Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco Second Quarter 2022 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded today, August 4, 2022. And now, I would like to turn the conference over to Ira Fils, Chief Financial Officer. Thank you. You may begin.

Thank you, operator, and good afternoon. By now, everyone has access to our second quarter 2022 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 impacts of the COVID pandemic and macroeconomic environment 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 second quarter of 2022 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. Now I would like to turn it over to Larry Roberts, our Chief Executive Officer.

Thank you, Ira, and good afternoon, everyone. Let me start by welcoming Ira to the El Pollo Loco family. As many of you know, he's a well-rounded and accomplished executive with a strong 20-plus year track record of leadership and experience in the restaurant industry. I look forward to his many contributions as we execute on our strategic priorities in 2022 and beyond. Turning to our second quarter results. System-wide comparable restaurant sales increased 7.5%, including a 2.9% increase at company-owned stores and a 10.6% increase at franchise locations, helped in part by the success of our Shredded Beef Birria limited time offer. Labor and commodity inflation continued to persist during the second quarter, pressuring our store-level margins. Nevertheless, our team continues to do a nice job managing our business, resulting in pro forma diluted earnings per share of $0.21. We believe efforts toward improving our brand differentiation and awareness were a key driver of our sales growth during the second quarter. As I noted on our last call, our Shredded Beef Birria promotion, which ran from mid-March to early June, performed exceptionally well, aided by our new social media-centric marketing approach. With its success, we will be evaluating whether beef can be a permanent item on our menu. At the very least, we know that we have an exceptional limited time promotion that will be on the calendar for years to come. To build upon this excitement, we launched our Tostada promotion in early June by utilizing a similar marketing approach as with Beef Birria. This includes creating a new and unique content across the major social media channels with a special emphasis on TikTok, all of which is allowing us to send targeted messages to various user groups, particularly our younger consumer base. To date, the response to…

Thank you, Larry, and good afternoon, everyone. Let me start by saying I am very excited to join the El Pollo Loco team, and thank you for welcoming me into the familia. Turning to the financials. For the second quarter ended June 29, 2022, total revenue increased 1.7% to $124.1 million compared to $122 million in the second quarter of 2021. Company-operated restaurant revenue decreased 0.5% to $106.5 million from $107 million in the same period last year. The decrease in company-operated restaurant sales was primarily due to a $2.7 million decrease due to the sale of 8 company-owned restaurants to a franchisee during 2021 and $1 million from restaurants closed during the past year. This decrease was partially offset by a 2.9% increase in company-operated comparable restaurant sales and $0.3 million in noncomparable restaurant sales. The increase in company-operated comparable restaurant sales was comprised of an 8% increase in average check and a 4.7% decrease in transactions. During the second quarter, our effective price increase versus 2021 was 9%. Based on current economic conditions and consumer sentiment, we continue to expect approximately 9% pricing for the full year, inclusive of a 2% to 3% price increase we will be taking in mid-August. Looking ahead, third quarter to date through July 27, system-wide comparable restaurant sales increased 2.4%, consisting of a 0.4% increase at company-owned restaurants and a 5.5% increase at franchise restaurants, all of which reflects the traffic softness that Larry alluded to earlier. Franchise revenue was $10.1 million during the second quarter compared to $8.4 million in the prior year period. This increase was driven by a franchise comparable restaurant sales increase of 10.6% as well as the opening of 5 new franchise restaurants opened during or subsequent to the second quarter of 2021 and revenue generated from…

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

My first question was really on the trajectory of sales. And you mentioned a deceleration in mid-June. We've been hearing from others kind of a mid-May when gas prices were high, COVID cases were spiking. So I just wanted to just dig into the kind of the mid-June commentary, it's a little bit different. And I'm wondering whether that has to do with kind of the benefit of the Beef Birria ending, I think, in early the promotion ending in early June? So just help us understand kind of the trajectory of the same-store sales? And then I had a follow-up question to that.

