NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Overview
El Pollo Loco Holdings, Inc. (“Holdings”) is a Delaware corporation headquartered in Costa Mesa, California. Holdings and its direct and indirect subsidiaries are collectively known as “we,” “us” or the “Company.” The Company's activities are conducted principally through its indirect wholly-owned subsidiary, El Pollo Loco, Inc. (“EPL”), which develops, franchises, licenses, and operates quick-service restaurants under the name El Pollo Loco® and operates under
one
operating segment. At
June 28, 2017
, the Company operated
208
and franchised
264
El Pollo Loco restaurants.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial statements and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments consisting of normal recurring adjustments necessary for a fair presentation of the Company's financial position and results of operations and cash flows for the periods presented. Interim results of operations are not necessarily indicative of the results that may be achieved for the full year. The condensed consolidated financial statements and related notes do not include all information and footnotes required by GAAP for annual reports. This quarterly report should be read in conjunction with the consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended
December 28, 2016
.
The Company uses a 52- or 53-week fiscal year ending on the last Wednesday of the calendar year. In a 52-week fiscal year, each quarter includes 13 weeks of operations; in a 53-week fiscal year, the first, second and third quarters each include 13 weeks of operations and the fourth quarter includes 14 weeks of operations. Every six or seven years a 53-week fiscal year occurs. Fiscal 2016 and 2017 are both 52-week years, ending on December 28, 2016 and December 27, 2017, respectively. Revenues, expenses, and other financial and operational figures may be elevated in a 53-week year.
Holdings has no material assets or operations. Holdings and Holdings’ direct subsidiary, EPL Intermediate, Inc. (“Intermediate”), guarantee EPL’s 2014 Revolver (see Note 4) on a full and unconditional basis, and Intermediate has no subsidiaries other than EPL. EPL is a separate and distinct legal entity and has no obligation to make funds available to Intermediate. EPL and Intermediate may pay dividends to Intermediate and to Holdings, respectively.
Under the 2014 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 officers, directors, or employees (or their estates) of the Company upon death, disability, or termination of employment, (ii) pay under its income tax receivable agreement (the “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 and officers, provided that those equity interests represent a portion of the consideration of the exercise price of those stock options, (b) pay up to $2.5 million per year pursuant to stock option plans, employment agreements, or incentive plans, (c) make up to $5.0 million in other restricted payments per year, and (d) make other restricted payments, provided that such payments would not cause, in each case, on a pro forma basis, (x) its lease-adjusted consolidated leverage ratio to equal or exceed 4.25 times and (y) its consolidated fixed charge coverage ratio to be less than 1.75 times.
Principles of Consolidation
The accompanying condensed consolidated financial statements include the accounts of Holdings and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and revenue and expenses during the period reported. Actual results could materially differ from those estimates. The Company’s significant estimates include estimates for
impairment of goodwill, intangible assets and property and equipment, insurance reserves, lease termination liabilities, closed-store reserves, stock-based compensation, income tax receivable agreement liability, and income tax valuation allowances.
Cash and Cash Equivalents
The Company considers all highly-liquid instruments with an original maturity of three months or less at the date of purchase to be cash equivalents.
Restricted Cash
The Company’s restricted cash represented cash collateral to one commercial bank for Company credit cards. During the
twenty-six
weeks ended
June 28, 2017
, the cash collateral was returned by the bank, and the Company reclassified such amounts to cash and cash equivalents.
Liquidity
The Company’s principal liquidity requirements are to service its debt and to meet capital expenditure needs. At
June 28, 2017
, the Company’s total debt (including capital lease liabilities) was
$94.9 million
. The Company’s ability to make payments on its indebtedness and to fund planned capital expenditures depends on available cash and on its ability to generate adequate cash flows in the future, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory, and other factors that are beyond the Company’s control. Based on current operations, the Company believes that its cash flow from operations, available cash of
$4.4 million
at
June 28, 2017
, and available borrowings under the 2014 Revolver (which availability was approximately
$97.4 million
at
June 28, 2017
) will be adequate to meet the Company’s liquidity needs for the next 12 months.
Gain on Recovery of Insurance Proceeds
In November 2015,
one
of the Company’s restaurants incurred damage resulting from a fire. During the
twenty-six
weeks ended
June 29, 2016
, we incurred costs directly related to the fire of less than
$0.1 million
, disposed of an additional
$0.1 million
in assets, and recognized gains of
$0.9 million
, related to the reimbursement of property and equipment. The Company received from the insurance company cash of
$1.0 million
during the
twenty-six
weeks ended
June 29, 2016
, net of the insurance deductible. The restaurant was reopened for business on March 14, 2016.
