ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our "Audited Consolidated Financial Statements" and accompanying "Notes to Consolidated Financial Statements" included elsewhere in this Annual Report. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties, and assumptions that could cause actual results to differ materially from management’s expectations. See “Forward-Looking Statements” and "Item 1A. Risk Factors” included elsewhere in this Annual Report. We assume no obligation to update any of these forward-looking statements.
Basis of Presentation
We use a 52- or 53-week fiscal year ending on the last Wednesday of each calendar year. Fiscal 2020, 2019, and 2018 ended on December 30, 2020, December 25, 2019 and December 26, 2018, respectively. 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. Approximately every six or seven years a 53-week fiscal year occurs. Fiscal 2020 was a 53-week fiscal year. Fiscal 2019 and 2018 were 52-week fiscal years. 53-week years may cause revenues, expenses, and other results of operations to be higher due to the additional week of operations. Fiscal years are identified in this report according to the calendar years in which they ended. For example, references to fiscal 2020 refer to the fiscal year ended December 30, 2020.
30
Table of Contents
Overview
El Pollo Loco is a differentiated and growing restaurant concept that specializes in fire-grilling citrus-marinated chicken and operates in the 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 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, Pollo Fit 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 better for you and more affordable 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 WHO announced a global health emergency in response to the emergence of COVID-19 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 our sales are associated with dine-in service. Many state and local governments continue to implement certain restrictions to try and contain the spread of the virus. As of December 30, 2020, the majority of our restaurants in markets outside of California have dining rooms open at a limited capacity, while the majority of our 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 to comply with the government mandates. Additionally, the Los Angeles market was heavily impacted by a spike in COVID-19 cases near the end of fiscal 2020. Due to our high concentration in this market, we were disproportionately impacted by this spike. Due to the impact of the COVID-19 pandemic, during the year ended December 30, 2020, we temporarily closed 154 restaurants, of which all but seven have reopened as of December 30, 2020. Similarly, during the year ended December 30, 2020, our franchisees temporarily closed 69 restaurants, of which all but three have reopened as of December 30, 2020. For both franchise-operated and company-operated restaurants, this represents total closures and may include more than one closure for the same restaurant. These closures typically lasted from one to three days. As of December 30, 2020, we had 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:
31
Table of Contents
During fiscal 2020, we incurred 4.9 million in COVID-19 related expenses, primarily due to leaves of absence and overtime pay.
The full impact of the COVID-19 outbreak continues to evolve as of the date of this report. We are continually evaluating the impact of the global crisis on our 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 the COVID-19 pandemic continue or worsen, 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, including the severity and transmission rates of COVID-19 variants, resurgences of COVID-19 that may continue to occur, the availability, distribution and efficacy of COVID-19 vaccines and how quickly and to what extent normal economic and operating conditions improve.
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
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.
As of December 30, 2020, we had 479 locations in six states. In fiscal 2020, we opened one new company-operated restaurant in Nevada, which was in process prior to the COVID-19 pandemic and our franchisees opened three new restaurants, two in California and one in Arizona. As a result of the COVID-19 crisis, we suspended company-operated new unit development until the timing of the economic recovery and our business improvement became more clear. In addition, we allowed franchisees to defer their 2020 new unit development obligations until 2021.
In fiscal 2019, we opened two new company-operated restaurants and our franchisees opened two new restaurants, all in California.
32
Table of Contents
In 2021, we intend to open three to five new company-operated and four to six new franchised restaurants. To increase comparable restaurant sales, we plan to increase customer frequency, attract new customers, and improve per-person spend.
Highlights and Trends
Comparable Restaurant Sales
In fiscal 2020, comparable restaurant sales system-wide decreased 2.4%. In fiscal 2019 and 2018, comparable restaurant sales system-wide increased 2.0% and 1.2%, respectively. Comparable restaurant sales growth/decline reflects the change in year-over-year sales for the comparable restaurant base. A restaurant enters our comparable restaurant base the first full week after its 15-month anniversary. System-wide comparable restaurant sales include restaurant sales at all comparable company-operated restaurants and at all comparable franchised restaurants, as reported by franchisees. Comparable restaurant sales at company-operated restaurants decreased 3.0% in fiscal 2020, increased 1.9% in fiscal 2019, and increased 0.4% in fiscal 2018. In fiscal 2020, the decrease in company-operated comparable restaurant sales was primarily the result of a decrease in transactions of 15.8%, partially offset by a 15.3% increase in average check size. The increase in average check includes a 4.1% and 3.6% benefit from gross menu price increases that were implemented during 2020 and 2019, respectively. In fiscal 2019, the increase in company-operated comparable restaurant sales was primarily the result of an increase in average check size of 2.9%, partially offset by a decrease in transactions of 1.0%. In fiscal 2018, the increase in company-operated comparable restaurant sales was driven by an increase in average check size of 1.4%, partially offset by a decrease in transactions of 1.0%. In fiscal 2020, comparable restaurant sales at franchised restaurants decreased 2.0%. In fiscal 2019 and 2018, comparable restaurant sales at franchised restaurants increased 2.0% and 1.8%, respectively.
Restaurant Development
In fiscal 2020, we opened one company-operated restaurant, and our franchisees opened three new restaurants. From time to time, we and our franchisees close restaurants. In fiscal 2020, we did not close any restaurants. Our franchisees closed seven restaurants. Our restaurant counts at the beginning and end of each of the last three years were as follows:
Fiscal Year Ended
Company-operated restaurant activity:
Openings 1 2 8
Restaurant sale to franchisee — (16) —
Closures — (4) (7)
Restaurants at end of period 196 195 213
Franchised restaurant activity:
Openings 3 2 9
Restaurant sale to franchisee — 16 —
Closures (7) (2) (3)
Restaurants at end of period 283 287 271
System-wide restaurant activity:
Openings 4 4 17
Closures (7) (6) (10)
Restaurants at end of period 479 482 484
As of December 30, 2020, together with our franchisees, we have remodeled 34 company-operated and 45 franchised restaurants using our 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 December 30, 2020, including new builds and remodels, we had 121 restaurants open with the "Vision" design in our system. Remodeling is a use of cash and has implications for our net property and depreciation line items on our consolidated balance sheets and statements of operations, among others. The cost of our restaurant remodels varies depending on the scope of work required, but on average the investment is
33
Table of Contents
$0.3 to $0.4 million per restaurant. We believe that our remodeling program will result in higher restaurant revenue and a strengthened brand. In addition, we have finalized a new restaurant 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 good new 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. As of the end of fiscal 2020, we have completed two remodels using the new asset design. If these are successful, beginning in 2021, 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 significantly reduced capital spending, including limiting our remodels in 2020. Our franchisees did not complete any remodels in 2020 as we deferred their remodel requirements until 2021. However, in 2021 we plan on resuming our standard practices for remodels including 15 company-operated and 40 franchised restaurants.
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
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 December 30, 2020, the amount of revenue deferred related to the earned points, net of redemptions, is $0.9 million. The Company had more than 2.1 million loyalty program members as of December 30, 2020.
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 15 “Revenue from Contracts with Customers”in the accompanying “Notes to Consolidated Financial Statements” in this Annual Report 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 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.
34
Table of Contents
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, and expenses incurred in support of franchisee information technology systems. Additionally, franchise expenses also include all expenses of the advertising fund representing the franchised restaurants portion of advertising expenses.
