El Pollo Loco Holdings, Inc. (LOCO) Q2 2021 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and thank you for standing by. Welcome to the El Pollo Loco's Second Quarter 2021 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode and the lines will be opened for your questions following the presentation. [Operator Instructions] Please note that this conference is being recorded today, August 5th, 2021. On the call today we have Bernard Acoca, President and Chief Executive Officer of El Pollo Loco; and Larry Roberts, Chief Financial Officer. And now I would like to turn the conference over to Larry Roberts.

Thank you operator and good afternoon. By now, everyone should have access to our second quarter 2021 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 the impact of the COVID-19 pandemic on our business and strategic actions we're taking in response as well as our marketing initiatives, cash flow expectations, capital expenditure plan, and plan for new store openings among others. These forward-looking statements are not guarantees of future performance and therefore you should not put undue reliance on them. These statements are also subject to numerous risks and uncertainties that could cause actual results to differ materially from what we currently expect. We refer you to our recent SEC filings including our Form 10-K for a more detailed discussion of the risks that could impact our future operating results and financial condition. We expect to file our 10-Q for the second quarter of 2021 tomorrow. I 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. Before I turn the call over to President and Chief Executive Officer, Bernard Acoca, I'd like to note that Bernard and I are in different locations today. Please bear with us if you experience any slight delays or minor audio quality issues. Bernard, please go ahead.