Recovery of Securities Class Action Legal Expense
During the thirteen and
twenty-six
weeks ended
June 28, 2017
, the Company received insurance proceeds of
$0.5 million
, related to the reimbursement of certain legal expenses paid in prior years for the defense of securities lawsuits. See Note 7, Commitments and Contingencies, Legal Matters.
Recent Accounting Pronouncements
In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-09, which provides clarity, reduces diversity in practice, and reduces cost and complexity when applying the guidance in Topic 718 Compensation—Stock Compensation, regarding a change to the terms or conditions of a share-based payment award. Specifically, an entity is to account for the effects of a modification, unless all of the following are satisfied: (1) the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified; (2) the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified; and (3) the classification of the modified award as an equity instrument or as a liability instrument is the same as the classification of the original award immediately before the original award is modified. ASU 2017-09 is effective for financial statements issued for annual periods beginning after December 15, 2017. The adoption of ASU 2017-09 is not expected to have a significant impact on the Company’s consolidated financial position or results of operations.
In January 2017, the FASB issued ASU 2017-04, simplifying the manner in which an entity is required to test for goodwill impairment by eliminating Step 2 from the goodwill impairment test. ASU 2017-04 is effective for financial statements issued for annual periods beginning after December 15, 2019. The adoption of ASU 2017-04 is not expected to have a significant impact on the Company’s consolidated financial position or results of operations.
In January 2017, the FASB issued ASU 2017-01, clarifying the definition of a business. ASU 2017-01 clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is effective for financial statements issued for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The adoption of ASU 2017-01 is not expected to have a significant impact on the Company’s consolidated financial position or results of operations.
In November 2016, the FASB issued ASU 2016-18, "Restricted Cash." ASU 2016-18 addresses the diversity in practice that exists regarding the classification and the presentation of changes in restricted cash on the statements of cash flows under Topic 230, Statements of Cash Flow, and other Topics. The amendments in ASU No. 2016-18 require that amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and the end-of-period total amounts set forth on the statements of cash flows. ASU 2016-18 is effective for financial statements issued for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The adoption of ASU 2016-18 is not expected to have a significant impact on the Company’s consolidated financial position or results of operations.
In August 2016, the FASB issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments." ASU 2016-15 addresses how certain cash receipts and cash payments are presented and classified in the statements of cash flows under Topic 230, Statements of Cash Flow, and other Topics. ASU 2016-15 is effective for financial statements issued for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The adoption of ASU 2016-15 is not expected to have a significant impact on the Company’s consolidated financial position or results of operations.
In February 2016, the FASB issued ASU 2016-02, “Leases.” The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Although early adoption is permitted, we will adopt these provisions in the first quarter of 2019. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company has
$307.2 million
of operating lease obligations as of
June 28, 2017
and upon adoption of this standard will record a ROU asset and lease liability equal to the present value of these leases, which will have a material impact on the balance sheet. However, the statement of income recognition of lease expense is not expected to change from the current methodology.
In January 2016, the FASB issued ASU 2016-01, "Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities." The pronouncement requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset, and eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. These changes become effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. The adoption of ASU 2016-01 is not expected to have a significant impact on the Company’s consolidated financial position or results of operations.
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (ASU 2014-09)”, which supersedes nearly all existing revenue recognition guidance under GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing GAAP.
The revised revenue standard is effective for public entities for annual periods beginning after December 15, 2017, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures).
In addition, the FASB has issued the following Technical Corrections, Practical Expedients and Improvements to Topic 606, Revenue from Contracts with Customers: ASU No. 2016-20, in December 2016, ASU No. 2016-12, in May 2016, and ASU No. 2016-10, in April 2016. All amendments are effective for financial statements issued for annual periods beginning after December 15, 2017, including interim periods within those annual periods, and early application is permitted, but no earlier than fiscal years beginning after December 15, 2016.
Based on the nature of the Company’s business, the adoption of ASU No. 2014-09, or any of the subsequent related ASU’s, are not expected to impact the majority of its revenue streams. The Company is currently in the process of evaluating current accounting policies to identify potential differences for the remaining revenue streams and, while the Company does anticipate some changes to revenue recognition for certain franchisee and development agreements, it does not currently believe the adoption of ASU 2014-09 will have a material impact to its consolidated financial position or results of operations. In addition, the Company is currently determining the transition method and disclosure requirements, and plans on finishing its analysis by the end of fiscal 2017.
Subsequent Events
Subsequent to
June 28, 2017
, the Company made a
$4.0 million
pre-payment on the 2014 Revolver, received an additional
$0.6 million
of insurance proceeds related to the reimbursement of certain legal expenses paid in prior years for the defense of securities lawsuits and completed
one
new store opening. In addition, one of our franchisees completed
one
new store opening.
