El Pollo Loco - Earnings Call - Q3 2020

Transcript

Speaker 0

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco Third Quarter twenty twenty Earnings Conference Call. At this time, all participants have been placed in a listen only mode and the lines will be opened for your questions following the presentation. Please note that this conference is being recorded today, 10/29/2020. 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.

Speaker 1

Thank you, operator, and good afternoon. By now, should have access to our third quarter twenty twenty earnings release. If not, it can be found at www.epeolloloco.com in the Investor Relations section. Before we begin our formal remarks, I need to remind everyone that our discussion today will include forward looking statements, including statements related to the impact of the COVID-nineteen pandemic on our business and strategic actions we are taking in response. 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 expect. We refer all of you to our recent SEC filings 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 2020 tomorrow, and we encourage you to review that document at your earliest convenience. During today's call, we will discuss non GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or 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.

Speaker 2

Thank you, Larry. Good afternoon, everyone, and thank you for joining us today. I hope that you and your families are staying safe and healthy. We're very pleased to be here today to discuss our third quarter results. We posted strong results for our most recent quarter that included a return back to positive comparable restaurant sales while continuing to take advantage of operational efficiency.

All in all, our efforts resulted in pro form a diluted earnings per share of $0.28 a 40% increase compared to last year. We also managed to achieve the highest restaurant contribution margin in over two years. System wide sales increased 1.8% during the third quarter. While system wide sales comps continue to remain slightly positive in the current quarter thus far, The softening trends we were seeing at the July, specifically in our core Los Angeles market, carried forward through the third quarter and into October. The Los Angeles economy has been hard hit, especially during the pandemic, with an unemployment rate of 15.1% in September, nearly double the national rate.

California was also hit with the second wave of the virus during the third quarter, leaving many businesses and schools as well as restaurant dining rooms closed to this day. As of now, none of our company operated restaurant dining rooms are open in the state. For a bit of context, it's worth noting that system comparable sales outside of Los Angeles increased 6% during the quarter, which gives us comfort that our LA sales trends are largely macro driven, enabling us to potentially realize upside once the economy and the CMA opens up and economic conditions improve. Likewise, we are encouraged that we are about to start on November 2 one of our historically strongest promotions to conclude the fiscal year, our holiday promotion that features our one of a kind handmade tamales. On the margin front, we achieved a 22.4% restaurant contribution margin within the quarter.

After adjusting for a one time COVID related insurance recovery settlement, our restaurants delivered a restaurant contribution margin of 20.3%, continuing the momentum achieved in the second quarter. This compared to 18.6% last year and was the first time we delivered margins greater than 20% in two years. Our teams continue to do a fantastic job delivering operational efficiencies with an acute focus on food and labor cost management that is readily apparent in our results. We also continue to benefit from significant average check growth that is offsetting softer traffic trends and helping to drive additional labor efficiency. We believe the improvement we are seeing in our operating efficiencies will benefit us as sales in our core LA market return to more normalized levels.

During the third quarter, we returned to new product news with the launch of our LA Mex burritos. As a reminder, LA Mex, which is the term we use to describe the food we serve, is the confluence of the healthy and active lifestyles of Los Angeles culture and Mexican inspired tradition. LA Mex burritos are the poster child for LA Mex cuisine, which is why the rollout included the world's first keto certified burrito, as well as our chickenless pollo burrito, which was certified vegan by the American Vegetarian Association. El Pollo Loco remains the only chicken brand that has rolled out a chicken alternative protein system wide, and we look forward to expanding our portfolio to include even more better for you products in 2021. We also continued our focus on family meals during the quarter as families continue to spend more time than ever at home, and our healthier and affordable complete meals remain a popular option.

As more meals these days become shared versus individual occasions, family meals continue to account for over 30% of our sales mix during the third quarter. In September, we relaunched our local rewards loyalty program with new enhancements that we believe will grow acquisition and increase engagement. As a result of the relaunch, local rewards recently reached a milestone of 2,000,000 members enrolled in the program, and our app downloads have grown approximately 45% since the September. As a reminder, the revised rewards program includes a new free sign up offer that can be redeemed immediately upon joining, a lower threshold to redeem loyalty rewards with a $5 award being issued for every $50 spent, and exclusive and relevant offers based on customers' purchase history intended to increase incremental visitation, check, and ultimately sale. We are encouraged by the momentum we are seeing as we look to make this program a bigger part of how we go to market over time.

