Portillo's Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 2, 2023

There are 13 speakers on the call.

Operator

Greetings, and welcome to the Portillo's Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Barbara Novareni, Portillo's Director of Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you, operator. Good morning, everyone, and welcome to our fiscal Q3 2023 earnings call, our 10 Q earnings press release and supplemental presentation are posted at investors. Portillos.com. With me on the call today is Michael Osohnloo, President and Chief Executive Officer and Michelle Hook, Chief Financial Officer. Any commentary made here about our future results and business conditions are forward looking statements, which are based on management's current expectations and are not guarantees of future performance.

Speaker 1

We do not update these forward looking statements unless required by law. Our 10 ks and our quarterly 10 Qs identify risk factors that may cause our actual results to vary materially from these forward looking statements. Today's earnings call will make reference to non GAAP financial measures, which are not an alternative to GAAP measures. Reconciliations of these non GAAP measures to their most comparable GAAP counterparts are included in this morning's posted materials. Finally, after we deliver our prepared remarks, we will open the lines for your questions.

Speaker 1

Now let me turn the call over to Michael Asanlu, President and Chief Executive Officer.

Speaker 2

Thank you, Barb. Good morning, everyone. Thank you for joining our Q3 2023 earnings call, we demonstrated excellent operating leverage this quarter as total sales growth of 10.4% translated into restaurant level EBITDA growth of 22.9%. These results highlight the benefit of our throughput, operational efficiency and labor utilization even as we continue to expand our restaurant base. Our ability to sustain profitable growth is a key differentiator The strength of our brand, the consistency of our operations and the ongoing execution of a disciplined development strategy all support our fantastic business model.

Speaker 2

At our Development Day in September, we talked about how profitable unit growth is the key driver for our valuation. We also shared our plans for accelerating that growth and expanding our markets, which we know fans across the country are excited about. In fact, we've already had a great reaction from fans in our new frontiers of Colorado, Nevada and Georgia. We can confidently play the long game because of the financial strength of our business. It continues to carry us through the ebbs and flows of the current economic environment.

Speaker 2

As a growth company, we expect the contributions of our newly opened restaurants to increase that momentum. And in Q3, we can already see the impact of new restaurant development as a countercyclical factor. Revenue contribution from our newly opened restaurants meaningfully drove year over year growth. The bulk of that improvement comes from our class of 2022 restaurants, which continue to outperform our underwriting expectations. We're opening and operating our new restaurants incredibly well and our early read on the Class of 2023 is that it will also continue this strong performance.

Speaker 2

In the 3rd quarter, same restaurant sales grew 3.9% despite an industry wide transaction sluggishness. The good news is that we've already seen improvements going into the 4th quarter. Comps will fluctuate as they've always done in this industry. What's different for us now is the growing strength of our development engine. Keep in mind that we entered this year with 72 restaurants and we'll end the year with 84 restaurants.

Speaker 2

So investors can count on our self funded development to drive revenue growth in the near term, not just in some far flung future. Our 3rd quarter restaurant level margin of 25.1 percent increased 250 basis points year over year. We're also well on track to deliver year over year margin expansion for full year 2023. We're doing this even as we add more restaurants in a single year than we ever have throughout our 60 year history. Again, this is a testament to our profitable business model.

Speaker 2

We generate enough operating cash flow to self fund all of the development plans we shared with you several few weeks ago And few growth companies can say that. Speaking of growth, let's talk about what's left for the Class of 'twenty three. In Q3, we successfully opened Queen Creek, Arizona and Allen, Texas, both of which feature our more efficient Modern Kitchen Design and we've since opened in Cicero, Illinois and will open next week in Arlington, Texas. The other 4 restaurants in the Class of 2023 Fort Worth, Texas, Claremont, Florida, Rosemont and Algonquin, Illinois are on track to open in the Q4. As a reminder, we will have opened 12 restaurants this year.

Speaker 2

9 of those are in the Sunbelt, 4 in Texas, 3 in Arizona and 2 in Florida, and we're still growing the Midwest with 3 in our home state of Illinois. As we continue to grow, I'd like to thank our amazing team members for bringing Portillo's to life. They're the reason why Portillo's is an experiential brand Guests can rely on Portillo's for a delicious meal at a great price point in a vibrant environment. I'm certain that by taking care of our guests, our team members make a meaningful impact on driving long term shareholder value. So with that, let me hand it over to Michelle to discuss the quarter's financial performance.

Speaker 3

Great. Thank you, Michael. In Q3, we continue to see strong top line revenue growth. Revenues were $166,800,000 reflecting an increase of 15,700,000 or 10.4% compared to the Q3 of 2022. This increase in revenues was primarily due to the opening of new restaurants we expect to be in 2020223 and an increase in our same restaurant sales.