Subsequent to
June 28, 2017
, the Company made a strategic decision to close three restaurants in Texas, one of which was fully impaired during the fourth quarter of 2016. While the company is still assessing an intended course of action regarding the restaurants, there could be an impairment charge of up to
$3.4 million
, related to the remaining assets of two of the restaurants during the third quarter.
The Company evaluated subsequent events that have occurred after
June 28, 2017
, and determined that there were no other events or transactions occurring during this reporting period that require recognition or disclosure in the condensed consolidated financial statements.
Concentration of Risk
Cash and cash equivalents are maintained at financial institutions and, at times, balances may exceed federally-insured limits. The Company has never experienced any losses related to these balances.
The Company had
no
suppliers for which amounts due at
June 28, 2017
totaled greater than 10% of the Company’s accounts payable. As of
December 28, 2016
, the Company had
one
supplier for which amounts due totaled
16%
of the Company’s accounts payable. Purchases from the Company’s largest supplier totaled
33%
of total expenses for the thirteen weeks ended
June 28, 2017
, and
34%
of total expenses for the thirteen weeks ended
June 29, 2016
. Purchases from the Company’s largest supplier totaled
32%
of total expenses for the
twenty-six
weeks ended
June 28, 2017
, and
34%
of total expenses for the
twenty-six
weeks ended
June 29, 2016
, of the Company’s purchases. Company-operated and franchised restaurants in the greater Los Angeles area generated, in the aggregate, approximately
73%
and
75%
of total revenue for the
thirteen and twenty-six
weeks ended
June 28, 2017
and
June 29, 2016
, respectively.
Goodwill and Indefinite Lived Intangible Assets
The Company’s indefinite lived intangible assets consist of trademarks. Goodwill represents the excess of cost over fair value of net identified assets acquired in business combinations accounted for under the purchase method. The Company does not amortize its goodwill and indefinite lived intangible assets. Goodwill resulted from historical acquisitions.
Upon a sale of a restaurant, the Company evaluates whether there is a decrement of goodwill. The amount of goodwill included in the cost basis of the asset sold is determined based on the relative fair value of the portion of the reporting unit disposed of compared to the fair value of the reporting unit retained.
The Company performs annual impairment tests for goodwill during the fourth fiscal quarter of each fiscal year, or more frequently if impairment indicators arise.
The Company reviews goodwill for impairment utilizing either a qualitative assessment or a two-step process. If the Company decides that it is appropriate to perform a qualitative assessment and concludes that the fair value of a reporting unit more likely than not exceeds its carrying value, no further evaluation is necessary. If the Company performs the two-step process, the first
step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired and the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step is performed to measure the amount of impairment by comparing the carrying amount of the goodwill to a determination of the implied value of the goodwill. If the carrying amount of goodwill is greater than the implied value, an impairment charge is recognized for the difference.
The Company performs annual impairment tests for indefinite lived intangible assets during the fourth fiscal quarter of each fiscal year, or more frequently if impairment indicators arise. An impairment test consists of either a qualitative assessment or a comparison of the fair value of an intangible asset with its carrying amount. The excess of the carrying amount of an intangible asset over its fair value is its impairment loss.
The assumptions used in the estimate of fair value are generally consistent with the past performance of the Company’s reporting segment and are also consistent with the projections and assumptions that are used in current operating plans. These assumptions are subject to change as a result of changing economic and competitive conditions.
The Company did
not
identify any indicators of potential impairment of its goodwill or indefinite-lived intangible assets during the
thirteen and twenty-six
weeks ended
June 28, 2017
or
June 29, 2016
, and therefore did not record any impairment during the respective periods.
Fair Value Measurements
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:
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•
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Level 1: Quoted prices for identical instruments in active markets.
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•
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Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs or significant value drivers are observable.
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•
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Level 3: Unobservable inputs used when little or no market data is available.
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As of
June 28, 2017
and
December 28, 2016
, the Company had no assets or liabilities measured at fair value on a recurring basis.
Certain assets and liabilities are measured at fair value on a nonrecurring basis. In other words, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment).
The following non-financial instruments were measured at fair value, on a nonrecurring basis, as of and for the
thirteen and twenty-six
weeks ended
June 28, 2017
(in thousands), reflecting certain property and equipment assets for which an impairment loss was recognized during the corresponding period, as discussed immediately below under "Impairment of Long-Lived Assets":
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Fair Value Measurements at June 28, 2017 Using
|
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Impairment Loss
|
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Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Thirteen Weeks Ended June 28, 2017
|
|
Twenty-Six Weeks Ended June 28, 2017
|
Property and equipment owned, net
|
$
|
302
|
|
|
$
|
—
|
|
|
$
|
—
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|
|
$
|
302
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|
$
|
387
|
|
|
387
|
|
The were no non-financial instruments that were measured at fair value, on a nonrecurring basis as of and for the
thirteen and twenty-six
weeks ended
June 29, 2016
.
