El Pollo Loco Holdings, Inc. — Q2 2018 Form 10-Q
Business context and reporting period. The filing covers the 13 and 26 weeks ended June 27, 2018, compared with the corresponding periods ended June 28, 2017. The company operates and franchises El Pollo Loco restaurants; at quarter-end it operated 211 and franchised 269 locations across six states.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Total revenue | $111.6 million | $105.6 million | $217.4 million | $205.3 million |
| Income from operations | $7.6 million | $12.7 million | $12.0 million | $22.1 million |
| Net income | $5.1 million | $7.8 million | $7.6 million | $12.7 million |
| Diluted earnings per share | $0.13 | $0.20 | $0.19 | $0.32 |
| Operating cash flow | — | $25.6 million | $30.7 million |
- Reported revenue grew 5.7% in Q2 and 5.9% year to date. The first-time gross presentation of franchise advertising contributions added $5.5 million and $10.6 million, respectively, to revenue and franchise expenses. Excluding that presentation change, revenue was $106.2 million for Q2 and $206.9 million year to date, versus $105.6 million and $205.3 million in the comparable periods.
- Q2 operating margin fell to 6.8% from 12.1%, and net margin to 4.5% from 7.4%. First-half operating margin was 5.5% versus 10.8%; net margin was 3.5% versus 6.2%.
- Company-operated restaurant contribution was $20.2 million in Q2, with a 20.3% margin, versus $21.6 million and 21.8%. First-half contribution was $37.9 million, with a 19.5% margin, versus $40.6 million and 21.1%.
- Adjusted EBITDA, a non-GAAP measure, was $17.5 million in Q2 versus $19.7 million, and $32.1 million for the first half versus $35.6 million.
- Cash and cash equivalents were $13.1 million at June 27, up from $8.6 million at December 27, 2017. First-half investing cash outflow was $14.0 million, principally capital expenditures; financing cash outflow was $7.1 million.
- Revolver borrowings were $86.0 million; total debt including capital leases was $86.3 million. The company reported $106.3 million of availability under its then-current facility and compliance with its covenants. Current assets were $26.0 million and current liabilities $50.6 million.
Changes versus the prior comparable period
- Company-operated comparable sales declined 1.6% in Q2 and 1.8% year to date. System-wide comparable sales declined 0.9% and 1.0%, respectively. Company-operated Q2 transactions fell 2.5%, partly offset by a 0.9% increase in average check.
- Food and paper costs improved as a share of company-operated revenue: 28.8% in Q2 versus 29.5%, and 28.8% year to date versus 29.2%. Labor costs rose to 28.0% from 26.9% in Q2 and to 28.6% from 27.8% year to date; occupancy and other operating costs also increased as a share of restaurant revenue.
- Lower profitability reflected weaker comparable sales and higher labor and occupancy costs, as well as higher general and administrative costs, impairment and closure reserves, and interest expense. Q2 general and administrative expense rose 30.3% to $12.5 million; first-half expense rose 33.0% to $25.7 million.
- First-half operating cash flow declined $5.1 million year over year, primarily from lower profitability after non-cash items, partly offset by working-capital movements. Capital spending fell to $14.0 million from $19.0 million.
Outlook, risks and unusual items
- Management expected to open 7–8 company-operated and 8–10 franchised restaurants in 2018, and forecast 2018 capital expenditures of $27–31 million. It stated that cash, operating cash flow and available revolver borrowings should cover liquidity needs for at least the next 12 months.
- On July 13, 2018, the company refinanced its prior facility with a $150 million, five-year senior secured revolving facility maturing July 13, 2023. On July 30, the board authorized discretionary share repurchases of up to $20 million through June 26, 2019.
- During the first half, the company recorded $1.7 million of non-cash impairment, primarily for one Arizona restaurant, and $5.1 million of closed-store reserves, including for four Texas restaurant closures and a discontinued Texas development project. It is monitoring additional restaurants, including in Arizona and Northern California, for possible impairment.
- After quarter-end, a court entered an $8.84 million judgment in the Lancaster franchisee dispute and ordered changes to franchise documents. The company intends to challenge the verdict and appeal if necessary. As of June 27, management and counsel assessed the loss as not probable, so no accrual was recorded at quarter-end.
- A securities class action was certified in July 2018; defendants were seeking appellate review of part of the certification order. The company also reported California wage-and-hour and shareholder derivative litigation. It received $4.1 million of insurance proceeds during the first half for previously paid securities-litigation defense costs.
- Key operating risks include wage and benefit inflation, commodity-price volatility, restaurant performance and impairment judgments, and legal claims. A 1 percentage-point increase in borrowing rates was estimated to add $0.9 million of annual pre-tax interest expense. The company had $282.3 million of operating lease obligations; adoption of the new lease standard was expected to materially increase reported assets and liabilities, without an expected change to lease expense recognition.
- Adoption of the new revenue standard changed franchise fee timing and the presentation of advertising contributions. The company recorded an approximately $3.5 million after-tax opening accumulated-deficit adjustment for franchise and development fees.
Most important facts for investors to verify
- Whether comparable-sales trends, particularly declining transactions, improve and whether restaurant-level margins stabilize.
- How much revenue growth reflects underlying activity versus the new gross presentation of franchise advertising fees.
- The status, appeal and potential financial impact of the $8.84 million Lancaster judgment, alongside the securities and labor-related litigation.
- Whether planned restaurant openings and $27–31 million of capital spending are achieved while maintaining cash generation and covenant compliance.
- The terms, borrowing levels and covenant headroom under the new $150 million facility, and the potential use of the authorized $20 million repurchase program.