Speaker 3

New restaurants contributed approximately $11,000,000 revenue growth in the quarter. Same restaurant sales increased 3.9% during the Q3, which was attributable to an increase in average check going into the Q4 and our combined transactions and mix. We are committed to delivering on our long term revenue growth targets, primarily through new restaurant growth, while continuing to deliver positive comp growth. Food, beverage and packaging costs as a percentage of revenues decreased to 33.3 percent in the Q3 of 2023 from 35.3% in the Q3 of 2022. This was primarily due to an increase in our revenue and lower third party delivery commissions, partially offset by 3.5% increase in commodity prices.

Speaker 3

We continue to estimate mid single digit commodity inflation for the full year. Labor as a percentage of revenues decreased to 25.5 percent in the Q3 of 2023 from 25.9% in the Q3 of 2022. This decrease is primarily driven by an increase in our revenue, partially offset by higher labor utilization, incremental investments at our team members, including hourly rate increases and variable based compensation. Hourly labor rates were up 1.9% in the Q3 of 2023 we remain committed to providing a compelling compensation and benefits package. We continue to estimate mid single digit labor inflation for the full year.

Speaker 3

Other operating expenses increased $1,700,000 or 10% in the Q3 of 2023. This was primarily due to the opening of new restaurants, higher credit card fees as our transition to cashless drive throughs drove an increase in credit card transactions as primarily driven by the opening of new restaurants in 20222023. As a percentage of revenues, occupancy expenses decreased 0 point we expect to be approximately $22,900,000 in the Q3 of 2023 from $34,100,000 in the Q3 of 2022. Restaurant level adjusted EBITDA margins were 25.1 percent in the Q3 of 2023 compared to 22 point 6% in the Q3 of 2022. The improvement of restaurant level adjusted EBITDA is on top of opening 6 new restaurants and the 1st 3 quarters of 2023, which all have a lower margin profile to start.

Speaker 3

We believe this improvement was the result of our ongoing efforts to we will deploy strategic pricing actions, elevate guest experiences and implement operational efficiencies. The strength of our brand, the consistency of our operations and the ongoing execution of a disciplined development strategy all drive long term shareholder value creation. Near term, we do anticipate pressure on restaurant level adjusted EBITDA margins from the planned openings of 6 new restaurants in the 4th quarter and the ongoing roll off of pricing. On pricing, as a reminder, we have taken 2 pricing actions this year. In January, we increased menu prices by approximately 2%.

Speaker 3

At the beginning of May, we increased menu prices by approximately 3%. These increases continue to combat inflationary cost pressures and contribute towards our goal of restaurant level adjusted EBITDA margin expansion for fiscal 2023. We did have 3.4 percent of pricing that rolled off in October, which puts us at an effective 5.5% price increase the last few months of this year. We will continue to monitor our cost pressures, the competitive landscape as well as consumer sentiment to inform our pricing decisions we will discuss our G and A expenses increased $800,000 to 11.3% in the Q3 of 2023 from 12% in the Q3 of 2022. This increase was primarily driven by higher variable based compensation and an increase in wages and related costs, partially offset by a decrease in professional fees and insurance expenses.

Speaker 3

We are currently estimating G and A to be in the range of $78,000,000 to $80,000,000 for the full fiscal year. Preopening expenses increased $1,600,000 to 1.4% in the Q3 of 2023 from 0.5% in the Q3 of 2022. The increase was due to the timing and geographic location of activities related to our planned new restaurant openings. All of this slide to adjusted EBITDA of $27,300,000 in the Q3 of 2023 versus $21,600,000 in the Q3 of 2022, an increase of 26.2%. Below the EBITDA line, interest expense was $6,600,000 in the Q3 of 2023, a decrease of $500,000 the Q3 of 2022.

Speaker 3

This decrease was primarily driven by improved lending terms associated with our 2023 term loan and revolver facility. As of the end of Q3, the effective interest rate on the term loan and revolver was 8.5%. Income tax expense was $2,600,000 in the Q3 of 2023, an increase of $1,600,000 from the Q3 of 2022. Our effective tax rate for the quarter was 28.6% versus 23.9% in the Q3 of 2022. Our effective tax rate increased versus the Q3 of 2022, primarily driven by an increase in Class A Equity Ownership, which increases our share of taxable income or loss.

