Good day, ladies and gentlemen and thank you for standing by. Welcome to the El Pollo Loco Third 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.

Please note, that this conference is being recorded today, November 4th, 2021. And now, I would like to turn the conference over to Larry Roberts, Interim Chief Executive Officer and Chief Financial Officer..

Thank you, operator and good afternoon. By now, everyone should have accessed to our third 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 discussion today will include forward-looking statements, including statements related to the impact of the COVID-19 pandemic on our business and strategic actions we are taking in response, as well as our marketing initiatives, cash flow expectations, capital expenditure plans and plans 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 third quarter of 2021 tomorrow and 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 go into the quarterly results, I’d like to quickly touch on the recent announcement of our CEO transition.

On behalf of everyone at El Pollo Loco, I would like to thank Bernard Acoca for his valuable contributions to the company. As you know, during Bernard’s tenure as CEO, our team developed a culture predicated on servant-led leadership, which we continue to drive throughout the organization.

In addition, under his leadership, we developed our LA-Mex brand positioning, accelerate our digital penetration through our delivery, loyalty and mobile ordering platforms and simplify their operations. These initiatives have positioned the company for success over the coming years.

With this transition, I look forward to continuing to build upon these accomplishments and working with our management team, franchisees and the Board to fully capitalize on the growth opportunities ahead. With that, let me share our third quarter results and discuss our course forward.

We are thrilled to see the continuation of our strong sales performance during the third quarter as we posted a 9.3% increase in system-wide comparable restaurant sales, resulting in a two-year system-wide comparable sales growth of 11.9%.

This momentum has continued into the fourth quarter with system-wide comparable sales growth as of October 27th of 8.4%. During the third quarter, system average weekly unit volumes again exceeded $40,000 and nine DMAs achieved record sales. These measures point to the strength of our business coming out of the pandemic.

Further, our restaurant contribution margin was 20.4%, which included a $3.2 million employee retention payroll tax credit and pro forma earnings per share for the quarter was $0.27. Our strong top line performance was partly driven by solid marketing and insightful advertising during the quarter as we promoted our $5 Fire-Grilled Combo offerings.

Instead of relying on introducing new products, this particular promotion took advantage of our consumer insights to effectively target an older Gen Z, younger millennial demographic. The tag line, Value Yourself has proven to resonate very well with this particular demographic group as they seek higher quality value-meal options.

This promotion was followed closely by new Double Chicken Nachos that were introduced in early September. This past Monday, we continued to build on our authentic routes with a day of a day promotion that featured two free loaves of Pan de Muerto bread with every family meal.

We also issued a new set of gift cards highlighting the holiday, which helped more than double gift card sales versus the same period in 2020.

On Tuesday, we kicked off the holidays with our Blessed Togetherness Marketing Campaign, which passed into the desire for families and friends to reconnect with each other over the holidays, especially in light of the challenges posed by the COVID pandemic over the past 20 months.

The campaign features new Tamale Bowls, Chicken Pozole and Mexican Hot Chocolate. These traditional holiday products along with a new packaging and point of sale graphics will help create a festive environment at our restaurants and have historically driven strong sales than previous years.

Our delivery and loyalty programs continue to grow as e-commerce sales averaged over 12% of total sales during our last marketing module, which is up over 2 percentage points from the beginning of the year.

E-commerce will only continue to grow as we continue to invest in these sale channels, including the addition of two new management positions to oversee our off-premise and CRM platforms.

We are also finalizing discussions to partner with a third-party to enhance our CRM and consumer data platform capabilities, which we expect to be implemented by early 2022.

As we consistently highlighted, we are excited about the progress we’ve made in our e-commerce business and believe that we’ve only just begun tapping into its full potential to build customer loyalty and drive sales. We also believe that e-commerce is critical that casting a wider net in order to attract younger consumers to El Pollo Loco.

While we are excited about the sales driving initiatives we have in place, I would now like to turn your attention to one of the biggest near-term challenges that we are experiencing along with the rest of the restaurant industry.

