El Pollo Loco Holdings, Inc. — Q3 2018 Form 10-Q
Reporting period: Thirteen weeks ended September 26, 2018; year-to-date figures cover the 39 weeks ended that date. Comparatives are the corresponding periods ended September 27, 2017. The company operated 212 restaurants and franchised 271 across six states.
Financial performance
| Metric | Q3 2018 | Q3 2017 | 39 weeks 2018 | 39 weeks 2017 |
|---|---|---|---|---|
| Total revenue | $112.2 million | $101.2 million | $329.6 million | $306.5 million |
| Operating income (loss) | $9.5 million | $(5.6) million | $21.5 million | $16.5 million |
| Net income (loss) | $6.8 million | $(4.0) million | $14.4 million | $8.7 million |
| Diluted EPS | $0.17 | $(0.11) | $0.37 | $0.22 |
| Operating cash flow | — | $41.6 million | $52.2 million |
- Reported revenue rose 10.9% in Q3 and 7.5% year to date. The company adopted ASC 606 in 2018: franchise advertising contributions are now shown as revenue with the related costs in expenses. Excluding this gross-up, 2018 revenue would have been $106.7 million for Q3 and $313.6 million year to date; the comparable increases versus 2017 were approximately 5.5% and 2.3%.
- Company-operated comparable sales increased 2.0% in Q3 but declined 0.6% year to date. Q3 growth reflected a 2.7% higher average check, partly offset by 0.7% fewer transactions. System-wide comparable sales increased 2.6% in Q3 and 0.2% year to date.
- Restaurant contribution margin, a company-defined non-GAAP measure, was 18.3% in Q3, unchanged year over year, and 19.1% year to date versus 20.2%. Adjusted EBITDA was $16.3 million in Q3 versus $16.2 million, and $48.4 million year to date versus $51.9 million.
- Q3 results benefited from lower impairment and closed-store charges than in the prior-year quarter, which included a $15.0 million impairment charge. Year-to-date 2018 included $1.8 million of impairment and $4.8 million of closed-store reserve expense. Q3 also included $2.0 million, and year to date $6.1 million, of insurance recoveries for prior securities-litigation legal costs.
- Food and paper costs improved to 28.3% of company-operated sales in Q3 and 28.6% year to date, compared with 29.3% in both prior-year periods. Labor costs rose to 29.2% in Q3 and 28.8% year to date, while occupancy and other operating costs rose to 24.2% and 23.5%, respectively.
Cash, debt and liquidity
- Cash was $8.1 million at September 26, 2018, compared with $8.6 million at December 27, 2017. Operating cash flow of $41.6 million was down from $52.2 million; capital expenditures were $20.7 million, versus $28.3 million.
- Revolver borrowings were $71.0 million, down from $93.0 million at year-end 2017; total debt including capital leases was $71.2 million. The new $150 million senior secured revolving facility matures July 2023. At quarter-end, $71.3 million was available, with $7.7 million of letters of credit outstanding. The company reported compliance with financial covenants.
- Management said cash, operating cash flow and available revolver borrowings should be sufficient for liquidity needs for at least 12 months. A 1 percentage-point increase in borrowing rates would add an estimated $0.7 million of annualized pretax interest expense.
Outlook, risks and notable items
- Management planned to open eight company-operated and nine to ten franchised restaurants in 2018. Expected 2018 capital expenditures were $25–$27 million. These are plans, not a full-year earnings forecast.
- A court entered an $8.84 million judgment in a franchisee dispute over two Lancaster restaurants and ordered changes to franchise disclosures and agreements. The company appealed and recorded no accrual, concluding the loss was not probable. Requests to stay the injunction were denied by the trial court and appeals court; the company appealed those denials. The filing warns the injunction could constrain expansion or reduce franchise revenue if it remains in effect.
- A securities class action was certified; the Ninth Circuit denied defendants’ petition for appellate review of part of the certification order on October 19, 2018. The company intends to defend the claims. Related shareholder derivative actions were stayed.
- Other risks include California wage-and-hour litigation, rising wages and labor costs, food commodity volatility, and concentration in the greater Los Angeles area, which generated 69% of revenue year to date. Purchases from the largest supplier were 28.8% of year-to-date total expenses.
- The company had $279.7 million of operating lease obligations at quarter-end and expected adoption of the new lease standard in fiscal 2019 to materially increase balance-sheet assets and liabilities, while not materially changing lease expense recognition.
Important facts for investors to verify
- How much reported revenue growth reflects underlying sales versus the ASC 606 advertising-fee gross-up and deferred franchise-fee recognition.
- Whether comparable-sales momentum persists, particularly given the year-to-date transaction declines at company-operated restaurants.
- The outcome and financial or expansion effects of the Lancaster judgment, injunction and appeals; no judgment-related accrual was recorded.
- Whether labor, occupancy, legal and other overhead costs pressure restaurant contribution and Adjusted EBITDA.
- Capital spending, cash generation, revolver availability and compliance with debt covenants as restaurant expansion proceeds.