Speaker 3

We expect the full year tax rate to be approximately 21% to 23%. We ended the quarter with $12,900,000 in cash. As a reminder, we invest our operating cash flows and available cash into our future by self funding our new restaurant growth. We currently estimate the CapEx range to be $75,000,000 to $80,000,000 versus the previous range of $70,000,000 to 75,000,000 we increased this range based on capital being deployed ahead of the 2024 pipeline. Our average net build cost per restaurant remain in the range we disclosed at Development Day in December.

Speaker 3

We remain committed to delivering healthy top line and bottom line growth in 2023 and beyond. Thank you for your time. And with that, I'll turn it back to Michael.

Speaker 2

Thanks, Michelle. And before we open for questions, I'd just like to reiterate how proud I am of Portillo's, our teams and all we have to offer. We're a growth company and we continuously earn the right to grow because we manage our core business profitably. Q3 was another quarter with really great margins. Our investors can count on us to deliver on both the top and bottom line to keep funding that growth.

Speaker 2

This starts with efficient operations, which our engaged team members drive every single day. Their dedication and hard work creates a fantastic experience for our guests and keeps them coming back. This is our flywheel and you'll see that it's really starting to we expect our momentum to last long into the future. And with that, let's open the line for questions. Thank you.

Operator

Thank you. We will now be conducting a question and answer session. Our first question comes from Sharon Zackfia with William Blair. Please go ahead.

Speaker 4

Hi, good morning. I know you don't normally talk about recent trends, But you did bring it up on the call and I think a lot of others have had to as well just given kind of what seemed to be a return to more normal seasonality in the quarter. I guess, do you concur that part of the slowdown that you saw in the Q3 was more normal kind of pre pandemic seasonality? Or do you think there's something else happening in the business. And as you think about the rebound here in October, how do you think about pricing power value proposition as you look towards 2024?

Speaker 2

Yes. Good morning, Sharon. Thanks. Great question. And yes, we don't normally like to talk and talk about what's going on.

Speaker 2

But Given the context and how everyone else has opined on it, we felt it was appropriate. We are seeing strong momentum Across the board in October. And I think you're 100% right. We're back to what I think is more of a normal rhythm in the restaurant industry Going back to 2019 kind of mindset, 3rd quarter is always a little bit of a sluggish quarter for the restaurant industry. And typically, we come roaring back in the 4th quarter.

Speaker 2

So we're seeing a much more consistent pattern with the past. So We're happy about that and we feel very optimistic for our Q4. With regards to the second part of your question, Look, we feel we are very, very, I guess, astute on monitoring our pricing versus all of our competitors. As we look at our typical basket versus everybody else, we compare ourselves to not just fast casual, but QSR and sort of the best of QSR. And we feel we have a very strong price position.

Speaker 2

But we're also a little cautious And we're going to play it by ear. We forego on we went we forewent, I guess, any pricing in October. As Michelle indicated, we're going to have a 2% pricing that we're going to lap off of in January, and we're still evaluating whether or not we do anything there. We feel we can. That's not the issue.

Speaker 2

But what we really do want to protect our price position and be a really great value for our guests. So that's the balancing act for

Speaker 4

Thanks. And I guess, I don't want to belabor the point, but I hear all the time from investors like, how does Portillo stack up as a long term investment if traffic is slightly negative, which has been for a couple of quarters. So It would be great if you could help contextualize, maybe what's happening in traffic. And I know you're burdened by this big Chicago base where you've got kind of declining population. But if you could help frame kind of why the optimism on the long term when investors look at the near term and they think, well, like what's the consumer saying with that traffic number.

Speaker 2

Yes, I think you actually said it well. Thank you for teeing up the answer. But Look, the Midwest and in particularly in Chicago, we're in a negative population state, right? So as population declines, that makes Transaction growth very, very challenging. You effectively have to steal share from other people.

Speaker 2

As I enumerated, the bulk of our growth is Texas, Florida, Arizona, all states with significant population growth. And so we are putting ourselves in a position where Just from a transaction standpoint, it's almost transaction arbitrage. We're in we are repurposing capital to states with Transaction tailwind, and we will be a beneficiary of that along with all the other restaurant companies that are in those markets. What we like to think is that in Chicagoland and in the Midwest, we can fight the negative macro trends with the strength of our brand and steal share where appropriate. But in these growth markets where we're repotting ourselves and putting all of our capital, we can rise with the rest of the tide there.

Speaker 2

So that's the play for us. I know that play is going to have some quarterly fluctuation. We're not frankly too torqued up about that. But over the period over the quarters, the years, we're very confident in Portillo's transaction strength, in Portillo's traffic strength, in Portillo's comp strength and especially our margin strength.

