I'm not concerned about that. In fact, Michelle would mention that aside from the irregularity in the first quarter, which we are almost past, we've seen some positive trends in the combination of transaction and mix over the last three quarters. So we feel reasonably good about that.

Yes. I think obviously, Brian, the macro environment is what it is. But when I look at the combination of transactions and mix and, to Michael's point, when you throw aside Q1 because we were rolling over Omicron which, as you know, in the entire industry, we saw improved transactions. We've actually seen improved combined transactions and mix going back to Q2 of last year and then going into Q2 in this year. So to Michael's point, I think we like where those trends are going. And we like the fact that when we look at the underlying metrics of the business, which Michael mentioned, guest satisfaction scores, order accuracy, speed of service, value perception, those all look really good, which for us is a leading indicator. So we feel good about the business. And then on the pricing front, yes, we have made no decisions on what we're going to do in the remainder of the year. We do know that we have about 3.4% pricing that's going to drop off at the beginning of Q4 in October. And so we have made no decisions on what we're going to do there. But, as I mentioned, we'll remain flexible in our decisions.

Yes, Michelle mentioned this earlier, Brian, and I want to emphasize it again. We are very pleased with our pricing in relation to our competition. We are achieving some of the highest guest satisfaction scores we have ever recorded. This includes metrics on overall satisfaction, speed of service, accuracy, and particularly strong scores on value perception, which is crucial. We are actively comparing our most popular bundles to those of our competitors, and in a comparison of various leading fast-casual restaurant chains, we find ourselves priced between $1 and $7 lower than their most popular bundles. Therefore, we are confident in our pricing strategy. Additionally, we believe we still possess pricing power, which I would prefer not to utilize. However, if necessary due to increases in commodity or labor costs, we are prepared to make adjustments.

And the next question comes from the line of Sara Senatore with Bank of America.

I have a couple of follow-up questions, if that's alright. First, regarding the wage investments, I want to clarify whether these were unexpected or if they were decided on more recently compared to earlier in the year. Were they part of a consistent strategy of ongoing increases, such as raises? If they were recent decisions, what led to the choice to make those labor investments? That's my first question, and I have one more after this.

Okay. Sarah, those considerations are always part of the discussion. The timing was somewhat uncertain, and it became a bit more complex to implement than in previous years. As minimum wages have continued to rise across the country, we noticed a narrowing wage gap between our long-standing veterans and newer team members. We wanted to ensure we were supporting our veterans, so we took a careful approach to allocating wage increases. Veterans who have been with us for 10, 15, or 20 years received appropriate raises, as they are typically very productive, great team members, and flexible. It's not a uniform percentage increase across the board; some employees received double-digit percentage increases, while others received low single-digit increases. It just required some time to execute and communicate to the field.

Got it. And then I just wanted to clarify what you were saying about the mix plus transactions. So both of those numbers I think were negative this quarter. To your point, 1Q is maybe exceptional in the sense that you have Omicron. But in the context of those, I guess, entree declines or however you want to characterize it, the 9.9% pricing, you talked about the relative value still being very strong. But do you see anything that would suggest that as your pricing is a little bit higher, a slight negative on transaction count also gets more negative? Just kind of trying to understand the dynamic between price and then potentially losing similar entrees.

Yes. I think Michael mentioned this, Sara. As we continue to look at our value scores, right, we continue to see those be at multiyear highs and benchmarking the bundles. And so I look at those as, do we see a sign of pushback and guest satisfaction scores, those value perception scores? We're not seeing that pushback and we monitor pricing and what other brands are doing. And there's a lot of brands too that are carrying over a decent amount of price. So I don't feel like we're out of line in terms of how we're approaching pricing from that respect. And we've talked about is we've seen the mix component, which is generally lower items per transaction, lower attachment to some of the orders. We continue to see that in the size category, I'd say, when you look at fries, cheese sauce, things of that nature. That's where we continue to see some of the impact, I would say, of the macro environment, more so than our pricing action.

I understand your concern, Sarah. I don't want to sound dismissive, but when we examine our business's underlying trends, including guest satisfaction and our execution, we feel confident. All the indicators we analyze suggest that we are on a positive path.

And the next question comes from the line of Gregory Francfort with Guggenheim.

I have a couple of lists. The first one highlights that you are planning to open around 11 or 12 restaurants this year. Can you explain how much this is impacting the margins this year compared to last year and what might be a more stable growth rate like 10%, 11%, or 12%?