Depreciation and Amortization
Depreciation and amortization primarily consist 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, as well as ROU assets in a net asset position, 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 consider a triggering event, related to long-lived assets or ROU assets in a net asset position, to have occurred related to a specific restaurant if the restaurant’s cash flows for the last twelve months are less than a minimum threshold or if consistent levels of undiscounted cash flows for the remaining lease period are less than the carrying value of the restaurant’s assets. Additionally, we consider a triggering event related to ROU assets, to have occurred related to a specific lease if the location has been subleased and future estimated sublease income is less than current lease payments. If we conclude that the carrying value of certain long-lived and ROU assets will not be recovered based on expected undiscounted future cash flows, an impairment loss is recorded to reduce the long-lived or ROU assets to their estimated fair value. The fair value is measured on a nonrecurring basis using unobservable (Level 3) inputs. There is uncertainty in the projected undiscounted future cash flows used in our impairment review analysis, which requires the use of estimates and assumptions. If actual performance does not achieve the projections, or if the assumptions used change in the future, we may be required to recognize impairment charges in future periods, and such charges could be material.
Prior to the adoption of Topic 842 "Leases," closure costs include non-cash restaurant charges such as up-front expensing of the net present value of unpaid rent remaining on the life of a lease, offset by assumed sublease income. Upon the adoption of Topic 842, the Company no longer recognizes a closed-store reserve when the Company closes a restaurant, as a lease liability related to the future lease payments is already recognized. Rather, when a restaurant is
35
Table of Contents
closed, the Company 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, in addition to property tax and common area maintenance ("CAM") charges for closed restaurants.
Loss on Disposition of Restaurants
Loss on disposal of restaurants includes the loss on the sale of restaurants to franchisees, or other third parties, and includes the difference between carrying value and sales price of leasehold improvements, equipment and other assets included in the sale.
Interest Expense, Net
Interest expense, net, consists primarily of interest on our outstanding revolving debt. Debt issuance costs are amortized on a straight-line basis over the life of the related debt.
Provision (Benefit) for Income Taxes
Provision (benefit) for income taxes consists of federal and state tax expense (recoveries) on our income (loss), and changes to our deferred tax asset and deferred tax liability.
36
Table of Contents
Results of Operations
Fiscal Year 2020 Compared to Fiscal Year 2019
Our operating results for the fiscal years ended December 30, 2020 and December 25, 2019, in absolute terms and expressed as a percentage 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:
Fiscal Year
(53-Weeks) (52-Weeks) Increase / (Decrease)
Statements of Operations Data:
Revenue
Cost of operations
Loss on disposition of restaurants — — 5,058 1.1 (5,058) N/A
Income tax receivable agreement expense 139 0.0 57 — 82 143.9
Company-Operated Restaurant Revenue
In fiscal 2020, company-operated restaurant revenue decreased $17.0 million, or 4.4%, due to a $11.9 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 the prior year, a decrease in company-operated restaurant revenue of $11.2 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 $1.8 million decrease due to temporary restaurant closures, primarily due to the COVID-19 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 $3.0 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 a $0.3 million increase in revenue recognized for our loyalty points program. Company-operated restaurant revenue was also favorably impacted by $4.6
37
Table of Contents
million for the additional week of operations in a 53-week fiscal year. The company-operated comparable restaurant sales decrease consisted of a decline in transactions of 15.8%, partially offset by a 15.3% increase in average check size. It is uncertain whether the increase in average check size will persist once the pandemic ends.
Franchise Revenue
In fiscal 2020, franchise revenue increased $0.6 million, or 2.1%. This increase was primarily due to the opening of three new franchised restaurants and sixteen company-operated restaurants sold by the Company to franchisees during or after the first quarter of the prior year, as well as $0.7 million for the additional week of franchise revenue recognized in a 53-week fiscal year. This franchise revenue increase was partially offset by a franchise comparable sales restaurant decline of 2.0%, which we believe was primarily due to the COVID-19 pandemic, and the closure of eight franchise locations during the same period. See above under “COVID-19 Impact” for additional information related to the impact of the COVID-19 pandemic on our business.
Franchise Advertising Fee Revenue
Franchise advertising fee revenue increased $0.2 million, or 0.9% from the comparable period in the prior year. As advertising fee revenue is a percentage of franchisees’ revenue, the year-to-date fluctuation was due to the increases noted in franchise revenue above.
Food and Paper Costs
Food and paper costs decreased $10.5 million, or 9.6%, in fiscal 2020, due to a $9.2 million decrease in food costs and a $1.3 million decrease in paper costs. The decrease in food and paper costs resulted primarily from lower company transactions due to the COVID-19 pandemic, lower food waste and increased efficiencies. These decreases were partially offset by a $1.2 million increase in food and paper costs for the additional week of operations in a 53-week fiscal year and commodity inflation. Food and paper costs as a percentage of company-operated restaurant revenue were 26.4% in fiscal 2020, compared to 27.9% in fiscal 2019. This percentage decrease was due primarily to an increase in pricing, partially offset by commodity inflation.
Labor and Related Expenses
Labor and related expenses decreased $2.2 million, or 1.9%, in fiscal 2020. The decrease 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, labor costs associated with the COVID-19 pandemic, and $1.6 million for the additional week of operations in a 53-week fiscal year. Labor and related expenses as a percentage of company-operated restaurant revenue were 30.6% in fiscal 2020, compared to 29.8% in fiscal 2019. The increase was due primarily to 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
Occupancy and other operating expenses increased $0.4 million, or 0.5%, in fiscal 2020. The increase was primarily due to a $2.5 million increase in customer order delivery fees payable to third parties due to an increase in delivery orders and a $0.3 million increase in other operating expenses, primarily related to the additional week of operations in a 53-week fiscal year. These increases were partially offset by an $0.8 million decrease in advertising expenses, a $0.7 million decrease in repair and maintenance costs, a $0.5 million decrease in utilities costs, and a $0.4 million decrease in occupancy costs, primarily related to a reduction in rent expense from restaurants closed or sold to franchisees. Occupancy and other operating expenses as a percentage of company-operated restaurant revenue were 24.7% in fiscal 2020, compared to 23.5% in fiscal 2019, primarily due to the increases noted above and sales deleverage.
Gain on Recovery of Insurance Proceeds, Lost Profits
In fiscal 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.
38
Table of Contents
General and Administrative Expenses
General and administrative expenses decreased $4.4 million, or 11.1%, in fiscal 2020. The decrease was due primarily to a $3.5 million decrease in legal expenses related primarily to a decrease in securities class action litigation costs, a $1.2 million decrease in labor related costs, largely related to a decrease in management bonus expense, a decrease in severance expense and lower group insurance costs, partially offset by the impact of an additional week of operations in a 53-week fiscal year. Further, there was a $0.2 million decrease in recruiting costs and a $0.3 million decrease in other general and administrative expenses. These decreases were partially offset by a $0.8 million increase in stock compensation expenses.
General and administrative expenses as a percentage of total revenue were 8.4% in fiscal 2020, compared to 9.1% in fiscal 2019. This decrease is primarily due to the cost decreases noted above.
Legal Settlements
Legal settlements were $2.6 million in fiscal 2020, 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 during fiscal 2020.
Franchise Expenses
Franchise expenses increased $1.1 million, or 4.2%, in fiscal 2020. The increase was primarily due to an increase in expenses initially paid by the Company on behalf of the franchisee, and subsequently reimbursed by the franchisee. Specifically, these expenses were related to advertising expenses and rent expense for locations sub-leased.