Thank you, Larry. Good afternoon everyone and thank you for joining us today. We're very pleased with the continued sales recovery in both our Los Angeles and outer market restaurants during the second quarter, culminating in a 21% increase in system-wide comparable restaurant sales. On a two-year basis which I believe captures a more complete picture of our performance coming out of this pandemic, our system-wide comparable sales grew 14.8%. As mentioned in our previous earnings call, this was a quarter in which we achieved not only our number one 1 and number two highest sales volume days in company history with our National Burrito Day and Cinco de Mayo promotions respectively, but also achieved company comparable restaurant weekly average unit volumes of over $40,000 for 18 straight weeks, further highlighting the strength we're seeing in our business. With the further relaxation of restrictions, our positive sales trajectory has continued into the third quarter. Through July 28, our third quarter-to-date system comparable sales are up 10.6% and on a two-year basis, system comparable sales have increased 14.6%. From a profitability standpoint, despite some pressure on labor and food costs, we were able to leverage our increased sales and post a strong restaurant operating profit margin of 20.8% during the quarter and pro forma earnings per share of $0.29. Looking at our sales in a bit more detail, restaurants outside of Los Angeles continued their positive sales trajectory during the second quarter. In addition, I'm especially pleased to report that our LA market has strengthened since the lockdowns were lifted. In fact the gap and system comparable sales performance between our LA and outer market restaurants improved throughout the second quarter with LA System comp sales exceeding out our markets in June by 150 basis points. You may remember that we began the second quarter with our LA restaurants operating at approximately 50% capacity increasing to 100% on June 15th in accordance with state and local law. Not surprisingly our dine-in traffic has increased at a steady pace and currently runs between 8% to 9% of transactions. This is still well below pre-COVID levels, which is one reason why we're optimistic about continued sales growth in the LA market. Helping to drive our strong sales results during the quarter were a number of marketing initiatives starting with our Tostada promotion, which demonstrated the power of a unique consumer insight to drive sales. The promotion did not include any new menu items, but instead the advertising focused on the many unique ways you can eat a Tostada with the tagline 'How Do You Tostada?' The execution of this insight was so well received that we achieved record sales of Tostadas during the promotion period and they have remained strong as we've transitioned into our next promotion, our $5 Fire-Grilled Combos. As with Tostadas, our $5 Fire-Grilled Combo promotion does not include any new products, instead our advertising continues to exploit meaningful consumer insights and targets in older Gen Z younger millennial demographic who are seeking higher quality value-meal options. Hence the tagline 'Value Yourself.' We believe that this approach will broaden our consumer base and drive incremental sales over a sustained period of time. During the quarter, we also introduced our new Thermo-To-Go packaging which was optimized to retain heat given how important our off-premise business has become and also eliminates the use of styrofoam from our brand completely. In fact the removal of styofoam from our restaurants will eliminate 21 Olympic sized swimming pools of styrofoam from the waste stream annually. We also continue to drive our off-premise business and are currently running a free delivery promotion for dispatch orders placed directly through elpolloloco.com or our app. To-date, we are seeing very positive impact from this promotion which has doubled our system dispatch sales and increased overall delivery sales to 7.7% over the past three weeks. To highlight our free delivery offer and new Thermo-To-Go packaging, we became the first national restaurant company to deliver food to customers' homes through the air via a drone-delivery service, which we have branded Air Loco. The drones are capable of delivering our food up to a two-mile radius. While a lot of work remains to be done to make drone delivery a viable everyday option, we are excited about its potential. You can learn more about Air Loco on the goairloco.com. Finally, we continue to enhance our loyalty program Loco Rewards and are extremely pleased with the progress we are making. Since the beginning of the year, we have added 330,000 members to the program for a total of $2.6 million. Equally exciting is the progress we are starting to see with transactions in the program. Through targeted offers and greater engagement with our loyalty members, loyalty transactions continue to grow 14% from the first to the second quarter with significant increases in frequency amongst our heavy and medium users. As our loyalty program continues to build momentum, we are confident that it will become an even greater driver of sales in the future. On the new unit development side, I'm very excited to announce that during the quarter, we concluded a four unit development agreement for a portion of the Denver market with an existing franchisee. This marks our first agreement in a new market and we expect more to follow. In addition, on July 1, we concluded the sale of our eight company-owned restaurants in Sacramento to an existing franchisee. The transaction included an agreement to build three additional restaurants in the market. We are encouraged that these transactions highlight the desire of our existing franchisees to grow with El Pollo Loco. With that, let me briefly discuss two challenges that we along with many other businesses are currently confronting. First, labor availability. To better navigate the current tight labor market, we've implemented several steps geared towards staffing and labor retention in our restaurants. These include increasing our recruiting resources to surface more candidates; increasing applicant flow and processing applications faster; increasing our discretionary budget in order to give pay raises to key employees in particular our ship supervisors; increasing pay if restaurants hit certain high-volume thresholds as a means of rewarding our general managers while creating the right kind of performance incentives. And also we've increased our training budget for new employees. Over the past month, these initiatives have significantly increased our number of new hires and improved retention and we've been able to avoid any significant disruptions to our business. We expect these and additional efforts will exert some pressure on our labor costs during the second half of the year. Secondly, our teams continue to work hard to ensure that our restaurants are continuously supplied with the products they need to feed our customers. While product supplies have improved transportation and logistics continue to be the biggest challenges. Through the efforts of our teams and vendors to date we have effectively managed through the supply challenges and have experienced very few product outages. While we expect supply issues to start improving in the fall, we expect higher inflation for the balance of the year as we source chicken outside of our contracts and packaging costs remain elevated. In order to contend with these inflationary pressures, coupled with our confidence in our ability to continue to command pricing power given the strengthening of our brand, we have moved up a planned price increase to start in September, our second of the year to mitigate some of these cost headwinds. Just to close out my comments about the quarter, I couldn't be more proud of what our team has accomplished. Despite labor and supply challenges, the hard work and dedication of our restaurant and support center teams have enabled us to ramp up our restaurant operations to 100% as efficiently and safely as possible, while also delivering exceptional financial results. As we look toward the back half of the year, we will continue our efforts to execute on the four pillars of our acceleration agenda to build on the momentum of our core business and further scale our brand for rapid and successful growth, especially in new geographies. As a reminder, these pillars include: one, expanding the brand by growing in new geographies in asset-light fashion with franchisees; two, supporting the brand and building the right organization for asset light growth; three, evolving the brand by continuing to digitize the business to compete and expand frictionless convenience for our customers no matter how they choose to interact with us; and four focusing the brand on our most valuable core equities and exaggerating to the -- them to the point where we really stand out in terms of what makes us so special and so unique. With that, I'd like to turn the call over to Larry to review our second quarter results in more detail.