Impairment of Long-Lived Assets
The Company reviews its long-lived assets for impairment on a restaurant-by-restaurant basis whenever events or changes in circumstances indicate that the carrying value of certain assets may not be recoverable. If the Company concludes that the carrying value of certain assets will not be recovered based on expected undiscounted future cash flows, an impairment write-down is recorded to reduce the assets to their estimated fair value. The fair value is measured on a nonrecurring basis using
unobservable (Level 3) inputs. Based on the results of the analysis, during the
thirteen and twenty-six
weeks ended
June 28, 2017
, the Company recorded a non-cash impairment charge of
$0.4 million
. For the
thirteen and twenty-six
weeks ended
June 29, 2016
, the Company recorded an immaterial non-cash impairment charge related to capital expenditures for stores fully impaired in previous years. The Company continues to monitor the recoverability of the carrying value of the assets of several restaurants on an ongoing basis. In particular, most of the Company’s (and its franchisees’) restaurants in Texas have opened since the beginning of 2015, and many since the beginning of 2016. Accordingly, given the difficulty in projecting results for newer restaurants in newer markets, the Company intends to continue to monitor the performance of its Texas portfolio. Based on most recent results, if the management plans to improve profitability are not successful, future significant impairment to the Company’s assets may occur as a result of the performance of these restaurants and the related future cash flow assumptions over the remaining lease term.
Income Taxes
The provision for income taxes, income taxes payable and deferred income taxes is determined using the asset and liability method. Deferred tax assets and liabilities are determined based on temporary differences between the financial carrying amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which the temporary differences are expected to reverse. On a periodic basis, the Company assesses the probability that its net deferred tax assets, if any, will be recovered. If, after evaluating all of the positive and negative evidence, a conclusion is made that it is more likely than not that some portion or all of the net deferred tax assets will not be recovered, a valuation allowance is provided by charging to tax expense to reserve the portion of deferred tax assets which are not expected to be realized. In the first quarter of fiscal 2017 the Company implemented ASU 2015-17, resulting in the classification of all deferred tax assets as non-current. As the Company implemented this ASU retrospectively,
$21.5 million
of deferred tax assets previously classified as current in fiscal year 2016 are now classified as noncurrent liabilities within the Company's balance sheets.
The Company reviews its filing positions for all open tax years in all U.S. federal and state jurisdictions where the Company is required to file.
When there are uncertainties related to potential income tax benefits, in order to qualify for recognition, the position the Company takes has to have at least a “more likely than not” chance of being sustained (based on the position’s technical merits) upon challenge by the respective authorities. The term “more likely than not” means a likelihood of more than 50 percent. Otherwise, the Company may not recognize any of the potential tax benefit associated with the position. The Company recognizes a benefit for a tax position that meets the “more likely than not” criterion at the largest amount of tax benefit that is greater than 50 percent likely of being realized upon its effective resolution. Unrecognized tax benefits involve management’s judgment regarding the likelihood of the benefit being sustained. The final resolution of uncertain tax positions could result in adjustments to recorded amounts and may affect our results of operations, financial position, and cash flows.
The Company’s policy is to recognize interest and penalties related to income tax matters in income tax expense. The Company had
no
accrual for interest or penalties at
June 28, 2017
or at
December 28, 2016
, and did
not
recognize interest or penalties during the
thirteen or twenty-six
weeks ended
June 28, 2017
or
June 29, 2016
, since there were no material unrecognized tax benefits. Management believes no material changes to the amount of unrecognized tax benefits will occur within the next twelve months.
On July 30, 2014, the Company entered into the TRA. The TRA calls for the Company to pay to its pre-IPO stockholders
85%
of the savings in cash that the Company realizes in its taxes as a result of utilizing its net operating losses and other tax attributes attributable to preceding periods.
