El Pollo Loco Holdings, Inc. — Q3 2019 Form 10-Q
Business context and reporting period. The 13-week quarter ended September 25, 2019; year-to-date (“YTD”) covers 39 weeks. El Pollo Loco operates and franchises quick-service restaurants. At quarter-end it had 201 company-operated and 284 franchised locations. Amounts below are in millions unless noted.
Financial performance
| Metric | Q3 2019 | Q3 2018 | YTD 2019 | YTD 2018 |
|---|---|---|---|---|
| Total revenue | $112.1 | $112.2 | $334.8 | $329.6 |
| Operating income | $10.1 | $9.5 | $33.0 | $21.5 |
| Net income | $6.4 | $6.8 | $21.4 | $14.4 |
| Diluted EPS | $0.18 | $0.17 | $0.56 | $0.37 |
| Adjusted EBITDA | $15.9 | $16.3 | $48.0 | $48.4 |
| Restaurant contribution margin | 18.6% | 18.3% | 18.7% | 19.1% |
Q3 operating margin was 9.0% of revenue, versus 8.5% a year earlier; net margin was 5.7%, versus 6.1%. YTD operating margin was 9.9%, versus 6.5%, and net margin was 6.4%, versus 4.4%. The filing does not provide a single comparable gross-margin measure.
- Comparable sales: System-wide comparable restaurant sales rose 1.1% in Q3 and 1.4% YTD. Company-operated comps increased 1.6% in Q3 and 1.2% YTD; average check growth was offset in part by lower transactions. Franchise comps rose 0.6% and 1.5%, respectively.
- Cash flow: YTD operating cash flow was $31.9 million, down from $41.6 million; investing used $6.1 million, versus $20.7 million; financing used $20.7 million, versus $21.3 million. Cash increased $5.1 million to $12.1 million.
- Debt and liquidity: Revolver borrowings were $101.0 million, up from $74.0 million at December 26, 2018. The $150 million facility had $40.5 million available after $8.5 million of letters of credit. The company reported covenant compliance. A $40 million interest-rate swap fixes the LIBOR component on that portion of borrowings at 2.81% through June 2023.
- Balance sheet: Current assets were $27.1 million and current liabilities $80.4 million. Operating lease liabilities were $216.8 million, including $17.9 million current. Total assets rose to $635.4 million from $450.2 million, largely reflecting adoption of lease accounting; comparative 2018 figures were not recast.
Material changes versus prior period
- Q3 revenue was essentially flat: company-operated revenue declined 1.0%, while franchise revenue rose 9.1%. YTD revenue increased 1.6%, with franchise revenue up 12.0%.
- Q3 net income fell 6.3% despite higher operating income, principally because tax expense increased and the prior-year quarter included a $2.0 million insurance recovery of securities-litigation legal costs.
- YTD net income increased 48.5%, but comparison benefited from $10.0 million of insurance proceeds related to the securities-class-action settlement, lower G&A/legal costs, and lower impairment and closed-store charges. These benefits were partly offset by a $5.1 million loss on restaurant sales and higher labor costs.
- YTD labor expense rose 4.1%; labor as a share of company-operated revenue increased to 29.7% from 28.8%, reflecting wage increases and higher workers’ compensation costs. Food and paper cost as a share of company-operated revenue improved to 27.9% from 28.6%.
- The company repurchased approximately $48.3 million of stock YTD, retiring about 4.4 million shares. Buybacks and settlement-related cash requirements contributed to higher revolver borrowings.
Outlook, risks, and unusual items
- Management expected to open two to three company-operated and two to three franchised restaurants in 2019. Expected 2019 capital expenditures were $12–15 million, including new restaurants, remodeling, maintenance, and corporate spending. These are plans, not guaranteed results.
- Management said cash, operating cash flow, and revolver availability should cover liquidity needs for at least 12 months from filing. No specific revenue or earnings guidance was provided.
- During YTD, the company sold 11 company-operated restaurants to franchisees for $4.8 million cash proceeds and recorded a $5.1 million net loss. Subsequent to quarter-end, it sold five Dallas-area restaurants with no proceeds or gain/loss and closed one Texas restaurant, expecting $0.8 million of closed-store reserve expense.
- A California wage-and-hour settlement covering approximately 32,000 putative class members was reached; court approval was anticipated in Q1 2020. A $16.3 million expected-settlement accrual had been recorded at year-end 2018. The filing reports $16.6 million of accrued legal settlements and professional fees at quarter-end, but does not clearly identify the components of that balance.
- A separate Lancaster franchisee judgment totaled about $8.8 million, plus a $1.4 million attorneys’ fee award; appeals were pending. Management and counsel considered loss not probable and recorded no accrual. The company also cited ordinary-course litigation and the possibility that future claims could materially affect results.
- Key operating risks include labor and commodity inflation, food safety and supply disruption, competition, dependence on the Los Angeles market, franchisee performance, lease obligations, litigation, and interest-rate exposure. The company noted supplier concentration; its largest supplier represented 28.9% of YTD total expenses.
Most important facts for investors to verify
- Whether the California wage-and-hour settlement received court approval and whether the recorded accrual adequately reflects expected costs.
- Developments in the Lancaster appeal and any change in management’s assessment of potential loss.
- Whether comparable-sales growth can persist as transactions declined and average-check increases provided much of the lift.
- How labor, commodity, and delivery costs affect restaurant-level margins and cash generation.
- Revolver utilization, covenant headroom, and the company’s capacity to fund capital spending, leases, settlements, and repurchases.
- The effects of restaurant refranchising, buybacks, and lease-accounting adoption when comparing reported results and balance-sheet trends.