Recovery of Securities Class Action Legal Expenses and Other Insurance Claims
During fiscal 2020, we received insurance proceeds of $0.1 million related to a property claim. During fiscal 2019, we received insurance proceeds of $10.0 million related to the settlement of the securities class action lawsuit. See Note 13, “Commitments and Contingencies—Legal Matters” in the accompanying "Notes to Consolidated Financial Statements" in this Annual Report.
Impairment and Closed-Store Reserves
During fiscal 2020, we recorded a $3.5 million 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 fiscal 2019, we recorded a $3.6 million non-cash impairment charge primarily related to the carrying value of the ROU assets of four restaurants sold to franchisees and one restaurant closed during fiscal 2019, and the long-lived 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.
During fiscal 2020, we recognized $1.2 million of closed-store reserve expense related to the amortization of ROU assets, property taxes and CAM payments for our closed locations.
During fiscal 2019, we closed two restaurants in California and two in Texas and recognized $1.3 million of closed-store reserve expense for fiscal 2019, primarily related to the amortization of ROU assets, property taxes and CAM payments for our closed locations.
Loss on Disposition of Restaurants
During fiscal 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
39
Table of Contents
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 fiscal year ended December 25, 2019. These restaurants are included in the total number of franchised El Pollo Loco restaurants.
Interest Expense, Net
For fiscal 2020, net interest expense, decreased by $0.4 million, 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. In each of fiscal 2020 and fiscal 2019 we recognized income tax receivable agreement expense of $0.1 million. In fiscal 2020 and 2019, we paid $5.2 million and $5.8 million, respectively, to our pre-IPO stockholders under the TRA.
Provision for Income Taxes
In fiscal 2020, we recorded an income tax expense of $5.7 million, compared to income tax expense of $9.7 million in fiscal 2019, reflecting an estimated effective tax rate of 18.8% and 28.0%, respectively. The difference between the 21.0% statutory rate and the Company’s effective tax rate of 18.8% for the year-to-date ended December 30, 2020 is primarily a result of windfall tax benefit related to stock options exercised and state taxes, a Work Opportunity Tax Credit benefit and the change in valuation allowance against certain state credits as a result of future forecasted income apportioned to the state jurisdiction.
The difference between the 21.0% statutory rate and the Company’s effective tax rate of 28.0% for the year ended December 25, 2019 is primarily a result of state taxes and the change in valuation allowance against our deferred tax assets recorded in each of fiscal 2018 and fiscal 2017.
Fiscal Year 2019 Compared to Fiscal Year 2018
Our operating results for the fiscal years ended December 25, 2019 and December 26, 2018, in absolute terms and expressed as a percentage 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:
Fiscal Year
(52-Weeks) (52-Weeks) Increase / (Decrease)
Statements of Operations Data:
Revenue
Cost of operations
40
Table of Contents
Loss on disposition of restaurants 5,058 1.1 — — 5,058 N/A
Company-Operated Restaurant Revenue
In fiscal 2019, company-operated restaurant revenue increased $2.3 million, or 0.6%, due to $7.6 million of additional sales from restaurants opened during or after the first quarter of the prior year. In addition, company-operated revenue was favorably impacted by an increase in company-operated comparable restaurant sales of $7.0 million, or 1.9%, and an increase in other revenue of $0.6 million. The growth in company-operated comparable restaurant sales was due primarily to an increase in average check size of 2.9%, partially offset by a decline in transactions of 1.0%, compared to the prior year. The increase in average check includes a 3.6% benefit from gross menu price increases that were implemented during 2018 and 2019. The increase in company-operated restaurant revenue was partially offset by $12.9 million of net impact of lost sales from restaurants closed in fiscal 2019 and 2018, and the 16 company-operated restaurants sold by the Company to franchisees during the 2019.
Franchise Revenue
In fiscal 2019, franchise revenue increased $3.0 million, or 11.8%. This increase was primarily due to higher fees received from franchised restaurants related to their use of our point-of-sales system, a franchise comparable restaurant sales increase of 2.0%, the opening of 11 new franchised restaurants during or after the first quarter of the prior year and 16 company-operated restaurants sold by the Company to franchisees during the year. This franchise revenue increase was partially offset by the closure of five franchise locations during the same period.
Franchise Advertising Fee Revenue
Franchise advertising fee revenue increased, which is paid as a percentage of the franchise restaurants' net sales, $1.2 million, or 5.5% from the comparable period in the prior year. This increase was primarily due to an increase in the number of franchise locations and increased franchise comparable restaurant sales.
Food and Paper Costs
Food and paper costs decreased $1.9 million, or 1.7%, in fiscal 2019, due to a $1.8 million decrease in food costs and a $0.1 million decrease in paper costs. The decrease in food and paper costs resulted primarily from lower company transactions, partially offset by higher commodity inflation. Food and paper costs as a percentage of company-operated restaurant revenue were 27.9% in fiscal 2019, compared to 28.6% in fiscal 2018. This percentage decrease was due primarily to an increase in pricing, partially offset by commodity inflation.
41
Table of Contents
Labor and Related Expenses
Payroll and benefit expenses increased $4.3 million, or 3.8%, in fiscal 2019. This increase was due primarily to additional labor needs arising from the opening of two new restaurants in fiscal 2019 and eight new restaurants in fiscal 2018, minimum wage increases in California and, specifically, Los Angeles, and higher workers' compensation expense due to increased claims activity, partially offset by a reduction in labor for restaurant closures and locations sold to franchisees in fiscal 2019 and 2018. Payroll and benefit expenses as a percentage of company-operated restaurant revenue were 29.8% in fiscal 2019, compared to 28.9% in fiscal 2018. This increase was primarily due to the wage increases noted above, partially offset by higher restaurant revenue from increases in pricing.
Occupancy and Other Operating Expenses
Occupancy and other operating expenses increased $0.6 million, or 0.7%, in fiscal 2019. This increase for the year-to-date period was due to a $1.1 million increase in customer order delivery fees due to increased delivery orders, a $0.2 million increase in repair and maintenance costs and a $0.2 million increase in utilities costs. These increases were partially offset by a $0.8 million decrease in advertising costs and a $0.1 million decrease in other operating expenses. Occupancy and other operating expenses as a percentage of company-operated restaurant revenue was 23.5% for both fiscal 2019 and fiscal 2018, primarily due to the higher costs noted above, offset by increased pricing.
General and Administrative Expenses
General and administrative expenses decreased $9.9 million, or 19.6%, in fiscal 2019. The decrease for the year-to-date period was due primarily to (i) a $10.2 million decrease in legal expenses related primarily to a decrease in securities class action litigation costs, (ii) a $0.5 million decrease in restaurant pre-opening costs, (iii) a $0.3 million decrease in travel expense and (iv) a $0.3 million decrease in recruiting costs. These decreases were partially offset by a $0.6 million increase in labor related costs, primarily related to an increase in estimated management bonus expenses, a $0.5 million increase in stock compensation expenses and a $0.3 million increase in other general and administrative expenses. General and administrative expenses as a percentage of total revenue were 9.1% in fiscal 2019, compared to 11.5% in fiscal 2018. This decrease is primarily due to the cost decreases noted above.
