Business context and reporting period
El Pollo Loco Holdings, Inc. filed this unaudited Form 10-Q for the 13 weeks ended June 28, 2017; comparable quarter ended June 29, 2016. Year-to-date figures cover 26 weeks. The company develops, operates and franchises El Pollo Loco restaurants. At quarter-end it had 208 company-operated and 264 franchised locations.
Financial performance
Amounts below are in millions of dollars except per-share data and percentages.
| Metric | Q2 2017 | Q2 2016 | 26 weeks 2017 | 26 weeks 2016 |
|---|---|---|---|---|
| Total revenue | $105.6 | $97.5 | $205.3 | $191.8 |
| Operating income | $12.7 | $13.4 | $22.1 | $23.7 |
| Net income | $7.8 | $7.3 | $12.7 | $12.7 |
| Diluted EPS | $0.20 | $0.19 | $0.32 | $0.33 |
| Operating margin | 12.1% | 13.7% | 10.8% | 12.4% |
- Quarterly revenue grew 8.3%; company-operated restaurant revenue rose 8.8% and franchise revenue 1.4%. Year-to-date revenue grew 7.0%.
- System-wide comparable sales increased 2.9% in Q2 and 1.3% year to date. Company-operated comparables rose 2.4% in Q2, with transactions up 0.5% and average check up 1.9%; year-to-date they rose 1.1%, as a 1.9% average-check increase was partly offset by a 0.8% transaction decline.
- Restaurant contribution margin, a company-defined non-GAAP measure, was 21.8% in Q2 versus 22.0%; year to date it was 21.1% versus 21.3%. Food and paper cost rates improved, but labor, occupancy and other operating cost rates increased year to date.
- Q2 net income rose 7.6%, while year-to-date net income was essentially flat. Lower tax expense helped quarterly earnings; operating income declined in both comparison periods.
Cash flow, debt and liquidity
- For the first 26 weeks, operating cash flow was $30.7 million, up from $21.0 million; capital expenditures were $19.0 million, versus $14.3 million. Investing cash use was $19.0 million and financing cash use was $9.5 million. Cash increased $2.2 million to $4.4 million.
- Revolver borrowings were $94.5 million at June 28, 2017; available revolver capacity was approximately $97.4 million, with $8.1 million of letters of credit outstanding. Total debt including capital leases was $94.9 million. The company reported covenant compliance.
- Management said cash, operating cash flow and available revolver borrowings should cover liquidity needs for at least 12 months. The company made a further $4.0 million revolver prepayment after quarter-end.
- Operating lease obligations were $307.2 million. The company expects the lease accounting standard to add right-of-use assets and lease liabilities, materially increasing balance-sheet amounts upon adoption, without an expected change to lease-expense recognition.
Outlook, changes and notable items
- For 2017, management planned 17–19 new company-operated restaurants and 9–11 franchised restaurants; 9 and 5, respectively, had opened year to date. Long-term unit growth objective is 8%–10% annually.
- Expected 2017 capital expenditures were $42–$44 million: $29–$31 million for new restaurants, $7 million for remodeling and $6 million for maintenance and corporate needs.
- After quarter-end, the company decided to close three Texas restaurants. It was assessing its plans; impairment charges of up to $3.4 million related to two restaurants’ remaining assets could be recorded in Q3. Separately, it recorded $0.4 million of impairment and $0.9 million of closed-store reserves during the first half.
- Management is monitoring its Texas portfolio; the carrying value of company-operated Texas restaurants was $28.4 million. It warned that unsuccessful profitability improvements could lead to significant future impairment.
- Q2 included a $0.5 million insurance recovery of prior securities-litigation legal expenses. The prior-year comparison included a $0.9 million fire-insurance recovery. These unusual items affect comparability.
- The company introduced its Loco Rewards points program in Q2; related deferred revenue was not material at quarter-end.
Risks, contingencies and governance
- Pending matters include California wage-and-hour litigation, a federal securities class action and Delaware shareholder derivative actions. Damages sought were unspecified; the company stated it intends to defend the securities claims. The SEC closed its earlier inquiry in July 2016.
- The CEO had announced plans to retire on or before December 31, 2017, subject to hiring a successor. The succession process could disrupt operations or strategy.
- After a director resignation, only four of eight directors qualified as independent. The company was relying on Nasdaq’s cure period, expected to run through September 25, 2017; failure to regain compliance could lead to delisting risk.
- Previously identified material weaknesses in financial-reporting controls were being remediated but were not yet considered fully remediated. Management concluded disclosure controls were effective at quarter-end.
- Revenue is geographically concentrated: greater Los Angeles-area restaurants generated approximately 73% of revenue in the reported periods. The largest supplier accounted for 32% of first-half purchases. Other stated exposures include minimum-wage and labor-cost increases, volatile food commodities, floating interest rates, restaurant competition and payment-data security.
Important facts for investors to verify
- Whether Texas restaurant performance improves and whether the possible Q3 impairment or planned closures materially affect results.
- Progress on CEO succession and Nasdaq board-independence compliance before the stated cure-period deadline.
- Developments in wage-and-hour, securities and derivative litigation, including any financial exposure or settlement.
- Delivery of the 2017 restaurant-opening and $42–$44 million capital-spending plans, and the resulting effect on cash flow and revolver borrowings.
- Whether comparable-sales growth and restaurant margins can offset labor, occupancy, other operating-cost pressures and continued geographic and supplier concentration.