El Pollo Loco Holdings, Inc. — Q1 2017 Form 10-Q
Reporting period: Thirteen weeks ended March 29, 2017; comparison is the thirteen weeks ended March 30, 2016. The company operated 204 and franchised 263 restaurants at quarter-end, for 467 locations across five states.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $99.8 million | $94.4 million | +5.7% |
| Operating income | $9.4 million | $10.3 million | −9.1% |
| Net income | $4.9 million | $5.4 million | −10.4% |
| Diluted EPS | $0.12 | $0.14 | Lower |
| Operating cash flow | $19.1 million | $11.0 million | Higher |
| Capital expenditures | $11.6 million | $5.9 million | Higher |
- Company-operated restaurant revenue rose 5.7% to $93.4 million; franchise revenue rose 5.6% to $6.3 million.
- System-wide comparable sales fell 0.3%. Company-operated comps declined 0.4%, reflecting transactions down 2.2%, partly offset by average check up 1.9%; franchise comps declined 0.2%.
- Restaurant contribution was $19.0 million, with a 20.3% margin versus $18.3 million and 20.7% a year earlier. Operating margin fell to 9.4% from 10.9%; net margin was 4.9% versus 5.8%.
- Food and paper costs improved to 29.0% of company restaurant revenue from 30.3%, primarily due to lower chicken commodity costs. Labor costs rose to 28.7% from 27.7%, while occupancy and other operating costs rose to 22.0% from 21.3%.
- Operating cash flow increased, supported by favorable working-capital movements. Investing cash use was $11.6 million; financing cash use was $3.0 million, including a $3.0 million revolver repayment. Cash ended at $6.7 million.
Balance sheet and liquidity
- Total assets were $463.4 million and stockholders’ equity was $270.2 million at March 29, 2017.
- Revolver borrowings were $101.0 million; total debt including capital leases was $101.4 million. The $200 million revolving facility had $90.9 million available after $8.1 million of letters of credit. The revolver matures in December 2019.
- The company reported compliance with its debt covenants and estimated available cash, operating cash flow, and revolver availability would meet liquidity needs for at least 12 months. It paid down a further $1.0 million on the revolver after quarter-end.
- Operating lease obligations were $280.1 million. The company expects adoption of the new lease standard in 2019 to materially increase reported assets and liabilities, without an expected change in lease-expense recognition.
- Deferred tax assets and liabilities changed substantially in presentation following retrospective adoption of ASU 2015-17, which requires deferred tax balances to be classified as noncurrent.
Outlook, developments, and risks
- Management planned 15–20 new company-operated restaurants and 8–12 franchised openings in 2017, and described a long-term target of 8%–10% annual unit growth. Expected 2017 capital expenditures were $40–$45 million.
- Management attributed cost pressure to California and Los Angeles minimum-wage increases, higher workers’ compensation claims, and costs associated with new restaurants. It noted that inflation and commodity-price movements may not always be offset through pricing or operating measures.
- Two company-operated restaurants were closed in the quarter, one in Arizona and one in Texas; $0.9 million of impairment and closed-store reserves was recorded. Five company-operated and four franchised restaurants opened during the quarter. Two additional restaurants opened after quarter-end.
- CEO Stephen Sather said he intended to retire on or before December 31, 2017, subject to hiring a successor; the company was conducting a search. The filing identifies leadership transition as a potential source of operational or strategic uncertainty.
- After a director’s resignation, only four of eight directors qualified as independent. The company relied on Nasdaq’s cure period, expected to run through September 25, 2017; failure to regain compliance could lead to delisting risk.
- Legal matters include a California wage-and-hour class action in settlement discussions, securities litigation with a further amended complaint filed in April 2017, and a Delaware shareholder derivative claim allowed to proceed. The SEC closed its inquiry in July 2016. The company did not quantify potential damages for the cited lawsuits.
- Disclosure controls were deemed effective, but remediation of material weaknesses in internal control identified in the prior annual report was still underway.
- Adjusted EBITDA was $16.0 million versus $16.0 million a year earlier; it is a non-GAAP measure and included adjustments such as litigation expense, pre-opening costs, and impairment/closed-store reserves.
Investor verification priorities
- Track comparable-sales trends, especially transaction counts, and whether labor and occupancy cost growth continues to outpace restaurant revenue.
- Verify execution against 2017 opening and capital-spending plans, and assess returns from new restaurants and remodels.
- Monitor revolver borrowings, interest-rate exposure, covenant headroom, and cash generation; a 1 percentage-point rate increase was estimated to add $1.0 million of annualized pretax interest expense.
- Follow CEO succession, Nasdaq board-independence compliance, and the status and potential financial exposure of the wage-and-hour and securities-related cases.
- Distinguish GAAP earnings and cash flow from Adjusted EBITDA, and account for the expected balance-sheet effects of lease-standard adoption and the deferred-tax reclassification.