Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Cautionary Statement Concerning Forward-Looking Statements
This report contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact included in this report are forward-looking statements. Forward-looking statements discuss our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements because they do not relate strictly to historical or current facts. These statements may include words such as “aim,” “anticipate,” “believe,” “estimate,” “expect,” “forecast,” “outlook,” “potential,” “project,” “projection,” “plan,” “intend,” “seek,” “may,” “could,” “would,” “will,” “should,” “can,” “can have,” “likely,” the negatives thereof and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. They appear in a number of places throughout this report and include statements regarding our intentions, beliefs or current expectations concerning, among other things, our results of operations, financial condition, liquidity, prospects, growth, strategies and the industry in which we operate. All forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those that we expected.
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While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors, and it is impossible for us to anticipate all factors that could affect our actual results. All forward-looking statements are expressly qualified in their entirety by these cautionary statements. You should evaluate all forward-looking statements made in this report in the context of the factors that could cause outcomes to differ materially from our expectations. These factors include, but are not limited to:
● the impacts of the novel coronavirus (COVID-19) pandemic on our company, our employees, our customers, our partners, our industry and the economy as a whole, as well as our franchisees ability to maintain operations in their individual restaurants;
● the adverse impact of economic conditions on our (i) operating results and financial condition, (ii) ability to comply with the terms and covenants of our debt agreements, and (iii) ability to pay or refinance our existing debt or to obtain additional financing;
● our ability to open new restaurants in new and existing markets, including difficulty in finding sites and in negotiating acceptable leases;
● our ability to compete successfully with other quick-service and fast casual restaurants;
● vulnerability to changes in consumer preferences and economic conditions;
● vulnerability to conditions in the greater Los Angeles area;
● vulnerability to natural disasters given the geographic concentration and real estate intensive nature of our business;
● our ability to effectively identify and secure appropriate new sites for restaurants;
● changes to food and supply costs, especially for chicken;
● negative publicity, whether or not valid, and our ability to respond to and effectively manage the accelerated impact of social media;
● our ability to continue to expand our digital business, delivery orders and catering;
● concerns about food safety and quality and about food-borne illness, particularly avian flu;
● dependence on frequent and timely deliveries of food and supplies and our dependence on a single supplier to distribute substantially all of our products to our restaurants;
● our ability to service our level of indebtedness;
● our reliance on our franchisees, who may incur financial hardships, lose access to credit, close restaurants, or declare bankruptcy, and our limited control over our franchisees and potential liability for their acts;
● the impact of any security breaches of confidential customer information in connection with our electronic process of credit and debit card transactions;
● the impact of any failure of our information technology system or any breach of our network security;
● ability to protect our name and logo and other proprietary intellectual property; and
● other risks set forth in our filings with the SEC from time to time, including under Item 1A, Risk Factors in our annual report on Form 10-K for the year ended December 25, 2019, under Item 1A, Risk Factors in our quarterly report on Form 10-Q for the quarter ended March 25, 2020 and under Item 1A, Risk Factors in our quarterly report on Form 10-Q for the quarter ended June 24, 2020, which such filings are available online at www.sec.gov , at www.elpolloloco.com or upon request from El Pollo Loco.
We caution you that the important factors referenced above may not contain all of the factors that are important to you. In addition, we cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences we anticipate or affect us or our operations in the ways that we expect. The forward-looking statements included in this report are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as required by law. If we do update one or more forward-looking statements, no inference should be made that we will make additional updates with respect to those or other forward-looking statements. We qualify all of our forward-looking statements by these cautionary statements.
Overview
El Pollo Loco is a differentiated and growing restaurant concept that specializes in fire-grilling citrus-marinated chicken and operates in the limited service restaurant (“LSR”) segment. We strive to offer food that integrates the culinary traditions of Mexico with the healthier lifestyle of Los Angeles, a combination that we call “LA-Mex”. Our distinctive menu features our signature product--citrus-marinated fire-grilled chicken--and a variety of Mexican and LA-inspired entrees that we create from our chicken. We serve individual and family-sized chicken meals, a variety of Mexican and
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LA-inspired entrees, and sides, and, throughout the year, on a limited-time basis, additional proteins like shrimp. Our entrees include favorites such as our Chicken Avocado Burrito, Under 500 Calorie entrees, chicken tostada salads, and Pollo Bowls. Our famous Creamy Cilantro dressings and salsas are prepared fresh daily, allowing our customers to create their favorite flavor profiles to enhance their culinary experience. Our distinctive menu with healthier alternatives appeals to consumers across a wide variety of socio-economic backgrounds and drives our balanced composition of sales throughout the day (our “day-part mix”), including at lunch and dinner.
COVID-19 Impact
On January 30, 2020, the World Health Organization (“WHO”) announced a global health emergency because of a new strain of coronavirus ("COVID-19") originating in Wuhan, China and the risks to the international community as the virus spreads globally beyond its point of origin. On March 11, 2020, the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally.
The COVID-19 pandemic has significantly disrupted our restaurant operations. Following the pandemic declaration in March 2020, federal, state and local governments began to respond to the public health crisis by requiring social distancing, "stay at home" directives, and restaurant restrictions - including government-mandated dining room closures - that limited business to off-premise services only (take-out, drive-thru and delivery). Historically, approximately 20% of the Company’s sales are associated with dine-in service. In May 2020, the “stay at home” directive was temporarily modified in most areas in which the Company operates, allowing for the opening of lower-risk workplaces, including restaurants, but with restrictions such as limited capacity. However, in July a surge in the COVID-19 pandemic caused many state and local governments to re-implement certain additional restrictions to try and contain the spread of the virus. As of September 23, 2020 the majority of the Company’s restaurants were permitted to be open with limited capacity; however, while most of the Company’s markets outside of California have dining rooms open at a limited capacity, the majority of the Company’s restaurants in California are continuing to operate on a take-away, mobile pick-up and delivery basis, as well as maintaining drive-thru operations where available, in order to protect their employees and customers from the spread of the COVID-19 pandemic and to comply with the government mandates. Due to the impact of the COVID-19 pandemic, during the thirteen and thirty-nine weeks ended September 23, 2020, we temporarily closed 40 restaurants and 65 restaurants, respectively, of which all but three have reopened as of September 23, 2020. Similarly, during the thirteen and thirty-nine weeks ended September 23, 2020, franchisees temporarily closed 15 restaurants and 36 restaurants, respectively, of which all but three have reopened as of September 23, 2020. As of September 23, 2020, we have not permanently closed any restaurants due to the COVID-19 pandemic.
Below is a summary of other actions we have taken to enhance financial and operating flexibility for the Company and for our franchisees, and to protect our employees and customers:
● As a precautionary measure, we initially bolstered our existing cash position by fully drawing down our $150 million 2018 Revolver, adding $34.5 million of cash to our balance sheet. However, subsequent to the initial drawdown, we paid down $57.7 million on our 2018 Revolver. See Note 4 to Item 1 above for further details regarding our current debt balances. Subsequent to September 23, 2020, we made an additional voluntary pre-payment of $28.0 million on the 2018 Revolver. Refer to “Subsequent Events” in Note 1 to Item 1 above.
● We have temporarily suspended all share repurchase activity, significantly reduced capital spending, reevaluated essential support center general and administrative expenses, and fine-tuned our restaurant labor model based on indoor dining room restrictions, limited dining room capacity in restaurants located in geographies where indoor dining is permitted, dining room closures and fluctuating sales volume.
● For our franchisees, we deferred 50% of their April royalties until July 1, 2020, when such royalties began to be repaid in even monthly installments over the remainder of fiscal 2020. In addition, we deferred 100% of our franchisees’ 2020 remodel and new restaurant build requirements until 2021. We also established a support team to assist franchisees in accessing funds and benefits provided by the CARES Act legislation.