Thanks, Bernard. Let me start with a development update. During the second quarter no new company or franchise restaurants were opened. We successfully completed two company remodels using our new L.A. Mex design in Los Angeles. Looking ahead we expect to open two to three company-owned and four to six franchise restaurants during the back half of the year. All in all, we continue to expect our capital spending for 2021 to be in the range of $20 million to $25 million. Now on to our financial results. For the second quarter ended June 30, 2021, total revenue increased 22.5% to $122 million compared to $99.6 million in the second quarter of 2020. Company-operated restaurant revenue increased 22% to $107 million compared to $87.7 million in the same period last year. The increase in company-operated restaurant sales was primarily due to a 16.4% increase in company-operated comparable restaurant sales and an increase of $2.4 million in non-comparable restaurant sales. The increase in company-operated comparable restaurant sales was comprised of a 0.4% increase in average check and a 15.9% improvement in transactions. During the quarter, our gross pricing increase versus 2020 was 3.6%. As Bernard mentioned earlier, our sales momentum has continued into the third quarter. Through July 28, third quarter system-wide comparable restaurant sales increased 10.6% consisting of a 7.2% increase at company-owned restaurants and a 13.1% increase at franchise restaurants. Franchise revenue was $8.4 million during the second quarter compared to $6.7 million in the prior year period. This increase was driven by a franchise comparable restaurant sales increase of 24.5% as well as the opening of two new franchise restaurants during or subsequent to the second quarter of 2020. This was partially offset by the closure of three franchise restaurants during the same period. Turning to expenses. Food and paper costs as a percentage of company restaurant sales held steady year-over-year at 26.1% as higher menu prices offset the impact of increased commodity costs and unfavorable sales mix. We expect commodity cost pressures to continue and now expect full-year inflation to be around 2% compared to our prior guidance of 1%. Labor and related expenses as a percentage of company restaurant sales decreased 10 basis points year-over-year to 29.5% as higher menu prices offset the impact of wage increases over time and increased labor hours resulting from higher transactions. While we have been able to manage through the tight labor market, with the steps that Bernard laid out earlier, we expect labor costs to increase during the second half of the year as a result of 4.5% to 5% wage inflation and continued investments in recruiting training and retaining restaurant team members. Occupancy and other operating expenses as a percentage of company restaurant sales, decreased 130 basis points to 23.7% as higher sales revenue offset increased maintenance spend operating cost rents and marketplace delivery fees. As a result of these cost pressures, we expect third quarter restaurant operating margins to be 250 to 300 basis points lower than the second quarter. As a reminder, our third quarter 2020 restaurant margin included the benefit of a onetime $2 million insurance reimbursement for COVID-19 related costs. General and administrative expenses held steady year-over-year at $10.5 million as higher labor-related expenses primarily due to higher bonus and stock option expenses were offset by a legal settlement that was incurred in Q2 2020. As a percent of total revenues, G&A decreased approximately 190 basis points to 8.6% as a result of higher revenues versus last year. We recorded a provision for income taxes of $3.4 million in the second quarter of 2021 for an effective tax rate of 27.8%. This compares to a provision for income taxes of $0.8 million and an effective tax rate of 12% in the prior year second quarter. We reported GAAP net income of $8.8 million or $0.24 per diluted share in the second quarter compared to GAAP net income of $5.5 million or $0.16 per diluted share in the prior year period. Pro forma net income for the quarter was $10.7 million or $0.29 per diluted share compared to pro forma net income of $6.9 million or $0.20 per diluted share in the second quarter of last year. For a reconciliation of pro forma net income and earnings per share to the comparable GAAP figures please refer to our earnings release. Before discussing our liquidity, I'd like to highlight that we are in the process of applying for employee retention credits, which are part of a CARE and American Rescue Plan Act. As we discussed on previous calls, we incurred significant costs in 2020 and Q1 2021 in order to keep our employees as safe as possible. While a lot of work remains to be done to quantify and apply for these credits, if approved they may result in a significant benefit to our results during the second half of the year. In terms of our liquidity, during the second quarter we paid down $13.8 million of debt and as of June 30 2021, we had $40 million of debt outstanding and $12.6 million in cash and cash equivalents. Lastly, due to the uncertainty surrounding the COVID-19 pandemic the company is not yet providing a financial outlook for the year ending December 29, 2021. However, we are reiterating the following limited guidance, the opening of three to five company owned restaurants and four to six franchise restaurants, remodeling of 15 company-owned restaurants and 40 franchise restaurants and pro forma income tax rate of 26.5%. This concludes our prepared remarks. We'd like to thank you again for joining us on the call today and we are now happy to answer any questions that you may have.

