Greetings, and welcome to the El Pollo Loco Third Quarter 2019 Earnings Conference Call. [Operator Instructions]. 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'd like to turn the conference over to Larry Roberts..

Thank you, Operator. Good afternoon. By now, everyone should have access to our third quarter 2019 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 discussion today will include forward-looking statements.

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 third quarter of 2019 tomorrow, and we'd 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. I'd now like to turn the call over to President and Chief Executive Officer, Bernard Acoca..

simplifying operations or making it easier to be an employee and franchisee at El Pollo Loco. On the operations front, our team has been focusing on simplification initiatives in order to reduce back-of-house complexity. Our focus in everything we do is to make it easier to be an employee and franchisee at El Pollo Loco.

To this end, we have virtually completed the company-wide rollout of our new inventory management system. And we are currently training our restaurants on our new simplified chicken-cooking process, which delivers a more consistent, higher-quality product while making the work much easier for our grill masters.

In addition, we've completed the rewriting and streamlining of all our standard operating procedures, which will further simplify working in our restaurants. We have taken an operations manual that used to be 477 pages in length and reduced it to only 74 pages.

One big example of how we are making it easier to work in our restaurants is that we have revised all of our recipes to ensure that they can be made in 6 steps or less.

We are extremely excited to roll these initiatives out in the fourth quarter as they will free up more time for employees to spend focusing on delivering exceptional customer experiences. I'm incredibly proud of our operations team. And what is really encouraging is that we've already begun to see improved results.

Our overall Blended Index score, which is an internal measurement of customer satisfaction based on mystery shops, customer surveys and complaints, has improved significantly and is at an all-time high since we implemented this program at the beginning of this year.

We believe this is just the start and expect operations to become a key sales driver for us as we continue to make it easier for employees to work in our restaurants so that they can focus more of their energy on providing moments of connection with our customers.

As we discussed last quarter, our continued focus on building a culture centered on leadership with heart involves helping the communities of which we are a part. In Southern California where the homeless crisis has reached epidemic proportions, we are committed to doing everything we can as an organization to assist those in need.

Based on this commitment, we have entered a partnership with the Food Donation Connection, which enables us to donate the food we used to throw away at the end of every evening to local shelters in the communities in which we do business. This program has been rolled out to the entire system.

And our goal is to get to 70% participation by year-end, which we anticipate will enable us to donate over 500,000 pounds of food annually. Along those same lines, we put a new twist on National Taco Day this year, which took place on October 4.

Instead of doing the typical gimmicky buy one, get one free promotion, we pledged instead to give away at a minimum 59,000 tacos, which symbolically represents the number of homeless people in the Greater Los Angeles area. Any tacos sold above this amount, we continue to match and donate to local shelters.

I'm extremely proud to share that through the efforts of our employees, franchisees and customers, we sold and will now donate 76,000 tacos.

The final thing I'd like to highlight today is that as part of our strategy to opportunistically refranchise restaurants, earlier this week, we transferred our 5 remaining company-operated restaurants in Dallas to our existing franchisee in that market.

We and our franchisee partner are excited about consolidating our Dallas restaurants under one owner and remain bullish on El Pollo Loco's long-term prospects in that market. Before I turn the call over to Larry, as always, I would like to thank all of our people for making these results possible.

To our employees and franchisee partners, it is your passion, commitment and dedication that make this brand and this family truly special. I'd now like to hand the call over to Larry to review our third quarter results in detail..

Thanks, Bernard. Before we get into our third quarter results, I'd first like to provide a quick update on our store base. During the quarter, we opened one new company-operated restaurant in Los Angeles. We expect to open 2 to 3 company-operated restaurants along with 2 to 3 franchised restaurants for the full year.

Additionally, we continue to make progress on our remodel efforts, completing 2 company-operated restaurant remodels in the quarter while franchisees completed 5. Our new asset design work is near completion, and we look forward to implementing it beginning with remodels in early 2020. Now on to our financial results.

For the third quarter ended September 25, 2019, total revenue was $112.1 million as compared to $112.2 million in the third quarter of 2018. Company-operated restaurant revenue decreased slightly to $99.1 million compared to $100 million in the same period last year.

The slight decrease in company-operated restaurant sales was driven by the sale of 11 company-operated restaurants to franchisees and the closure of 5 restaurants during and subsequent to the third quarter of 2018.