● For our employees, we continue to implement actions to help protect them from the coronavirus while working in our restaurants. These include implementing pre-shift health assessments, enhanced cleaning procedures in our restaurants, providing gloves and masks to all system restaurant employees, installing plexiglass shields at company restaurant cashier stations and initiating other social distancing measures. We are providing extended sick leave benefits to employees impacted by COVID-19, and we have granted two weeks paid leave for employees who are 65 or older.
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● We have shifted our marketing to highlight our free delivery program; our Family Meals as a healthier and affordable option; and our meaningful value platform. Additionally, we have added curbside pick-up, enabling customers to pick-up their orders from the safety of their own cars.
● We delayed making April, May and June rent payments on the majority of our leased properties, and we have reached rent abatement and/or deferment agreements with our landlords for those properties.
● We have taken advantage of provisions available under the CARES Act. Specifically, we have deferred payment of employer Social Security taxes that are otherwise owed for wage payments.
The full impact of the COVID-19 outbreak continues to evolve as of the date of this report. Management is continually evaluating the impact of the global crisis on its financial condition, liquidity, operations, suppliers, industry, and workforce and will take additional actions as necessary. The disruption in operations has led to us considering the impact of the COVID-19 pandemic on our liquidity, debt covenant compliance, and recoverability of long-lived and ROU assets, goodwill and intangible assets, among others. If these disruptions to our operations from COVID-19 pandemic continue, they may have a material negative impact on our financial results, future operations and liquidity. The extent of such negative impact will depend, in part, on the longevity and severity of the COVID-19 pandemic.
Due to the rapid development and fluidity of this situation, we cannot determine the ultimate impact that the COVID-19 pandemic will have on our consolidated financial condition, liquidity, and future results of operations, and therefore any prediction as to the ultimate materiality of the adverse impact on our consolidated financial condition, liquidity, and future results of operations is uncertain.
Growth Strategies and Outlook
As of September 23, 2020, we had 478 locations in six states. In fiscal 2019, we opened two new company-operated and two new franchised restaurants all in California. For the thirty-nine weeks ended September 23, 2020, one new company-operated restaurant was opened in Nevada, which was in process prior to the COVID-19 pandemic, and two franchised restaurants were opened, one in California and one in Arizona. As a result of the COVID-19 crisis, we have suspended company-operated new unit development until the timing of the economic recovery and our business improvement becomes more clear. In addition, we are allowing franchisees to defer their 2020 new unit development obligations until 2021. As a result, we do not expect to open any additional company-operated or franchised restaurant during the remainder of 2020.
It is our intention to return to the following long-term growth strategy after the impact of the COVID-19 pandemic subsides. We plan to continue to expand our business, drive restaurant sales growth, and enhance our competitive positioning, by executing the following strategies:
● expand our restaurant base;
● increase our comparable restaurant sales; and
● enhance operations and leverage our infrastructure.
To increase comparable restaurant sales, we plan to increase customer frequency, attract new customers, and improve per-person spend. Success of these growth plans is not guaranteed.
Highlights and Trends
Comparable Restaurant Sales
System-wide, for the thirteen and thirty-nine weeks ended September 23, 2020, comparable restaurant sales increased by 1.8% and decreased by 3.2%, respectively, from the comparable period in the prior year. For company-operated restaurants, comparable restaurant sales for the thirteen and thirty-nine weeks ended September 23, 2020 increased by 0.2% and decreased by 3.0%, respectively. For company-operated restaurants, the quarter’s change in comparable restaurant sales consisted of an approximately 18.1% increase in average check size, partially offset by a decline in transactions of 15.2%, and the year-to-date change in comparable restaurant sales consisted of a 15.2% decline in transactions, partially offset by a 14.4% increase in average check size. For franchised restaurants, comparable restaurant
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sales increased 3.0% and decreased 3.3% for the thirteen and thirty-nine weeks ended September 23, 2020, respectively. Refer to Comparable Restaurant Sales definition in "Key Performance Indicators" section below.
Restaurant Development
Our restaurant counts at the beginning and end of each of the last three fiscal years and the thirty-nine weeks ended September 23, 2020, were as follows.
Thirty-Nine Weeks Ended
Fiscal Year Ended
September 23, 2020
2019
2018
2017
Company-operated restaurant activity:
Beginning of period
195
213
212
201
Openings
1
2
8
16
Restaurant sale to franchisee
—
(16)
—
—
Closures
—
(4)
(7)
(5)
Restaurants at end of period
196
195
213
212
Franchised restaurant activity:
Beginning of period
287
271
265
259
Openings
2
2
9
7
Restaurant sale to franchisee
—
16
—
—
Closures
(7)
(2)
(3)
(1)
Restaurants at end of period
282
287
271
265
System-wide restaurant activity:
Beginning of period
482
484
477
460
Openings
3
4
17
23
Closures
(7)
(6)
(10)
(6)
Restaurants at end of period
478
482
484
477
Restaurant Remodeling
As of September 23, 2020, together with our franchisees, we had remodeled 34 company-operated and 45 franchised restaurants using our newest Vision restaurant design. The Vision design elevates the brand image with exterior and interior features that embrace the brand’s authentic roots with warm textures, rustic elements and a focus on the signature open kitchen layout established in previous designs. As of September 23, 2020, including new builds and remodels, we had 120 restaurants open with the Vision design in our system. Remodeling is a use of cash and has implications for our net property and equipment owned and depreciation and amortization line items on our condensed consolidated balance sheets and consolidated statements of income, among others. The cost of our Vision design restaurant remodels varied depending on the scope of work required, but on average, the investment was $0.3 million to $0.4 million per restaurant. We believe that our Vision design remodeling program resulted in higher restaurant revenue and a strengthened brand. In addition, we are currently working on a new asset design that we believe will clearly differentiate and communicate our brand, both on the exterior and interior. We believe that this new design will deliver improved unit volumes and cash on cash returns in both existing and new markets. We also believe that our remodels using this new design will result in higher restaurant revenue and a strengthened brand. If tests are successful, this new design will replace our “Vision” design, which was implemented in 2016. However, given the uncertainty surrounding the severity and longevity of the COVID-19 pandemic, as a precautionary measure we have significantly reduced capital spending in 2020 and plan to limit our remodels to two restaurants using the new design in the fourth quarter. We do not expect our franchisees to complete any remodels in 2020 as we have deferred their remodel requirements until 2021.
Loco Rewards
During the second quarter of 2017, we introduced a new loyalty rewards points program in an effort to increase sales and loyalty among our customers, by offering rewards that incentivize customers to visit our restaurants more often each month. Customers earn points for each dollar spent and as of August 4, 2020, 50 points can be redeemed for a $5 reward to be used for a future purchase. Prior to August 4, 2020, 100 points could be redeemed for a $10 reward. If a customer does not earn or use points within a one-year period, their account is deactivated and all points expire. Additionally, if a reward is not used within six months, it expires. When a customer is part of the rewards program, the obligation to provide future discounts related to points earned is considered a separate performance obligation, to which
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a portion of the transaction price is allocated. The performance obligation related to loyalty points is deemed to have been satisfied, and the amount deferred in the balance sheet is recognized as revenue, when the points are transferred to a reward and redeemed, the reward or points have expired, or the likelihood of redemption is remote. A portion of the transaction price is allocated to loyalty points, if necessary, on a pro-rata basis, based on stand-alone selling price, as determined by menu pricing and loyalty point’s terms.
In addition, customers can earn additional points and free entrées for a variety of engagement activities. As points are available for redemption past the quarter earned, a portion of the revenue associated with the earned points will be deferred until redemption or expiration. As of both September 23, 2020 and December 25, 2019, the revenue allocated to loyalty points that have not been redeemed is $1.0 million and $1.1 million, respectively, which is reflected in the Company’s accompanying condensed consolidated balance sheets within other accrued expenses and current liabilities. The Company had almost 2.0 million loyalty program members as of September 23, 2020.
