Business context and reporting period
El Pollo Loco Holdings, Inc. operates and franchises quick-service restaurants specializing in fire-grilled chicken. This unaudited Form 10-Q covers the 13 weeks ended September 27, 2017 (the third quarter) and the 39 weeks ended September 27, 2017, compared with the periods ended September 28, 2016. At quarter-end, the company operated 208 restaurants and franchised 265, across five states.
Key financial results
| Metric | Q3 2017 | Q3 2016 | 39 weeks 2017 | 39 weeks 2016 |
|---|---|---|---|---|
| Total revenue | $101.2 million | $95.8 million | $306.5 million | $287.6 million |
| Operating income (loss) | $(5.6) million | $9.0 million | $16.5 million | $32.7 million |
| Net income (loss) | $(4.0) million | $5.2 million | $8.7 million | $17.9 million |
| Diluted earnings (loss) per share | $(0.11) | $0.13 | $0.22 | $0.46 |
| Adjusted EBITDA | $16.2 million | $17.3 million | $51.9 million | $51.3 million |
| Operating cash flow | Not separately presented for the quarter | $52.2 million | $39.7 million |
Revenue, margins, and operating performance
- Q3 revenue increased 5.6%; company-operated revenue rose 5.8% to $95.0 million and franchise revenue rose 1.6% to $6.2 million. Year-to-date revenue increased 6.6%.
- System-wide comparable restaurant sales increased 1.7% in Q3 and 1.5% year to date. Company-operated comps rose 0.9% and 1.0%, respectively; higher average checks were partly offset by 0.8% fewer transactions in both periods. Franchise comps increased 2.4% in Q3 and 1.8% year to date.
- Company restaurant contribution margin fell to 18.3% from 20.9% in Q3 and to 20.2% from 21.2% year to date. Higher labor and occupancy costs pressured margins; food and paper costs improved as a share of company-operated revenue, helped by lower chicken commodity costs.
- Q3 operating loss and net loss primarily reflected a $15.0 million non-cash impairment charge. Total asset impairment and closed-store reserves were $16.0 million for the quarter and $17.3 million year to date. The filing reports no impairment of goodwill or trademarks.
Balance sheet, debt, and liquidity
- At September 27, cash was $7.1 million, total assets $453.7 million, total liabilities $179.0 million, and stockholders’ equity $274.7 million. Cash increased from $2.2 million at December 28, 2016.
- Revolver borrowings were $85.0 million, down from $104.0 million at year-end 2016; capital lease obligations brought reported total debt to approximately $85.3 million. The $200 million revolver had approximately $106.9 million available, with $8.1 million of letters of credit outstanding. The facility matures in December 2019. The company reported covenant compliance.
- Year-to-date cash flow from operations was $52.2 million; capital expenditures were $28.3 million; and $19.0 million was paid down on the revolver. Management said cash, operating cash flow, and available revolver capacity should fund liquidity needs for at least 12 months.
- Operating lease obligations were $307.5 million. The company expected adoption of the new lease standard in 2019 to add a material right-of-use asset and lease liability to the balance sheet.
Changes, outlook, and management commentary
- Despite revenue growth, year-to-date operating income declined 49.6% and net income declined 51.7%, reflecting substantially higher impairment and closed-store charges, higher labor and operating costs, and increased depreciation.
- The company opened 12 company-operated and six franchised restaurants year to date. Its 2017 plan was to open 15–16 company-operated and 7–9 franchised restaurants. It expected full-year 2017 capital expenditures of $39–$41 million.
- Management highlighted continued monitoring of its Texas restaurant portfolio. It stated that unsuccessful plans to improve sales and profitability could lead to further significant impairment; the carrying value of company-operated Texas restaurants was $15.6 million.
- The company anticipated an approximately $11.0 million income tax receivable agreement payment to pre-IPO stockholders in Q4 2017. The agreement generally requires payment of 85% of realized tax savings attributable to specified pre-IPO tax attributes.
- Hurricane Harvey caused temporary closures, food spoilage, and wage-continuation costs at Houston-area locations. The company also received $1.1 million of insurance reimbursements for prior securities-litigation legal expenses during the first 39 weeks, plus $0.5 million after quarter-end.
- CEO Steve Sather had announced plans to retire on or before December 31, 2017, subject to hiring a successor; the search was underway. Management identified possible operational or strategic disruption during the transition.
Risks, contingencies, and unusual items
- Pending matters included a California wage-and-hour class action and securities and shareholder derivative litigation. Damages sought in the described cases were unspecified. The company intended to defend the securities claims; the SEC had closed its separate inquiry in 2016. The filing states ordinary-course claims could have adverse effects if their number or amounts increased.
- The business is geographically concentrated: the greater Los Angeles area generated approximately 73% of revenue in the cited periods. Natural disasters, competition, labor and minimum-wage increases, commodity-price volatility, and execution in newer markets were identified risks.
- One supplier represented 17.4% of accounts payable at quarter-end; purchases from the largest supplier were 30% of total expenses year to date. Disruption or cost changes could affect operations.
- The company disclosed contingent exposure on five assigned leases: potential undiscounted payments of $2.9 million, for which it recorded no liability. It also had an estimated $11.3 million chicken purchase commitment.
- Management reported that previously identified internal-control material weaknesses had been remediated and that disclosure controls and procedures were effective at period-end.
Important facts for investors to verify
- Whether comparable-sales and transaction trends improve, and whether the company can recover restaurant-level margins from the Q3 decline.
- Whether Texas and other at-risk locations meet the assumptions used in impairment testing, and whether further closures or impairment charges arise.
- Actual new-store openings and capital spending versus the 2017 plans, including the performance of newer-market restaurants.
- Liquidity after the anticipated TRA payment, revolver repayments, capital spending, and interest-rate changes; the revolver is floating-rate debt.
- Developments in the CEO succession and pending litigation, as well as the balance-sheet effects of adopting the lease accounting standard.