This was partially offset by 1.6% growth in company-operated comparable restaurant sales, the contribution from the 6 new restaurants opened during and subsequent to the third quarter of 2018 and $500,000 related to an increase in revenue recognized from our loyalty point program.

The increase in company-operated comparable restaurant sales was comprised of a 2.0% increase in average check partially offset by a 0.4% decrease in transactions. As Bernard noted, we were pleased with the progression of our sale trends during the quarter as well as our current fourth quarter momentum.

Franchise revenue increased 9.1% in the third quarter to $7.3 million compared to $6.7 million in the prior year period.

The increase was driven by a 0.6% increase in comparable restaurant sales; the transfer of the 11 company-operated restaurants to franchisees, as mentioned earlier; and the contribution from 7 new franchised restaurants opened during and subsequent to the third quarter of 2018.

This increase was partially offset by 3 restaurant closures during the same period. Turning to expenses. Food and paper cost as a percentage of company restaurant sales decreased 50 basis points year-over-year to 27.8%. The improvement was predominantly due to higher menu prices and favorable sales mix.

Looking ahead to next year, we expect commodity inflation of approximately 1% to 2% in 2020. Labor and related expenses as a percentage of company restaurant sales increased 40 basis points year-over-year to 29.6%.

The increase in labor expenses was due primarily to higher hourly wages in California, especially Los Angeles; and higher workers' compensation expense, partially offset by increased menu prices. We expect labor inflation of 6% to 6.5% in 2020, which continues to reflect the tight labor market and minimum wage increases.

Occupancy and other operating expenses as a percentage of company restaurant sales decreased 10 basis points year-over-year to 24.1% as higher prices and lower advertising costs offset increases in occupancy costs and marketplace delivery fees. General and administrative expenses decreased by $2.6 million year-over-year to $9.5 million.

Included in G&A are approximately $230,000 of expenses related to legal expenses associated with securities litigation and executive transition costs compared to approximately $3.7 million in the third quarter of 2018.

Excluding the costs associated with the securities litigation and executive transition costs, G&A expenses in the third quarter of 2019 increased approximately $815,000 year-over-year to 8.3% of total revenue for an increase of approximately 70 basis points versus the prior year.

The increase in G&A expenses was primarily due to higher stock option expense, severance costs and project spending. Depreciation and amortization expense decreased to $4.3 million from $4.5 million in the third quarter last year or by 10 basis points year-over-year as a percentage of company revenue.

Additionally, in last year's third quarter, we received $2 million related to the reimbursement of legal costs associated with the securities class action lawsuit. We recorded a provision for income taxes of $2.9 million in the third quarter of 2019 for an effective tax rate of 31.5%.

This compares to a provision for income taxes of $2.4 million and an effective tax rate of 25.9% in the prior year third quarter. We reported GAAP net income of $6.4 million or $0.18 per diluted share in the third quarter compared to net income of $6.8 million or $0.17 per diluted share in the prior year period.

Pro forma net income for the quarter was $7.2 million as compared to pro forma net income of $7.6 million in the third quarter of last year. Pro forma diluted earnings per share were $0.20 for the third quarter of 2019 compared to $0.19 in the prior year period.

For a reconciliation of pro forma net income and earnings per share to the comparable GAAP figures, please refer to our earnings release. In terms of liquidity and balance sheet, we had $12.1 million in cash and equivalents as of September 25, 2019, and $101 million in debt outstanding.

For the foreseeable future, we expect to finance our operations, including new restaurant development and maintenance capital, through cash from operations and borrowings under our credit facility. For 2019, we expect our capital expenditures to total $12 million to $15 million.

During the quarter, we purchased 2,825,896 shares for approximately $29.9 million or an average price of $10.57 excluding brokerage fees. Subsequent to the end of the third quarter, we completed the sale of 5 company-operated restaurants within the Dallas area to an existing franchisee.

The sale did not result in any cash proceeds nor any gain or loss as the assets had previously been fully impaired. Turning to our outlook for 2019, we are revising our guidance for the full year as follows. We expect pro forma diluted net income per share of $0.71 to $0.74. This compares to pro forma diluted net income per share of $0.74 in 2018.

Our pro forma net income per share guidance for 2019 is based in part on the following annual assumptions. We expect system-wide comparable restaurant sales growth to be approximately 1% to 2%. As I noted, we expect to open 2 to 3 new company-owned restaurants and expect our franchisees to open 2 to 3 new restaurants.