Yes. Thanks, Jake. I think you kind of hit on one of the things I think that delayed the softness we were seeing. Again, as we look through Q2, we got off to a very strong start with Beef Birria, continue to see good momentum with that product. And so for us, we really didn't see a noticeable, I'll say, softening, especially relative to our internal forecast until that mid-June time frame. And that's when we really started to see a softening in the dinner business as being what we thought was the primary driver of that softness. So I do think the Beef Birria promotion may have been something that delayed the onset of the softness in our business because Birria was selling both at lunch and dinner. It skewed more lunch, but it was still a pretty big dinner product. So it wasn't until that was winding down and then we saw the softness of dinner that led to the softening that we highlighted around mid-June.

Got it. And then my next question is just on the consumer and how you're positioned. Maybe if you could remind us what your kind of average income consumer is? And maybe confirm the weakness that you saw was really specifically from that lower income consumer that seems to be feeling the most pressure right now? And I guess all related to that question, just bigger picture, how you feel El Pollo Loco is positioned if this current situation worsens? How do you feel about your value positioning now versus the great recession? I don't have data going back thus far, but maybe you could help me understand how you did then, but -- and how it might be different now, that would be helpful?

Sure. Yes. So when we look at our consumer base, we have roughly somewhere around 45% of consumers -- it's not consumers, actually households. So 45% of our consumers live in households with income of $50,000 or less. So some of the QSRs were certainly highlights that we have a good portion of our consumer base that would be called a lower income consumer base. And so again, I think that's one of the reasons why we think we saw the drop-off with dinner and not necessarily because of our pricing at dinner is just dinner eating out as a big ticket item. And so we think our consumers, especially lower income consumers have pulled back on that. The other thing I'd highlight again, I mentioned it on the opening remarks is we haven't advertised family meals and certainly a price point family meals since the beginning of the year, it's really end of last year, it was the last time we did that. So I think not being out there with a message around family meals and a price point around family meals was also a contributor to the value piece. Now looking forward, like I highlight in the call, we're going to do the $24 family feast. We're working on the combo meal starting at $5. So we see those as great avenues to highlight the value that we provide. The other piece on the value equation that we've made huge progress on, and we actually see it in some of the consumer data that we're pulling is as we've really improved our company operations, we've seen a value metric improve. So it's not just the experience metrics that consumers come back with is when we look at the value scores, we're seeing -- they're actually improving fairly…

Great. That's really helpful. And then my other question was on your food costs and the inflation that you're seeing pretty -- if I heard correctly, it went from 21% in the second quarter to you expect 24% in the third. In my notes, I believe back in January, you talked about having 80% of your chicken prices locked in, for instance. So what are the big moving pieces that have driven the inflation so much higher? It continues to drive it higher when I think when I look at the spot markets for a lot of these commodities, I'm seeing items coming off their peaks. So that's one question. And then as you look into '23, it looks like you could have a pretty material deflation as you lap this incredible inflation that you're seeing now. Is there any reason to think that wouldn't be the case? And maybe as you think about that 80% of the chicken that was locked in at the beginning of the year, was that a price that's lower than the spot price now? I mean, you've kind of visibility in that chicken piece to make us feel like maybe you could see some material deflation next year?

Yes. Jake, first of all, I mean, just to -- and I'm sorry if I confused you on a previous call. When we were talking about what was locked in, is that 80% of our chicken on the bone was locked in, right? So probably somewhere around 30% or so of our chicken business is non-chicken or bone, it's boneless breast, boneless thigh meat. And those were always floating. So we had a portion of the chicken on the bone that was floating, and then we had all of our non-chicken on the bone that was floating. So that's why you see higher inflation on the chicken as we move through because those pieces were not locked in. Having said that, we are right now starting to see some movement on some of these things. And it's really week to week. I mean it is really week to week around seeing some improvement around -- it's still on chicken, the boneless chicken especially. But just recently starting to see some around avocados, some of the produce, some of the other things that we're starting to see. I just -- we haven't banked on it yet, but we are starting to see a little improvement there. And again, we really do expect to start seeing some more of that in the fourth quarter and then going into next year, I think it's very difficult to predict in this current economic situation, for sure, what's going to happen next year, but we certainly would expect commodity inflation to be quite a bit less than this year. Could we get the deflation? I'm not sure. I think chicken on the bone will be the variable that will determine that because we do have chicken on the bone, the 80% that is locked in at pretty favorable cost relative to market costs right now. But again, these markets are moving very, very fast. So we will see as we enter into our chicken on the bone negotiations, which is starting right about now or in a couple of weeks to see where we're coming out on that. If we get favorable chicken on the bone pricing as we head into next year, then there certainly would be potential for deflation next year.

