El Pollo Loco Holdings, Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended December 27, 2017 (52 weeks). The filing also reports fourth-quarter results. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless otherwise noted.
Business context and reporting period
El Pollo Loco operates and franchises fire-grilled chicken restaurants. At year-end, its system comprised 477 restaurants: 212 company-operated and 265 franchised, primarily in California. About 73% of fiscal 2017 revenue came from the greater Los Angeles area. The company operates in one segment.
Financial performance and liquidity
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Total revenue | $401.7 million | $380.1 million | Up 5.7% |
| Company-operated restaurant revenue | $376.6 million | $355.5 million | Up 5.9% |
| Franchise revenue | $25.1 million | $24.7 million | Up 1.7% |
| Operating income | $6.8 million | $34.6 million | Down 80.3% |
| Net income | $8.6 million | $18.3 million | Down 53.0% |
| Diluted earnings per share | $0.22 | $0.47 | Down |
| Operating cash flow | $53.7 million | $49.3 million | Up |
| Cash and cash equivalents at year-end | $8.6 million | $2.2 million | Up |
| Total debt, including capital leases | $93.3 million | $104.5 million | Down |
- System-wide sales, including franchised restaurant sales, were $841.8 million, up 5.8%. System comparable sales grew 1.5%; company-operated comparable sales rose 1.0% as 1.9% higher average checks offset a 0.9% transaction decline.
- Company-operated restaurant contribution was $74.5 million; its margin fell to 19.8% from 20.5%. GAAP operating margin was 1.7% and net margin was 2.1%.
- Adjusted EBITDA was $65.3 million, approximately flat with $65.6 million in 2016. This non-GAAP measure includes significant adjustments, notably impairment and closed-store charges.
- Capital expenditures were approximately $36.2 million, including $24.1 million for new restaurants, $5.7 million for remodels and $6.4 million for maintenance and other corporate projects. Operating cash flow less investing cash outflow was approximately $17.4 million.
- The $200 million revolving facility had $93.0 million drawn, $7.7 million in outstanding letters of credit and $99.3 million available at year-end. The company reported compliance with all debt covenants. The facility matures in December 2019; borrowings carried a 3.3% rate at year-end.
- Current assets of $20.7 million were below current liabilities of $47.3 million. Contractual operating lease payments totaled approximately $298.1 million, before sublease income.
Material changes versus the prior comparable period
- Revenue growth reflected new restaurant openings and modest comparable-sales growth. Company-operated sales from new restaurants contributed $20.9 million; comparable sales added approximately $3.4 million.
- Operating income declined sharply, principally because asset impairment and closed-store reserves rose to $33.6 million from $8.6 million. The charge included $27.7 million for the remaining capitalized assets of company-operated Texas restaurants; the company also impaired restaurants in Arizona and California.
- Company restaurant expenses rose 7.0%, faster than company-operated revenue, with labor and related expenses up 9.3%. Labor costs reflected California minimum-wage increases and new-unit staffing; occupancy and other operating costs also increased.
- Net income benefited from a $5.6 million income-tax-receivable-agreement (TRA) accounting benefit, compared with a $0.4 million expense in 2016. The 2017 tax provision was $0.5 million, including effects of the Tax Act and a lower federal corporate tax rate taking effect in 2018.
- Year-end debt declined from $104.5 million to $93.3 million. The company paid $11.1 million under the TRA during 2017 and reported an accrued TRA obligation of approximately $22.0 million at year-end.
Outlook, management commentary, risks and unusual items
- For fiscal 2018, management planned to open 6–8 company-operated and 6–8 franchised restaurants, fewer total openings than in 2017. No numerical comparable-sales, revenue or earnings guidance is provided in the filing.
- Management said results in newer markets, especially Houston and Dallas–Fort Worth, were below expectations and that growth there would slow. Two Texas restaurants were closed in January 2018 and a third Texas development was abandoned; the company expected a $3.0 million closed-store reserve in first-quarter 2018.
- After year-end, the company made an $8.0 million prepayment on the revolving facility and received an additional $1.6 million of insurance proceeds related to prior securities-litigation legal costs.
- A Lancaster franchisee lawsuit produced a jury verdict for the plaintiffs on a good-faith-and-fair-dealing claim. Damages were not determined, and the company said it could not reasonably estimate a range. It intended to challenge the verdict and, if necessary, appeal. Securities class-action and wage-and-hour litigation also remain outstanding; the SEC had closed its earlier inquiry.
- Other key risks include exposure to California labor costs, chicken and other input prices, reliance on a primary distributor and concentrated suppliers, geographic concentration, franchisee performance, food safety, and variable-rate debt. The company had fixed prices for all planned 2018 poultry purchases, but noted that costs and availability remain risks.
- Bernard Acoca was appointed CEO effective March 12, 2018, succeeding retiring CEO Stephen Sather. The filing describes substantial sign-on compensation and equity awards for the incoming CEO.
- Management reported that previously identified internal-control material weaknesses had been remediated by September 2017 and that internal control over financial reporting and disclosure controls were effective at year-end. The independent auditor issued an unqualified opinion on the financial statements but did not audit internal-control effectiveness.
- The company disclosed adoption of the new lease accounting standard would materially increase reported assets and liabilities, while it did not expect a material change in lease expense. It expected revenue-standard adoption to shift recognition of certain franchise and development fees over contract terms.
Most important facts for investors to verify
- Whether the large 2017 impairment charge signals continuing weakness in Texas, Arizona or Northern California, and whether further closures or impairments follow.
- Whether comparable-sales growth can improve through transaction gains rather than check increases alone, and whether restaurant contribution margins stabilize amid wage and occupancy pressure.
- Progress against the reduced 2018 opening plan and performance of newer-market restaurants and franchise development commitments.
- The ultimate outcome and potential financial exposure from the Lancaster verdict and the outstanding securities and employment-related litigation.
- Liquidity and refinancing capacity ahead of the 2019 revolving-credit maturity, including lease commitments, TRA payments and covenant headroom.
- Whether the incoming CEO transition and new strategic direction deliver improved operating performance; also review the CEO employment and incentive terms.