We expect restaurant contribution margin of between 18.2% and 18.6% as compared to our previous range of 18.2% to 18.7%. This adjustment reflects our expectation in the fourth quarter of higher food costs associated with the tamale promotion, increased marketplace delivery fees and restaurant-level training costs.

We expect G&A expenses of between 8.1% to 8.3% of total revenue excluding legal fees related to securities class action litigation and reflecting our change in accounting for franchise advertising fees. We expect adjusted EBITDA of between $61 million and $63 million, and we're using a 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..

[Operator Instructions]. Our first question comes from the line of Jake Bartlett with SunTrust..

First, I just wanted to understand the performance in September and October and trying to figure out how much you think was attributed to the success of the $5 bundle or bowl that you're offering.

And also, just remind us, what's different about that offer versus some of the $5 combos that you've had in the past and also had on the menu permanently in the past?.

Sure. So I think we attribute the growing momentum we experienced in the quarter, both on the top line and more -- well, equally as important in transactions, due to, I'd say, 3 things. I think it was the strength of the fire-grilled combos promotion. It was the expansion of our delivery capabilities.

So we added both Postmates and Uber Eats in the quarter in addition to our existing partner DoorDash. And then I would say the third is in operations improvement. So we're seeing significant improvement in customer compliments.

And as I mentioned, our internal measurement of customer satisfaction, what we term our overall Blended Index, has been steadily increasing throughout the course of the year and is now at an all-time high. So I'd say it was the confluence of all 3 of those factors.

Specifically addressing your question on the $5 combos, I think the main difference is, one, we added nachos to that lineup. So we had some success with nachos as an LTO in the past and saw a lot of take on that product. So we decided to do a $5 Fire-Grilled Combos version of it. And I think that was one of the big contributing factors.

But I think it was also, frankly speaking, how we executed it both with our advertising and in our restaurants..

Got it. That makes a lot of sense. And then in terms of the sale of the stores in Dallas, what is the state of the company-owned stores in Houston? I'm wondering whether that's something that you're also pursuing.

And then just philosophically, as you look at the company versus the franchise mix, do you see yourself moving more towards the franchise mix and shedding some of the -- maybe the weaker-performing markets?.

Well, in the case of Dallas, we had an opportunity there to sell our stores to a franchisee who already had a significant presence in that market. So it made all the sense for us to transfer ownership under a strong local partner. He's based out of that part of the world. He knows that local market really well. We all know that Texas is a unique animal.

So we thought we'd be better served putting it under local ownership. The good news, whether it be Dallas or whether it be Houston, is that those stores have been steadily improving in their performance. In the case of Houston, we're still committed to that market, and that market continues to show progress.

But as we've mentioned, just as a general statement, we're looking at franchisee transference or, I should say, the sale of company markets to franchisees opportunistically. And as things present themselves that make sense, we'll consider them..

Yes. And Jake, the only thing I'd add on top of that is I don't see us having a major shift in the company franchise mix. And as Bernard highlighted, it will be opportunistic. But I wouldn't expect to go through a big selling program of selling company restaurants..

Got it. And then last question. It looks like you're making some progress here on the same-store sales improvements and getting some traction there. When do you think that starts to translate into new unit growth? And I know you've talked in the past about wanting to open a new market or two in 2020.

Where do you stand in your progress towards that goal?.

Yes. So we're still finalizing those two markets, 1 or 2 markets as we speak.

And we have been working assiduously on our restaurant design of the future, which we, day by day, get more increasingly excited about, not only because of the design aesthetic that's going to present to the world through the lens of our new brand, but also, in keeping with our third strategic pillar of the transformation agenda, we have massively simplified the back-of-house in a way that we think is going to make us more competitive than we've ever been.

So right now, we are on track to open at least one new market next year but don't have much more I can share with you at this point..

Our next question comes from the line of David Tarantino with Robert W. Baird..

Just first question on delivery. I think, Bernard, you mentioned that you've curated a special menu for that to make it, I guess, a little bit closer margin to what your in-restaurant transactions are.

Could you maybe explain how that works and whether there is a difference there? And then secondly, if you could comment on whether you think the transactions you're seeing there are incremental or not, that would be helpful. And then I have a couple of follow-ups..

Sure. So we have -- we call, internally termed, the bifurcated delivery pricing strategy. So if you're a customer and you go through our El Pollo Loco website or through our mobile app, we're going to offer you the full entire El Pollo Loco menu at regular price.

And then whatever delivery fees get attached to that, we pass on to the customer, so we retain 100% margin on those sales.