2. PROPERTY AND EQUIPMENT
The costs and related accumulated depreciation and amortization of major classes of property and equipment are as follows (in thousands):
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June 28, 2017
|
|
December 28, 2016
|
Land
|
$
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12,323
|
|
|
$
|
12,323
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Buildings and improvements
|
141,457
|
|
|
125,159
|
|
Other property and equipment
|
70,727
|
|
|
65,831
|
|
Construction in progress
|
5,649
|
|
|
11,539
|
|
|
230,156
|
|
|
214,852
|
|
Less: accumulated depreciation and amortization
|
(103,525
|
)
|
|
(96,382
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)
|
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$
|
126,631
|
|
|
$
|
118,470
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Depreciation expense was
$4.6 million
and
$4.0 million
for the thirteen weeks ended
June 28, 2017
and
June 29, 2016
, respectively, and
$8.9 million
and
$7.7 million
for the
twenty-six
weeks ended
June 28, 2017
and
June 29, 2016
, respectively. The gross value of assets under capital leases for buildings and improvements was
$1.6 million
at
June 28, 2017
and
December 28, 2016
. Accumulated depreciation for assets under capital leases was
$1.5 million
as of
June 28, 2017
and
December 28, 2016
. For the thirteen weeks ended
June 28, 2017
, capital expenditures totaled
$7.4 million
, including
$1.4 million
for restaurant remodeling and
$4.4 million
for new restaurant expenditures. For the
twenty-six
weeks ended
June 28, 2017
, capital expenditures totaled
$19.0 million
, including
$2.8 million
for restaurant remodeling and
$13.9 million
for new restaurant expenditures. For the thirteen weeks ended
June 29, 2016
, capital expenditures totaled
$8.4 million
, including
$0.1 million
for restaurant remodeling and
$6.3 million
for new restaurant expenditures. For the
twenty-six
weeks ended
June 29, 2016
, capital expenditures totaled
$14.3 million
, including
$1.6 million
for restaurant remodeling and
$9.2 million
for new restaurant expenditures. Capital expenditures for these periods exclude unpaid purchases of property and equipment.
Based on the Company’s review of its long-lived assets for impairment, the Company recorded non-cash impairment charges of
$0.4 million
for both the
thirteen and twenty-six
weeks ended
June 28, 2017
. For the
thirteen and twenty-six
weeks ended
June 29, 2016
, the Company recorded an immaterial non-cash impairment charge related to capital expenditures for stores fully impaired in previous years.
3. STOCK-BASED COMPENSATION
At
June 28, 2017
, options to purchase
2,302,319
shares of common stock were outstanding, including
1,835,285
vested and
467,034
unvested. Unvested options vest over time. However, upon a change in control, the board may accelerate vesting. At
June 28, 2017
,
1,563,549
premium options, options granted above the stock price at date of grant, remained outstanding. For both the
thirteen and twenty-six
weeks ended
June 28, 2017
, there were stock option exercises of
17,661
. For both the
thirteen and twenty-six
weeks ended
June 29, 2016
, there were stock option exercises of
115,340
shares. For the
thirteen and twenty-six
weeks ended
June 28, 2017
,
128,252
stock options were granted at the fair market value on the date of grant. For the
thirteen and twenty-six
weeks ended
June 29, 2016
,
319,798
stock options were granted at the fair market value on the date of grant. At
June 28, 2017
, we had total unrecognized compensation expense of
$1.5 million
related to unvested stock options, which we expect to recognize over a weighted-average period of
3.1
years.
For the
thirteen and twenty-six
weeks ended
June 28, 2017
,
169,676
restricted shares were granted at the fair market value on the date of grant. The restricted shares will vest ratably over four years for employees and three years for directors, from their grant date. There were
7,806
restricted shares granted at the fair market value on the date of grant during the
thirteen and twenty-six
weeks ended
June 29, 2016
. At
June 28, 2017
, there were
194,387
unvested restricted shares outstanding. At
June 28, 2017
, we had total unrecognized compensation expense of
$2.5 million
related to unvested restricted shares, which we expect to recognize over a weighted-average period of
3.6
years.
Total stock-based compensation expense was
$0.3 million
and
$0.4 million
for the
thirteen and twenty-six
weeks ended
June 28, 2017
, respectively, and
$0.1 million
for the
thirteen and twenty-six
weeks ended
June 29, 2016
. In connection with the separation of our former audit committee chair, the Company has modified previously granted equity awards to allow for additional time to exercise previously vested awards following his separation date. As a result, the Company incurred incremental stock-based compensation expense of less than $
0.1 million
for the
thirteen and twenty-six
weeks ended
June 28, 2017
.
4. CREDIT AGREEMENTS
On December 11, 2014, the Company refinanced its debt, with EPL, Intermediate, and Holdings entering into a credit agreement with Bank of America, N.A., as administrative agent, swingline lender, and letter of credit issuer, the lenders party thereto, and the other parties thereto, which provides for a
$200.0 million
five
-year senior secured revolving facility (the “2014 Revolver”). The 2014 Revolver includes a sub limit of
$15.0 million
for letters of credit and a sub limit of
$15.0 million
for swingline loans. At
June 28, 2017
,
$8.1 million
of letters of credit, and
$94.5 million
of the revolving line of credit were outstanding. The amount available under the revolving line of credit was
$97.4 million
at
June 28, 2017
. The 2014 Revolver will mature on or about
December 11, 2019
.