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

A couple of questions related to the margins and then I've got one on unit development as well. So first on the margin, I think, Ira, you mentioned the potential for increased pressure on the margins in the second half of the year, and I was wondering if you could perhaps elaborate on what your comment was intended to mean. Do you mean that margin on an absolute basis could be less than what we saw in the second quarter or the year-over-year change is going to be different? I guess anything you can do to maybe help how you're thinking about the margin?

Yes, David, I'll jump on that one. Yes, that commentary was really around what we're seeing in the third quarter with the little deceleration in sales and the higher cost inflation. We would anticipate margins to come in under where we were in Q2. Now again, that was the outlook for Q3. As we look to Q4, then we will start looking to see margins improving based on lower commodity inflation, the idea that we'll really get the overtime other labor costs under control. Because again, I don't want to digress too much, but when we look at second quarter and even in the third quarter, our #1 priority has really been around getting the restaurant staff, making the investments we need to do to get applicant flow, hire new people, train new people. Our expectation is as we get in the fourth quarter, some of those hours will start coming back in line to where we've traditionally been even pre-COVID. So that will be another positive on the margin side as we get into the fourth quarter. And then again, we'll be looking at the pricing that we take in August here in a couple of weeks and potentially looking at another price increase as we move through later in the year. So the expectation would be the third quarter with the highest inflation will probably be below Q2 in terms of margins, but then we look to start rebounding and rebound in Q4 on the margin side.

Got it. And Larry, is there a certain long-term margin that you think is a reasonable target that you want to get to? I know we've had all this inflation, but let's assume that some of it sticks, I guess, where do you want to ideally operate longer term?

Well, I think as I said in the last call, David, I'm looking to get back, and I'm saying, I always like a set rather than a super long-term goal. Okay. What would you expect over the next year, 1.5 years or so as we get into 2023. And just getting the current situation, who knows what's going to happen, but I'd be looking to get into the, call it, the higher teens on the margin side and then go from there to try to get back up to 20% over the longer term.

Got it. Okay. And then my question on the unit development. You mentioned converting some of the pipeline into signed agreements, and I was wondering if you could elaborate on the scale of those agreements and what type of number of units, for example, or sort of in process in some of those contracts?

David, I don't want to get too far out in front of ourselves on that, but the ones that were progressing to and the people we're talking to, I will tell you, tend to be multiunit franchisees, fairly good-sized businesses looking to do, I'll call it, size development agreement. So they'll be somewhere 5, 10, maybe more than 10 restaurants over a period of time. I'll just highlight a few facts is -- because of the investments we've made on the franchising efforts, our applicant flow or I would call it, people who have initiated discussions with us or at least shown an interest, we're high -- we're above where we were for the full year of 2011. So we've had more inquiries this year -- so far this year than we did all of last year. And of course, those are just inquiries and you have to work your way down to find out, okay, which ones are really viable and you do a lot of work on that. So with that, though, we have seen a larger number of people in the pipeline that we're talking to that we think are good prospects, working through those. And again, these prospects tend to be larger franchise organizations that can step up and do a number of restaurants, 5, 10 or somewhere in that range. But again, probably one of the bigger focuses we've had this year has been on that and feel good about the progress we're making.

[Operator Instructions] There are no further questions at this time. I'd like to hand it back to Larry Roberts for closing remarks.

Okay. Well, I just want to thank everybody for joining the call today. And as we highlighted, we had some headwinds we're dealing with in the near term. We feel great about the progress we're making on our strategic initiatives, and we're very, very excited about the prospects for El Pollo Loco as we move through the balance of this year and into next year. So again, thanks, everybody, for joining us.

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.