If someone orders through 1 of 3 delivery marketplaces of which we're currently part of, and we'll add Grubhub for a fourth in December, then we have a more curated menu, a smaller menu with a heavy emphasis on combos, family meals and actually exclusive configurations because we add chips and salsa to a lot of those menu items that are not -- cannot be found on elpolloloco.com or through our mobile app.

And we charge a price premium through those third-party marketplaces.

Let's call it -- I'm going to include our franchisees here, although we don't have any influence over their pricing, but anywhere from, let's call it, 13% to 15% markup on those products to mitigate some of the margin loss given that we have to pay a commission rate to those third-party delivery marketplace providers..

And what's been the customer feedback? Or do you have the ability to get feedback as you look at sort of the execution and the overall kind of value proposition to the customer? Anything you can offer on that front?.

Yes. I mean the only thing I could really -- just from a kind of more of an empirical point of view, I think if you take a look at just our delivery growth in terms of sales mix, it's largely come in this quarter from our delivery marketplace providers.

So we don't see resistance necessarily from the more elevated pricing that we're charging in those channels. I think consumers there are looking to pay for convenience, first and foremost. And so we're kind of enthusiastic and excited about the progress we're making with these providers..

Great.

And then, Larry, is there a P&L benefit that you expect to see from the sale of the Dallas restaurants?.

Yes, we do. I think in the past, I've highlighted the margin, I'll call it, drain that -- the other markets I provided. So we will see a margin benefit from the sale of the Dallas restaurants and should see an EBITDA benefit from the Dallas restaurants as we go into next year..

And would you help us in terms of quantifying that?.

The margin benefit should be somewhere around 50 basis points..

Great. And then on next year, I might have missed this, but I think you mentioned that you're going to enter at least one new market.

Do you have a current development plan in terms of company-operated and franchise growth that you're willing to share at this point?.

We are still working through that, David. Right now, what I would say is I would expect it to be in the 10 to 15 total restaurant range for next year and probably split roughly half and half..

[Operator Instructions]. Our next question comes from the line of Matthew DiFrisco from Guggenheim Securities..

Just wanted to also -- can you just specify, did you say there were 3 Dallas stores that were transferring over to make the entire market franchise?.

Five..

Five, okay.

And are any of those going to not have a royalty? Or right away, will they have a royalty in there? Is there any sort of deal as far as transferring them where there might be some abatements initially?.

Yes. So we have -- basically, in the initial, I think, couple of years, there will be no royalty on those restaurants..

But it'll still be earnings accretive in -- and that the proceeds are going to be -- are you getting proceeds to offset or buy back stock or just carry the balance? I'm trying to think of how this is to a P&L basis -- aside from the 50 basis point improvement to the margin, you're selling dollars.

What are you getting in return to offset that as far as the lost EBITDA contribution?.

No. We'll get a positive EBITDA contribution, Matt..

They were losing money?.

Yes..

Got it. Okay. So you removed the depreciation. And you're going to gain....

Well, no, there was no depreciation because the restaurants have been fully impaired. But there will be an EBITDA/cash flow positive benefit or EBITDA benefit from the sale of those restaurants..

Excellent.

And then just as far as some of the guidance here, the G&A guidance of 8.2 -- 8.1% to 8.3% as a percent of sales, I'm assuming you're doing that off of your gross sales, so the number of $112 million in this quarter, so inclusive of franchise ad revenue?.

Yes. That's the way we're reporting that, yes..

And then you back out the legal, which was only in the first quarter of $2.2 million?.

Only in the first quarter of $2.2 million. Well, I do -- we back out the legal expenses associated with the securities litigation..

What's the total year-to-date of that?.

Give me a second. It's at $2.8 million..

We do have a follow-up question from the line of Jake Bartlett..

This is one, I think, I typically ask every quarter, but I just want to ask what the systemwide sales were for the quarter..

$227,950,000, so $227.95 million..

Great. And then lastly, you guys have a unique perspective there in California and specifically Southern California.

Wondering, any comments you can make on the wildfires that are going on and any impact to your stores positive or negative?.

Yes. So naturally, we're all watching it very, very carefully. So far, the impact has been minimal. It has -- we've had a little bit of power outage here or there in a few stores. The number has been extremely small at this point. It's not to say that if the situation gets bigger or wider, it won't be cause for greater concern.

But at least at this juncture, the impact of that has been pretty minimal..

