SANTA ANA, Calif. (CN) - A minimum wage increase and a menu change were hurting Pollo Loco's profits, but company insiders dumped $132 million of their stock before they disclosed it, shareholders claim in a class action.
Since opening its first restaurant on Alvarado Street in Los Angeles in 1980, El Pollo Loco has grown to 415 outlets in five states.
Lead plaintiff Daniel Turocy sued El Pollo Loco Holdings, CEO Stephen J. Sather and other controlling shareholders on Monday in Federal Court, on behalf of shareholders who bought common stock between May 15 and Aug. 13.
The defendants acquired the company in 2005 and took it public in 2014, issuing 8.2 million shares of stock at $15 per share, for $123 million. Under a shareholder agreement, the defendants controlled 60 percent of Pollo Loco stock, according to the complaint.
The fast-growing chain suffered a blow when California raised its minimum wage from $8 to $9 an hour in July 2014, with another increase, to $10 an hour, coming in January 2016, the complaint states.
Since its Los Angeles restaurants generate around 80 percent of its revenue, Pollo Loco decided to kill its $5 "value meal" and replace it with higher-priced entrees of steak and shrimp, to offset increased labor costs, the shareholders say.
The strategy backfired because shrimp and steak cost more than chicken, and dumping the value meal "drove away value-conscious customers," the complaint states.
Turocy claims the company concealed the "deleterious impact" of these business decisions by issuing "false and misleading statements" that claimed annual revenue had increased by 11.1 percent, or almost $10 million, from the first quarter of 2014 to the first quarter of 2015, thanks to sales growth.
In a May 2015 conference call, the defendant CEO and CFO assured investors that El Pollo Loco sales were expected to continue increasing at a rate of 3 to 5 percent in the second quarter, the complaint states.
When asked why the company had seen moderate decline in sales growth in the first quarter of 2015, the defendant Chief Marketing Officer blamed the New Year's holiday and decreased emphasis on the "under 500 calorie" menu, which he promised to revamp in June, according to the complaint.
Turocy claims the defendants' "unbridled enthusiasm" was designed to inflate stock prices while company insiders dumped their shares.
Though none of the defendants had sold any El Pollo Loco shares since November 2014, immediately after the conference call they collectively sold 6 million shares "for more than $132.4 million in gross proceeds," the complaint states.
Turocy claims they "recklessly" concealed that store traffic had substantially decreased after the death of the $5 value meal, cutting projected growth for the years' second quarter by one-half.
After the close of trading on Aug. 13, the company acknowledged that focusing on premium entrees and getting rid of the value menu had driven down sales, resulting in growth of only 1.3 percent during the second quarter, and a decrease of 0.5 percent for company-operated restaurants, rather than the 3 to 5 percent projected increase, according to the complaint.
"In response to the above revelations, El Polio Loco's stock price declined by 20 percent from its closing price of $18.36 per share on Aug. 13, 2015 to $14.56 per
share on Aug. 14, 2015, 33 percent below the price where defendants had just sold $132 million of their own El Pollo Loco shares and 42 percent below El Pollo Loco's class period high of $25.37 per share on May 15, 2015, erasing more than $382 million in market capitalization," the complaint states.
Turocy claims the defendants knowingly made false statements to the public to deceive the market for their own benefit at the expense of public shareholders.
El Pollo Loco did not respond to a request for comment Tuesday.
Turocy seeks class certification and compensatory damages for violations of the Securities Exchange Act.
He is represented by Darren Robbins with Robbins, Geller, Rudman & Dowd of San Diego, who did not respond to a request for comment.
Defendants include CEO Stephen J. Sather, CFO Laurance Roberts, Chief Marketing Officer Edward J. Valle, Trimaran Pollo Partners, Trimaran Capital Partners and Freeman Spogli & Co.
According to the lawsuit, Trimaran Pollo was the biggest profit-taker, selling 5.4 million shares at $21.85 on May 19 this year, for $118 million. CEO Sather cashed in $7.9 million in shares on the same day, and Chief Marketing Officer Valle $3.8 million that day, according to the complaint. The complaint does not report any specific stock sales from CFO Roberts.
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