Borrowings under the 2014 Revolver (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 prime rate of Bank of America, or (c) LIBOR plus
1.00%
. For LIBOR loans, the margin is in the range of
1.75%
to
2.50%
, and for base rate loans the margin is in the range of
0.75%
to
1.50%
. The interest rate range was
2.69%
to
2.96%
and
2.44%
to
2.96%
for the
thirteen and twenty-six
weeks ended
June 28, 2017
, respectively, and
2.19%
to
2.20%
and
2.02%
to
2.20%
for the
thirteen and twenty-six
weeks ended
June 29, 2016
, respectively.
The 2014 Revolver includes a number of negative and financial covenants, including, among others, the following (all subject to certain exceptions): a maximum lease-adjusted consolidated leverage ratio covenant, a minimum consolidated fixed charge coverage ratio, and limitations on indebtedness, liens, investments, asset sales, mergers, consolidations, liquidations, dissolutions, restricted payments, and negative pledges. The 2014 Revolver also includes certain customary affirmative covenants and events of default. The Company was in compliance with all such covenants at
June 28, 2017
. See Note 1 for restrictions on the payment of dividends under the 2014 Revolver.
Maturities
There are
no
required principal payments prior to maturity for the 2014 Revolver. During the
thirteen and twenty-six
weeks ended
June 28, 2017
, the Company elected to pay down
$6.5 million
and
$9.5 million
, respectively, of outstanding borrowings on our 2014 Revolver, primarily from our cash flow from operations.
5. OTHER ACCRUED EXPENSES AND CURRENT LIABILITIES
Other accrued expenses and current liabilities consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
June 28, 2017
|
|
December 28, 2016
|
Accrued sales and property taxes
|
$
|
3,802
|
|
|
$
|
4,223
|
|
Income tax receivable agreement payable
|
24,255
|
|
|
12,349
|
|
Gift card liability
|
1,659
|
|
|
1,870
|
|
Other
|
4,101
|
|
|
3,579
|
|
Total other accrued expenses and current liabilities
|
$
|
33,817
|
|
|
$
|
22,021
|
|
6. OTHER NONCURRENT LIABILITIES
Other noncurrent liabilities consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
June 28, 2017
|
|
December 28, 2016
|
Deferred rent
|
$
|
8,534
|
|
|
$
|
8,328
|
|
Income tax receivable agreement payable
|
14,526
|
|
|
26,306
|
|
Other
|
2,724
|
|
|
2,354
|
|
Total other noncurrent liabilities
|
$
|
25,784
|
|
|
$
|
36,988
|
|
7. COMMITMENTS AND CONTINGENCIES
Legal Matters
On or about February 24, 2014
, a former employee filed a class action in the Superior Court of the State of California, County of Orange, under the caption
Elliott Olvera, et al v. El Pollo Loco, Inc., et al
(Case No. 30-2014-00707367-CU-OE-CXC) on behalf of all putative class members (all hourly employees from 2010 to the present) alleging certain violations of California
labor laws, including failure to pay overtime compensation, failure to provide meal periods and rest breaks, and failure to provide itemized wage statements. The putative lead plaintiff’s requested remedies include compensatory and punitive damages, injunctive relief, disgorgement of profits, and reasonable attorneys’ fees and costs. No specific amount of damages sought was specified in the complaint. The parties executed a Stipulation of Class Settlement and Release which the court recently refused to approve on the grounds that it did not provide sufficient compensation for the putative class members. Further settlement discussions were not successful, and the litigation is moving forward with plaintiff’s class certification motion due to be filed September 1, 2017. Purported class actions alleging wage and hour violations are commonly filed against California employers. We have similar cases pending and fully expect to have to defend against similar lawsuits in the future.
Daniel Turocy, et al. v. El Pollo Loco Holdings, Inc., et al.
(Case No. 8:15-cv-01343) was filed in the United States District Court for the Central District of California on August 24, 2015, and
Ron Huston, et al. v. El Pollo Loco Holdings, Inc., et al.