Critical Accounting Policies and Use of Estimates
The preparation of our condensed consolidated financial statements in accordance with GAAP requires us to make estimates and judgments that affect our reported amounts of assets, liabilities, revenue, and expenses, and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under current circumstances in making judgments about the carrying value of assets and liabilities that are not readily available from other sources. We evaluate our estimates on an on-going basis. Actual results may differ from these estimates under different assumptions or conditions.
Accounting policies are an integral part of our condensed consolidated financial statements. A thorough understanding of these accounting policies is essential when reviewing our reported results of operations and our financial position. Management believes that the critical accounting policies and estimates discussed below involve the most difficult management judgments, due to the sensitivity of the methods and assumptions used. For a summary of our critical accounting policies and a discussion of our use of estimates, see “Critical Accounting Policies and Use of Estimates” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our annual report on Form 10-K for the year ended December 25, 2019.
There have been no material changes to our critical accounting policies or uses of estimates since our annual report on Form 10-K.
Recent Accounting Pronouncements
Recent accounting pronouncements are described in Note 1 to our condensed consolidated financial statements included in Item 1 above.
Key Financial Definitions
Revenue
Our revenue is derived from three primary sources: company-operated restaurant revenue, franchise revenue, which is comprised primarily of franchise royalties and, to a lesser extent, franchise fees and sublease rental income, and franchise advertising fee revenue. See Note 10 to Item 1 above for further details regarding our revenue recognition policy.
Food and Paper Costs
Food and paper costs include the direct costs associated with food, beverage and packaging of our menu items. The components of food and paper costs are variable in nature, change with sales volume, are impacted by menu mix, and are subject to increases or decreases in commodity costs.
Labor and Related Expenses
Labor and related expenses include wages, payroll taxes, workers’ compensation expense, benefits, and bonuses paid to our restaurant management teams. Like other expense items, we expect labor costs to grow proportionately as our
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restaurant revenue grows. Factors that influence labor costs include minimum wage and payroll tax legislation, the frequency and severity of workers’ compensation claims, health care costs, and the performance of our restaurants.
Occupancy Costs and Other Operating Expenses
Occupancy costs include rent, common area maintenance, and real estate taxes. Other restaurant operating expenses include the costs of utilities, advertising, credit card processing fees, restaurant supplies, repairs and maintenance, and other restaurant operating costs.
General and Administrative Expenses
General and administrative expenses are comprised of expenses associated with corporate and administrative functions that support the development and operations of our restaurants, including compensation and benefits, travel expenses, stock compensation costs, legal and professional fees, and other related corporate costs. Also included are pre-opening costs, and expenses above the restaurant level, including salaries for field management, such as area and regional managers, and franchise field operational support.
Legal Settlements
Legal settlements include expenses such as judgments or settlements related to legal matters, legal claims and class action lawsuits.
Franchise Expenses
Franchise expenses are primarily comprised of rent expenses incurred on properties leased by us and then sublet to franchisees, expenses incurred in support of franchisee information technology systems, and the franchisee’s portion of advertising expenses.
Depreciation and Amortization
Depreciation and amortization primarily consists of the depreciation of property and equipment, including leasehold improvements and equipment.
Loss on Disposal of Assets
Loss on disposal of assets includes the loss on disposal of assets related to retirements and replacement or write-off of leasehold improvements or equipment.
Impairment and Closed-Store Reserves
We review long-lived assets such as property, equipment, and intangibles on a unit-by-unit basis for impairment when events or circumstances indicate a carrying value of the assets that may not be recoverable. We determine if there is impairment at the restaurant level by comparing undiscounted future cash flows from the related long-lived assets to their respective carrying values and record an impairment charge when appropriate. In determining future cash flows, significant estimates are made by us with respect to future operating results of each restaurant over its remaining lease term, including sales trends, labor rates, commodity costs and other operating cost assumptions. If assets are determined to be impaired, the impairment charge is measured by calculating the amount by which the asset carrying amount exceeds its fair value. This process of assessing fair values requires the use of estimates and assumptions, including our ability to sell or reuse the related assets and market conditions, which are subject to a high degree of judgment. If these assumptions change in the future, we may be required to record impairment charges for these assets and these charges could be material.
When the Company closes a restaurant, it will evaluate the right-of-use (“ROU”) asset for impairment, based on anticipated sublease recoveries. The remaining value of the ROU asset is amortized on a straight-line basis, with the expense recognized in closed-store reserve expense, in addition to property tax and common area maintenance ("CAM") charges for closed restaurants.
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Interest Expense, Net
Interest expense, net, consists primarily of interest on our outstanding debt. Debt issuance costs are amortized at cost over the life of the related debt.
Provision for Income Taxes
Provision for income taxes consists of federal and state taxes on our income.
Comparison of Results of Income
Our operating results for the thirteen weeks ended September 23, 2020 and September 25, 2019 and expressed as percentages of total revenue, with the exception of cost of operations and company restaurant expenses, which are expressed as a percentage of company-operated restaurant revenue, are compared below.
Thirteen Weeks Ended
September 23, 2020
September 25, 2019
Increase / (Decrease)
($,000)
(%)
($,000)
(%)
($,000)
(%)
Statements of Income Data
Company-operated restaurant revenue
$
97,276
87.7
$
99,052
88.4
$
(1,776)
(1.8)
Franchise revenue
7,781
7.0
7,273
6.5
508
7.0
Franchise advertising fee revenue
5,922
5.3
5,742
5.1
180
3.1
Total revenue
110,979
100.0
112,067
100.0
(1,088)
(1.0)
Cost of operations
Food and paper costs (1)
24,922
25.6
27,512
27.8
(2,590)
(9.4)
Labor and related expenses (1)
28,756
29.6
29,292
29.6
(536)
(1.8)
Occupancy and other operating expenses (1)
23,836
24.5
23,844
24.1
(8)
(0.0)
Gain on recovery of insurance proceeds, lost profits (1)
(2,000)
(2.1)
—
—
(2,000)
N/A
Company restaurant expenses (1)
75,514
77.6
80,648
81.4
(5,134)
(6.4)
General and administrative expenses
9,803
8.8
9,539
8.5
264
2.8
Franchise expenses
7,572
6.8
7,006
6.3
566
8.1
Depreciation and amortization
4,092
3.7
4,343
3.9
(251)
(5.8)
Loss on disposal of assets
29
0.0
35
0.0
(6)
(17.1)
Impairment and closed-store reserves
1,776
1.6
367
0.3
1,409
383.9
Loss on disposition of restaurants
—
—
11
0.0
(11)
(100.0)
Total expenses
98,786
89.0
101,949
91.0
(3,163)
(3.1)
Income from operations
12,193
11.0
10,118
9.0
2,075
20.5
Interest expense, net of interest income
770
0.7
973
0.9
(203)
(20.9)
Income tax receivable agreement income
(144)
(0.1)
(197)
(0.2)
53
(26.9)
Income before provision for income taxes
11,567
10.4
9,342
8.3
2,225
23.8
Provision for income taxes
1,647
1.5
2,940
2.6
(1,293)
(44.0)
Net income
$
9,920
8.9
$
6,402
5.7
$
3,518
55.0
(1) Percentages for line items relating to cost of operations and company restaurant expenses are calculated with company-operated restaurant revenue as the denominator. All other percentages use total revenue.
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Our operating results for the thirty-nine weeks ended September 23, 2020 and September 25, 2019 and expressed as percentages of total revenue, with the exception of cost of operations and company restaurant expenses, which are expressed as a percentage of company-operated restaurant revenue, are compared below.