Thank you. [Operator Instructions] And we do have a question coming from the line of Jake Bartlett with Truist Securities. Please go ahead.

Hi, guys. It's actually Jack on for Jake. Thanks for taking the question and congrats on some strong results here. First, I just wanted to ask about current sales trends and what's really driving that. It's good to see the dine-in business coming back. But I think pre-COVID you were about 30% of your sales mix was dine-in. Do you see it getting back to that level, or you think the enhancements that you've made to your drive through and your digital platforms are -- are you really targeting something below that? And then I guess, the consumer who's coming back to dine in is that your core Hispanic consumers returning, or is some of the new consumers you've picked up during COVID?

Yes. So I think what we're seeing is the longer a market has been opened -- California was one of the last, if not the last open. Over time that dine-in business continues to get stronger and stronger. Will it return back to pre-COVID levels? Tough to say because I think some consumer behaviors have irrevocably changed given, how much they've gotten accustomed to the convenience of the off-premise side of the business. But what's interesting is that we're looking at this and it's -- while it's too early to tell, some of this dine-in business is now starting to look maybe a bit more incremental to the business than we previously had anticipated. So it's coming back albeit slowly. Will it come back to pre-COVID levels, tough to say. But right now we're just encouraged by the fact that it's a steady build.

Great. That's really helpful. And then I guess on your planned price increase in the second half do you -- would you get the details of, how much you think price you think you can take at this point, or are you still working on that?

We're still working through it. I would say, it's going to be somewhere in the range of the 2% to 3% range -- is what we're looking at. But again we still have a little work to do in terms of analyzing it and determining what the final price increase will be.

Great. Thanks. I’ll pass it along.

Thanks for the question.

Our next question comes from the line of Todd Brooks with C.L. King & Associates. Please proceed.

Hey good afternoon, and congrats on the momentum in the quarter.

Hey Todd.

Thanks Todd.

Couple quick questions. One if -- going back to that price increase question, what will you be running for price in late Q3, Q4? Do you stack the anticipated increase over what you're running right now?

Yeah. So Q3 would be -- again since we're still determining exactly the amount. These are rough numbers. But Q3 would be somewhere in the 4.5% range and then Q4 would be anywhere from -- it could be 4.5% to 5% in that range.

Okay. And then you talked about just some labor cost pressure in the back half of the year. I guess if you're looking at your inflationary cost inputs relative to the planned pricing increase. How much of the pressure you're looking to absorb? How do we think about how labor especially should be pressured in the back half of the year?

Yeah. So we're still looking at as I said in my opening remarks that the full year wage inflation number will be somewhere 4.5% to 5% range. That's just wage rates increased pay the impact that will have. But on top of that we've got the other impacts, which is around some of the things that Bernard highlighted in his section, extra training dollars some additional pay for key employees mainly shift supervisors would be the area where we think we need to boost the pay a little bit to be competitive with what's going on in the marketplace. And then as we highlighted we also have done a general manager stipend in which we're paying some extra pay to GMs who are managing our high-volume restaurants, which one is compensates them for that complexity but it also creates a great incentive for them to continue growing sales in those restaurants. So I guess I'd frame it up as you got your base wage inflation 4.5% to 5% and then you've got these additional costs in the business that we've invested in to attract and retain people.

Okay, great. And then a final one for me if I could. If you look at -- and Bernard you talked about some of your product focus activities here in the second quarter that were focused on existing products whether it was the $5 Fire-Grilled Combo or the Tostadas and finding a new way to market and make them relevant within the period. As you look to the second half, I mean, I guess, if we can talk about potential menu newness or new platforms that you're excited about. Or are you finding efficiencies with messaging against the existing menu that you feel like you can drive the same type of traffic lifts if you're successful on how you promote them and jump the awareness on them? Thanks.

