Business context and reporting period
El Pollo Loco Holdings, Inc. operates and franchises quick-service restaurants specializing in fire-grilled chicken. This unaudited Form 10-Q covers the 13 weeks ended March 27, 2019; the comparison is the 13 weeks ended March 28, 2018. At quarter-end, the company operated 211 restaurants and franchised 273, across six states.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Total revenue | $109.0 million | $105.8 million |
| Operating income | $2.3 million | $4.4 million |
| Net income | $0.9 million | $2.5 million |
| Diluted EPS | $0.02 | $0.06 |
| Operating cash flow | $10.0 million | $12.3 million |
| Capital expenditures | $4.2 million | $6.6 million |
| Cash at period-end | $6.7 million | $6.2 million |
Revenue increased 3.0%. Company-operated restaurant revenue rose 2.7% to $97.2 million; franchise revenue increased 5.5% to $6.4 million, and franchise advertising fee revenue rose 5.6% to $5.4 million. System-wide comparable restaurant sales grew 2.4%; company-operated comps rose 1.5% and franchise comps 3.2%. Company-operated comps reflected a 4.6% increase in average check, offset by a 3.1% decline in transactions.
Company restaurant expenses were $80.0 million, or 82.3% of company-operated revenue, versus 81.2% a year earlier. Restaurant contribution was $17.2 million, with a 17.7% margin, down from $17.7 million and 18.8%. Food and paper costs improved to 27.9% of company-operated revenue from 28.8%; labor rose to 30.4% from 29.3%, with management citing wage increases and higher workers’ compensation claims. Adjusted EBITDA was $14.2 million versus $14.6 million; this non-GAAP measure includes adjustments for items such as litigation expense and the held-for-sale loss.
Cash flow from operations declined $2.4 million, primarily due to less favorable working-capital changes. Cash decreased $0.3 million during the quarter. The company reported $71.0 million drawn on its $150 million revolving facility, $8.5 million in letters of credit, and $70.5 million of availability. Reported total debt was $71.2 million, including finance leases. Revolver rates were 3.96%–4.01%, and the company was in compliance with its financial covenants. The filing states liquidity is expected to cover needs for at least 12 months.
Material changes versus the prior period
- Operating income declined 48.5% and net income declined 63.9%. Results included a $4.1 million loss on assets classified as held for sale; Q1 2018 included a $1.6 million insurance recovery for prior securities-litigation legal costs.
- General and administrative expenses fell 14.0%, mainly from lower securities-litigation legal costs, executive transition costs, and dead-site costs. The income tax receivable agreement moved from $0.9 million of income to $0.2 million of expense.
- Operating cash flow was lower, while capital spending and cash used for financing also declined year over year. The company repurchased 255,554 shares for approximately $3.4 million.
- The company adopted lease accounting Topic 842 in Q1 2019. It recognized operating lease right-of-use assets and liabilities; at March 27, operating lease liabilities were $218.1 million. Prior comparative periods were not restated, and management reported no material impact on the income statement or cash flows.
Outlook, risks, contingencies and unusual items
- For 2019, management expected to open three to four company-operated restaurants and three to five franchised restaurants. Capital expenditures were forecast at $14 million–$19 million, including new restaurants, remodels, maintenance and corporate spending.
- The company agreed in principle to sell four San Francisco-area and seven Phoenix-area restaurants to franchisees, recording $4.1 million in losses and $4.5 million of assets held for sale. Subsequent to quarter-end, it completed the sale of the four San Francisco restaurants.
- Subsequent events included a $4.0 million revolver borrowing and board authorization of a new share repurchase program of up to $30 million, expected to begin June 27, 2019, after the current program expires.
- California wage-and-hour cases were settled in principle, covering approximately 32,000 putative class members and claims through April 1, 2019; the company had recorded a $16.3 million accrual as of December 26, 2018. Court approval was anticipated, not yet assured.
- A Lancaster franchisee dispute resulted in a judgment totaling $8.8 million, plus a $1.4 million attorneys’ fee award. The company appealed and stated it considered a loss not probable; no accrual was recorded at March 27, 2019.
- Other key exposures include labor and minimum-wage inflation, food commodity volatility, interest-rate risk, restaurant-level impairment risk, and geographic concentration: the greater Los Angeles area generated 69.2% of revenue. The company cited an estimated $0.7 million annualized pre-tax interest-cost increase from a 1% rate rise on borrowings.
Important facts for investors to verify
- Whether comparable-sales growth can persist given declining company-operated transactions and pressure on restaurant contribution margin.
- Final terms, court approval and payment timing for the California wage-and-hour and securities litigation settlements; the status and potential outcome of the Lancaster appeal and related costs.
- Completion and economics of the planned Phoenix restaurant sale, and the effect of restaurant transfers on future company-operated revenue and margins.
- Actual 2019 openings and capital expenditures versus management’s plans, and the remaining authorization and execution of the new share repurchase program.
- Cash generation, revolver utilization and covenant compliance, including the impact of lease obligations and variable borrowing rates on liquidity.