(Case No. 8:15-cv-01710) was filed in the United States District Court for the Central District of California on October 22, 2015. The
two
lawsuits have been consolidated, with co-lead plaintiffs and class counsel. A consolidated complaint was filed on January 29, 2016, on behalf of co-lead plaintiffs and others similarly situated, alleging violations of federal securities laws in connection with Holdings common stock purchased or otherwise acquired and the purchase of call options or the sale of put options, between May 1, 2015 and August 13, 2015 (the “Class Period”). The named defendants are Holdings; Stephen J. Sather, Laurance Roberts, and Edward J. Valle (collectively, the “Individual Defendants”); and Trimaran Pollo Partners, L.L.C., Trimaran Capital Partners, and Freeman Spogli & Co. (collectively, the “Controlling Shareholder Defendants”). Among other things, Plaintiffs allege that, in 2014 and early 2015, Holdings suffered losses due to rising labor costs in California and, in an attempt to mitigate the effects of such rising costs, removed a
$5
value option from our menu, which resulted in a decrease in traffic from value-conscious consumers. Plaintiffs further allege that during the Class Period, Holdings and the Individual Defendants made a series of materially false and misleading statements that concealed the effect that these factors were having on store sales growth, resulting in Holdings stock continuing to be traded at artificially inflated prices. As a result, Plaintiffs and other members of the putative class allegedly suffered damages in connection with their purchase of Holdings’ stock during the Class Period. In addition, Plaintiffs allege that the Individual Defendants and Controlling Shareholder Defendants had direct involvement in, and responsibility over, the operations of Holdings, and are presumed to have had, among other things, the power to control or influence the transactions giving rise to the alleged securities law violations. In both cases, Plaintiffs seek an unspecified amount of damages, as well as costs and expenses (including attorneys’ fees).
On July 25, 2016, the Court issued an order granting, without prejudice, Defendants’ Motion to Dismiss plaintiff’s complaint for failure to state a claim. Plaintiffs were granted leave to amend their complaint, and filed an amended complaint on August 22, 2016. Defendants moved to dismiss the amended complaint, and on March 20, 2017, the Court dismissed the amended complaint and granted Plaintiffs leave to file another amended complaint. Plaintiffs filed another amended complaint on April 17, 2017. Defendants filed a motion to dismiss the amended complaint on or about May 17, 2017. The Court took the motion under submission, and the parties are waiting on the Court’s decision. Defendants intend to continue to defend against the claims asserted.
In addition, on September 16, 2015, Holdings and certain of its officers and directors received an informal, non-public inquiry from the SEC requesting voluntary production of documents and information. All parties cooperated fully with the SEC's request. On July 15, 2016, Holdings was informed that the SEC was closing its inquiry as to all parties.
On or about November 5, 2015, a purported Holdings shareholder filed a derivative complaint on behalf of Holdings in the Court of Chancery of the State of Delaware against certain Holdings officers, directors and Trimaran Pollo Partners, L.L.C., under the caption
Armen Galustyan v. Sather, et al.
(Case No. 11676-VCL). The derivative complaint alleges that these defendants breached their fiduciary duties to Holdings and were unjustly enriched when they sold shares of Holdings at artificially inflated prices due to alleged misrepresentations and omissions regarding EPL’s comparable store sales in the second quarter of 2015. The Holdings shareholder’s requested remedies include an award of compensatory damages to Holdings, as well as a court order to improve corporate governance by putting forward for stockholder vote certain resolutions for amendments to Holdings’ Bylaws or Certificate of Incorporation. The parties have stipulated to, which the court has ordered, a stay of these proceedings pending the outcome of
Turocy v. El Pollo Loco Holdings, Inc
., discussed above. A second purported Holdings shareholder filed a derivative complaint on or about September 23, 2016, under the caption
Diep v. Sather
, CA 12760-VCL in the Delaware Court of Chancery. The
Diep
action is also purportedly brought on behalf of Holdings, names the same defendants and asserts substantially the same claims on substantially the same alleged facts as does
Galustyan
. Defendants moved to stay or dismiss the
Diep
action.
On March 17, 2017, the Delaware court granted in part, and denied in part, the motion to stay the
Diep
action. The court denied defendants' motion to dismiss the complaint for failure to state a claim. No trial date for the
Diep
action has been set.
We are also involved in various other claims and legal actions that arise in the ordinary course of business. We do not believe that the ultimate resolution of these other actions will have a material adverse effect on our financial position, results of operations, liquidity, or capital resources. A significant increase in the number of claims, or an increase in amounts owing under successful claims, could materially and adversely affect our business, financial condition, results of operations, and cash flows.
Purchasing Commitments
The Company has long-term beverage supply agreements with certain major beverage vendors. Pursuant to the terms of these arrangements, marketing rebates are provided to the Company and its franchisees from the beverage vendors based upon the dollar volume of purchases for system-wide restaurants which will vary according to their demand for beverage syrup and fluctuations in the market rates for beverage syrup. These contracts have terms extending through the end of 2017 with an estimated Company obligation totaling
$4.7 million
as of
June 28, 2017
.