Thirty-Nine Weeks Ended
September 23, 2020
September 25, 2019
Increase / (Decrease)
($,000)
(%)
($,000)
(%)
($,000)
(%)
Statements of Income Data
Company-operated restaurant revenue
$
277,617
87.9
$
296,341
88.5
$
(18,724)
(6.3)
Franchise revenue
21,562
6.8
21,635
6.5
(73)
(0.3)
Franchise advertising fee revenue
16,567
5.2
16,808
5.0
(241)
(1.4)
Total revenue
315,746
100.0
334,784
100.0
(19,038)
(5.7)
Cost of operations
Food and paper costs(1)
73,357
26.4
82,550
27.9
(9,193)
(11.1)
Labor and related expenses(1)
83,208
30.0
88,140
29.7
(4,932)
(5.6)
Occupancy and other operating expenses(1)
67,867
24.4
70,103
23.7
(2,236)
(3.2)
Gain on recovery of insurance proceeds, lost profits(1)
(2,000)
(0.7)
—
—
(2,000)
N/A
Company restaurant expenses(1)
222,432
80.1
240,793
81.3
(18,361)
(7.6)
General and administrative expenses
29,599
9.4
30,235
9.0
(636)
(2.1)
Franchise expenses
21,110
6.7
20,692
6.2
418
2.0
Depreciation and amortization
12,629
4.0
13,558
4.0
(929)
(6.9)
Loss on disposal of assets
156
0.0
213
0.1
(57)
(26.8)
Recovery of securities lawsuits related legal expenses and other insurance claims
(123)
(0.0)
(10,000)
(3.0)
9,877
(98.8)
Impairment and closed-store reserves
4,615
1.5
1,241
0.4
3,374
271.9
Loss on disposition of restaurants
—
—
5,062
1.5
(5,062)
(100.0)
Total expenses
290,418
92.0
301,794
90.1
(11,376)
(3.8)
Income from operations
25,328
8.0
32,990
9.9
(7,662)
(23.2)
Interest expense, net of interest income
2,583
0.8
2,754
0.8
(171)
(6.2)
Income tax receivable agreement expense (income)
26
0.0
(120)
—
146
(121.7)
Income before provision for income taxes
22,719
7.2
30,356
9.1
(7,637)
(25.2)
Provision for income taxes
3,700
1.2
8,954
2.7
(5,254)
(58.7)
Net income
$
19,019
6.0
$
21,402
6.4
$
(2,383)
(11.1)
(1) Percentages for line items relating to cost of operations and company restaurant expenses are calculated with company-operated restaurant revenue as the denominator. All other percentages use total revenue.
Company-Operated Restaurant Revenue
For the quarter, company-operated restaurant revenue decreased $1.8 million, or 1.8%, from the comparable period in the prior year. The decline in company-operated restaurant sales was primarily due to a decrease in company-operated restaurant revenue of $1.9 million from the closure of two restaurants and the five company-operated restaurants sold by the Company to franchisees during or subsequent to the third quarter of 2019, a $0.6 million decrease due to temporary restaurant closures due to the COVID-19 pandemic and a $0.2 million decrease in revenue recognized for our loyalty points program. This company-operated restaurant sales decrease was partially offset by an increase of $0.7 million of non-comparable restaurant sales on restaurants that had not been open the fifteen months required to be included in comparable restaurant sales and an increase of $0.2 million due to a 0.2% increase in company-operated comparable restaurant sales. The company-operated comparable restaurant sales increase consisted of an approximately 18.1% increase in average check size, partially offset by a decline in transactions of 15.2%. It is uncertain whether the increase in average check size will persist once the pandemic ends.
Year-to-date, company-operated restaurant revenue decreased $18.7 million, or 6.3%, from the comparable period in the prior year. The decline in company-operated restaurant sales was primarily due to a $11.3 million decrease in revenue from the closure of four restaurants and the 16 company-operated restaurants sold by the Company to franchisees during or subsequent to the first quarter of 2019, a decrease in company-operated restaurant revenue of $8.5 million due to a 3.0% decrease in company-operated comparable restaurant sales, which we believe was primarily related to the impact of the COVID-19 pandemic, and a $1.0 million decrease due to temporary restaurant closures due to the COVID-19
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pandemic. See above under “COVID-19 Impact” for additional information related to the impact of the COVID-19 pandemic on our business. This company-operated restaurant sales decrease was partially offset by an increase of $2.1 million of non-comparable restaurant sales on restaurants that had not been open the fifteen months required to be included in comparable restaurant sales. The company-operated comparable restaurant sales decrease consisted of a decline in transactions of 15.2%, partially offset by a 14.4% increase in average check size. It is uncertain whether the increase in average check size will persist once the pandemic ends.
Franchise Revenue
For the quarter, franchise revenue increased $0.5 million, or 7.0%, from the comparable period in the prior year. This increase was primarily due to a franchise comparable restaurant sales increase of 3.0%, the opening of two new franchised restaurants and revenue generated from five company-operated restaurants sold by the Company to franchisees during or subsequent to the third quarter of 2019, and revenue recognized related to franchise development agreements. This franchise revenue increase was partially offset by the closure of nine franchise locations during or subsequent to the third quarter of 2019.
Year-to-date, franchise revenue decreased less than $0.1 million, or 0.3%, from the comparable period in the prior year. This decrease was primarily due to a franchise comparable restaurant sales decrease of 3.3%, which we believe was primarily due to the COVID-19 pandemic, the closure of nine franchise locations during or subsequent to the first quarter of 2019 and a decrease in fees received from franchised restaurants related to their use of our point-of-sales system. See above under “COVID-19 Impact” for additional information related to the impact of the COVID-19 pandemic on our business. This franchise revenue decrease was almost fully offset by the opening of four new franchised restaurants and revenue generated from 16 company-operated restaurants sold by the Company to franchisees during or subsequent to the first quarter of 2019.
Franchise Advertising Fee Revenue
For the quarter, franchise advertising fee revenue increased $0.2 million, or 3.1%, from the comparable period in the prior year. Year-to-date, franchise advertising fee revenue decreased $0.2 million, or 1.4%, from the comparable period in the prior year. As advertising fee revenue is a percentage of franchisees’ revenue, both the quarter and year-to-date fluctuations were due to the increases and decreases noted in franchise revenue above.
Food and Paper Costs
For the quarter, food and paper costs decreased $2.6 million, or 9.4%, from the comparable period in the prior year, primarily due to a $2.5 million decrease in food costs and a $0.1 million decrease in paper costs. Year-to-date, food and paper costs decreased $9.2 million, or 11.1%, from the comparable period in the prior year, due to a $8.1 million decrease in food costs and a $1.1 million decrease in paper costs. The decrease in food and paper costs, for the quarter and year-to-date periods, resulted primarily from lower company transactions, due to the COVID-19 pandemic, lower food waste and a vendor rebate received. For the quarter, food and paper costs as a percentage of company-operated restaurant revenue were 25.6%, down from 27.8% in the comparable period of the prior year. Year-to-date, food and paper costs as a percentage of company-operated restaurant revenue were 26.4%, down from 27.9% in the comparable period of the prior year. The percentage decrease for the quarter and year-to-date periods was due primarily to an increase in pricing, lower food usage, effective waste management and favorable sales mix, partially offset by commodity inflation.
Labor and Related Expenses
For the quarter, labor and related expenses decreased $0.5 million, or 1.8%, from the comparable period in the prior year. Year-to-date, labor and related expenses decreased $4.9 million, or 5.6%, from the comparable period in the prior year. The decrease for the quarter and year-to-date periods was due primarily to a reduction in labor by restaurants closed or sold to franchisees, adjustments to the labor model based on dining room closures, operating hours and lower sales volumes and lower group insurance and workers compensation expense due to decreased claims activity. These decreases were partially offset by higher wages primarily due to minimum wage increases in California during fiscal 2019 and 2020, and labor costs associated with the COVID-19 pandemic.