Lastly, as it relates to our third quarter initiatives, we launched GPS enabled curbside pickup on September 28. Now available at over 90% of our system wide restaurants, customers can place their order through our app, park in one of our dedicated curbside parking spaces, and have their orders delivered to their car with restaurant being notified of their arrival through the GPS functionality. Execution of the launch went exceptionally well, and we are very pleased with the seamlessness of the technology. Customer feedback has been positive, and continue to reduce average wait times with our goal of being one minute or less. Over time, we expect an increasing number of customers to utilize curbside pickup as it provides an additional need to conveniently and safely access our brand, especially in a COVID world.

Looking ahead, we have a number of initiatives underway or planned for the fourth quarter. We just recently celebrated Hispanic Heritage Month by supporting small Latina business owners who have been disproportionately impacted by the effects of the COVID-nineteen pandemic. Our partnership with We All Grow Latina enabled us to create the first of its kind Latina small business directory for food related businesses to encourage the community to patronize these businesses, as well as award $130,000 in grant money to 13 Latina small business owners. In addition, the El Pollo Loco leadership team will be providing one on one mentoring opportunities to these grant recipients as a means of helping them navigate through these challenging economic times. During the fourth quarter, we will also roll out stage one of our new drive thru initiative.

It's no secret that the drive thru has taken on added value as a result of COVID, and we believe that we have an opportunity to enhance the drive thru experience for our customers with improvements in speed and accuracy. We've just completed training our teams on proper labor deployment, drive through processes, side item projections and prepacking, food preparation and line layout. We believe that this initiative will reduce window and order times, and thereby significantly enhance drive thru capacity. To further enhance our drive thru operation, we are currently testing order taking tablets capable of taking credit card payments, and holding equipment with further plans to test additional technology to improve the drive thru experience for our customers. Our goal is to cut in half the time it takes for customers to place orders and pick them up at the drive thru window.

Finally, given the success we have had over the past two years, we will once again celebrate the holidays in a big way at El Pollo Loco, tapping into what makes this time of year so special. We are excited to bring back our holiday tamale bowls in addition to two other El Pollo Loco seasonal classics, our homemade pasole verde, a traditional Mexican holiday soup, and our decadent Mexican hot chocolate made with abuelita chocolate. All our holiday food and drinks will be served in festive holiday packaging and cups, which have become a seasonal iconic feature of our brand. In addition, we will be offering a lineup of holiday themed gift cards in restaurants, retail outlets, and online. Before I turn the call over to Larry, I'd like to reiterate again how appreciative I am of the extraordinary efforts of our employees and franchisees.

Their resilience and passion for our brand have been instrumental in navigating this unprecedented environment. While the COVID crisis will likely continue to present challenges, I continue to be very excited about the progress we've made against our transformation agenda. Our culture and brand fundamentals are now well established, and we are driving against our off premise strategy. Our new product pipeline has never been stronger, and our operations continue to improve as we institute systems and processes to ensure our customers have an exceptional experience in our restaurants. Lastly, as we finalize and test our new restaurant of the future during the fourth quarter, we will have completed the final piece of the transformation agenda, which sets us up well for future sales and unit growth as we seek to expand in our existing and new markets in the years ahead.

Now I'd like to turn the call over to Larry to review our third quarter results in more detail.

Speaker 1

Thanks, Bernard. As discussed previously, in March, we fully drew down our $150,000,000 revolving credit facility adding $34,500,000 of cash to our balance sheet. During the third quarter, we paid down $55,000,000 of debt and as of 09/23/2020, had $83,800,000 of debt outstanding and $29,500,000 in cash and equivalents. Subsequent to the end of the third quarter, we paid down an additional $28,000,000 of debt. Before we get into our third quarter results, I'd like to reiterate that we have temporarily halted company operated unit development and as a result, do not expect any additional new company owned restaurants in 2020, nor do we expect franchisees to open new restaurants during the balance of 2020.

We will complete two remodels during the fourth quarter using a new asset design, which will then be used for all new builds and our next round of remodels in 2021. Now on to our financial results. For the third quarter ended 09/23/2020, total revenue was approximately $111,000,000 compared to approximately $112,100,000 in the 2019. Company operated restaurant revenue was $97,300,000 compared to $99,100,000 in the same period last year. The modest decline in company operated restaurant sales was driven by the sale of five company operated restaurants to franchisees and the closing of two restaurants during or subsequent to the 2019, as well as a $600,000 decrease due to temporary closures primarily related to the COVID-nineteen pandemic.