Legal Settlements
Legal settlements decreased $36.3 million in fiscal 2019. The decrease was due to (i) an accrual in 2018 of a settlement amount in fiscal 2019 related to an agreement in principle to settle all claims and allegations for the securities class action as discussed in Note 13 “Commitments and Contingencies—Legal Matters" in the accompanying "Notes to Consolidated Financial Statements" in this Annual Report and (ii) an accrual in 2018 of an expected settlement amount related to an agreement in principle to settle all claims and allegations related to multiple wage and hour class action suits as discussed in Note 13 “Commitments and Contingencies—Legal Matters" in the accompanying "Notes to Consolidated Financial Statements" in this Annual Report.
Franchise Expenses
Franchise expenses increased $3.2 million, or 13.0%, in fiscal 2019. The increase for the year-to-date period was primarily due to increase in expenses initially paid by the Company on behalf of the franchisee, and subsequently reimbursed by the franchisee. Specifically, related to advertising expenses, rent expense for locations sub-leased and the franchisee use of our point-of-sale system.
Impairment and Closed-Store Reserves
During fiscal 2019, we determined that the carrying value of ROU assets and long-lived assets at certain restaurants may not be recoverable. As a result, we recorded a $3.6 million impairment expense primarily related to the carrying value of the ROU assets of four restaurants sold to franchisees and one restaurant closed during fiscal 2019, and the long-lived assets of one restaurant in California.
42
Table of Contents
During fiscal 2018, we determined that the carrying value of assets at certain restaurants may not be recoverable. As a result, we recorded a $5.1 million impairment expense primarily related to four restaurants in Arizona, California and Texas, including a restaurant in Texas that opened in early 2018.
During fiscal 2018, we closed seven restaurants in Arizona, California and Texas. These closures resulted in closed-store reserve expenses of $4.5 million during fiscal 2018.
Subsequent to the adoption of Topic 842, the Company no longer recognizes a closed-store reserve when the Company closes a restaurant, as there is already a lease liability on its books related to the future lease payments. Rather, when a restaurant is closed, the Company 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.
During fiscal 2019, the Company closed two restaurants in California and two in Texas and recognized $1.3 million of closed-store reserve expense for fiscal 2019, primarily related to the amortization of ROU assets for the closed stores.
The Company continues to monitor the recoverability of the carrying value of the assets of several other restaurants.
Interest Expense, Net
For fiscal 2019, net interest expense, increased by $0.2 million, primarily due to higher outstanding balances on our 2018 Revolver, partially offset by interest income received related to the interest rate swap entered into during fiscal 2019. See Note 6 “Long-Term Debt-Interest Rate Swap" in the accompanying "Notes to Consolidated Financial Statements" in this Annual Report.
Income Tax Receivable Agreement
In fiscal 2019 we recognized income tax receivable agreement expense of $0.1 million as a result of changes to future forecasted results. In 2018, we incurred income tax receivable agreement income of $0.8 million, resulting from changes to future forecasted results and timing of the deductibility of certain temporary differences including the current year legal settlement accrual. In fiscal 2019 and 2018, we paid $5.8 million and $7.3 million, respectively, to our pre-IPO stockholders under the TRA.
Provision for Income Taxes
In fiscal 2019, we recorded an income tax expense of $9.7 million, compared to income tax benefit of $3.2 million in fiscal 2018, reflecting an estimated effective tax rate of 28.0% and 26.3%, respectively. The higher effective tax rate in 2019 resulted primarily from an increase in disallowed executive compensation under section 162(m) and a decrease in benefit from Workers Opportunity Tax Credit relative to pretax book income. In addition, there was a $1.0 million valuation allowance against our deferred tax assets recorded in each of fiscal 2018 and fiscal 2017. The valuation allowance against our deferred tax assets resulted from certain tax credits that may not be realizable prior to the time the credits expire.
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, system-wide sales, comparable restaurant sales, company-operated average unit volumes ("AUV"), restaurant contribution, restaurant contribution margin, new restaurant openings, EBITDA, and Adjusted EBITDA. In fiscal 2020, our restaurants generated company-operated restaurant revenue of $374.1 million and system-wide sales of $879.6 million, and system comparable sales decline of 2.4%, consisting of company-operated restaurant comparable sales decline of 3.0% and franchised comparable sales decline of 2.0%. The company-operated comparable sales decrease consisted of a 15.8% transaction decrease, partially offset by a 15.3% check growth. In fiscal 2020, for company-operated restaurants, our annual AUV was $1.9 million, restaurant contribution margin was 18.8%, and Adjusted EBITDA was $61.6 million.
43
Table of Contents
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 transactions 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 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.
System-Wide Sales
System-wide sales are neither required by, nor presented in accordance with, accounting principles generally accepted in the United States of America (“GAAP”). System-wide sales are the sum of company-operated restaurant revenue and sales from franchised restaurants. Our total revenue in our consolidated statements of operations is limited to company-operated restaurant revenue and franchise revenue from our franchisees. Accordingly, system-wide sales should not be considered in isolation or as a substitute for our results as reported under GAAP. Management believes that system-wide sales are an important figure for investors, because they are widely used in the restaurant industry, including by our management, to evaluate brand scale and market penetration.
The following table reconciles system-wide sales to company-operated restaurant revenue and total revenue:
Fiscal Year
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 December 30, 2020, December 25, 2019 and December 26, 2018, there were 465, 460, and 449 comparable restaurants, 190, 195, and 195 company-operated and 275, 265 and 254 franchised, 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 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 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
44
Table of Contents
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 shareholders 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 as substitutes for 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.
A reconciliation of restaurant contribution and restaurant contribution margin to company-operated restaurant revenue is provided below:
Fiscal Year
Restaurant contribution:
Add (less):
Loss on disposal of assets 189 266 278
Impairment and closed-store reserves 4,691 4,852 9,650
Loss on sale of restaurants — 5,058 —
Company-operated restaurant revenue:
Less:
Restaurant contribution margin (%) 18.8 % 18.7 % 19.0 %
45
Table of Contents
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 (loss) before interest expense, provision (benefit) for income taxes, depreciation, and amortization. Adjusted EBITDA represents net income (loss) before interest expense, provision (benefit) 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 Annual 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 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 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 as benchmarks to compare our performance to that of our competitors.
46
Table of Contents
The following table sets forth reconciliations of our net (loss) income to EBITDA and Adjusted EBITDA:
Fiscal Year
Non-GAAP adjustments:
Provision (benefit) for income taxes 5,651 9,682 (3,208)
Interest expense, net of interest income 3,292 3,687 3,502
Loss on disposal of assets (b) 189 266 278
Impairment and closed-store reserves (d) 4,691 4,852 9,650
Loss on disposition of restaurants (e) — 5,058 —
Income tax receivable agreement expense (income) (f) 139 57 (761)
Securities class action legal expense (g) 604 3,181 13,532
Legal settlements (h) 2,566 — 36,258
Executive transition costs (j) — 151 1,081
During fiscal 2020, we recognized $1.2 million of closed-store reserve expense, primarily related to the amortization of ROU assets, property taxes and CAM payments for our closed locations.
In fiscal 2019, we recorded impairment charges of $3.6 million, primarily related to the carrying value of the ROU assets of four restaurants sold to franchisees and one restaurant closed during fiscal 2019, and the long-lived assets of one restaurant in California. Additionally, during fiscal 2019, we closed two restaurants in California and two restaurants in Texas and recognized $1.3 million of closed-store reserve expense for the fiscal year ended 2019, primarily related to the amortization, property taxes and CAM payments for our closed locations.
In fiscal 2018, we recorded a non-cash impairment charge of $5.1 million, primarily related to the carrying value of four restaurants in Arizona, California and Texas, including a restaurant in Texas that opened in early 2018. Additionally, during fiscal 2018, we closed seven restaurants in Texas, California and Arizona. These closures resulted in closed-store reserve expenses of $4.5 million during fiscal 2018.