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For the quarter, labor and related expenses as a percentage of company-operated restaurant revenue were 29.6%, consistent with the comparable period in the prior year. This percentage was impacted by wage increases in California and labor costs associated with the COVID-19 pandemic, offset by an increase in pricing and labor efficiencies. Year-to-date payroll and benefit expenses as a percentage of company-operated restaurant revenue were 30.0%, up from 29.7% in the comparable period in the prior year. The increase for the year-to-date period was due primarily to sales deleverage, wage increases in California, and labor costs associated with the COVID-19 pandemic. Partially offsetting these increases were the positive impacts of an increase in pricing and labor efficiencies.
Occupancy and Other Operating Expenses
For the quarter, occupancy and other operating expenses was flat from the comparable period of the prior year. Fluctuations in occupancy and other expenses consisted primarily of a $0.6 million increase in customer order delivery fees payable to third parties due to an increase in delivery orders and a $0.2 million increase in other operating expenses. These increases were offset by a $0.3 million decrease in utilities costs, a $0.2 million decrease in occupancy costs, primarily related to a reduction in rent expense from restaurants closed or sold to franchisees, and a decrease in other operating expenses of $0.3 million. Year-to-date, occupancy and other operating expenses decreased $2.2 million, or 3.2%, from the comparable period of the prior year. The decrease was primarily due to a $1.0 million decrease in repair and maintenance costs, a $1.0 million decrease in utilities costs, a $0.9 million decrease in occupancy costs, primarily related to a reduction in rent expense from restaurants closed or sold to franchisees, a $0.8 million decrease in advertising expenses, a $0.4 million decrease in credit card fees primarily related to a decrease in rates and transactions and a $0.1 million decrease in other operating expenses. These decreases were partially offset by a $2.0 million increase in customer order delivery fees payable to third parties due to an increase in delivery orders.
For the quarter, occupancy and other operating expenses as a percentage of company-operated restaurant revenue were 24.5% up from 24.1% in the comparable period in the prior year. Year-to-date, occupancy and other operating expenses as a percentage of company-operated restaurant revenue were 24.4%, up from 23.7% in the comparable period of the prior year. The increases for the quarter and year-to-date periods resulted primarily from the increases noted above and sales deleverage.
Gain on Recovery of Insurance Proceeds, Lost Profits
During the thirteen and thirty-nine weeks ended September 23, 2020, we received business interruption insurance proceeds of $2.0 million, primarily related to restaurant sales losses and expenses related to the COVID-19 pandemic and resulting dining room closures.
General and Administrative Expenses
For the quarter, general and administrative expenses increased $0.3 million, or 2.8%, from the comparable period in the prior year. The increase for the quarter was due primarily to a $0.8 million increase in labor related costs, primarily related to an increase in management bonus expense, and a $0.4 million increase in stock compensation expenses. This increase was partially offset by a $0.4 million decrease in legal expenses, a $0.2 million decrease in restaurant pre-opening costs, a $0.2 million decrease in recruiting costs and a $0.1 million decrease in other general and administrative expenses. Year-to-date, general and administrative expenses decreased $0.6 million, or 2.1%, from the comparable period in the prior year. The decrease for the year-to-date period was due primarily to a $0.6 million decrease in labor related costs, largely related to a decrease in management bonus expense, decrease in severance expense and lower group insurance costs. Additionally, there was a $0.1 million decrease in legal expenses related primarily to a decrease in securities class action litigation costs, partially offset by a $2.5 million legal settlement related to the resolution of the longstanding lawsuit involving a contract dispute with one of the Company’s franchisees concerning asserted territory rights. These decreases were partially offset by a $0.1 million increase in other general and administrative expenses.
For the quarter, general and administrative expenses as a percentage of total revenue were 8.8%, up from 8.5% in the comparable period of the prior year. Year-to-date, general and administrative expenses as a percentage of total revenue were 9.4%, up from 9.0% in the comparable period of the prior year. The percentage increase for the quarter and year-to-date periods resulted primarily from the decline in revenue, as well as the cost increases discussed above.
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Recovery of Securities Class Action Legal Expenses and Other Insurance Claims
During the thirty-nine weeks ended September 23, 2020, we received insurance proceeds of $0.1 million related to a property claim. During the thirty-nine weeks ended September 25, 2019, we received insurance proceeds of $10.0 million related to the settlement of the securities class action lawsuit. See Note 7, “Commitments and Contingencies, Legal Matters.”
Loss on Disposition of Restaurants
During the thirteen and thirty-nine weeks ended September 25, 2019, we completed the sale of four company-operated restaurants within the San Francisco area to an existing franchisee and seven company-operated restaurants in the Phoenix area to another existing franchisee. We determined that these restaurant dispositions represent multiple element arrangements, and as a result, the cash consideration received was allocated to the separate elements based on their relative selling price. Cash proceeds included upfront consideration for the sale of the restaurants and franchise fees, as well as future cash consideration for royalties and lease payments. We also considered the future lease payments in allocating the initial cash consideration received. The cash consideration per restaurant for franchise fees is consistent with the amounts stated in the related franchise agreements, which are charged for separate standalone arrangements. We initially defer and subsequently recognize the franchise fees over the term of the franchise agreement. Future royalty income is also recognized in revenue as earned.
These sales resulted in cash proceeds of $4.8 million and a net loss on sale of restaurants of $5.1 million for the thirty-nine weeks ended September 25, 2019. These restaurants are included in the total number of franchised El Pollo Loco restaurants.
Impairment and Closed-Store Reserves
During the thirteen and thirty-nine weeks ended September 23, 2020, we recognized a $1.5 million and $3.5 million non-cash impairment charge, respectively, primarily related to the carrying value of the ROU assets of one restaurant in Texas and the long-lived assets of four restaurants in California. During the thirteen and thirty-nine weeks ended September 25, 2019, we recorded a non-cash impairment charge of $0.1 million and $0.3 million, respectively, primarily related to the carrying value of the assets of one restaurant in California. Given the inherent uncertainty in projecting results for newer restaurants in newer markets, as well as the impact of the COVID-19 pandemic, the Company is monitoring the recoverability of the carrying value of the assets of several restaurants on an ongoing basis. For these restaurants, if expected performance is not realized, an impairment charge may be recognized in future periods, and such charge could be material.
When a restaurant is closed, we will evaluate the ROU asset for impairment, based on anticipated sublease recoveries. The remaining value of the ROU asset is amortized on a straight-line basis, with the expense recognized in closed-store reserve expense. Additionally, any property tax and CAM payments relating to closed restaurants are included within closed-store expense. During the thirteen and thirty-nine weeks ended September 23, 2020, we recognized $0.3 million and $1.1 million, respectively, of closed-store reserve expense related to the amortization of ROU assets, property taxes and CAM payments for our closed locations. During the thirty-nine weeks ended September 25, 2019, we closed one restaurant in California and one restaurant in Texas and recognized $0.3 million and $1.0 million of closed-store reserve expense for the thirteen and thirty-nine weeks ended September 25, 2019, respectively, primarily related to the amortization of ROU assets, property taxes and CAM payments for our closed locations.
Interest Expense, Net
For each of the quarter and year-to-date periods, interest expense, net, decreased $0.2 million from the comparable period in the prior year. The decrease is primarily related to lower interest rates and lower outstanding balances on our 2018 Revolver.
Income Tax Receivable Agreement
On July 30, 2014, we entered into the TRA. The TRA calls for us to pay to our pre-IPO stockholders 85% of the savings in cash that we realize in our taxes as a result of utilizing our net operating losses and other tax attributes attributable to preceding periods. For the thirteen and thirty-nine weeks ended September 23, 2020, we recorded income tax receivable
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agreement income of $0.1 million and income tax receivable expense of less than $0.1 million, respectively, and for the thirteen and thirty-nine weeks ended September 25, 2019 we recorded income tax receivable agreement income of $0.2 million and $0.1 million, respectively.