Yeah, Todd. Yeah. So it's always a balance right? I think in the case of Tostada and $5 Combos, we were a bit deliberate in why we chose those. Well, I'd say it's a dual purpose. two reasons. One, we -- again as I mentioned in my opening comments through consumer research identified ways to present these in a fresh new way as being even more relevant to the customers that we're going after. That's one. But two we actually wanted to clear the decks a little bit for a period of time. In this case 16 straight weeks for our franchisees and our company operators because we saw where labor was going. We saw how challenging the environment was going to be. And so what we didn't want to do was add any more additional complexity in regards to training, new SKU what have you during a ready -- what is already a trying period of time for the entire restaurant industry. I think we have fared far better than most. Hence you see it in our sales. And I think relatively minimal disruption to our business. And so I think it was a smart move in that regard. Now with that being said, looking to the fall being a little bit more bullish and optimistic that the macro environment is going to improve a bit. We're turning back to new product news for the balance of the year. And so I'm extremely excited about what we have in the pipeline and can't wait to be very candid with you to launch some very exciting products starting in this September.

That's great. Super helpful. And it makes a ton of sense with the labor challenges for why you focused on that, so thank you and continued good luck.

Thanks Todd.

Our next question comes from the line of Drew North with Baird. Please proceed.

Great. Thanks for taking the question. I wanted to ask about the recent sales momentum in a slightly different way to see if we can get some perspective there. Wondering if management thinks that what you're seeing today in July or in Q3 is a new run rate for the business in terms of the absolute volumes, or if it's depressed in any way due to the pandemic or inflated I guess by any macro or company specific factors. Any perspective from a high level that you could provide would be helpful as we think about the second half?

Yeah. I mean I think that's why we're really focusing in on our two-year comps and how strong those have been is to, kind of, maybe take out some of the noise from last year. I think we're very bullish on our sales momentum and the growth drivers we have in place to continue to sustain strong positive same-store sales growth for the balance of the year. We're growing this business through transactions. The nice thing is even though we had huge check lift last year, we're still seeing check growth albeit not what we used to see. But we're really encouraged by the trends the sales trends that we've been seeing particularly on a two-year front. And so that coupled with what I just mentioned in terms of really marketing working in conjunction with our franchisees and our company operating team to drive these strong results. There's been a lot of nice growth levers in the business. I mentioned in my opening comments around what we're seeing with the strength of delivery, which we believe is incremental. What we're seeing with loyalty. And last year and in the last earnings call I talked pretty consistently about how our loyalty program is doing a very nice job of driving incremental average check compared to people who weren't enrolled in our loyalty program. The thing that we're starting to see now to complement that is incremental frequency of visitation or transactions. And that's super encouraging because that was something that was alluding us a bit in 2020. We think the noise naturally of what was going on with COVID made that hard to achieve. But now that the momentum in our business has returned that higher average check lift and now starting to see this increase in frequency of visitation with the loyalty program gives us a lot of optimism. So I think we can continue to deliver very strong sales growth for the balance of the year.

The one thing I'd add is -- just to give a little more detail on that is if you look through the monthly numbers April, May, June, July the two-year comps have been very consistent. That really within a range of one to two percentage points, through the entire time. So just I think further highlights, the consistency we're seeing in the business, as we move into the third quarter.

Great. That's helpful. And Larry did you mention that Q3 restaurant-level margin could be 250 basis points to 300 basis points lower in Q3 than Q2? And if that's the case, how should we think about, the Q4 margin? Do you expect it to pick backup a bit, as that price increase takes hold? And then, just maybe higher level, how are you thinking about the longer-term margin, that you'd like to deliver?