Speaker 3

Sharon, I'll just jump in for a minute and reiterate our long term growth algorithm, right, of that low single digit comp growth and And the revenue growth that we're going to generate from the new units as we talked about on the call that's really going to drive that revenue growth as we go forward. And we're definitely not saying I know how important comp is. And as Michael said in his prepared remarks that will ebb and flow, but that new unit growth in the development that we see in the pipeline, I think is really going to propel us. And so I'd say that's definitely the investment

Operator

Our next question comes from Andy Barish with Jefferies. Please go ahead.

Speaker 5

Hey, good morning, guys. On the labor line, some nice leverage there, again, where seasonality maybe goes against you a little bit. I think you quoted the wage increases were only around 2% for the quarter. So Did we read into that the wage investment that you took kind of picked up steam in the latter part of the 3Q? Just trying to jive you know those comments with the results.

Speaker 3

No, I think, Andy, you're right. Q3 labor was up 1.9 we did make the investments in late June, early July in terms of those wage increases And they were normal increases. So there was nothing with the increases that was out of the ordinary, I'll call it. And as we go into Q4, I we expect that the Q4 inflation rate will be very similar to what we saw in Q3. So nothing I would call out, Andy, that Indicates that Q4 would look any different than Q3 from an inflationary standpoint.

Speaker 2

Keep in mind, Andy, Year to date number on wage inflation is 4.8%. So that's something that you just have in your head.

Speaker 3

Yes. We started to lap, Andy, Some of the wage increases that we had given in prior years that started to roll off. And again, to Michael's point, we're up just under 5% year to date. And when you look at even versus 2021, we're up just under 17% and actually up 30% when you go back versus 2020. So Yes, we've made significant investments in labor over the past 3 years, but we're starting to see that normalize.

Speaker 6

Great.

Speaker 5

And then just with the number of openings in the Q4, Any kind of guardrails or guidance on that restaurant level margin sequentially or year over year? I'm Assuming it's going to be down sequentially with all those new openings, but anything there? Does this kind of help us With those 6 openings in the quarter?

Speaker 3

Yes. I would say, Andy, when you look at we already said Cicero opened in October And Michael mentioned Arlington is going to open shortly. And then when you look at the remaining restaurants, those are going to open later in Q4. And so yes, you get a little bit of impact to the margins, but also the pricing that rolls off to the 3.4% pricing that rolls off, Does impact you when you look at that margin picture in Q4 as well. And so yes, I do expect sequential margin decline Q3 versus Q4.

Speaker 3

But I do expect when you look at quarter over quarter Q4 2022 versus Q4 of 2023, I'll just have margin improvement.

Speaker 5

Got it. And then just one final one for me. I'm happy to hear about the start To the Q4, kind of in line with what we've been hearing from others and seeing in industry data. I think last year, your Catering business kind of really got hurt with the weather and the sort of the holiday week. Anything else that we should Be aware of just as the Q4 unfolds versus year ago kind

Speaker 7

of cadence?

Speaker 2

Yes. You're excellent recollection, Andy. We had Winter Storm Elliot, a name that will live in infamy for me, but it ruined the Christmas holiday season. It was the week right after Christmas and it's a really big week for us from a catering standpoint. So it really pulled the rug out from under our catering business.

Speaker 2

We're hoping for more mild weather, I guess, in the Midwest. So knock on wood for that. But that did pull the rug out from underneath us. And you will recall that this is a unique year and that we have a 53rd week. So, obviously, we'll report like for like numbers 52 week, but we do have a 53rd week, which will create a little bit of extra I don't know, momentum for the year.

Speaker 5

Thank you.

Operator

Our next question comes from David Tarantino with Baird. Please go ahead.

Speaker 8

Hi, good morning. Michael, for what it's worth, I'm also hoping for more mild weather in the Midwest.

Speaker 2

Hey, man. Hey, man.

Speaker 6

I had

Speaker 8

a couple of questions. One is on the October trend that you referenced. I was hoping maybe you could give us some Sense of magnitude of the improvement from what you saw in the Q3 just so that we're all on the same page here.

Speaker 2

Michelle is giving me a dirty look as is my IR person. Let's just say that we're definitely into territory in terms of transactions, and I think that's all I can say right now. So we're very optimistic about that. We've Yes, we're also in part of that G and A spend, we spent a little bit of money on advertising in Chicagoland. If you're an unfortunate Bears fan and you've been watching Bears games or Monday Night Football or the World Series, you will have seen some Portillo's advertising.

Speaker 2

Whenever we do brand enhancing marketing like that, it tends to have a positive impact for us. And so, we've seen A little bit of that and I wouldn't be surprised if that continues to drive some momentum into the Q4. So we're optimistic And I think we're pulling some levers to make sure that the traffic trends remain what we have seen.