Provision for Income Taxes
For the quarter ended September 23, 2020, we recorded an income tax provision of $1.6 million, reflecting an estimated effective tax rate of 14.2%. For the quarter ended September 25, 2019, we recorded an income tax provision of $2.9 million, reflecting an estimated effective tax rate of approximately 31.5%. Year-to-date ended September 23, 2020, we recorded an income tax provision of $3.7 million, reflecting an estimated effective tax rate of approximately 16.3%. Year-to-date ended September 25, 2019, we recorded an income tax provision of $9.0 million, reflecting an estimated effective tax rate of approximately 29.5%. The difference between the 21.0% statutory rate and the Company’s effective tax rate of 16.3% for the year-to-date ended September 23, 2020 is primarily a result of state taxes, a Work Opportunity Tax Credit benefit, the change in valuation allowance against certain state credits as a result of future forecasted income apportioned to the state jurisdiction, non-deductible executive compensation, changes to total expected TRA payments due to changes in future forecasted taxable income and windfall tax benefit related to stock options exercised, recorded as a discrete item during the thirteen and thirty-nine weeks ended September 23, 2020.
Key Performance Indicators
To evaluate the performance of our business, we utilize a variety of financial and performance measures. These key measures include company-operated restaurant revenue, comparable restaurant sales, company-operated average unit volumes, restaurant contribution, restaurant contribution margin, new restaurant openings, EBITDA, and Adjusted EBITDA.
Company-Operated Restaurant Revenue
Company-operated restaurant revenue consists of sales of food and beverages in company-operated restaurants net of promotional allowances, employee meals, and other discounts. Company-operated restaurant revenue in any period is directly influenced by the number of operating weeks in such period, the number of open restaurants, and comparable restaurant sales.
Seasonal factors and the timing of holidays cause our revenue to fluctuate from quarter to quarter. Our revenue per restaurant is typically lower in the first and fourth quarters due to reduced January and December traffic and higher in the second and third quarters. As a result of seasonality, our quarterly and annual results of operations and key performance indicators such as company-operated restaurant revenue and comparable restaurant sales may fluctuate. In addition, we expect our quarterly company-operated restaurant revenue and comparable restaurant sales to continue to fluctuate significantly due to the current COVID-19 pandemic. See above under “COVID-19 Impact” for additional information related to the impact of the COVID-19 pandemic on our business.
Comparable Restaurant Sales
Comparable restaurant sales reflect year-over-year sales changes for comparable company-operated, franchised, and system-wide restaurants. A restaurant enters our comparable restaurant base the first full week after it has operated for fifteen months. Comparable restaurant sales exclude restaurants closed during the applicable period. At September 23, 2020 and September 25, 2019, there were 468 and 462 comparable restaurants, 191 and 198 company-operated restaurants and 277 and 264 franchised restaurants, respectively. Comparable restaurant sales indicate the performance of existing restaurants, since new restaurants are excluded.
Comparable restaurant sales growth can be generated by an increase in the number of meals sold and/or by increases in the average check amount, resulting from a shift in menu mix and/or higher prices resulting from new products or price increases.
Company-Operated Average Unit Volumes
We measure company-operated average unit volumes (“AUVs”) on both a weekly and an annual basis. Weekly AUVs consist of comparable restaurant sales over a seven-day period from Thursday to Wednesday. Annual AUVs are
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calculated using the following methodology: First, we divide our total net sales for all company-operated restaurants for the fiscal year by the total number of restaurant operating weeks during the same period. Second, we annualize that average weekly per-restaurant sales figure by multiplying it by 52. An operating week is defined as a restaurant open for business over a seven-day period from Thursday to Wednesday. This measurement allows management to assess changes in consumer spending patterns at our restaurants and the overall performance of our restaurant base.
Restaurant Contribution and Restaurant Contribution Margin
Restaurant contribution and restaurant contribution margin are neither required by, nor presented in accordance with, GAAP. Restaurant contribution is defined as company-operated restaurant revenue less company restaurant expenses which includes food and paper cost, labor and related expenses and occupancy and other operating expenses, where applicable. Restaurant contribution excludes certain costs, such as general and administrative expenses, depreciation and amortization, impairment and closed-store reserve and other costs that are considered normal operating costs and accordingly, restaurant contribution is not indicative of overall Company results and does not accrue directly to the benefit of stockholders because of the exclusion of certain corporate-level expenses. Restaurant contribution margin is defined as restaurant contribution as a percentage of net company-operated restaurant revenue.
Restaurant contribution and restaurant contribution margin are supplemental measures of operating performance of our restaurants, and our calculations thereof may not be comparable to those reported by other companies. Restaurant contribution and restaurant contribution margin have limitations as analytical tools, and you should not consider them in isolation, or superior to, or as substitutes for the analysis of our results as reported under GAAP. Management uses restaurant contribution and restaurant contribution margin as key metrics to evaluate the profitability of incremental sales at our restaurants, to evaluate our restaurant performance across periods, and to evaluate our restaurant financial performance compared with our competitors. Management believes that restaurant contribution and restaurant contribution margin are important tools for investors, because they are widely-used metrics within the restaurant industry to evaluate restaurant-level productivity, efficiency, and performance. Restaurant contribution and restaurant contribution margin may also assist investors in evaluating our business and performance relative to industry peers and provide greater transparency with respect to the Company’s financial condition and results of operation.
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A reconciliation of restaurant contribution and restaurant contribution margin to company-operated restaurant revenue is provided below:
Thirteen Weeks Ended
Thirty-Nine Weeks Ended
(Dollar amounts in thousands)
September 23, 2020
September 25, 2019
September 23, 2020
September 25, 2019
Restaurant contribution:
Income from operations
$
12,193
$
10,118
$
25,328
$
32,990
Add (less):
General and administrative expenses
9,803
9,539
29,599
30,235
Franchise expenses
7,572
7,006
21,110
20,692
Depreciation and amortization
4,092
4,343
12,629
13,558
Loss on disposal of assets
29
35
156
213
Franchise revenue
(7,781)
(7,273)
(21,562)
(21,635)
Franchise advertising fee revenue
(5,922)
(5,742)
(16,567)
(16,808)
Recovery of securities lawsuits related legal expenses and other insurance claims
—
—
(123)
(10,000)
Impairment and closed-store reserves
1,776
367
4,615
1,241
Loss on sale of restaurants
—
11
—
5,062
Restaurant contribution
$
21,762
$
18,404
$
55,185
$
55,548
Company-operated restaurant revenue:
Total revenue
$
110,979
$
112,067
$
315,746
$
334,784
Less:
Franchise revenue
(7,781)
(7,273)
(21,562)
(21,635)
Franchise advertising fee revenue
(5,922)
(5,742)
(16,567)
(16,808)
Company-operated restaurant revenue
$
97,276
$
99,052
$
277,617
$
296,341
Restaurant contribution margin (%)
22.4
%
18.6
%
19.9
%
18.7
%
New Restaurant Openings
The number of restaurant openings reflects the number of new restaurants opened by us and our franchisees during a particular reporting period. Before a new restaurant opens, we and our franchisees incur pre-opening costs, as described below. New restaurants often open with an initial start-up period of higher than normal sales volumes, which subsequently decrease to stabilized levels. New restaurants typically experience normal inefficiencies in the form of higher food and paper, labor, and other direct operating expenses and, as a result, restaurant contribution margins are generally lower during the start-up period of operation. The average start-up period after which our new restaurants’ revenue and expenses normalize is approximately fourteen weeks. When we enter new markets, we may be exposed to start-up times and restaurant contribution margins that are longer and lower than reflected in our average historical experience.
EBITDA and Adjusted EBITDA
EBITDA represents net income before interest expense, provision for income taxes, depreciation, and amortization. Adjusted EBITDA represents net income before interest expense, provision for income taxes, depreciation, amortization, and items that we do not consider representative of our on-going operating performance, as identified in the reconciliation table below.