This was partially offset by a 0.2% increase in company operated comparable restaurant sales and an increase in revenue generated from the three new restaurants opened during the same time period. The increase in company operated comparable restaurant sales was comprised of an 18.1% increase in average check, partially offset by a 15.2% decline in transaction. During the quarter, our gross pricing versus 2019 was 3.7%. Franchise revenue was $7,800,000 during the third quarter compared to $7,300,000 in the prior year period. This increase was primarily due to a franchise comparable restaurant sales increase of 3% as well as the opening of two new franchise restaurants and additional revenue generated from five company operated restaurants sold by the company to franchisees during or subsequent to the 2019.

This increase was partially offset by the closure of nine franchise locations during the same period. Turning to expenses. Food and paper costs as a percentage of company restaurant sales decreased two twenty basis points year over year to 25.6%. The improvement was predominantly due to higher menu prices, lower food and paper usage, which was largely a result of dining room closures and effective waste management and favorable sales mix. These were partially offset by commodity inflation.

Labor and related expenses as a percentage of company restaurant sales were 29.6%, which was the same as last year, as higher hourly wages in California and labor costs associated with the COVID-nineteen pandemic were offset by increased menu prices and operating efficiency. Occupancy and other operating expenses as a percentage of company restaurant sales increased 40 basis points to 24.5%, primarily due to sales deleverage and increases in operating costs and marketplace delivery fees. During the 2020, the company received insurance proceeds of $2,000,000 related to sales losses and expenses related to the COVID-nineteen pandemic and resulting dining room closure. General and administrative expenses increased by approximately $300,000 year over year to $9,800,000 The increase was a result of higher management bonuses and stock compensation expense, largely offset by decreases in legal fees, preopening costs and other miscellaneous expenses. As a percentage of total revenues, general and administrative expenses increased approximately 30 basis points to 8.8%.

We reported a provision for income taxes of $1,600,000 in the 2020 for an effective tax rate of 14.2%. This compares to a provision for income taxes of $2,900,000 and an effective tax rate of 31.5% in the prior year third quarter. We reported GAAP net income of $9,900,000 or $0.28 per diluted share in the third quarter compared to net income of $6,400,000 or $0.18 per diluted share in the prior year period. Pro form a net income for the quarter was $9,900,000 as compared to pro form a net income of $7,200,000 in the third quarter of last year. Pro form a diluted earnings per share were $0.28 for the 2020 compared to $0.20 in the prior year period.

For a reconciliation of pro form a net income and earnings per share to the comparable GAAP figures, please refer to our earnings release. Now looking to the balance of 2020. While market and economic conditions continue to be challenging due to the COVID-nineteen pandemic, based on current information, we are providing the following limited outlook for the 2020. Systems same store sales of approximately 1% to 2% restaurant contribution margin of 18% to 18.5%, which includes an estimated 60 basis point negative impact from this year's sixty third week. G and A spend of $9,600,000 to $10,000,000 excluding legal costs associated with the securities derivative lawsuit.

This concludes our prepared remarks. I'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.

Speaker 0

Thank you. We will now be conducting a question and answer session. You. Our first questions come from the line of Jake Bartlett with Truist Securities. Please proceed with your question.

Speaker 3

Hey guys, this is actually Jack on for Jake. Thanks for taking the question. I'd love to start by asking about the margins. The guidance implies a decent step down in the fourth quarter. I just what is driving that?

Is it opening more dining rooms and labor increasing there? Or is any color you can give on that?

Speaker 1

Jack. I think it's driver of the margins in the fourth quarter. First of all, generally the fourth quarter is the, I'll call, softest margin quarter that we have because of the holidays. We have Thanksgiving and Christmas there, which are lower volume, therefore lower March which kind of usually throughout fourth quarter to be a bit lower. The thing I would highlight is again as I said in my opening comments is if you adjust for the 60 basis points, you actually get to a range of above twenty nineteen.

And those would actually be the best fourth quarter margins that we've delivered since at least 2016. I don't see it as a huge step down in terms of our operating performance and how we manage costs. It's a reflection of, again, what we normally see in the fourth quarter, which is a little softer on March because of the holiday.