Yes, I don't think we actually discuss that number, Greg. It's a great question. We have four from the Class of 22 and eight from this class, so we will have opened 12 this year, which is a very high number for us. When we open a brand-new restaurant, the first six to nine months typically show lower margins compared to a steady-state restaurant, especially when considering our overall margins. There tends to be a margin drag, but we are not experiencing it to the same degree as in the past. This improvement is due to overachieving revenue, as well as our enhanced execution in restaurant openings, support requirements, and how quickly these locations reach a steady state. We haven't quantified that number.

No. No, we have not.

And Michelle shaking her head vigorously, so don't try. But there's an undeniable margin drag with new restaurants in the first, call it, six to 12 months of their existence. But it's not as bad as we had thought.

Can you provide an update on turnover and what you're observing in the labor market? What is the most critical aspect of that?

Yes. If you compare us to black box and the competition, we're continuing to perform exceptionally well. We're likely 20 to 30 percentage points ahead of everyone else in terms of hourly performance, and another 15 to 20 percentage points better in management. There are clear hard costs associated with high turnover, such as the expenses involved in hiring new employees. However, there are even greater soft costs, like lost productivity and misalignment among staff regarding our processes and teamwork. Therefore, reducing turnover remains a vital strategy for us, as maintaining a highly engaged and satisfied workforce is a major objective, and we will keep working diligently to achieve that.

And maybe the last one for me is just, Michael, I think you're opening up another small box like Joliet, I think it's later this year. Can you talk about what you might be changing in the format? And is the square footage smaller, drive-thru, any different? Just what changes you're taking from Joliet to the new box?

The new location is in Rosemont, Illinois, just outside O'Hare, in a dining and hotel area near car service drop-offs at a large hotel. It's a great spot, and we're really excited about it. Joliet has been a fantastic success and has exceeded our expectations. However, we always seek improvement and have identified some things we didn’t like about the Joliet build. We may have overbuilt it and lacked enough space for customers who wanted to pick up food in person. So, we've made adjustments: a smaller kitchen and footprint that should cost less to build while still generating significant revenues. We're very enthusiastic about it; it's like a version 2.0 of the Portillo's pickup. I fully believe it will outperform Joliet in functionality and operational ease, and I'm confident that Version 3.0 will be even better. This could potentially lead us to a point where we can mass produce these locations.

And the next question comes from the line of Chris O'Cull with Stifel.

I had a follow-up question related to cannibalization and then a question on development strategy. And I apologize if I missed this, but is the level of cannibalization in line with the Company's projections when they selected the site?

Yes. Yes, Chris, those are in line. And we knew as we put Schererville, Indiana in place, we knew as we put Gilbert in place, there was going to be a little bit of cannibalization, and that's where we're seeing that. And which is why we've kind of introduced this concept, and we've talked about this before. But I wanted to make sure as we have three Illinois restaurants coming online later this year that you all understand that, yes, we do expect some level of cannibalization. However, to Michael's point before, the incrementality of the revenue that we're going to generate clearly is well worth that. And we're very comfortable with that, and it was absolutely expected.

I think that's a great challenge for us. I mean, here's the flip side of that. There's an undeniable benefit to our business when we achieve local scale. So getting to six, seven, eight restaurants in a metropolitan area, you just see the benefit on the bottom line. We've shared that example, particularly with Arizona, where going from two to four restaurants improve by 370 basis points.

We had 70 basis points.

Yes. In Arizona, we improved margins by 370 basis points after going from two to four restaurants. We see a clear advantage in achieving density and scale in markets. However, entering a new market presents significant operational challenges, particularly with the initial opening. We believe in minimizing risks with our investments to ensure their success. Our plan is to enter one new market each year, and this year that was Dallas. I am pleased with the performance of the Colony, which is doing exceptionally well. We have three more openings planned for the second half of the year in the Dallas-Fort Worth area, which we feel very positive about. Looking ahead, we plan to expand into Houston next year. While it's still in Texas, Houston presents unique geographical challenges and requires a different allocation of resources. Therefore, we see it as feasible to enter one or two new markets annually and achieve density quickly, which will help those restaurants meet our high internal expectations for revenue and margins as soon as possible.

Okay. And then just lastly, I think one of the benefits of having several sales channels would be the opportunity to raise menu prices in different channels. And I'm just curious if you could kind of share with us what the in-restaurant or drive-thru restaurant pricing is. I'm just wondering if you're taking more pricing maybe in catering or other channels that may be less sensitive to price?