47
Table of Contents
Legal settlements of $36.3 million in fiscal 2018 included (i) an accrual of an expected settlement amount in fiscal 2018 related to an agreement in principle to settle all claims and allegations for the securities class action and (ii) an accrual of an expected settlement amount in fiscal 2018 related to an agreement in principle to settle all claims and allegations, related to multiple wage and hour class action suits. For additional information on legal settlements, see Note 13 “Commitments and Contingencies—Legal Matters" in the accompanying "Notes to Consolidated Financial Statements" in this Annual Report.
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), legal defense costs, lease obligations, interest payments on our debt, working capital and general corporate needs. 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. Our restaurants do not require significant inventories or receivables. We believe that these sources of liquidity and capital are sufficient to finance our continued operations for at least the next 12 months from the issuance of the 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 (as defined below), specifically the lease-adjusted coverage ratio and fixed-charge coverage ratio.
48
Table of Contents
The following table presents summary cash flow information for the years indicated:
Fiscal Year
Net cash provided by (used in)
Net increase (decrease) in cash $ 5,149 $ 1,101 $ (1,581)
Operating Activities
In fiscal 2020, net cash provided by operating activities increased by $4.4 million compared to fiscal 2019. This increase was due primarily to favorable working capital fluctuations, partially offset by a decline in profitability after non-cash items for the year ended December 30, 2020 compared to the prior year, which we believe related to the COVID-19 pandemic.
In fiscal 2019, net cash provided by operating activities decreased by $9.3 million compared to fiscal 2018. This was due primarily to unfavorable working capital fluctuations.
Investing Activities
In fiscal 2020, net cash used in investing activities decreased by $4.0 million compared to fiscal 2019. This was due primarily to purchases of property and equipment of $6.7 million in fiscal 2020 compared to $15.4 million in fiscal 2019. This was partially offset by cash proceeds of $4.8 million received during the year ended December 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. Capital expenditures for these periods exclude unpaid purchases of property and equipment.
In fiscal 2019, net cash used in investing activities decreased by $17.1 million compared to fiscal 2018. This was due to a decrease of $12.4 million in capital expenditure spending, due primarily to opening two new company-operated restaurants in fiscal 2019, compared to eight new restaurants in fiscal 2018, and cash proceeds of $4.8 million 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. In fiscal 2019, we incurred capital expenditures of approximately $15.4 million, consisting of $6.6 million related to new restaurants, $2.4 million related to the remodeling of existing restaurants, and $6.4 million related to major maintenance and other corporate capital expenditures. Capital expenditures for these periods exclude unpaid purchases of property and equipment.
Financing Activities
In fiscal 2020, net cash used by financing activities increased by $4.3 million compared to fiscal 2019. This increase was due primarily to $34.2 million of net pay downs on the 2018 Revolver during fiscal 2020, compared to net borrowings of $23.0 million in fiscal 2019. This was partially offset by $48.4 million of cash outflow related to stock buybacks in fiscal 2019 and an increase of $4.4 million of proceeds received from the issuance of common stock upon exercise of stock options in fiscal 2020 compared to fiscal 2019.
In fiscal 2019, net cash used by financing activities increased by $5.1 million compared to fiscal 2018. This was due primarily to an increase in repurchases of common stock of $47.4 million and a decrease in proceeds received from stock option exercises of $0.4 million in fiscal 2019 compared to fiscal 2018, partially offset by an increase in net borrowings on our revolving debt of $42.7 million.
Debt and Other Obligations
Current Credit Agreement
On July 13, 2018, the Company refinanced its 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 (the "2014 Revolver")
49
Table of Contents
pursuant to a credit agreement (the "2018 Credit Agreement") among El Pollo Loco, Inc. ("EPL"), our indirect wholly owned operating subsidiary, as borrower, and the Company and EPL Intermediate, Inc. ("Intermediate"), Holdings’ direct subsidiary, as guarantors, 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 $150.0 million five-year senior secured revolving credit facility (the “2018 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 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 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. The 2018 Credit Agreement contains certain financial covenants. The Company was in compliance with all such covenants at December 30, 2020.
Borrowings under the 2018 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 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 the range of 0.25% to 1.25%. For borrowings under the 2018 Revolver during fiscal 2020, the interest rate range was 1.6% to 3.3%. For borrowings under the 2018 Revolver during fiscal 2019, the interest rate range was 3.2% to 6.0%. The interest rate under the 2018 Revolver was 1.6% at December 30, 2020 and 3.2% under the 2018 Revolver at December 25, 2019.
At December 30, 2020, $8.4 million of letters of credit and $62.8 million of the revolving line of credit were outstanding. The amount available under the revolving line of credit was $78.8 million at December 30, 2020.
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
The following table represents our contractual commitments to make future payments pursuant to our debt and other obligations disclosed above and pursuant to our restaurant operating leases outstanding as of December 30, 2020:
Payments Due by Period
(Amounts in thousands) Total 2021 2023 2025 thereafter
Purchasing commitments—chicken 32,307 32,307 — — —
50
Table of Contents
Off-Balance Sheet Arrangements
At both December 30, 2020 and December 25, 2019, we had $8.4 million of borrowing capacity on the 2018 Revolver pledged as collateral to secure outstanding letters of credit.
Critical Accounting Policies and Use of Estimates
The preparation of our 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 disclosure 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 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. Our significant accounting policies are described in Note 2 “Summary of Significant Accounting Policies" in the accompanying "Notes to Consolidated Financial Statements" in this Annual Report.
Revenue Recognition
We record revenue from company-operated restaurants as food and beverage products are delivered to customers and payment is tendered at the time of sale. We present sales net of sales-related taxes and promotional allowances. In the case of gift card sales, we record revenue when the gift card is redeemed by the customer. We record royalties from franchised restaurant sales based on a percentage of restaurant revenues in the period that the related franchised restaurants’ revenues are earned. The initial franchise services, or exclusivity of the development agreements, are not distinct from the continuing rights or services offered during the term of the franchise agreement and are, therefore, treated as a single performance obligation. As such, initial franchise and development fees received, and subsequent renewal fees, are recognized over the franchise, or renewal, term, which is typically 20 years. For additional information regarding the revenue recognition see "Note 2. Summary of Significant Accounting Policies" and "Note 15. Revenue from Contracts with Customers" in our accompanying "Notes to Consolidated Financial Statements" in this Annual Report.
Goodwill and Indefinite-Lived Intangible Assets, Net
Intangible assets consist primarily of goodwill and trademarks.
We do not amortize our goodwill and indefinite-lived intangible assets. We perform an annual impairment test for goodwill during the fourth fiscal quarter of each year, or more frequently if impairment indicators arise.
We perform an annual impairment test for indefinite-lived intangible assets during the fourth fiscal quarter of each 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.
These assumptions used in our estimates of fair value are generally consistent with past performance and are also consistent with the projections and assumptions that we use in our forward-looking operating plans. These assumptions are subject to change as a result of changing economic and competitive conditions. Changes in these estimates and assumptions could materially affect our determinations of fair value and impairment.