Speaker 3

Okay, great. That makes a lot of sense. And I guess moving forward with margins into next year as you reopen dining rooms and add some of that labor back, how should we think about margins long term? I know it's difficult to give a little longer term guidance right now, but just help us frame that a little bit for 2021.

Speaker 1

Yes. I mean longer term, like I think I laid in the last call, the margin challenges will be around number one, how much pricing do we take this fourth quarter? We're going to be taking a little over 4% effective price to obviously help the margins. And next year, we'll be looking at how much pricing we feel comfortable taking. Again, we'll look to take somewhere in the range of what we've taken this year.

The other big driver, the one you really highlighted is well, actually, there's two. One is next year's sales as we see transactions increase relative to check, that will put more labor in restaurants because we grow our labor model in transaction group. So I expect again to see the labor cost rise a bit as transactions increase relative to the deck. And then the second factor is as we open 10 rooms, that's the piece that's not yet clear. Because I think what we'd look to do is as transaction increase use that labor in the dining room.

So I wouldn't add any incremental labor on top of what the transactions are. But that's still something we have to assess and what kind of requirements we have based on the COVID and cleaning and other features in the that have been maintained to be in compliance with local regulations and things. So that's the piece that's still a little bit open. But I think just the rise in transaction levels will probably impact margins, but at the same time they should improve sales. So the overall profitability is likely to improve, but the margins may be perhaps a bit because of the transaction driven sales growth that we'll see.

Speaker 3

All right. Thank you very much.

Speaker 2

Hey, Larry, in the meantime, you can get real close to the phone, you get a little bit of static in listening to what your commentary is. I'm not

Speaker 1

sure if it's on our end or the

Speaker 2

operator's end, but just to make sure we're hearing you clearly.

Speaker 1

Okay.

Speaker 0

Thank you. Our next question has come from the line of Andy Barish with Jefferies. Please proceed with your questions.

Speaker 4

Hey guys, good to hear from you. For the last year or so, you were beating the franchisees in terms of same store sales, and that flipped around here in the 3Q. Can you give us a sense of what's going on there? Is it geographic or pricing? Just trying to understand that difference in the 3Q.

Speaker 2

Yes, Andy. I think it has more to do with what I referred to in my prepared remarks in terms of the concentration of our restaurants predominantly in California. We have more of them on the company side. So I think you're seeing that reflected a bit in the difference in the results company versus franchise. So as I mentioned, we are encountering greater economic headwinds in this part of the world in Los Angeles specifically.

Whereas in our out markets we have been seeing really strong performance. And as I mentioned in my prepared remarks, 6% sales in that part of the world. So I think that has more to do with it than anything else.

Speaker 1

Just to add a little firmer data onto that Andy. If you look at the number of restaurants, I mean the company we have about 73% of restaurants in LA where franchise is about 47%. So clearly, the outer markets outperform franchisees outperform since they have a percentage of the restaurants in outer markets.

Speaker 2

Then, Phil, I'll just make on that just if it's not abundantly clear. California, all company restaurant dining rooms are shut down. In our outer markets, most of the dining rooms are open. So just another an important point.

Speaker 4

Understood. And then can you give us a sense of real estate pipeline, kind of how things are shaping up for next year, opportunities maybe created or not out there from the crisis at this point?

Speaker 1

Yes, Andy, I'll take that one. We are still working through next year. I think the piece I'm fairly comfortable saying is that I expect the company restaurant development, company owned to be somewhere between three and five restaurants. I'd say we're working through the franchise piece, just seeing where they are based on where COVID impact and things are. Certainly, expect franchise development to be higher than this year, which was basically I think two restaurants.

But we're still working through that. But again, I was a company three to five and still working through franchise, which should certainly be more than this year.

Speaker 4

Great. Thank you very much.

Speaker 0

Thank you. Our next questions come from the line of Todd Brooks with C. L. King and Associates. Please proceed with your question.

Speaker 5

Hey, good afternoon guys. Few questions. One, now that we're close to birthing the two remodels and the Restaurant of the Future design, Is there any I know it was a fluid process due to learnings through COVID. Is there any kind of sneak preview you can give us on what we should be seeing in the remodels and what enhancements or changes were made out of learnings from the pandemic?