The challenges of recruiting and labor retention have impacted our restaurants system-wide, but especially our company-owned restaurants.

We believe that this issue is a primary driver of the performance gap between franchise and company restaurants during the third quarter, with 12.6% comp growth for our franchise restaurants versus 4.8% comp growth in our company-owned restaurants.

While there may be a number of reasons for the sales performance gap, fundamentally, we believe that our franchisees have done a better job adapting to the realities of the new labor market than we have in our company-owned restaurants.

During the third quarter, the number of restaurants impacted by labor availability challenges increased and we’ve had to reduce operating hours and/or service modes in a number of company-owned restaurants. This is negatively impacting our company-owned comparable restaurant sales by 4 to 6 percentage points.

Addressing this issue is our number one business objective. To that end, we are maniacally focused on employee recruiting and more importantly, retention.

With regards to recruiting, in addition to ensuring that the wages we offer are competitive, we have increased resources to resurface more candidates and process applications faster and are assisting our area leaders and restaurant managers to proactively recruit team members in their respective trade areas.

To further improve our labor retention, we’ve increased our training budget to better – for new employees, and we are launching Employee Appreciation Month in November, which will include an employee engagement survey to better understand what’s in the minds of our team members.

Most importantly, we are increasing our efforts to create a familiar culture in each and every one of our restaurants by increasing employee recognition and continuing to develop servant-led leaders.

Lastly, in addition to staffing our restaurants, our other top priority is to further simplify our operations in an effort to make our team members’ jobs easier to execute and more rewarding.

As highlighted previously, we have made good progress on this, but we must do more if we are going to continue to retain employees and deliver great service to our customers. This will include a system-wide initiative that will include both franchise and company operators.

Together, we will implement short and long-term initiatives that we believe can significantly simplify our operations further. Several of these have already been implemented, including removing certain product offerings and packaging options from our restaurants beginning last Tuesday.

We believe these efforts are critical given the staffing challenges that plague our industry. I have two other topics I’d like to briefly touch on. First, we have not been immune to the global supply chain challenges facing our industry and many others.

Insurance applied to our restaurants continues to be challenging however is now primarily isolated to packaging. Our teams have done an outstanding job managing this difficulty and will not suffer any significant disruptions to the business. We will continue to closely monitor all aspects of our supply chain for challenges as they arise.

Second, we signed our second four-restaurant development agreement for Denver with an existing franchisee. This further highlights the strength of our concept and the confidence our franchisees having their success in new markets.

Despite the current challenges, as we look forward to the end of the year into 2022, we could not be more excited about our brand position today and a growth opportunity we have ahead of us. Let me assure you that our strategy has not changed.

We will continue to focus on our acceleration agenda to build on the momentum in our core business for rapid and successful growth over the next three years. This roadmap is built upon the following four key pillars. First, expand the brand by growing in new geographies in an asset-light fashion.

The second, support the brand by building the right organization for asset-light growth. Third, evolve the brand through digital innovation and expand frictionless convenience for our customers, no matter how they choose to interact with us.

And lastly, focus the brand on our most valuable core equities, exaggerate them to the point where we really stand out in terms of what makes us so special and unique. With that, let me now review our third quarter financial results in greater detail.

For the third quarter ended September 29th, 2021, total revenue increased 4.3% to $115.7 million compared to $111 million in the third quarter of 2020. Company-operated restaurant revenue increased 2.8% to $100 million from $97.3 million in the same period last year.

The increase in company-operated restaurant sales was primarily due to a 4.8% increase in company-operated comparable restaurant sales, an increase of $0.9 million in non-comparable restaurant sales and an increase of $0.4 million from restaurants that were temporarily closed due to the pandemic during last year’s third quarter.

The increase in company-operated comparable restaurant sales was comprised of a 3.5% increase in average check and a 1.2% improvement in transactions. During the third quarter, our gross pricing increase versus 2020 was 5.2%. As I mentioned earlier, our sales momentum has continued into the fourth quarter.