51
Table of Contents
Due to the recent impact of the COVID-19 pandemic to the global economy, including but not limited to the volatility of our stock price as well as that of our competitors and the challenging environment for the restaurant industry generally, we determined that there were indicators of potential impairment of our goodwill and indefinite-lived intangible assets during fiscal 2020. As such, we performed an impairment assessment for both goodwill and indefinite-lived intangible assets and concluded that the fair value of these assets substantially exceeded their carrying values. Accordingly, we did not record any impairment to goodwill or indefinite-lived intangible assets during the year ended December 30, 2020. The ultimate severity and longevity of the COVID-19 pandemic and the extent and duration of any economic downturn is unknown, and therefore, it is possible that impairments could be identified in future periods, and such amounts could be material.
Long-Lived Assets
We state the value of our property and equipment, including primarily leasehold improvements and restaurant equipment, furniture, and fixtures, at cost, minus accumulated depreciation and amortization. We calculate depreciation using the straight-line method of accounting over the estimated useful lives of the related assets. We amortize our leasehold improvements using the straight-line method of accounting over the shorter of the lease term (including reasonably assured renewal periods) or the estimated useful lives of the related assets. We expense repairs and maintenance as incurred, but capitalize major improvements and betterments. We make judgments and estimates related to the expected useful lives of those assets that are affected by factors such as changes in economic conditions and changes in operating performance. If we change our assumptions in the future, we may be required to record impairment charges for these 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. The Company considers a triggering event to have occurred related to a specific restaurant if the restaurant’s cash flows for the last twelve months are less than a minimum threshold or if consistent levels of undiscounted cash flows for the remaining lease period are less than the carrying value of the restaurant’s assets. 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. There is uncertainty in the projected undiscounted future cash flows used in our impairment review analysis. If actual performance does not achieve the projections, we may recognize impairment charges in future periods, and such charges could be material.
Insurance Reserves
We are responsible for workers’ compensation, general, and health insurance claims up to a specified amount. We maintain a reserve for estimated claims both reported and incurred but not reported, based on historical claims experience and other assumptions. In estimating our insurance accruals, we utilize independent actuarial estimates of expected losses, which are based on statistical analyses of historical data. Our actuarial assumptions are closely monitored and adjusted when warranted by changing circumstances. Should claims occur or medical costs increase in greater amounts than we have expected, accruals may not be sufficient, and we may record additional expenses.
Accounting for Lease Obligations
We lease a substantial number of our restaurant properties. At the inception of each lease, we evaluate the property and the lease to determine whether the lease is an operating lease or a finance lease. This lease accounting evaluation may require significant judgment in determining the fair value and useful life of the leased property and the appropriate lease term. The lease term used for the evaluation includes renewal option periods only in instances in which the exercise of the renewal option can be reasonably assured because failure to exercise such an option would result in an economic penalty. Such an economic penalty would typically result from our having to abandon a building or fixture with remaining economic value upon vacating a property.
We make significant assumptions and judgments related to determination of whether a contract contains a lease and the discount rate used for the lease. In determining if any of our contracts contain a lease, we make assumptions and judgments related to our ability to direct the use of any assets stated in the contract and the likelihood of renewing any short-term contracts for a period extending past twelve months. We also make significant assumptions and judgments in determining an appropriate discount rate for property leases. These include using a consistent discount rate for a
52
Table of Contents
portfolio of leases entered into at varying dates, using the full 20-year term of the lease, excluding any options, and using the total minimum lease payments. We utilize a third-party valuation firm to assist in determining the discount rate, based on the above assumptions. For all other leases, we use the discount rate implicit in the lease, or the Company’s incremental borrowing rate.
Franchise Operations
We sublease a number of restaurant properties to our franchisees. As such, we remain principally liable for the underlying leases. If sales trends or economic conditions worsen for our franchisees, their financial health may worsen, our collection rates may decline, and we may be required to assume the responsibility for additional lease payments on what are presently franchised restaurants.
Income Taxes
We use the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are determined based on temporary differences between the financial carrying amounts and the tax basis of assets and liabilities using enacted tax rates in effect in the years in which the temporary differences are expected to reverse. As of December 30, 2020, we had no federal and less than $0.1 million state net operating loss (“NOL”) carryforwards. These State NOLs expire beginning 2028.
A valuation allowance is required when there is significant uncertainty as to whether certain deferred tax assets can be realized. The ability to realize deferred tax assets is dependent upon our ability to generate sufficient taxable income within the carryforward periods provided for in the tax law for each tax jurisdiction. We have considered the following possible sources of taxable income when assessing the realization of our deferred tax assets:
● future reversals of existing taxable temporary differences;
● tax-planning strategies; and
● taxable income in prior carryback years.
We will continue to reevaluate the continued need for a valuation allowance. Relevant factors include:
● current financial performance;
● the overall market environment; and
● the volatility and trends in the industry in which we operate.
All of the factors that we consider in evaluating treatment of a deferred tax asset valuation allowance involve significant judgment. For example, there are many different interpretations of “cumulative losses in recent years” that can be used. Also, significant judgment is involved in making projections of future financial and taxable income, especially because our financial results are significantly dependent upon industry trends. Any change in our valuation allowance will significantly impact our financial results in the period of that change.
When there are uncertainties related to potential income tax benefits, in order to qualify for recognition, the position we take 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 responsible authorities. The term “more likely than not” means a likelihood of more than 50%. Otherwise, we may not recognize any of the potential tax benefits associated with that position. We recognize a benefit for a tax position that meets the “more likely than not” criterion as the largest amount of tax benefit that is greater than 50% likely to be realized upon its effective resolution. Unrecognized tax benefits involve our judgment regarding the likelihood of a benefit being sustained. The final resolutions of uncertain tax positions could result in adjustments to
53
Table of Contents
recorded amounts and affect our results of operations, financial position, and cash flows. However, we anticipate that any such adjustments would not materially impact our financial statements.
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. We are permitted to make TRA payments under the 2018 Revolver. In fiscal 2020, we recognized an expense of $0.1 million as a result of changes to future forecasted results and deduction of 2018 legal settlement accrual in current year. In fiscal 2019, we recognized an expense of less than $0.1 million as a result of changes to future forecasted results. In fiscal 2018, we recognized a benefit of $0.8 million, as a result of changes to future forecasted results and the timing of the deductibility of certain temporary differences including the current year legal settlement accruals.
In addition, in fiscal 2014, we applied for various tax credits that resulted in $6.7 million of additional deferred tax assets and tax benefits. As of fiscal 2020, the deferred asset balance related to these various tax credits, net of valuation allowance was $2.5 million. The fiscal 2020 provision includes a $6.1 million valuation allowance against our deferred tax asset, resulting from certain tax credits that may not be realizable prior to the time the credits expire. Also, in fiscal 2020, federal work opportunity tax credits (“WOTC”) of approximately $0.3 million were generated.
On March 27, 2020, President Trump signed into a law a stimulus package, the Coronavirus Aid, Relief and Economic Security ("CARES") Act, which contains several tax provisions and deferral of employer Social Security taxes that are otherwise owed for wage payments. The tax provisions include a correction of a previous drafting error related to qualified improvement property ("QIP") and immediate refundability of all remaining alternative minimum tax ("AMT") credits. The new provisions did not have a material impact on our consolidated financial statements.
During the year ended December 30, 2020, we received a Notice of Proposed Adjustment (“NOPA”) for the years ended December 27, 2017 and December 28, 2016, related to our methodology regarding the ordering of utilization of AMT NOLs. This resulted in payment of $0.4 million, and the audit is closed. As a result of the CARES Act, discussed above, this amount is immediately refundable upon filing of a Form 1139, which we filed during the year ended December 30, 2020 and recognized a receivable, included in Accounts and other receivables within the consolidated balance sheet as of December 30, 2020.
