El Pollo Loco Holdings, Inc. — Q1 2018 Form 10-Q
Business context and period: The filing covers the 13 weeks ended March 28, 2018, compared with the 13 weeks ended March 29, 2017. El Pollo Loco operates and franchises quick-service restaurants; at quarter-end it operated 212 restaurants and franchised 268, for 480 locations in six states.
Key financial results
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Total revenue | $105.8 million | $99.8 million |
| Operating income / margin | $4.4 million / 4.2% | $9.4 million / 9.4% |
| Net income | $2.5 million | $4.9 million |
| Diluted EPS | $0.06 | $0.12 |
| Operating cash flow | $12.3 million | $19.1 million |
| Capital expenditures | $6.6 million | $11.6 million |
- Company-operated restaurant revenue was $94.6 million, up 1.2%. Franchise revenue was $6.1 million, down 3.4%.
- Company-operated restaurant contribution was $17.7 million, with an 18.8% margin, versus $19.0 million and 20.3% a year earlier.
- Cash and cash equivalents were $6.2 million at quarter-end, down from $8.6 million at fiscal year-end. The company repaid $8.0 million on its revolver during the quarter.
- Revolver borrowings were $85.0 million; total debt including capital leases was $85.3 million. About $107.3 million of revolver availability remained, after letters of credit. The facility matures around December 11, 2019; the company reported compliance with its covenants.
- Total assets were $440.9 million and total liabilities were $166.4 million at March 28, 2018. Operating lease obligations were $286.5 million; adoption of the new lease standard was expected to materially increase balance-sheet assets and liabilities.
Material changes versus the prior period
- Reported revenue rose 6.0%, but the comparison is affected by adoption of the new revenue standard. The company began presenting franchise advertising contributions as revenue and related advertising costs as expense, adding $5.1 million to each in Q1. Without that presentation change, Q1 2018 revenue would have been $100.7 million; the new standard reduced reported Q1 net income by $12,000. Adoption also resulted in an approximately $3.5 million after-tax cumulative adjustment to opening accumulated deficit.
- System-wide comparable restaurant sales declined 1.1%; company-operated comps fell 2.0% (transactions down 1.7%, average check down 0.3%), while franchised comps declined 0.4%.
- Operating income fell 52.5% and net income fell 48.1%. Higher general and administrative costs—including increased securities-litigation legal expense and stock compensation—and $2.8 million of closed-store reserves were significant factors. Restaurant labor and occupancy costs also rose as percentages of company-operated revenue.
- Operating cash flow decreased by approximately $6.8 million, primarily due to unfavorable working-capital fluctuations. Capital spending was lower than the prior-year quarter.
Outlook, risks and unusual items
- Management planned to open 6–8 company-operated and 6–8 franchised restaurants in 2018, and forecast 2018 capital expenditures of $27–31 million. It stated that available cash, operating cash flow and revolver availability were expected to meet liquidity needs for at least 12 months.
- After quarter-end, the company disclosed a May 1, 2018 jury damages verdict in the Lancaster franchise dispute: $4.36 million in impact damages and $4.48 million in lost-opportunity damages. The court said the amounts were largely duplicative and would be reduced to avoid double recovery; the company expected a possible reduction of as much as one-half and intended to challenge the verdict and, if necessary, appeal. The company said no accrual had been made as of March 27 because management and counsel did not consider the loss probable at that time. The court’s final award and subsequent accounting treatment were not yet resolved in the filing.
- The company received $1.6 million of insurance proceeds reimbursing prior securities-litigation legal costs during the quarter, and an additional $0.3 million after quarter-end. Subsequent to quarter-end, it also reported a $3.0 million revolver borrowing and anticipated a further $2.0 million closed-store reserve associated with two Texas closures.
- Other exposures include California wage-and-hour and securities class actions, derivative suits, and contingent liability on five assigned restaurant leases. The company disclosed a $22.1 million estimated chicken-purchasing commitment. One supplier represented 20.2% of accounts payable at quarter-end, and the greater Los Angeles area generated 69.2% of quarterly revenue.
- Management cited wage inflation, commodity-price volatility, and the possibility that costs may not be offset through pricing or productivity. It monitored impairment risk at several restaurants, including in Arizona and Northern California. The company reported no material changes to the risk factors in its latest annual report.
Important facts for investors to verify
- Track comparable sales, traffic, average check and restaurant-level margins to assess whether operating trends are improving.
- Separate underlying revenue trends from the new gross presentation of franchise advertising fees when comparing periods.
- Follow the Lancaster case for the final damages award, any accrual, motions, appeal and cash impact.
- Monitor cash generation, planned capital spending, revolver utilization and the December 2019 facility maturity.
- Assess the effect of operating-lease accounting, labor and commodity costs, and geographic and supplier concentration.