EBITDA and Adjusted EBITDA as presented in this report are supplemental measures of our performance that are neither required by, nor presented in accordance with, GAAP. EBITDA and Adjusted EBITDA are not measurements of our financial performance under GAAP and should not be considered as alternatives to net income, operating income, or any other performance measures derived in accordance with GAAP, or as alternatives to cash flow from operating
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activities as a measure of our liquidity. In addition, in evaluating EBITDA and Adjusted EBITDA, you should be aware that in the future we will incur expenses or charges such as those added back to calculate EBITDA and Adjusted EBITDA. Our presentation of EBITDA and Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or nonrecurring items.
EBITDA and Adjusted EBITDA have limitations as analytical tools, and you should not consider them in isolation, or as substitutes for analysis of our results as reported under GAAP. Some of these limitations are (i) they do not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments, (ii) they do not reflect changes in, or cash requirements for, our working capital needs, (iii) they do not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt, (iv) although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements, (v) they do not adjust for all non-cash income or expense items that are reflected in our statements of cash flows, (vi) they do not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of our on-going operations, and (vii) other companies in our industry may calculate these measures differently than we do, limiting their usefulness as comparative measures.
We compensate for these limitations by providing specific information regarding the GAAP amounts excluded from such non-GAAP financial measures. We further compensate for the limitations in our use of non-GAAP financial measures by presenting comparable GAAP measures more prominently.
We believe that EBITDA and Adjusted EBITDA facilitate operating performance comparisons from period to period by isolating the effects of some items that vary from period to period without any correlation to core operating performance or that vary widely among similar companies. These potential differences may be caused by variations in capital structures (affecting interest expense), tax positions (such as the impact on periods or companies of changes in effective tax rates or net operating losses) and the age and book depreciation of facilities and equipment (affecting relative depreciation expense). We also present EBITDA and Adjusted EBITDA because (i) we believe that these measures are frequently used by securities analysts, investors and other interested parties to evaluate companies in our industry, (ii) we believe that investors will find these measures useful in assessing our ability to service or incur indebtedness, and (iii) we use EBITDA and Adjusted EBITDA internally for a number of benchmarks including to compare our performance to that of our competitors and for compensation performance benchmarks.
The following table sets forth reconciliations of EBITDA and Adjusted EBITDA to our net income:
Thirteen Weeks Ended
Thirty-Nine Weeks Ended
(Amounts in thousands)
September 23, 2020
September 25, 2019
September 23, 2020
September 25, 2019
Net income
$
9,920
$
6,402
$
19,019
$
21,402
Non-GAAP adjustments:
Provision for income taxes
1,647
2,940
3,700
8,954
Interest expense, net of interest income
770
973
2,583
2,754
Depreciation and amortization
4,092
4,343
12,629
13,558
EBITDA
$
16,429
$
14,658
$
37,931
$
46,668
Stock-based compensation expense (a)
909
668
2,170
1,797
Loss on disposal of assets (b)
29
35
156
213
Recovery of securities lawsuits related legal expense and other insurance claims (c)
—
—
(123)
(10,000)
Impairment and closed-store reserves (d)
1,776
367
4,615
1,241
Loss on disposition of restaurants (e)
—
11
—
5,062
Income tax receivable agreement (income) expense (f)
(144)
(197)
26
(120)
Securities class action legal expense (g)
289
179
527
2,809
Legal settlements (h)
—
—
2,566
—
Pre-opening costs (i)
—
158
110
193
Executive transition costs (j)
—
51
—
151
Adjusted EBITDA
$
19,288
$
15,930
$
47,978
$
48,014
(a) Includes non-cash, stock-based compensation.
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(b) Loss on disposal of assets includes the loss on disposal of assets related to retirements and replacement or write-off of leasehold improvements or equipment.
(c) During thirty-nine weeks ended September 23, 2020, we received insurance proceeds of $0.1 million related to a property claim. During the thirteen and thirty-nine weeks ended September 25, 2019, we received insurance proceeds of $10.0 million related to the settlement of the securities class action lawsuit. See Note 7, “Commitments and Contingencies, Legal Matters.”
(d) Includes costs related to impairment of long-lived assets and closing restaurants. During the thirteen and thirty-nine weeks ended September 23, 2020, we recognized $1.5 million and a $3.5 million, respectively, non-cash impairment charge, primarily related to the carrying value of the ROU assets of one restaurant in Texas and the long-lived assets of four restaurants in California. During the thirteen and thirty-nine weeks ended September 25, 2019, we recorded a non-cash impairment charge of $0.1 million and $0.3 million, respectively, primarily related to the carrying value of the assets of one restaurant in California. Given the difficulty in projecting results for newer restaurants in newer markets, as well as the impact of the COVID-19 pandemic, we are monitoring the recoverability of the carrying value of the assets of several restaurants on an ongoing basis. For these restaurants, if expected performance is not realized, an impairment charge may be recognized in future periods, and such charge could be material.
When a restaurant is closed, we will evaluate the ROU asset for impairment, based on anticipated sublease recoveries. The remaining value of the ROU asset is amortized on a straight-line basis, with the expense recognized in closed-store reserve expense. Additionally, any property tax and CAM payments relating to closed restaurants are included within closed-store expense. During the thirteen and thirty-nine weeks ended September 23, 2020, we recognized $0.3 million and $1.1 million, respectively, of closed-store reserve expense related to the amortization of ROU assets, property taxes and CAM payments for our closed locations. During the thirty-nine weeks ended September 25, 2019, we closed one restaurant in California and one restaurant in Texas, and recognized $0.3 million and $1.0 million of closed-store reserve expense for the thirteen and thirty-nine weeks ended September 25, 2019, respectively, primarily related to the amortization of ROU assets, property taxes and CAM payments for our closed locations.
(e) During the thirteen and thirty-nine weeks ended September 25, 2019, we completed the sale of four company-operated restaurants within the San Francisco area to an existing franchisee and seven company-operated restaurants in the Phoenix area to another existing franchisee. These sales resulted in cash proceeds of $4.8 million and a net loss on sale of restaurants of $0.9 million and $5.1 million for the thirteen and thirty-nine weeks ended September 25, 2019, respectively. These restaurants are now included in our franchised restaurant totals.
(f) On July 30, 2014, we entered into the TRA. This agreement calls for us to pay to our pre-IPO stockholders 85% of the savings in cash that we realize in our taxes as a result of utilizing our net operating losses and other tax attributes attributable to preceding periods. For the thirteen and thirty-nine weeks ended September 23, 2020 and September 25, 2019, income tax receivable agreement (income) expense consisted of the amortization of interest expense and changes in estimates for actual tax returns filed, related to our total expected TRA payments.
(g) Consists of costs related to the defense of securities lawsuits. See Note 7, “Commitments and Contingencies, Legal Matters."
(h) Includes an expense related to resolution of the longstanding lawsuit involving a contract dispute with one of the Company’s franchisees concerning asserted territory rights, as well as amounts incurred related to the payment of the final settlement amounts for consolidated wage and hour class action lawsuits resolved in prior quarters.
(i) Pre-opening costs are a component of general and administrative expenses, and consist of costs directly associated with the opening of new restaurants and incurred prior to opening, including management labor costs, staff labor costs during training, food and supplies used during training, marketing costs, and other related pre-opening costs. These are generally incurred over the three to five months prior to opening. Pre-opening costs also include occupancy costs incurred between the date of possession and the opening date for a restaurant.
(j) Includes costs associated with the transition of our CEO, such as CEO sign-on bonus.
