El Pollo Loco Holdings, Inc. — Q3 2014 Form 10-Q
Business context and reporting period
The filing covers the 13 and 39 weeks ended September 24, 2014, compared with the corresponding 2013 periods. El Pollo Loco operates and franchises quick-service restaurants; at quarter-end it operated 166 and franchised 239 locations. Fiscal 2014 is a 53-week year, so full-year figures may be elevated relative to 52-week years.
Key financial metrics
| Metric | 13 weeks ended Sep. 24, 2014 | 13 weeks ended Sep. 25, 2013 | 39 weeks ended Sep. 24, 2014 | 39 weeks ended Sep. 25, 2013 |
|---|---|---|---|---|
| Total revenue | $86.6 million | $79.8 million | $254.9 million | $238.5 million |
| Operating income | $13.6 million | $10.7 million | $38.0 million | $32.7 million |
| Net income | $25.8 million | $0.9 million | $37.9 million | $1.3 million |
| Diluted EPS | $0.70 | $0.03 | $1.13 | $0.04 |
| Adjusted EBITDA | $15.2 million | $13.7 million | $46.6 million | $42.0 million |
| Operating cash flow | Not presented quarterly | $29.8 million | $12.5 million |
Quarter revenue rose 8.5%; year-to-date revenue rose 6.9%. System-wide comparable sales increased 7.9% for the quarter and 6.8% year to date. Company-operated comparable sales rose 6.4% and 5.6%, respectively; quarterly growth reflected 3.1% higher average check and 3.3% higher traffic.
Company restaurant contribution margin, calculated as company-operated restaurant revenue less company restaurant expenses as a percentage of company-operated revenue, was 20.7% for the quarter, flat year over year, and 21.8% year to date versus 21.3%. Reported operating margins were 15.7% and 14.9%, respectively, including a $2.7 million restaurant-sale gain; excluding that gain, operating margins were approximately 12.7% and 13.9%.
At September 24, cash was $41.8 million and total current assets were $53.1 million, versus cash of $17.0 million and current assets of $27.3 million at December 25, 2013. Total debt was reported as $188.7 million; the company had $7.7 million of available capacity under its $15 million revolver after letters of credit. Total liabilities were $277.7 million and stockholders’ equity was $199.3 million. Year-to-date investing cash use was $14.0 million, including $19.4 million in property and equipment purchases; financing cash inflow was $8.9 million.
Material changes versus the prior comparable period
- IPO closed July 30, raising approximately $112.3 million net. The company used about $101.5 million to repay the $100 million second-lien loan, including prepayment costs. The repayment reduced debt and lowered interest expense; year-to-date net interest expense fell 48% to $15.3 million.
- Reported net income was materially affected by nonrecurring and tax-related items. The company recorded a $40.1 million charge for the present value of expected tax receivable agreement payments, a $5.1 million debt-extinguishment charge, and a $61.4 million quarterly income tax benefit. It released an approximately $65 million deferred-tax valuation allowance and recorded $5.4 million of tax benefits from tax credits.
- Sale of six San Antonio company restaurants generated $5.4 million cash proceeds and a $2.7 million gain; the locations became franchised. The buyer also agreed to develop eight San Antonio and twelve Houston restaurants.
- Year-to-date operating cash flow increased by $17.3 million, which management attributed principally to higher sales and lower interest payments.
Outlook, commentary, risks and unusual items
- Management plans to expand the restaurant base, grow comparable sales, and improve operations. Its long-term target is annual unit growth of 8% to 10%. For 2014, it expected nine to eleven new company-operated restaurants and four new franchised restaurants; five company-operated locations had opened year to date. It anticipated one to two company-store closures.
- Management forecast approximately $28.2 million of 2014 capital expenditures: $16.1 million for new restaurants, $7.7 million for remodels, and $4.4 million for maintenance and corporate needs. It expected cash, operating cash flow, and revolver availability to meet liquidity needs for at least 12 months.
- The company remains exposed to variable interest rates: a 1 percentage-point increase on outstanding borrowings would raise annualized pretax interest expense by about $1.9 million. Interest-rate caps cover $150 million of notional principal, with expirations in 2015 and 2016.
- Risks include a California labor-law class action with indeterminate outcome and potential material impact; significant concentration in greater Los Angeles, which generated about 80% of revenue year to date; reliance on two suppliers; food and other cost inflation; and California minimum-wage increases. The company stated it was in compliance with debt covenants.
- The company entered an income tax receivable agreement requiring it to pay pre-IPO stockholders 85% of certain realized tax savings. It recorded a substantial present-value liability for expected payments.
Important facts for investors to verify
- Separate underlying operating performance from the large tax benefit, tax receivable agreement expense, debt-extinguishment charge, and restaurant-sale gain when assessing reported earnings.
- Review the assumptions, timing, and cash-payment profile of the tax receivable agreement, including the $40.1 million recorded charge and $40.1 million total TRA payable reported on the balance sheet.
- Track comparable-sales momentum, food costs, labor costs, and whether operating margins improve as revenue grows.
- Confirm the pace and returns of planned openings and remodels, the $28.2 million capital-spending plan, and available liquidity after debt service and TRA payments.
- Monitor the California labor class action, supplier concentration, Los Angeles market concentration, and exposure to interest-rate and wage increases.