Yes, that's a great question. When we determine our pricing, we use a variety of tiers that reflect the local market's cost structure. For example, municipalities with minimum wages around $15 or $16 an hour will have different cost structures compared to those with different wage levels, leading us to adjust our pricing accordingly. Our approach is not a uniform percentage increase; for instance, the 3% increase we implemented in May was not applied evenly across the board. Instead, we analyze each channel and item to find effective pricing opportunities. Recently, we focused on catering and third-party delivery pricing, recognizing a significant difference between our rates in these areas. We aimed to align pricing between catering and third-party delivery while excluding the in-restaurant experience from this adjustment. Our pricing strategy is thoughtful, examining the mix, channel, and product line to achieve our goals in a way that minimizes the impact on customer transactions. Does that make sense?

And the next question comes from the line of Dennis Geiger with UBS.

Michael and Michele. I want to start off with one question, higher level, and I know you spent a lot of time sort of addressing this. But Michael, if you could kind of speak a bit more to some of the learning from new openings over the last several years and how much better or more efficient those openings have been given sort of the strength of, let's call it, a reasonably new team ramping up on the brand, etc. And just how much better as you've observed it that the team has gotten and sort of maybe what that means on the go forward, just kind of adding to your confidence in the development story, even adjustments to make the story even better. Just at a high level, if there's anything extra to add as we think about that impact on the development story.

Yes, that's a great question, Dennis. I want to highlight a couple of key points that may sound obvious. Firstly, we only open new restaurants with an experienced Portillo's General Manager, which is significant. All eight restaurants we're opening this year have experienced GMs, and those we're targeting for 2024 will as well. These GMs understand how Portillo's is meant to operate. Additionally, every restaurant opening this year has an experienced assistant general manager, and 60% to 70% of other management positions are filled with seasoned Portillo's employees. This is crucial because while you can't rely on hourly team members to manage new restaurants, having experienced leadership ensures that the operations align with our culture and standards. This experienced leadership is the primary way we reduce risks when opening new locations. We have focused on building a talent pipeline over the past few years, training individuals who are eager to be promoted. We've established training programs to support this effort. Another area we've improved is our training approach for speed. In other fast casual or quick service restaurants, a busy hour might yield $2,000 to $3,000 in sales, but at Portillo's, it's not uncommon to see $6,000 to $7,000 during lunch hours. We train our teams to manage this volume and speed without becoming overwhelmed. This change has positively affected how our teams respond to busy periods, reducing burnout and stress. Furthermore, we've made significant investments in our new restaurant opening teams, enabling us to potentially open three locations simultaneously. Our NRO team has the capacity to handle over 30 openings if necessary. This investment ensures we have a top-notch team ready to open new locations efficiently before moving on to the next. These strategies greatly increase the chances of a successful opening and ensure we are operating sustainably. In the first three months, we have a prime opportunity to impress first-time guests, making it critical to execute well during this initial period.

Thank you, Michael. I appreciate it. Michelle, I'm curious if you could provide any additional insights on the overall impact of the margin pressures related to wages and the dynamics of new openings concerning expected pricing. I'm looking for a high-level overview of how your margin expectations for the full year have evolved. We can estimate some of it, but without specific numbers, is there anything you could share regarding how your perspective on margins this year compares to the previous quarter?

Yes. I think, Dennis, really, when I think about the commodity outlook, it's coming in roughly where we thought it was, right? We're still planning that mid-single digits I think as we look at labor, I mentioned still for the full year, we're expecting mid-single digits on labor inflation for the full year. So I wouldn't say there's a change in my outlook in the back half of the year at all. What I would say is we don't know what we don't know in terms of some of the outlooks on the commodities. As I mentioned, we are 64% locked in the back half of the year, but we're still floating with some items there. So we still got some exposure there. And Michael said it, too, look, we don't want to take price again this year, but we're not going to be as firm to say we're not going to because we need to have that flexibility to pull that lever as those input costs move. And so with the wage environment, I think we have a fairly good outlook on what's going to happen in the rest of the year. But there's still a little bit of unknown if markets start to move. But no, I would say there's no change to my outlook in the back half of the year versus sitting here during the first quarter discussions.