Through October 27th, fourth quarter system-wide comparable restaurant sales increased 8.4%, consisting of a 2.1% increase at company-owned restaurants and a 12.9% increase at franchise restaurants, while two-year system-wide comparable restaurant sales were up 8.5%.

Franchise revenue was $8.9 million during the third quarter compared to $7.8 million in the prior year period.

This increase was driven by a franchise comparable restaurant sales increase of 12.6% as well as the opening of one new franchise restaurant during or subsequent to the third quarter of 2020 and revenue generated from eight company-owned restaurants sold to an existing franchisee during the quarter.

This was partially offset by the closure of two franchise restaurants during the same period. Turning to expenses.

Food and paper costs as a percentage of company restaurant sales increased 110 basis points to 26.7% as higher menu prices were more than offset by increased commodity costs, investments in new packaging and higher usage of salsa and beverages as a result of reopening dining rooms.

We expect commodity cost pressures to continue and now expect full year inflation to be around 3% compared to our prior guidance of 2%.

Labor and related expenses as a percentage of company restaurant sales decreased 180 basis points year-over-year to 27.8% as higher wage inflation, overtime costs and training expenses, along with increased labor hours due to increased transactions were more than offset by higher menu prices and a $3.2 million employee retention credit which was recorded as an offset to payroll tax expense and classified as part of labor and related expenses.

While we put steps in place to manage labor, we continue to expect labor cost pressure for the remainder of 2021 as a result of 5% to 5.5% wage inflation, which is raised from our prior guidance of 4.5% to 5% and continued investments in recruiting, training and retaining restaurant team members that I mentioned earlier.

Occupancy and other operating expenses as a percentage of company restaurant sales increased 60 basis points to 25.1% due to higher utility costs, rents and marketplace delivery fees. These were partially offset by higher sales revenue. During the third quarter of 2020, we received an insurance reimbursement of $2 million.

Our restaurant contribution margin for the quarter was 20.4% and 17.2% after adjusting for the $3.2 million employee retention payroll tax credit.

General and administrative expenses decreased slightly to $9.4 million from $9.8 million in the year ago period due to a $1.3 million decrease in labor-related costs, primarily related to a decrease in estimated management bonus expense.

This was partially offset by higher recruiting fees, outside service fees as well as an increase in legal and professional expenses. As a percentage of total revenues, G&A decreased approximately 30 basis points to 8.5% as a result of a decreased labor cost and higher revenues versus last year.

We recorded a provision for income taxes of $3.7 million in the third quarter of 2021 for an effective tax rate of 26.5%. This compares to a provision for income taxes of $1.6 million and an effective tax rate of 14.2% in the prior year third quarter.

We reported GAAP net income of $10.2 million or $0.28 per diluted share in the third quarter compared to GAAP net income of $9.9 million or $0.28 per diluted share in the prior year period.

Pro forma net income for the quarter was $10 million or $0.27 per diluted share compared to pro forma net income of $9.9 million or $0.28 per diluted share in the third quarter of last year. For a reconciliation of pro forma net income and earnings per share to the comparable GAAP measures, please refer to our earnings release.

With that, let me quickly review our development plan. During the third quarter, there were no company or franchise restaurants opened. However, we successfully completed five companies and two franchise remodels using our new LA-Mex design.

Looking ahead, due to permitting and equipment delivery delays, we now expect to open two to three company-owned restaurants and one to three new franchise restaurants for 2021. As a result of new unit and remodel delays, we now expect our capital spending for 2021 to be in the range of $15 million to $20 million.

As we mentioned on our last call, we concluded the sale of our eight company-owned restaurants in Sacramento to an existing franchisee during the third quarter. As a reminder, this transaction included an agreement to build three additional restaurants in the market.

In addition, along with the four-unit development agreement mentioned earlier for Denver, we concluded three agreements for an additional six restaurants in various territories in California during the third quarter. Turning to liquidity. During the third quarter, we did not pay down any debt.