Speaker 2

Yeah, sure. So I think what you are seeing is, you know, we consider what we've been encountering with COVID to be actually a blessing for us from the standpoint that we've learned a lot about what adjustments we need to make on a go forward basis in these remodels and in this new restaurant design of the future, primarily around technology and the drive thru, what we want to really create there. So future rebuilds will have a double drive thru. Naturally with the expansion of curbside pickup, you will find that in every one of our restaurants going forward now that we have it 90 plus percent of the system. Smaller dining room footprints.

And in some cases we won't even have dining rooms at all. So we've got several different models that are very flexible depending on the trade area, depending on the geographic area, depending on whether or not we have a heavier drive thru market versus dine in market. So, some will just actually have a double drive thru and perhaps a pickup takeout window. Some will have a much smaller dining room footprint. But when we do build a dining room, we've created a modular design whereby you can lift the garage, essentially what look like garage doors open to create a much more open dining room to a larger and large patio where customers would feel more comfortable dining given how their mindsets have changed during this pandemic.

In regards to the remodels we've got in Q4 naturally, these are not ground ups. These are remodels. So we're going to have more of what we've learned influencing the back of the house in terms of the technology we'll be incorporating there and the equipment that we'll be incorporating there. But what you'll see more front of house there will be digital pickup where it'll be very, very clear to the customer based on if they've placed their orders ahead given through our mobile app, how they can readily pick up their food. That's kind of just a gist of what you should expect from us going forward, naturally in addition to the new brand look that we've been implementing over the course of the past two years.

Speaker 5

That's super helpful. Thank you. And then you touched on just your work around drive thru efficiency. And I guess in tests, there anything you could share with us about successes that you've had in shrinking transaction time so we can start to get our

Speaker 1

mind

Speaker 5

around potential capacity additions with drive thru productivity gains?

Speaker 2

Yes, we've been maniacally focused on two things: window time and order time. And in order to speed those things up and we've got an aspirational target of getting to forty five seconds window time. That's really what drives maximum capacity in the drive thru. We've implemented a bunch of different things or are still in the process of testing things. But from the equipment layout at the drive thru to having just completely rolled out deployment training throughout our company organization so that, you know, we put ACEs in their places, they understand what their roles and responsibilities are, and they understand how to drive maximum efficiencies in the drive through.

One of the other things that we're in the process of testing right now is order taking tablets that can also take credit card payment in the drive thru in our pursuit to getting to a forty five second window time. But essentially, we're looking to cut our drive thru times in half at the window right now. And we've actually on our path to eventually getting to that goal have set targets along the way. For instance, in the fourth quarter we're taking some incremental steps to get to forty five seconds eventually. But a lot of work and attention being placed there.

When we get to the new remodels, we'll be looking to implement things like digital menu boards in the drive thru, which we don't currently have today, preview boards in the drive thru that could speed things up, etcetera. So we're putting a disproportionate amount of our attention on that channel, given that we've gone from driving 45% of our business prior to the pandemic to close to 70% of it now. And we think we can even drive more through that channel and realize even greater sales comp upside.

Speaker 5

Very helpful. And then just a final question. I know the environment is tough and there's some uncertainty, but obviously El Pollo Loco's performance with the return to positive same store sales. Just wondering on the franchising side, can you talk about efforts and any sort of progress in drawing new franchisee partners to the brand? Thank you.

Speaker 1

Yeah, I'll take that one.

Speaker 0

You want take that one?

Speaker 1

Yeah, I got it. So a couple of things on that. First

Speaker 3

of

Speaker 1

all, this is an area that we are now pushing aggressively or setting ourselves up to push aggressively. So we have hired an outside consultant to work with us. We are putting together, I'll call it the package that we will go to market with. We've identified the markets that we're going to focus on. So I expect by year end, we will be out there really starting our recruitment of franchisees, new franchisees for new markets.

Having said that, at the same time, we've had a number of franchisee candidates, I would say contact us unsolicited, whom we are talking to. I mean, it's not a huge number, but it's probably two or three franchisee that they're interested in some of the markets that we are looking to expand into. We are talking with them. But the bigger push will really be starting end of this year, very early next year as we complete the package and get out there and really target the specific markets we really want to target and start really working to attract franchisees into the system.

Speaker 0

There are no further questions at this time. I would like to turn the call back over to Bernard Acoca for his closing comments.

Speaker 2

Well, just want to thank everyone for joining us today. We look forward to sharing our future results with you. In the meantime, please stay safe and healthy. Be well.

Speaker 0

Thank you. This does conclude today's conference call. You may disconnect your lines at this time. Thank you for your participation, and have a great night.