Very helpful. One more, if I may, please. You commented on the strength in the satisfaction scores across a whole bunch of metrics, which is encouraging. I think as you kind of commented on the number of items for order changing is really maybe one of the only observed changes in customer behavior. But any other behavior changes, whether it's day part, day of the week, off-premise versus on delivery. Anything else there that's changed? It's been an interesting observation. I appreciate the questions.

No. Nothing that I would call out, Dennis. I think just what I called out before is we're still seeing the lower items per transaction. And when we look at, again, Michael mentioned, when we look at the combined metric of transactions and mix, we feel comfortable with where we're at, especially when we look at the industry and we compare to black-box in our performance there versus the industry as a whole, I think we feel very good about that. So no, nothing I would call out.

I would just reiterate what Michele said, but be a little bit more specific that it does seem like channels have really stabilized over the last six months for us. So our channel mix of drive-thru inside delivery, catering, etc., has had very, very little movement over the last six months. It seems like we're at some level of new normal.

And the next question comes from the line of David Tarantino with Baird.

A couple of questions here. First, Michelle, as we think about building our models for the second half of the year, and really, I think we know what your pricing contribution would be if you didn't take any more. But what I'm really asking about here is on the traffic and mix component. Is there anything unusual to think about for the back half of the year relative to maybe the most recent quarter that we should factor in when we're making our assumptions for those metrics?

Yes, David, from a pricing perspective, we initially set a price in Q2 that was a bit higher, at 9.9%. I expect Q3 to be around 9% compared to the 9.9% we observed in Q2. Looking at the trends, excluding Q1, in Q4 of 2022, we were just over 4%, specifically 4.2%. The numbers we released today for Q2 were 3.9%, which I would describe as approximately 4%. Combined, I don't anticipate any significant changes in these trends for the second half of the year. I don't foresee the environment dramatically improving. Therefore, I don't expect a substantial shift in the trends we've been observing for those two metrics together. That's my perspective, David, and you are already aware of the pricing aspect.

Yes. Great. That's very helpful. And then Michael, just maybe a question on development. It seems like last year was extremely backloaded and you had some slippage into this year and this year again is very backloaded in terms of when the openings occur. I guess, is 2024 going to be similarly backloaded? Or I know you'd ideally like to have it a little more evenly spread across the year. So any update on the progress to getting it more even loaded? It's not enjoyable to be this backloaded, and I won't sugarcoat that. We have a significantly better pipeline for 2024 compared to this time last year for 2023 and two years ago for 2022. We're in a much stronger position regarding the deals we are actively working on and finalizing. We currently have more signed deals for 2024 than we had previously, so we're ahead of schedule. However, 2024 will still have timing challenges. We will definitely see more activity in the first half of 2024 compared to this year or 2022. Ideally, I would prefer not to open any new restaurants in November and December; I'd rather open all our new locations in the first ten periods of the year. November and December are extremely busy for us, making it more challenging to open during those months. My aim is that by 2025, we won't have to do that. While we may still have some openings in the second half of 2024, I sincerely hope it will be much better than this year.

And the next question comes from the line of Brian Harbour with Morgan Stanley.

Could you just comment on the food side, what's primarily locked? And I guess, more generally, do you think there'd be similar kind of improvement in food cost in the second half or maybe, in fact, better?

Yes, Brian. So most of what we have locked is going to be on our beef commodities and on that beef line item in the back half of the year. We have some locks on some other smaller items. But as you know, beef is 30-plus percent of our overall basket. So most of the lock is going to come in, in that form. We've taken some positions on the flat into Q1 of '24, but for the back half of the year, it's mostly on that line item. And so, as I mentioned, 64% locked for the rest of the year. And so we're feeling good about where we sit there. And when I look at the trend, as you know, Q1, our inflation on commodities was up 8.9%. We saw that taper down to 5.5% in Q2. I expect a little bit of tapering down from what we saw in Q2 in the back half of the year to get us to that mid-single digit. So I do expect a little bit of tapering in the back half versus what we saw in Q2 to get us to the mid-single digits for the full year.

Okay. Got it. Just in terms of the kind of margin impact of new stores, is there less of a drag from Chicago stores versus some of the other markets?

Yes, that's a great point. The Chicago stores have recently opened with very high revenues, and their margin profile benefits from establishing scale in the area. As a result, they launch with increased revenues and improved margins. This slight cannibalization is justifiable because the Chicago restaurants typically have less of a negative impact on margins compared to other markets.

Ladies and gentlemen, there are no further questions in the queue, and that concludes the question-and-answer session. That also concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.