And as of September 29th, 2021, we had $40 million of debt outstanding and $24.7 million in cash and cash equivalents. Lastly, due to the uncertainty surrounding the COVID-19 pandemic, the company is not providing a financial outlook for the year ending December 29th, 2021. However, we are updating the following limited guidance for fiscal 2021.

The opening of two to three company-owned restaurants and one to three franchise restaurants. The remodeling of 10 company-owned restaurants and 10 franchise restaurants.

Accelerating commodity, labor and utility costs were further pressured margins in the fourth quarter of 2021 relative to the third quarter of 2021 and pro forma income tax rate of 26.5%. This concludes our prepared remarks. I’d like to thank you again for joining us on the call today, and I’m now happy to answer any questions that you may have..

Ladies and gentlemen, we will now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Andy Barish with Jefferies. Please proceed..

Hey, Larry. Just a couple of quick things.

On the negative mix that you’re seeing, you know is that just the dining room reopening more kind of individual transactions? Or is there anything else to read into as we look at that check average versus pricing component?.

Yeah. And I’m not a 100% sure what you’re getting at. But what we’ve seen around check is, obviously, we’ve got the pricing and we’re also seeing more items for check, which is you know continue to drive a check.

And again, you know we always thought that the average check would start coming down in negative by this time after lapping COVID, but just staying positive as a reflection of, again, a little bit more favorable mix than we expected in family meals and then we’ve got the pricing.

And like I said, we’re also seeing more items per transaction, you know, all of which are keeping the check up relative to where we thought it would be, given what we’re lapping last year..

Okay. And then, just I assume the margin base for the third quarter is the 17.2% that you’re kind of looking off of to you know to see pressure in the fourth quarter.

Am I thinking about that correctly?.

That’s correct. Yes..

Excellent. Okay. I’ll pass it on if anybody else has some questions. Thanks..

Thank you..

Thank you. Our next question is from Jack Corrigan with Truist Securities. Please proceed..

Hey, Larry. Thanks for taking my question. First, can I just ask about you know commodity inflation and what that implies that the fourth quarter would be just as along the same page, is that –.

Yeah. So you know fourth quarter commodity inflation is probably in a range of 8% to 8.5% is what we’re seeing. That’s really driven across the Board, a number of the commodities, probably packaging is the one that has been a little bit more surprising than we thought.

And part of that inflation in packaging is, I mean, you had the core inflation around just the makeup of packaging, but we’re also continuing to see you know packaging held up in the port. So we’re having to outsource additional different packaging, which is causing some of those increases in the packaging costs..

Great, that’s helpful.

And then I guess in terms of current sales trends and the labor environment, do you think that you know the labor situation has been the primary driver to you know the decelerating trends that you’re seeing? Is there anything on the consumer demand side that you think is impacting that as well? And I guess do you think that the labor has peaked, to say in terms of your problems with the labor environment –.

Yeah, let me give a little more –.

Do you think getting better from here?.

Yeah. Let me give you a little more detail about the labor situation that we’re seeing. I mean first of all, I mean, it’s not across all of our restaurants. And as we dig into it, there is a number of restaurants that are you know more significantly impacted by the staffing challenges.

So those are the ones we are really focused on right now, and we put together project teams and operations within investments in terms of adding more people to really support those restaurants that have really significant staffing changes.

And again, it’s not all the restaurants, it’s probably you know 15% to 20% of our restaurants where we’re seeing it, many of which are actually east of LA that tends to be – we’re seeing more staffing challenges. So I just want to clarify, it’s not entirely across the entire business.

It’s really a group of restaurants that are most significantly impacted that we’re really, really focused on. And those are the ones that we’re seeing the comp sales shortfall certainly relative to the balance so. And then when we break it down, we’re pretty sure right now we’re not seeing a consumer pushback on the brand.

Number one is, you’re seeing the franchisees continue to drive strong transactions and strong comp sales. If you break out the restaurants from those that are having the most significant staffing challenges to those that aren’t, again, there’s a big difference.

Those that have not had a bad staffing challenges they continue to be very positive in sales, you know positive in transactions, I mean not insignificantly positive in transactions.

