Business context and reporting period
El Pollo Loco Holdings, Inc. filed this unaudited Form 10-Q for the 13- and 26-week periods ended June 24, 2020. The company operates and franchises quick-service restaurants under the El Pollo Loco name; at period-end it had 196 company-operated and 283 franchised restaurants. Results were heavily affected by COVID-19 restrictions on restaurant dining.
Financial performance
Amounts below are in millions of dollars, except per-share data. Comparisons are with the corresponding 2019 periods.
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Total revenue | $99.6 | $113.7 | $204.8 | $222.7 |
| Operating income | $7.4 | $20.6 | $13.1 | $22.9 |
| Net income | $5.5 | $14.1 | $9.1 | $15.0 |
| Diluted EPS | $0.16 | $0.37 | $0.26 | $0.38 |
| Operating margin | 7.5% | 18.1% | 6.4% | 10.3% |
| Net margin | 5.5% | 12.4% | 4.4% | 6.7% |
| Adjusted EBITDA | $15.3 | $17.9 | $28.7 | $32.1 |
- Q2 revenue fell 12.4%; company-operated restaurant revenue declined 12.4%, franchise revenue 15.1%, and franchise advertising revenue 8.9%. First-half revenue fell 8.1%.
- Comparable sales declined system-wide 9.7% in Q2 and 5.7% for the first half. Company-operated comps were down 8.5% and 4.7%, respectively; franchise comps were down 10.6% and 6.4%. Company-operated Q2 transactions fell 25.4%, partly offset by a 22.5% increase in average check.
- Q2 company restaurant expenses were 80.4% of company-operated revenue versus 80.1% a year earlier; food and paper costs improved to 26.1% from 27.8%, while labor was 29.4% versus 29.2% and occupancy/other costs 25.0% versus 23.0%. First-half restaurant contribution margin was 18.5%, down from 18.8%.
- First-half cash from operating activities was $11.1 million versus $12.9 million; investing activities used $2.5 million versus $1.1 million. Financing provided $43.7 million, primarily reflecting revolver borrowings. Cash increased $52.3 million to $60.3 million.
Balance sheet, debt and liquidity
- At June 24, 2020, cash was $60.3 million and revolver borrowings were $138.8 million, versus $8.1 million and $97.0 million at December 25, 2019. The company also had $11.1 million of letters of credit and just $0.1 million of revolver availability under its $150 million facility.
- Operating lease liabilities totaled $207.0 million, including $18.0 million current; finance lease obligations were $0.1 million. Total assets were $665.6 million and stockholders’ equity $256.6 million.
- The company drew on the revolver as a precaution amid pandemic uncertainty and to support litigation-related payments. It reported compliance with debt covenants at quarter-end, but warned that prolonged disruption could threaten lease-adjusted coverage and fixed-charge coverage covenants. Management believed cash and operating cash flow would cover needs for the next 12 months, subject to pandemic conditions.
Outlook, risks and unusual items
- COVID-19 restrictions materially disrupted operations; historically, about 20% of sales were dine-in. Most restaurants were limited to take-away, mobile pickup, delivery and available drive-thru service. Temporary closures affected company and franchise locations; no company restaurants had been permanently closed due to COVID-19 as of June 24.
- Management suspended company-operated new restaurant development, substantially reduced capital spending, paused share repurchases and deferred franchisees’ 2020 remodel and new-build requirements until 2021. The company did not expect additional restaurant openings during the remainder of 2020; it planned to limit remodels to two test locations in Q4. No formal earnings guidance was provided.
- Rent payments for April through June were delayed at most leased properties, with abatement and/or deferral agreements reached with landlords. Franchisees received deferrals of half of April royalties and their 2020 development and remodel obligations. These measures support near-term cash but defer obligations.
- Q2 2020 included a $2.5 million accrual for an agreement in principle to settle a franchisee territory-rights lawsuit, subject to appellate court approval. Subsequent to quarter-end, the surety released its $2.7 million letter of credit collateral demand. The company also recorded $2.0 million of first-half non-cash impairment charges and $0.9 million of closed-store reserves.
- Comparability is affected by unusual prior-year items: 2019 included $10.0 million of insurance proceeds related to a securities class-action settlement and a $5.1 million first-half loss on restaurant dispositions. The company paid a separate $16.3 million wage-and-hour settlement in February 2020.
- Key risks include the duration and resurgence of COVID-19, covenant headroom and liquidity, labor and food-cost inflation, restaurant impairment, franchisee financial health, reliance on a major supplier, and geographic concentration: the greater Los Angeles area generated 71.7% of first-half revenue. A major supplier represented 44.5% of accounts payable at quarter-end.
- Trimaran Pollo Partners held approximately 47.7% of shares as of the report date; the filing said the process to dissolve the holder and distribute shares was expected to begin on or after July 27, 2020, creating potential resale pressure.
Important facts for investors to verify
- Whether comparable sales and restaurant traffic recover, and whether the higher average check can persist without further transaction declines.
- Available liquidity after rent deferrals, the minimal remaining revolver availability, and continued compliance with credit covenants.
- Amounts and timing of deferred rent and franchise payments, and the effect of any further closures or restrictions.
- Final approval and cash cost of the franchisee lawsuit settlement, along with any other material legal or insurance developments.
- Whether restaurant asset impairments, supplier concentration, or potential share sales by the large stockholder create additional downside risk.