Speaker 8

Great. Thank you for that context. The other question I had is on new unit contribution. And so I guess the way we model it, it came in a little light of what we had modeled And it looked like maybe the average weekly sales for the new units is a little lower than what you saw in prior quarters. So I just wanted to Understand that dynamic and whether it might be related to kind of coming off some of the honeymoons in the early part of the year or if there's something else going on.

Speaker 2

I would encourage you to double check your models and adjust timing because I think that depending on if you The mid quarter convention for each new unit. We honestly didn't do that. Most of our units are opening up towards the end of each quarter. Like the ones in the Q4, you should be modeling them late in Q4. Obviously, we're already into the Q4.

Speaker 2

But it's not a function of they're coming in softer. It's a

Speaker 8

Michael, on the 2nd Texas location, how that's open so far?

Speaker 2

We're very happy with Allen. We're very happy with Allen. I think Arlington is going to be I mean, we're super excited about Texas. I'm eager to get Arlington open. It's a beautiful restaurant.

Speaker 2

The team is chomping at the bit. And We've got Fort Worth coming in shortly after that and we already pre announced Denton early 'twenty four. So I'm excited to get to 5 restaurants in the state of Texas In Dallas Metro within 12 months, which is for us that's an audacious Task that we just took on and accomplished.

Speaker 8

Great. Thank you very much.

Speaker 2

Thank you, David.

Operator

Our next question comes from Chris O'Cull with Stifel. Please go ahead.

Speaker 9

Thanks. Good morning, guys.

Speaker 2

Good morning,

Speaker 9

Chris. Good morning. Michael, the industry has started to get more promotional. I think you mentioned incremental advertising here recently. But What other initiatives can the company take to keep traffic flat to positive if it needs to?

Speaker 2

Yes. So I want to knit Nat with one thing. So the industry has gotten promotional. Portillo's does not get promotional. We don't discount.

Speaker 2

So you're not going to see a dollar menu. We're not going to do shrinkflation. That's just not who we are. I support when we do brand enhancing activities. Just a reminder of who Portillo's is.

Speaker 2

And our marketing is showing pictures of our food, right? It's Because it's craveable, it's delicious, it's a reminder of why people love Portillo's. I think our team did an amazingly creative job with the existing advertising, which is The sounds of Portillo's hearing, sort of the crunch of the onion rings as they fall onto your plate, things like that. So it's brilliant Brand enhancing advertising. And we're seeing the impact of all of the macro trends, Chris.

Speaker 2

So Our dining rooms are really full and that's because I think that with price points where they are in casual dining, we are a refuge from that. We have fantastic food in a beautiful environment and it's working really well for us. Our drive throughs did get a little slowdown in Q3 And that's because of exactly what you're describing, some very aggressive discounting activities by QSR, which again, We don't discount. And so there's going to be a shopper that chooses to go get a dollar burger or a $2 burger versus our burger. And When economy gets better, they'll come back to us or when they want to sit down with their family, they'll come into our dining rooms.

Speaker 2

And so I think we just ride that ebb and flow a little bit. We're happy with where we're positioned. We're not going to promote we're not going to discount, but we are going to remind people of how delicious our food is and how craveable it is in a brand enhancing way. The other lever for us to pull is excellent execution. One of the things that I don't think people talk about because it's not a short term fix, it's a medium and long term fix is when you give great experiences to guests every single day, that's the number one reason why they choose to go back to a restaurant.

Speaker 2

It's not because of a coupon or a discount or something, But it's because when I went there, I had a great experience and I want to go back. And so that's another way that you can differentiate yourself over the medium and long term And drive consistent traffic by just being operationally sound. And that is our mantra internally. We're going to be the most operationally sound restaurant company we can be and that will drive performance.

Speaker 9

Okay. That's fair. And then the margin performance was clearly impressive this quarter. And I'm just wondering whether there's whether you think there may be an opportunity to to give back some of that margin improvement to enhance the value proposition either through changes to some of the Menu items or maybe something else that you think could maybe improve value?

Speaker 2

Yes. I think that's a great another great question. It's one of the reasons why we decided to forego any pricing for the remainder of this year. And that's essentially where our pricing is coming down to 5 point Percent and that's one way of giving value back. We did not engage in any shrinkflation lowering quality doing anything like that over the last couple of years.

Speaker 2

In fact, what we've done is we've added value, right? We spend more money on bacon. We have, I think, the best bacon in the restaurant that we're selling right now. So if you try our bacon burgers, they're amazing. And we've consistently done that.