And so that’s why we really feel like this is a staffing challenge – and more importantly, a retention challenge and that’s why we continue to put more and more emphasis and programs against solving that issue. We get that issue solved.

Our comp sales will be you know right back more in line with where we have been with franchisees, and it will take care of itself. So that is the big focus. Again, just to reiterate, it’s a group of restaurants that are most significantly impacted outside of that from a consumer perspective, you know things are still looking very positive..

Great. That’s really helpful. And then just one last one on development in the stores you know pushed off into ‘22.

Do you expect those to open in the first quarter or first half of ‘22? Is there – are they pretty much ready to go? Or there’s just you know one or two key pieces of equipment missing? Or you know what’s kind of the status of those that have been pushed off?.

Well, it’s a mixture of two things, really it’s working through the permitting or its equipment being delayed. Either way, the expectation would be that both the company and franchise restaurants would get built the first half of next year..

Great. That’s it from me. Thanks..

Our next question is from Drew North with Baird. Please proceed..

Thanks for taking the question.

Larry, you touched on this a bit in your prepared remarks, but I thought to ask if you see any changes in the company’s strategy or near-term priorities as you take over that company?.

Yeah. I mean, as I said in the call, I mean the strategy stays the same in terms of focus on the acceleration agenda.

Obviously, the current market conditions are requiring us to shift the focus and put actually more focus on exactly what I talked about earlier, which was around the operations, you know we need to resolve the staffing retention challenges that we have in these restaurants that are challenged right now.

And I believe also the big push needs to be around simplifying the operations. Again, we’ve done things over the last couple of years that have helped.

But I really believe that going forward, with the environment we’re likely to see at least through most of next year and maybe in the future, that we have a lot more we can be doing to make it easier to execute in the restaurants so that it’s easier to retain employees and potentially free up labor in the restaurants that focus on customers rather than you know doing some of the things we’re doing today in the restaurants.

So, I think on top of the acceleration agenda, those are the two big things right now that we are really, really focused on..

That’s helpful.

And on the staffing challenges, I guess, is there a way to frame up where you are today in your company restaurants versus optimal levels? And are you seeing any initial signs that your initiatives are working around hiring and retaining employees?.

Yeah. And you know I thought about in my opening remarks talking about that a bit. But we’re again early into – we’re about three weeks into it, we are seeing positive signs. We are seeing various restaurants you know get up the staffing level that need to be at.

We are seeing some restaurants, turn around their comp sales and getting back to you know certainly less negative, even positive. So we are seeing some early success. But in my view is, you know that’s nice, but you got to keep that focus and see that sustained. So that’s what we’re focused on. So yes, we are seeing progress.

You know we’re reporting on every single week on those, and I have calls every week to go through with the team. Where we are, what the progress is. So we do feel very good about it. We’ll work on the right things. We’re seeing the progress in those restaurants. But again, we need to sustain that over time. We still have ways to go.

I mean in those restaurants, we’re still short in probably several hundred staff members you know that’s across our business. But again, a lot of that will be in the short of staff restaurants that I talked about..

And then I was hoping to squeeze one more in on Q4. You spoke about the margin pressure sequentially versus Q3.

But can you give us a ballpark estimate on maybe where you would expect Q4 restaurant level margins given the current sales and cost outlook? I mean, how much of the inflation or extra costs in Q4 do you think are temporary versus structural? And so then how could we think about that right annualized margin picture as we look into 2022?.

Yeah. So as I go through it, I think a lot of it is going to be shorter-term in nature. I mean like shorter-term, I mean, I don’t know what the short-term and long-term is at this point, given supply chain challenges and everything else. But I think longer-term, a lot of this will work its way out.

So on the supply chain side, I mean, almost all of the inflation should at some point come back to normal once supply chains get back to normal. Now and that is a great question, right. But there’s nothing there that says you know those are going to be long-term structural issues that they’ll never come back down to the levels they were before.