Liquidity and Capital Resources
Our primary sources of liquidity and capital resources have been cash provided from operations, cash and cash equivalents, and the 2018 Revolver. Our primary requirements for liquidity and capital are new restaurants, existing restaurant capital investments (remodels and maintenance), interest payments on our debt, lease obligations, and working capital and general corporate needs. However, in light of the COVID-19 pandemic, we have temporarily suspended all new restaurants and capital investments. Our working capital requirements are not significant, since our customers pay for their purchases in cash or by payment card (credit or debit) at the time of sale. Thus, we are able to sell many of our inventory items before we have to pay our suppliers for them. Our restaurants do not require significant inventories or
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receivables. We believe that our sources of liquidity and capital are sufficient to finance our continued operations for at least the next twelve months from the filing of the condensed consolidated financial statements. However, depending on the severity and longevity of the COVID-19 pandemic, the efforts taken to reduce its spread (including government-mandated closures of our dining rooms) and the possibility of a subsequent resurgence of the COVID-19 outbreak after the current outbreak subsides, our financial performance and liquidity could be further impacted and could impact our ability to meet certain financial covenants required in our 2018 Credit Agreement, specifically the lease-adjusted coverage ratio and fixed-charge coverage ratio.
The following table presents summary cash flow information for the periods indicated.
Thirty-Nine Weeks Ended
(Amounts in thousands)
September 23, 2020
September 25, 2019
Net cash provided by (used in)
Operating activities
$
33,519
$
31,895
Investing activities
(4,349)
(6,078)
Financing activities
(7,711)
(20,717)
Net increase in cash
$
21,459
$
5,100
Operating Activities
For the thirty-nine weeks ended September 23, 2020, net cash provided by operating activities increased by approximately $1.6 million from the comparable period of the prior year. This increase was due primarily to favorable working capital fluctuations, partially offset by a decline in profitability after non-cash items for the thirty-nine weeks ended September 23, 2020 compared to the prior year, which we believe related to the COVID-19 pandemic.
Investing Activities
For the thirty-nine weeks ended September 23, 2020, net cash used in investing activities decreased by $1.7 million from the comparable period of the prior year. This was due primarily to purchases of property and equipment of $4.3 million in the thirty-nine weeks ended September 23, 2020 compared to $10.8 million in the thirty-nine weeks ended September 25, 2019. This was partially offset by cash proceeds of $4.8 million received during the thirty-nine weeks ended September 25, 2019 related to the sale of four company-operated restaurants within the San Francisco area to an existing franchisee and seven company-operated restaurants in the Phoenix area to another existing franchisee.
Given the uncertainty surrounding the severity and longevity of the COVID-19 pandemic, as a precautionary measure we have significantly reduced capital spending.
Financing Activities
For the thirty-nine weeks ended September 23, 2020, net cash used in financing activities decreased by $13.0 million from the comparable period of the prior year. This decrease was due primarily to $47.4 million of cash outflow related to stock buybacks during the thirty-nine weeks ended September 25, 2019 and $5.8 million of proceeds received from the issuance of common stock upon exercise of stock options during the thirty-nine weeks ended September 23, 2020. This was partially offset by $13.2 million of net pay downs on the 2018 Revolver during the thirty-nine weeks ended September 23, 2020, compared to net borrowings of $27.0 million for the thirty-nine weeks ended September 25, 2019.
Debt and Other Obligations
On July 13, 2018, the Company entered into the 2018 Credit Agreement, which provides for the 2018 Revolver to refinance the previous 2014 Revolver. The 2018 Revolver includes a sub limit of $15.0 million for letters of credit and a sub limit of $15.0 million for swingline loans. The 2018 Revolver and 2018 Credit Agreement will mature on July 13, 2023. The obligations under the 2018 Credit Agreement and related loan documents are guaranteed by the Company and Intermediate. The obligations of the Company, EPL and Intermediate under the 2018 Credit Agreement and related loan documents are secured by a first priority lien on substantially all of their respective assets.
Under the 2018 Revolver, Holdings may not make certain payments such as cash dividends, except that it may, inter alia, (i) pay up to $1.0 million per year to repurchase or redeem qualified equity interests of Holdings held by past or present
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officers, directors, or employees (or their estates) of the Company upon death, disability, or termination of employment, (ii) pay under its TRA, and (iii) so long as no default or event of default has occurred and is continuing, (a) make non-cash repurchases of equity interests in connection with the exercise of stock options by directors, officers and management, provided that those equity interests represent a portion of the consideration of the exercise price of those stock options, (b) pay up to $0.5 million in any 12 month consecutive period to redeem, repurchase or otherwise acquire equity interests of any subsidiary that is not a wholly-owned subsidiary from any holder of equity interest in such subsidiary, (c) pay up to $2.5 million per year pursuant to stock option plans, employment agreements, or incentive plans, (d) make up to $5.0 million in other restricted payments per year, and (e) make other restricted payments, subject to its compliance, on a pro forma basis, with (x) a lease-adjusted consolidated leverage ratio not to exceed 4.25 times and (y) the financial covenants applicable to the 2018 Revolver.
Borrowings under the 2018 Credit Agreement (other than any swingline loans) bear interest, at the borrower’s option, at rates based upon either LIBOR or a base rate, plus, for each rate, a margin determined in accordance with a lease-adjusted consolidated leverage ratio-based pricing grid. The base rate is calculated as the highest of (a) the federal funds rate plus 0.50%, (b) the published Bank of America prime rate, or (c) LIBOR plus 1.00%. For LIBOR loans, the margin is in the range of 1.25% to 2.25%, and for base rate loans the margin is in a range of 0.25% to 1.25%. Borrowings under the 2018 Revolver may be repaid and reborrowed. The interest rate range was 1.67% to 1.68% and 1.67% to 3.29% for the thirteen and thirty-nine weeks ended September 23, 2020, respectively, and 3.65% to 3.90% and 3.65% to 6.00% for the thirteen and thirty-nine weeks ended September 25, 2019, respectively.
The 2018 Credit Agreement contains certain financial covenants. The Company was in compliance with the financial covenants as of September 23, 2020. However, depending on the severity and longevity of the COVID-19 pandemic, the efforts taken to reduce its spread and the possibility of a resurgence of the COVID-19 outbreak after the initial outbreak subside, the Company’s financial performance and liquidity could be further impacted and could impact the Company’s ability to comply with certain financial covenants required in our 2018 Credit Agreement, specifically the lease-adjusted coverage ratio and fixed-charge coverage ratio.
At September 23, 2020, $8.4 million of letters of credit and $83.8 million of borrowings were outstanding under the 2018 Revolver. There were $57.8 million remaining borrowings available under the 2018 Revolver at September 23, 2020. Subsequent to September 23, 2020, the Company made a voluntary $28.0 million pre-payment on its 2018 Revolver. As of October 30, 2020, the Company had $55.8 million in outstanding borrowings under the 2018 Revolver and $85.8 million in borrowing availability.
During the year ended December 25, 2019, we entered into an interest rate swap with a notional amount of $40.0 million, related to the outstanding borrowings under our 2018 Revolver. The interest rate swap was designated as a cash flow hedge and effectively converted a portion of our outstanding borrowings to a fixed rate of 1.31%, plus the applicable margin spread, which is currently 1.5%. The interest rate swap matures in June 2023.
Contractual Obligations
Our contractual obligations outstanding on September 23, 2020 have not changed materially since those disclosed under “Debt and Other Obligations – Contractual Obligations” in Part II, Item 7 of our annual report on Form 10-K for the year ended December 25, 2019 other than (i) the impact of our delay in making April, May and June rent payments on the majority of our leased properties as discussed under to COVID-19 Impact in the "Overview" section above and (ii) subsequent borrowings and pre-payments under our 2018 Revolver as disclosed under Note 4, “Long-Term Debt” in Item 1 above. . Our contractual commitments relate to future (i) debt payments, including expected interest expense, calculated based on current interest rates, (ii) restaurant operating lease payments, (iii) income tax receivable agreement payments, and (iv) purchasing commitments for chicken.
Off-Balance Sheet and Other Arrangements
As of September 23, 2020 and December 25, 2019, we were using $8.4 million of borrowing capacity on the 2018 Revolver for letters of credit in support of our insurance programs.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.