Speaker 2

We've added quality. And so that's the other thing that we do is, I'd rather in terms of reducing prices, getting to some sort of lower value, lower we'd rather just improve the other aspects of value. We'd rather improve the quality of what you're getting. We'd rather improve the quantity of what you're getting. We'd rather improve your experience and then maintain prices as opposed to raising prices.

Speaker 9

Okay. Thank you.

Operator

Our next question comes from Dennis Geiger with UBS. Please go ahead.

Speaker 10

Great. Thanks. Good morning, guys. Wanted to ask if anything additional to highlight on the sort of observed customer behavior changes perhaps whether it's dayparts, days of the week, off premise versus on, delivery, anything discernible over the last several months there, Michael and Michelle, you would call out.

Speaker 2

I think we're largely in some ways our channel mix is very stable. Unsurprisingly, our drive thrus have a little bit of pressure on them, given the promotional activity in QSR. And our dining rooms we have a little bit of extra momentum given the pressures that casual dining is facing. And so It's for us, it's a really nice dynamic. The other thing that frankly surprises all of us every day we look at is that Our 3rd party delivery partners are still doing a really good job with us.

Speaker 2

We continue to grow 3rd party delivery and that it's great news. It's also a little bit mystifying given consumer pressures out there, but we're doing we feel really confident with where we are right now.

Speaker 10

That's great. Thanks, Michael. And then just one maybe 2 part question. First, I guess, maybe I missed this, but as it relates to cannibalization, anything there that you saw in the quarter even if modest worth calling are? And the second sort of unrelated part of the I know we were just spent a month a month and a half ago spent some time on development, of course, but any kind of latest update on timing, permitting, etcetera, I assume it's probably steady as she goes since 1.5 months ago, but any update there?

Speaker 10

A lot of folks have been shifting into next year, you guys obviously are going to get these open. So just curious if anything has shifted with the open environment on some of that timing stuff?

Speaker 3

Yes, Dennis, I'll take the cannibalization. There's been no changes since we gave the impact last quarter at the 60 to 80 basis points. We're seeing roughly the same impact in Q3, so continues to be fairly insignificant for us. So we don't expect that to be a significant headwind As we move forward, but it was roughly the same as it was in Q2.

Speaker 2

And then with regard to permitting and those things, I don't want to sound too glib, but it's sort of whatever that military acronym is for snafu, situation normal, all messed up. We continue to face delays and all kinds of like last minute things with getting utilities hooked up, etcetera, etcetera. We're just I think we have reconciled ourselves to this is a new normal. And so we continue to pad hours and weeks, Actually months into the building cycle for us, so that we can still control what we can control, build the restaurants Quickly and as adeptly as we can. And then, the stuff that you can't control, just build enough cushion so you're not disappointed from budgeting, timelines, etcetera.

Speaker 2

Great. Thanks guys. Appreciate it. You bet. Thanks, Dennis.

Operator

Our next question comes from Sarah Sanitore with Bank of America. Please go ahead.

Speaker 11

Thank you. Michelle, I wanted to ask you a little bit about the idea of like sort of what flow through margin should look like. And I think in Specifically, you took sort of a fair amount of price, most of the margin expansion seem to come from food. I think through like labor and occupancy particularly or other operating, I should say, in the context of maybe additional drags from new units coming on in Q4, do you have any sort of framework for like what's the right comp number to get margin expansion on some of those six lines, and similarly in the same vein like G and A is creeping up a little bit. So just trying to kind of Calibrate incremental revenues or same store sales versus flow through margin on the restaurant line and also, G and A?

Speaker 11

And then I'll have one follow-up

Speaker 3

Yes, Sarah. I think when you look quarter over quarter, I'll talk Q4 2022 versus 2023, Right. You really you hit the nail on the head. I mean commodities when you look at that and you look at what we're running on that food line for us. I think that's where you see some of the improvement quarter over quarter.

Speaker 3

I think if you're talking sequentially Q3 versus Q4, we do have the pricing rolling off, so that's going to be a headwind. And as these new units come on, we talked about they're coming on later in the quarter, but that does have a bit of an impact when you think about particularly that labor line. And so I see the improvement coming year over year and quarter over quarter, primarily from that commodities line when you look at that because I I think labor is generally when you look at Q4 2022 versus 2023 will generally be in line, and so you get the impact of the commodities. But sequentially, I think we'll be impacted with that pricing rolling off.

Speaker 11

Okay. Yes, I was more thinking year over year, just this idea that 3Q versus 3Q, you had some improvement, But most of it seem from commodities. So is that sort of the same Yes.