Let me just give you a little perspective on Q3 relative to Q2. And that is normally in the business, if you go back historically, you'll see that Q3 margins are generally below Q2, I mean almost every year they are. And there's a reason for that. Because although the sales volumes will be roughly the same, what you see is, a much higher cost utilities in the third quarter, because it's the summer months. And so you have higher electricity and gas usage, across the business. And then, we always have wage rate increases basically end of June, our merit increases in our restaurants, our restaurant managers, increases, so you need to see also that pressure. So you almost always see Q3 margins, lower than Q2. And then, we've got the other impact on top of that, kind of driving the balance which is around the packaging investment that we made, that we rolled out in the second quarter. And I'd just highlight that, allowed us to get to completely out of Styrofoam in our business which we think is a critical long-term investment. We've got the labor investments that I highlighted earlier and Bernard highlighted in the call. And then, we did see commodity inflation pickup at the end of Q2. And really around chicken prices, because we had to go outside our contract to source some chicken. Now I think that -- I'm cautiously optimistic that, that will go away overtime as our suppliers get back up to their capacity -- their full capacities to produce the chicken products that we use. So that's just the third quarter and an overview of what's driving that. I mean, the reason why we didn't give full year guidance or even fourth quarter guidance is I think it's really challenging right now to provide that giving all the moving -- things moving in the business around the labor challenges, and the supply chain challenges. So there's some gives and takes on that, which leaves us not real sure where the fourth quarter is. I mean, there are some things I think will be alleviated like, overtime pay and like I said commodity inflation. You do have lower volumes in the fourth quarter, so you do get less sales leverage in the fourth quarter. So I think it's just a little early to make a call on the fourth quarter and the full year, as we work through the labor and supply chain challenges, we have right now. But hopefully a little more flavor on Q3 thing gives you, what's going on in the business. And again, some of that will continue in the fourth quarter. Some of it hopefully will not.

Great. Thank you. I'll pass it on.

[Operator Instructions] Our next question comes from Sharon Zackfia with William Blair. Please go ahead.

Hi. Good afternoon. I wanted to ask about, California, since it's recently been completely open. Is that a market where you're seeing it build week-to-week, at this point?

Yeah. I mean, I think, as we've indicated, Sharon, you remember this story all too well. We used to have this kind of tale of two cities in our business throughout 2020. That carried into a little bit of Q1. And what we said was, once we kind of put COVID behind in our rearview mirror, we expect LA not only to come back, but to come back really, really strong -- strongly. And I think we've seen that in the second quarter. LA restaurants, started to outpace, the outer market restaurants which had fared well ever since July of 2020. And so to see LA come back as strongly as it has, is very, very encouraging. And that's our bread and butter business. And if that's not strong, vibrant and healthy the business is just off in general. So we're very, very pleased to see that come back as strongly as it has.

And I know the comp performance throughout the pandemic has been led by ticket until this quarter. But I think traffic is still below pre-pandemic levels. I'm curious, -- I'm sure part of that is just the shift to off premises. And I know more people per ticket. But I'm curious if you were able to lower your labor hours per restaurant, because you were being driven by ticket? And whether there's more incremental hiring per unit that needs to happen as transactions start to come back up again?

Yeah. So, I mean, when you look year-over-year, as you saw -- as you highlighted, I mean, this quarter we saw a lot of sales growth driven by transactions, which of course in our labor model means, there's more labor which is one of the drivers of year-over-year labor costs. So that -- and so as they move through the balance of the year, transactions are you're correct are still a good level below where they were two years ago. So we would expect that we'll continue having to bring more labor run more labor hours, as that sales growth continues as long as it's transaction driven.

Maybe a different way to ask the question is, I mean, where are labor hours today, like as a percent of 2019? And do they have to come all the way back, or have you learned new efficiencies where you can do the transactions per unit of 2019, but do it in a more efficient way?

Yeah. I'll be honest with you. I'm not sure where labor hours are today relative to 2020. I know that the trend -- or 2019. I know that the transactions are still I think around 10% or so below, where they were two years ago. So roughly, you'd say, -- it's probably roughly the same in terms of labor hours, right?

Okay.

As those come back -- have we found ways to be more efficient? I don't think so. I think the reality is that, as those transactions come back we want to provide great service. And so at this time, I would expect that we'd stay with our labor model. And add the hours as transactions come back, assuming they come back to the levels that they were a couple of years ago.

Okay. Thank you very much.

Mr. Acoca, there are no further questions at this time. I'll turn the call back to you for closing remarks.

Okay. Well thanks again everyone for joining us today. And continue to stay safe. And have a good evening.

That does conclude the conference call for today. We thank you once again for your participation. And ask that you please disconnect your lines.