Stock-Based Compensation
We measure and recognize compensation expense for the estimated fair value of equity instruments for employees and non-employee directors based on the grant-date fair value of the award. For awards that are based on a service requirement, the cost is recognized on a straight-line basis over the requisite service period, usually the vesting period. The Company did not grant any options during fiscal 2020. In fiscal 2020, the Company granted 415,022 restricted stock awards, with an exercise price equal to the fair market value of the common stock on the date of grant. The awards granted in fiscal 2020, 2019 and 2018 had a four-year vesting period for employees and three-year vesting period for directors. Included in the fiscal 2018 restricted stock award grants were 72,116 performance share units which have a five-year term. Performance share units are granted at fair market value on the date of grant and are subject to service-based and market-based vesting conditions. For stock options that were based on performance requirements, costs were recognized over the periods to which the performance criteria related. In order to calculate our stock options’ fair values and the associated compensation costs for share-based awards, we utilize the Black–Scholes option pricing model.
Derivative Financial Instruments
We use an interest rate swap, a derivative instrument, to hedge interest rate risk and is not used for trading purposes. The derivative contract is entered into with financial institutions.
We record the derivative instrument at fair value within other assets on its consolidated balance sheet. The derivative instrument qualifies as a hedging instrument in a qualifying cash flow hedge relationship, the gain or loss on the derivative instrument is reported as a component of accumulated other comprehensive income (“AOCI”) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. For any derivative instruments not designated as hedging instruments, the gain or loss will be recognized in earnings immediately. If a derivative previously designated as a hedge is terminated, or no longer meets the qualifications for hedge accounting, any balances in AOCI will be reclassified into earnings immediately.
54
Table of Contents
As a result of the use of an interest rate swap, we are exposed to risk that the counterparty will fail to meet their contractual obligations. To mitigate the counterparty credit risk, we will only enter into contracts with major financial institutions, based upon their credit ratings and other factors, and will continue to assess the creditworthiness of the counterparty. As of December 30, 2020, the counterparty to our interest rate swap has performed in accordance with their contractual obligation
Recent Accounting Pronouncements
Recent accounting pronouncements are described in Note 2 “Summary of Significant Accounting Policies" in our accompanying "Notes to Consolidated Financial Statements" in this Annual Report.
55
Table of Contents
ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
We are exposed to market risk from changes in interest rates on our debt, which bears interest at USD LIBOR plus a margin between 1.25% and 2.25%. As of December 30, 2020, we had outstanding borrowings of $62.8 million related to our 2018 Revolver and another $8.4 million of letters of credit in support of our insurance programs, and the applicable margin on outstanding borrowings under 2018 Revolver was 1.5%. In addition, LIBOR is expected to be phased out beginning after 2021. Organizations are currently working on industry wide and company specific transition plans as it relates to financial and other derivative contracts exposed to LIBOR. When LIBOR ceases to exist, we may need to enter into an amendment to the 2018 Credit Agreement and we cannot predict what alternative index would be negotiated with our lenders. If future rates based upon a successor rate are higher than LIBOR rates as currently determined or if our lenders have increased costs due to changes in LIBOR, we may experience potential increases in interest rates on our variable rate debt, which could adversely impact our interest expense, results of operations and cash flows. After giving effect to the $40.0 million of interest rate swaps, we effectively had $22.8 million of long-term debt subject to variations in interest rates and a one percent increase in the variable rate of interest would increase annual interest expense by $0.2 million.
We manage our interest rate risk through normal operating and financing activities and, when determined appropriate, through the use of derivative financial instruments. To balance our portfolio, we entered into an interest rate swap during the year ended December 25, 2019 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 applicable margin, which is currently 1.5%. The interest rate swap matures in June 2023.
Inflation
Inflation has an impact on food, paper, construction, utility, labor and benefits, general and administrative, and other costs, all of which can materially impact our operations. We have a substantial number of hourly employees who are paid wage rates at or based on the applicable federal, state, or local minimum wage, and increases in the minimum wage will increase our labor costs. In general, we have been able to substantially offset cost increases resulting from inflation by increasing menu prices, managing menu mix, improving productivity, or making other adjustments. We may not be able to offset cost increases in the future.
Commodity Price Risk
We are exposed to market price fluctuation in food product prices. Given the historical volatility of certain of our food product prices, including chicken, other proteins, grains, produce, dairy products, and cooking oil, these fluctuations can materially impact our food and beverage costs. While our purchasing commitments partially mitigate the risk of such fluctuations, there is no assurance that supply and demand factors such as disease or inclement weather will not cause the prices of the commodities used in our restaurant operations to fluctuate. In periods where the prices of commodities drop, we may pay higher prices under our purchasing commitments. In rapidly-fluctuating commodities markets, it may prove difficult for us to adjust our menu prices in accordance with input price fluctuations. Therefore, to the extent that we do not pass along cost increases to our customers, our results of operations may be adversely affected. At this time, we do not use financial instruments to hedge our commodity risk.
ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
EL POLLO LOCO HOLDINGS, INC. AND SUBSIDIARIES
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
Audited Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm 58
Consolidated Balance Sheets – December 30, 2020 and December 25, 2019 61
56
Table of Contents
Notes to Consolidated Financial Statements 67
57
Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and Board of Directors
El Pollo Loco Holdings, Inc.
Costa Mesa, California
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of El Pollo Loco Holdings, Inc. (the “Company”) as of December 30, 2020 and December 25, 2019, the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 30, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 30, 2020 and December 25, 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 30, 2020, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company's internal control over financial reporting as of December 30, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated March 15, 2021 expressed an unqualified opinion thereon.
Change in Accounting Method Related to Leases
As discussed in Notes 2 and 5 to the consolidated financial statements, the Company has changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Codification (“ASC”) 842 - Leases.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
58
Table of Contents
Impairment of Restaurant Property and Equipment
As discussed in Notes 2 and 3 to the consolidated financial statements, the Company reviews its long-lived assets related to restaurants held and used in the business, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. For certain restaurants, indicators of impairment of the related property and equipment were present. As such, for these restaurants, management compared the projected undiscounted cash flow to the carrying value, concluding that their carrying values were not recoverable. To determine the loss for impairment, the Company was required to estimate the fair value of certain restaurants. Total property and equipment, net of accumulated depreciation was $79.6 million as of December 30, 2020. For the year ended December 30, 2020, the Company recorded an impairment loss of $3.0 million on restaurant property and equipment.
We identified the Company’s evaluation of impairment of restaurant property and equipment as a critical audit matter. The undiscounted future cash flows used in the Company's restaurant property and equipment impairment analysis requires management to develop estimates and assumptions about future revenue transaction growth rates, pricing changes, and restaurant operating margins, which are made more uncertain by the significant and evolving impact of COVID-19 on the Company’s business. For those restaurants where the carrying value of the related property and equipment were not deemed recoverable, management estimated the fair value of the assets. Auditing these significant judgments and assumptions involved especially challenging auditor judgment and increased effort in performing procedures.