You know the same with natural gas. And then labor, of course, you know as you’re adjusting rates and things that probably stays in the business longer-term, because it’s going to be very hard to take down wages.

But I do think some of the other costs and labor we’re seeing around overtime you know meal break penalties and those types of things that are really staffing related, those should come down over time and get back to where they had been in the past.

And so to offset maybe some of those structural issues, you know we will be relooking or obviously, we’re doing pricing, we’re looking at pricing. As we go into next year from a pricing perspective, it’s not just going to be probably across the Board price increases.

But I think there’s more we can do around really getting target on certain menu items, limit-time offers. I think we can adjust the pricing on. I think we can look at other areas where you know we can reduce pricing maybe it’s discounting, we do some discounting.

So it’s going to be a very targeted approach to how else you actually get some pricing without just doing across the Board menu price increases that you know we’ve oftentimes done in the past. In terms of fourth quarter margins, I mean, I just – there’s so many variables going on.

I think what we’re seeing is, you know as Andy pointed out, you work off the 17.2 percentage point restaurant operating profit margin. And you know we’re indicating that we will come in below that given the inflationary pressures we’re seeing around commodities and then the labor costs and utilities.

And then also, you know you can work in the comp sales, but it will be you know a bit below the 17.2%..

Understood. Thanks for the color..

[Operator Instructions] Our next question is from Sharon Zackfia with William Blair. Please proceed..

Hey, good afternoon.

Larry, that labor impact at the company-owned locations you mentioned, is that kind of manifesting itself and throughput? I mean, is it just everything slower and so consumers are baulking at the drive-thru? Or how is that manifesting the sales?.

A couple of areas, Sharon. One is, a number of these restaurants we’ve had to reduce the operating hours..

Yeah, that’s right. Okay..

Another group of restaurants, we’ve actually had to reduce the sales channels. The main one being is the go orders.

We basically had to – you know we don’t have a front counter cashier, so we don’t have to go orders in a group of restaurants, which is you know not insignificant impact when you say 20% of your mix is basically to go inside the restaurant. And then the third element is, there are you know throughput challenges also..

Okay. And then you mentioned pricing in the last question.

Can you remind us what kind of price you have right now in the menu? And I mean, would you be proactive in trying to fully insulate margins early in 2022 if this persist? I mean, how do we think about kind of how quickly you would pull the trigger on some of these dynamics?.

Well, the first trigger we’re pulling here is about a week from now. We are going to take additional pricing here in a week or so. And that is going to take our Q4 pricing up to about 6.8%. And then that will roll into next year. And as we’re rolling that into next year, we’re also going to be looking at very quickly to at least have ready to go.

I’m targeting that ready to go in January is, as I’ve talked about earlier, is some other areas where we can look at pricing on the menu, but more specifically, maybe around limit-time offer pricing.

It may be that some of the deal offers what we do that we adjust the prices on those to bringing kind of more in line with where our menu prices are as a whole. So reduce the discount that were given.

So there’s a number of things we’re going to be working on over the next couple of months to be ready to go early January where we can even take more effective pricing if we need to, depending on where commodities and labor are coming out as we enter 2022..

And I’m sorry if I missed this, but are you locked in at all on ‘21 on your commodities? And like if so, if you were re-upping for ‘22 today, like how much additional inflation would you be seeing?.

There is going to be some additional inflation in 2022, mainly around the chicken contracts, right. I mean and so what gets hard to tell is, I’ve got – I know I have chicken price increases coming.

But I expect some of the other commodities will come down like tomatoes, avocadoes and those things should come down as we get into 2022, because some of them are you know somewhat seasonally-driven. But even from Q4 you know we highlighted 8%, 8.5% commodity inflation in the fourth quarter.

I expect that to be a little bit higher as we enter into 2022..

Okay, thank you..

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back to Larry Roberts for any closing remarks..

I’d just like to thank everybody for joining us today. Really appreciate it. And everybody, have a great night. Thank you..

This concludes today’s conference. You may disconnect your lines at this time. Thank you very much for your participation..