Speaker 3

You have the

Speaker 2

nail on

Speaker 3

the head. If you look at Okay. Yes, Q3 of last year, we were running at about just over 35% versus the 33% this year. And so I don't expect Q4 of this year to change much sequentially, I think inflation will be very similar to what we saw in Q3 from a commodity standpoint.

Operator

Okay.

Speaker 11

And so as we think about the complexion of margin, year over year 4Q should look similar to 3Q in the sense of most of the tailwind coming from the commodities?

Speaker 3

Correct.

Speaker 11

Okay. And then even with perhaps better transaction trends?

Speaker 3

As Michael mentioned, in October, we are seeing better trends. And I said in my prepared remarks, when we look at transactions mix combined, yes, we're seeing improved trends versus what we saw In Q3.

Speaker 11

Right. But still thinking about the margin construct similarly even though trends. Okay. And I'll follow-up with you. Okay.

Speaker 11

And then just on again on G and A, sort of thinking through that increase, how should sort of I think about sort of your the variable comp in terms of when we think about your long term algorithm, should we think about your sort of internal goals as consistent with that so that as we're trying to sort of think about where there might be upside in terms of variable comp, it should look sort of similar to what you've articulated as your long term growth targets?

Speaker 3

Yes, correct. As you know, long term, we're targeting 75% of that revenue Great. As we think about and you think about modeling G and A in the future, absolutely. That's how we think about it internally. For the Q4, we increased the range.

Speaker 3

I think Michael mentioned the incremental dollars we're spending on advertising in the Q4 within our just our core market of Chicagoland where we have scale. We think that's definitely, I think to Chris' question earlier, one of the levers that we can pull as we're in this, as Michael mentioned, it's sluggish environment in a market that we have scale like our market of Chicago, we can pull that lever, Sarah. And that's where we're seeing in the investment that we made in G and A and that's why you're seeing that range go up in particular in for the full year why we raised that range. Okay, got it.

Speaker 11

Thank you.

Speaker 3

Yes.

Operator

Our next question comes from Gregory Francfort with Guggenheim. Please go ahead.

Speaker 7

Hey, thanks. I just had a couple of quick ones. The first is, I know you guys have not historically wanted to comment a lot about trends regionally, but just given the traffic declines, I'm curious, Any big differences between either Chicago and non Chicago or regional things to call out?

Speaker 2

No. I mean, Greg, first, good morning. I wouldn't say so. I think that we obviously look very carefully at our traffic trends and transaction trends and we use Black Box. Compare ourselves within Chicagoland, that's not Chicagoland.

Speaker 2

And I would tell you overall, the trends are pretty consistent and the improvements are pretty consistent. So I don't think there's anything idiosyncratic there. With our performance versus market, yes.

Speaker 7

Okay. Got it. And then just we've seen a few companies start to talk about 2024 labor inflation in the mid single digit range, I think it's interesting that you guys are running sort of below that. I don't know if that's something to do with either where you are regionally or I'm just curious if you kind of think that that's I know it might be a little bit early if that's something that would be What you guys would expect or if you guys might be able to run below that next year?

Speaker 2

So a couple of thoughts. Keep in mind that our labor inflation year to date is 4.8%, right? So that's where we are. And I'll let Michelle talk about what's going to happen going forward. But there's it's so there's a whole bunch of noise in this.

Speaker 2

So our overall labor is negatively affected by wage inflation. It's kind of a mixed news our staffing is really good right now. We are much better staffed than we were last year, which is a good news and a bad news. The good news is it means our guests are getting Great experiences. Our restaurants are fully staffed.

Speaker 2

We can handle volume. The bad news is it puts a little bit of pressure on the labor line because it means you're It pays off over time, so it's a no brainer to do that. And then the really positive news, and I'm very proud of our ops team, is we continue to get appropriate labor leverage and operational efficiencies. I made kind of a big deal about we've got a new kitchen design in Queen Creek and Allen, Texas. That new kitchen design is meant to reduce wasted effort.

Speaker 2

And by wasted effort, I mean, needless conveyance, people walking 50 feet to go get something when there should be a refrigerator bin right by their feet. And so our kitchens are more efficiently designed. It reduces conveyance. We've gotten Smart about reducing prep work, etcetera. So it's those three factors really, Greg, affect labor: rising rates, How well staffed you are and then are you getting efficiency by removing effort that is not value added.

