El Pollo Loco Holdings, Inc. — Q2 2019 Form 10-Q
Reporting period: Thirteen and twenty-six weeks ended June 26, 2019, compared with the periods ended June 27, 2018. Amounts below are in millions unless otherwise noted.
Business context and reporting period
The company operates and franchises El Pollo Loco restaurants. At quarter-end it had 200 company-operated and 284 franchised locations. During the first half, it sold 11 company-operated restaurants to franchisees, opened two franchised restaurants, and closed two company-operated restaurants.
Key financial metrics
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Total revenue | $113.7 | $111.6 | $222.7 | $217.4 |
| Operating income | $20.6 | $7.6 | $22.9 | $12.0 |
| Net income | $14.1 | $5.1 | $15.0 | $7.6 |
| Diluted EPS | $0.37 | $0.13 | $0.38 | $0.19 |
| Adjusted EBITDA | $17.9 | $17.5 | $32.1 | $32.1 |
| Operating cash flow | — | — | $12.9 | $25.6 |
Q2 company-operated restaurant revenue was $100.1 million, up 0.5%. Franchise revenue increased 20.8% to $7.9 million; franchise advertising revenue rose 4.2% to $5.7 million. System-wide comparable sales increased 0.7% in Q2 and 1.5% year to date. Company-operated comparable sales rose 0.4% in Q2: average check increased 3.1%, while transactions fell 2.7%. First-half company-operated comparable sales rose 1.0%, with average check up 3.9% and transactions down 2.9%.
Company restaurant contribution margin was 19.9% in Q2 versus 20.3% and 18.8% for the first half versus 19.5%. Food and paper costs improved as a percentage of company-operated revenue, but labor costs rose to 29.2% from 28.0% in Q2, principally reflecting wage increases and workers’ compensation claims.
Cash and equivalents were $11.3 million at June 26, 2019. Revolver borrowings were $85.0 million, with $56.5 million available; the company reported compliance with its financial covenants. Operating lease liabilities totaled $217.3 million, including $18.7 million current. The company adopted the new lease standard in December 2018, recognizing right-of-use assets and lease liabilities; prior-period balance-sheet figures were not restated. First-half investing cash outflow was $1.1 million, including $5.9 million of property and equipment purchases and $4.8 million of restaurant-sale proceeds. Financing cash outflow was $7.4 million, including $18.2 million of stock buybacks.
Material changes versus prior periods
- Reported operating income and net income rose substantially, but results included a $10.0 million insurance recovery related to the securities class-action settlement, compared with a $2.4 million recovery in Q2 2018. This is a significant nonrecurring contributor to reported improvement.
- General and administrative expense declined 25.1% in Q2 and 19.4% year to date, mainly because securities-litigation legal costs were lower.
- First-half operating cash flow declined by $12.8 million, primarily due to a $10.0 million securities-settlement payment net of insurance reimbursements and less favorable working-capital movements.
- The sale of 11 company-operated restaurants generated $4.8 million in proceeds and a $5.1 million first-half net loss on disposition. The Q2 loss was $0.9 million.
- Stock repurchases reduced issued and outstanding shares; 1.56 million shares were repurchased for approximately $18.3 million in the first half.
Outlook, risks and unusual items
- Management planned two to three new company-operated restaurants and two to three new franchised restaurants in 2019. First-half capital expenditures were limited; full-year capital expenditure expectations were $12 million to $15 million. Management stated that available cash, operating cash flows and revolver capacity were expected to meet liquidity needs for at least the next 12 months.
- A new stock repurchase program authorizes up to $30 million and began June 27, 2019, after quarter-end. The company disclosed an additional $8.0 million revolver borrowing after quarter-end, primarily related to repurchases under the prior plan.
- The company recorded a $16.3 million accrual for a California wage-and-hour class-action settlement covering approximately 32,000 putative class members; court approval was anticipated before year-end.
- A Lancaster franchisee dispute resulted in an $8.84 million judgment and a separate $1.39 million attorneys’ fee award. The company appealed and recorded no accrual, stating management and counsel did not consider the loss probable.
- Other exposures include a $14.8 million estimated chicken-purchase commitment and contingent lease guarantees with $2.2 million of undiscounted potential payments. One supplier represented 37.1% of accounts payable, and the greater Los Angeles area generated 69.3% of revenue.
- Management highlighted sensitivity to wage inflation, food and commodity prices, interest rates and restaurant-level performance. A 1 percentage-point increase in borrowing rates would increase annualized pretax interest expense by approximately $0.9 million. No material risk-factor changes from the prior annual report were reported.
Important facts for investors to verify
- How much of the earnings increase reflects recurring restaurant operations versus the $10.0 million insurance recovery and lower litigation expense.
- Whether traffic declines and higher labor costs continue to pressure company-operated restaurant contribution margins.
- The final approval, payment terms and any remaining costs associated with the wage-and-hour and securities settlements.
- The status and potential outcome of the Lancaster appeal, including whether any loss accrual becomes appropriate.
- Post-quarter borrowing and repurchases, remaining capacity under the new $30 million buyback authorization, and the effect on leverage and liquidity.
- Progress toward 2019 opening and capital-expenditure plans, and the performance of newer restaurants subject to impairment monitoring.