The primary procedures we performed to address this critical audit matter included:
Impairment of Right of Use Assets for Closed Restaurant Locations
As discussed in Notes 2 and 5 to the consolidated financial statements, the Company reviews its long-lived assets related to restaurants held and used in the business, including right of use (“ROU”) assets, for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable, for example, if the leased location has been closed or subleased and future estimated sublease income is less than current lease payments. For some leases, indicators of impairment of operating lease ROU assets were present. As such, for these leases, management compared the projected undiscounted cash flow models to the respective carrying values, concluding that the carrying values were not recoverable. This required the Company to estimate the fair value of the ROU assets for these leases in order to measure the amount of impairment expense. Total operating lease ROU assets, net related to closed or subleased restaurant locations was $27.7 million as of December 30, 2020. For the year ended December 30, 2020, the Company has recorded an impairment loss of $0.5 million on operating lease ROU assets.
We identified the Company’s evaluation of impairment of ROU assets for closed restaurant locations as a critical audit matter. The projected undiscounted cash flow models used in the Company's operating lease ROU asset impairment analysis for closed restaurant locations requires management to make subjective estimates and assumptions about the current market lease-up period and sublease rental rates. Auditing these significant judgments and assumptions involved especially challenging auditor judgment and increased effort in performing procedures, including the involvement of individuals with specialized skills and knowledge.
The primary procedures we performed to address this critical audit matter included:
59
Table of Contents
/s/ BDO USA, LLP
We have served as the Company’s auditor since 2011.
Costa Mesa, California
March 15, 2021
60
Table of Contents
EL POLLO LOCO HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
December 30, December 25,
Assets
Current assets:
Cash and cash equivalents $ 13,219 $ 8,070
Accounts and other receivables, net 9,963 8,505
Prepaid expenses and other current assets 3,865 5,718
Property and equipment held under finance lease, net 1,661 —
Liabilities and Stockholders’ Equity
Current liabilities:
Current portion of obligations under finance leases $ 70 $ 34
Current portion of obligations under operating leases 19,907 16,406
Accrued salaries and vacation 10,166 8,618
Accrued interest 89 302
Current portion of income tax receivable agreement payable 1,577 4,935
Other accrued expenses and current liabilities 16,715 28,597
Obligations under finance leases, net of current portion 1,692 83
Obligations under operating leases, net of current portion 178,658 197,492
Income tax receivable agreement payable, net of current portion 1,562 3,301
Commitments and contingencies (Note 13)
Stockholders’ Equity
Accumulated other comprehensive (loss) income (833) 253
Total liabilities and stockholders’ equity $ 605,221 $ 624,752
See notes to consolidated financial statements.
61
Table of Contents
EL POLLO LOCO HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except share data)
For the Fiscal Years Ended
Revenue
Cost of operations
Gain on recovery of insurance proceeds, lost profits (2,000) — —
Loss on disposition of restaurants — 5,058 —
Income tax receivable agreement expense (income) 139 57 (761)
Provision (benefit) for income taxes 5,651 9,682 (3,208)
Net income (loss) per share
Weighted-average shares used in computing net income (loss) per share
See notes to consolidated financial statements.
62
Table of Contents
EL POLLO LOCO HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Amounts in thousands)
For the Fiscal Years Ended
December 30, December 25, December 26,
Other comprehensive (loss) income
Changes in derivative instruments
Reclassifications of losses (gains) into net income 278 (84) —
Income tax benefit (expense) 398 (93) —
Other comprehensive (loss) income, net of taxes (1,086) 253 —
See notes to consolidated financial statements.
63
Table of Contents
EL POLLO LOCO HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Amounts in thousands, except share data)
Accumulated
Additional Other Total
Common Stock Paid-in Accumulated Comprehensive Stockholders’
Shares Amount Capital Deficit Income (Loss) Equity
Stock-based compensation — — 2,005 — — 2,005
Repurchase of common stock (66,409) (1) (980) — — (981)
Net loss — — — (8,994) — (8,994)
Stock-based compensation — — 2,474 — — 2,474
Stock-based compensation — — 3,093 — — 3,093
Other comprehensive loss, net of income tax — — — — (1,086) (1,086)
See notes to consolidated financial statements.
64
Table of Contents
EL POLLO LOCO HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
For the Fiscal Years Ended
December 30, December 25, December 26,
Cash flows from operating activities:
Bad debt expense 190 — —
Income tax receivable agreement expense (income) 139 57 (761)
Loss on disposition of restaurants — 5,058 —
Closed-store reserve expense — — 4,503
Amortization of deferred financing costs 252 251 280
Amortization of favorable and unfavorable leases, net — — (47)
Changes in operating assets and liabilities:
Prepaid expenses and other current assets 1,853 (2,727) (319)
Income taxes receivable/payable (2,145) (448) 37
Payment related to tax receivable agreement (5,237) (5,764) (7,272)
Cash flows from investing activities:
Proceeds from disposition of restaurants — 4,770 —
Net cash flows used in investing activities (6,690) (10,669) (27,802)
Cash flows from financing activities:
Payments on revolver and swingline loan (93,700) (19,000) (33,000)
Payment of obligations under finance leases (39) (68) (132)
Deferred financing costs for revolver loan — — (138)
Repurchases of common stock — (48,382) (981)
Net cash flows used in financing activities (28,708) (24,365) (19,221)
Increase (decrease) in cash and cash equivalents 5,149 1,101 (1,581)
Cash and cash equivalents, beginning of period 8,070 6,969 8,550
Cash and cash equivalents, end of period $ 13,219 $ 8,070 $ 6,969
65
Table of Contents
For the Fiscal Years Ended
December 30, December 25, December 26,
Supplemental cash flow information
Cash paid during the period for interest $ 2,956 $ 3,649 $ 3,393
Cash paid during the period for income taxes $ 4,225 $ 558 $ 183
Unpaid purchases of property and equipment $ 1,925 $ 746 $ 1,543
Schedule of non-cash transactions
Borrowing on revolver for financing fees $ — $ — $ 693
See notes to consolidated financial statements.
66
Table of Contents
EL POLLO LOCO HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
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 ®. The restaurants, which are located principally in California but also in Arizona, Nevada, Texas, Utah and Louisiana, specialize in fire-grilling citrus-marinated chicken in a wide variety of contemporary Mexican and LA-inspired entrees, including specialty chicken burritos, chicken quesadillas, chicken tostada salads, chicken tortilla soup, variations on our Pollo Bowl®, Pollo Salads and our Pollo Fit entrees. At December 30, 2020, the Company operated 196 (143 in the greater Los Angeles area) and franchised 283 (136 in the greater Los Angeles area) El Pollo Loco restaurants. In addition, the Company currently licenses one restaurant in the Philippines. The Company’s largest stockholder is Trimaran Pollo Partners, L.L.C. (“LLC”), which is controlled by affiliates of Trimaran Capital, L.L.C. LLC acquired Chicken Acquisition Corp. (“CAC”), a predecessor of Holdings, on November 17, 2005 (the “Acquisition”) and has a 46.0% ownership interest as of December 30, 2020. LLC’s only material asset is its investment in Holdings.
On April 22, 2014, CAC, its wholly owned subsidiary, Chicken Subsidiary Corp (“CSC”) and CSC’s wholly owned subsidiary, the former El Pollo Loco Holdings, Inc. (“Old Holdings”) entered into the following reorganization transactions: (i) Old Holdings merged with and into CSC with CSC continuing as the surviving corporation; (ii) CSC merged with and into CAC with CAC continuing as the surviving corporation and (iii) CAC renamed itself El Pollo Loco Holdings, Inc.
Holdings has no material assets or operations. Holdings and Holdings’ direct subsidiary, EPL Intermediate, Inc. (“Intermediate”), guarantee EPL’s 2018 Revolver (see Note 6, “Long-Term Debt”) 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.