Speaker 2

So the net of those is how we are going to manage our labor line. And I think we can we're still targeting to offset most of the wage inflation. Michelle, let me

Speaker 3

Yes. Greg, I would just add as we look at 2024, obviously, we're putting those plans together. Nothing that I'm Seeing today indicates that we're going to be different than what we saw this year, which when you think about that mid single digit wage inflation, I don't anticipate us being outside of that range as I sit here today.

Speaker 7

Got it. And then maybe just one last one. I know this is kind of more model focused than I would like for this call. The last week between Christmas and New Year's, I think it shifts between 1Q and 4Q this the coming two quarters. Is that a big Sales volume weak for you and just in terms of rightsizing both the impact on 4Q, but also potentially impact on 1Q of next year?

Speaker 3

Yes. That's generally the week after Christmas. And so as Michael mentioned, we see a lot of catering leading up To that Christmas time, Greg, as he mentioned. And so I would say what we saw last year, Michael mentioned Elliott, And we saw like an immediate pickup in sales last year right after the year ended in 2022. So that 1st week In fiscal 2023, we saw a big pickup.

Speaker 3

So as we're lapping that week, that week could be that 53rd week, let me just say, it could be year over year a little bit pressured because you had the pickup from Elliot last year versus this year, if that makes sense to you. So long story short, I don't say it's like a we have a huge blowout week for us. I think the week prior, when you look at that Christmas Eve Christmas timing, is a lot of the bigger catering volume that we see.

Speaker 7

Understood. Thank you.

Speaker 3

No problem.

Operator

Our next question comes from Brian Harbour with Morgan Stanley. Please go ahead.

Speaker 6

Yes. Thank you. Good morning.

Speaker 2

Good morning, Brian.

Speaker 6

Michelle, just to kind of follow on those comments about 2024, do you have any kind of early thoughts on commodities next year at this point? Or even on the beef side, do you think There could be a little less inflation than 2023 or maybe something similar?

Speaker 3

I don't think beef is going to lighten up, Brian into next year, so I think that will still be pressured. I mentioned on the last call, we're still taking we're taking positions into 24. And so when we look at the B flats, we're trying to de risk some of that line item and we have taken some positions into both Q1 and Q2 Of next year to de risk that, but no, I expect that to continue to be pressured. But when we look at the overall basket, I'll say the same thing I said about labor. As I sit here today, I don't expect to be outside of that mid single digit range.

Speaker 3

We'll update you all as we get into the new year at ICR with what we're seeing for the full 2024 fiscal year, but I'm not seeing anything today that would indicate anything beyond that mid single digit for 2024 as well on the commodity line.

Speaker 6

Okay. Yes, sounds good. Just on 4 wall margins, I mean, they have been quite strong year to date, so you're kind of Probably higher as you've suggested. Do you think that's mainly influenced by just strong new store openings? Maybe they're kind of Ramping a bit quicker than you thought or anything else broadly that you'd characterize has really helped store margins?

Speaker 2

I want to brag about my team because I will tell you that the labor efficiencies that we've gotten by putting people in the right position And reducing conveyance has been a big help. Otherwise, labor would have been out of control. Michelle and her team have done a brilliant job of Forward buying beef and so and doing other creative things to make sure that we're not as we're not held hostage to the beef prices. So we track very carefully where our beef flats are versus The market and we're really happy with what we're paying versus the market and I give a lot of credit to my team for that. So it's a lot of Brian, it's a lot of pick and Double work behind the scenes to make sure that those margins are as robust as they are.

Speaker 2

Absolutely, having great new restaurants that open above Your target helps. Undeniably that helps. But there's a lot of like heavy lifting behind the scenes that goes into maintaining those kind of margins and our team across the board is doing a great job of protecting our shareholders and funding our growth.

Speaker 6

Thank you.

Speaker 3

Thanks, Brian.

Operator

Our next question comes from Brian Mullen with Piper Sandler. Please go ahead.

Speaker 12

Hi, good morning. This is Ashling on for Brian. I'm just wondering if you could comment on mix. It looks like it was still negative in the quarter, but it's improved sequentially. I know this negative mix dynamic is not unique to Portillo's, but just wondering if there's any changes as to what's driving this and what it could look like as we progress into 2024?

Speaker 12

Thanks.

Speaker 3

Yes, no problem. Yes, absolutely, we did see improvements to your point in the mix, going from negative 2.7 in Q2 to about negative 1.8 in Q3. I think, Ashing, to Michael's point, in Q4, we're seeing improvements on both transactions So we're seeing some improvements of that into Q4. I'd say nothing's changed underlying that in terms of we're still seeing the Lower attachment, the less items per transaction, that's the main component of that mix change. So nothing I would call out that's changed from what we previously

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Earnings Conference Call
Portillo's Q3 2023
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