Yes. And just to add a little more color, I mean really, we've only seen really a minimal number of actual closures, company and franchise. And as we're watching our comp sales, we're really not seeing any impact on comp sales at this point in time..

Great. And then actually, lastly, one more. Bernard, you made the comment that you're lapping -- you had positive -- your same-store sales were strong in September, but you're lapping 2% -- or sorry, 3%. I want to make sure that was 3% in traffic overall. I want to make sure you're not referring just to traffic. But that's one question.

And looking at the fourth quarter of last year, there was a meaningful acceleration in the comps. Larry, can you give us an idea of how the monthly progression of same-store sales went last year? I know that there was, I think, momentum kind of heading into the fourth quarter, but it looks like it actually built beyond that.

So I just want to confirm..

First of all, I mean your first question regarding the -- I think, the 3% comparison in September. That was actually the comp, not just transaction..

Great, yes..

Okay. And then if you look at last year's movement in comps, yes, I mean you saw an acceleration really in November and December. So last year, October and September are roughly in line, and then you saw an acceleration November and December..

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

A couple of just follow-ups and then some new stuff.

On the new Postmates and Uber Eats, what -- when in September did that roll? Was it for most of the month?.

Yes, for most of the month. We started late August, and then it kind of was in full effect starting in September..

Okay. And then on the mix in the quarter, it seems like you're running mid- to high 3s on pricing, so it implies the mix down a couple of points. Can you just give us what was kind of moving there? With delivery picking up, I imagine that carries certainly a higher ticket. But $5 combo is obviously an offset maybe..

Yes. I'll let Larry go into a little bit more detail on it. But I think the thing that we were encouraged by, as I mentioned before, was that the transactions through the quarter got steadily stronger.

And some of the -- so while that was improving and getting steadily stronger, our check was something that we were watching carefully because for the last quarter or 2, we think that there's been a little bit of a macroeconomic California effect with the consumer where they're being careful about how they're spending their dollars.

So we saw that within the quarter. We're not quite sure if it's going to sustain itself. We think it's something that's a little bit more short-term than longer-term.

But Larry, do you want to talk a little bit more about that?.

Yes. Just adding on to what Bernard was highlighting, I mean there were a couple of other key factors. One was we did have a little higher discounting in the quarter. The other one was our LTO at the beginning of the quarter was quesadillas, which were at a lower price point. At least we have one quesadilla at a lower price point versus prior year.

So that was also a factor. And as Bernard highlighted, we think we're seeing what I would call some customer check management as a -- probably as a result of higher gas prices, I think, here in California. So the real positive is we're getting more transaction. We're getting more people into the restaurant.

But I think we are seeing a little pullback from customers in terms of what they're spending in restaurants..

Helpful. And then finally, just on labor, certainly, a lot better than it looked in the first half of the year. So the improvement in comps, I'm sure, is some of that.

But was there anything else specific to the quarter other than the operational improvements the teams have been putting in place? And then dovetailing into the new cooking procedures, does that actually create some opportunity for labor efficiency or productivity? Or is it really focused on product quality and ease of execution?.

Yes. So let me -- I'll start with the end of that question first. The new cooking procedures, we're looking at as making easier to execute in the restaurants. We don't have plans to pull any labor out as a result of that. It's really making it a lot easier for our cooks to execute.

And what we're seeing also is better product quality because of the easier procedures. So that's the real driver on that. In terms of on the labor line, yes, nothing really unique. I mean we continue to see the 6% to 6.5% labor inflation that we talked about all year, the wage inflation.

The one thing we did see was probably a little better efficiencies in the third quarter on labor, which helped. But going into the fourth quarter, we'll continue to see that labor inflation. We've also -- just so to manage expectations a little bit, we're also making some investments in terms of new processes we're rolling out to the restaurants.

I mean we've talked about that earlier in the call. So that will involve training costs. So that will be some incremental labor costs during the quarter, which will have some impact on labor as a percent of sales and our margins. So I expect to see a little bit or a little more cost on labor line in the fourth quarter relative to the third quarter.

And the other thing I'd highlight also, in the fourth quarter, you generally have lower AUVs versus the third quarter. So again, you may see a little bit more margin impact on the labor line in the fourth quarter..

There are no further questions in the queue. I'd like to hand the call back to Mr. Acoca for closing remarks..

Well, I want to thank everyone for joining us today, and I want to wish everyone a very happy holiday with their families. And we look forward to talking to all of you soon. Take care..

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day..