At
June 28, 2017
, the Company’s total estimated commitment to purchase chicken was
$20.3 million
.
Contingent Lease Obligations
As a result of assigning the Company’s interest in obligations under real estate leases in connection with the sale of company-operated restaurants to some of the Company’s franchisees, the Company is contingently liable on
five
lease agreements. These leases have various terms, the latest of which expires in
2036
. As of
June 28, 2017
, the potential amount of undiscounted payments the Company could be required to make in the event of non-payment by the primary lessee was
$3.0 million
. The present value of these potential payments discounted at the Company’s estimated pre-tax cost of debt at
June 28, 2017
was
$2.6 million
. The Company’s franchisees are primarily liable on the leases. The Company has cross-default provisions with these franchisees that would put them in default of their franchise agreements in the event of non-payment under the leases. The Company believes that these cross-default provisions reduce the risk that payments will be required to be made under these leases. Accordingly, no liability has been recorded in the Company’s condensed consolidated financial statements related to these contingent liabilities.
Employment Agreements
The Company has employment agreements with
four
of the officers of the Company on an at will basis. These agreements provide for minimum salary levels, possible annual adjustments for cost-of-living changes, and incentive bonuses that are payable under certain business conditions.
Indemnification Agreements
The Company has entered into indemnification agreements with each of its current directors and officers. These agreements require the Company to indemnify these individuals to the fullest extent permitted under Delaware law against liabilities that may arise by reason of their service to the Company and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified. The Company also intends to enter into indemnification agreements with future directors and officers.
8. NET INCOME PER SHARE
Basic net income per share is calculated using the weighted-average number of shares of common stock outstanding during the thirteen weeks ended
June 28, 2017
and
June 29, 2016
. Diluted net income per share is calculated using the weighted-average number of shares of common stock outstanding and potentially dilutive during the period, using the treasury stock method.
Below are basic and diluted net income per share data for the periods indicated, which are in thousands except for per share data.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended
|
|
Twenty-Six Weeks Ended
|
|
June 28, 2017
|
|
June 29, 2016
|
|
June 28, 2017
|
|
June 29, 2016
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
$
|
7,819
|
|
|
$
|
7,267
|
|
|
$
|
12,696
|
|
|
$
|
12,710
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average shares
outstanding—basic
|
38,449,240
|
|
|
38,294,575
|
|
|
38,443,130
|
|
|
38,289,505
|
|
Weighted-average shares
outstanding—diluted
|
39,123,961
|
|
|
38,962,802
|
|
|
39,102,501
|
|
|
38,981,610
|
|
Net income per share—basic
|
$
|
0.20
|
|
|
$
|
0.19
|
|
|
$
|
0.33
|
|
|
$
|
0.33
|
|
Net income per share—diluted
|
$
|
0.20
|
|
|
$
|
0.19
|
|
|
$
|
0.32
|
|
|
$
|
0.33
|
|
Anti-dilutive securities not considered in
diluted EPS calculation
|
763,761
|
|
|
473,836
|
|
|
763,761
|
|
|
473,836
|
|
Below is a reconciliation of basic and diluted share counts.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thirteen Weeks Ended
|
|
Twenty-Six Weeks Ended
|
|
June 28, 2017
|
|
June 29, 2016
|
|
June 28, 2017
|
|
June 29, 2016
|
Weighted-average shares outstanding—
basic
|
38,449,240
|
|
|
38,294,575
|
|
|
38,443,130
|
|
|
38,289,505
|
|
Dilutive effect of stock options and
restricted shares
|
674,721
|
|
|
668,227
|
|
|
659,371
|
|
|
692,105
|
|
Weighted-average shares outstanding—
diluted
|
39,123,961
|
|
|
38,962,802
|
|
|
39,102,501
|
|
|
38,981,610
|
|
9. RELATED PARTY TRANSACTIONS
Trimaran Pollo Partners, L.L.C. (“LLC”), owns approximately
43.3%
of the Company’s outstanding common stock. This large position means that LLC and its majority owners—predecessors and affiliates of, and certain funds managed by, Trimaran Capital Partners and Freeman Spogli & Co. (collectively, “Trimaran” and “Freeman Spogli,” respectively)—possess significant influence when stockholders vote on matters such as election of directors, mergers, consolidations and acquisitions, the sale of all or substantially all of the Company’s assets, decisions affecting the Company’s capital structure, amendments to the Company’s certificate of incorporation or by-laws, and the Company’s winding up and dissolution. So long as LLC maintains at least
40%
ownership, (i) any member of the board of directors may be removed at any time without cause by affirmative vote of a majority of the Company’s common stock, and (ii) stockholders representing
40%
or greater ownership may cause special stockholder meetings to be called.