Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
 
(Mark one)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 25, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-36556
  
 
EL POLLO LOCO HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
 
 
Delaware
 
20-3563182
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
3535 Harbor Blvd., Suite 100, Costa Mesa, California
 
92626
(Address of principal executive offices)
 
(Zip Code)
 
(714) 599-5000
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.01 per share
LOCO
The Nasdaq Stock Market LLC
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ☒  Yes    ☐  No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    ☒  Yes    ☐  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.




Large accelerated filer
Accelerated filer
 
 
 
 
Non-accelerated filer
☐ 
Smaller reporting company

 
 
 
 
 
 
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ☐  Yes    ☒  No
As of October 25, 2019, there were 34,882,844 shares of the issuer’s common stock outstanding.
 




Table of Contents
Page


3



PART I—FINANCIAL INFORMATION
Item 1. Financial Statements.

4



EL POLLO LOCO HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Amounts in thousands, except share data)
 
September 25, 2019
 
December 26, 2018
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
12,069

 
$
6,969

Accounts and other receivables, net
10,857

 
9,599

Inventories
2,085

 
2,479

Prepaid expenses and other current assets
2,123

 
2,998

Total current assets
27,134

 
22,045

Property and equipment owned, net
93,364

 
104,145

Property held under finance leases, net
5

 
16

Property held under operating leases, net ("ROU Asset")
198,659

 

Goodwill
248,674

 
248,674

Trademarks
61,888

 
61,888

Other intangible assets, net

 
280

Deferred tax assets
4,305

 
11,709

Other assets
1,399

 
1,469

Total assets
$
635,428

 
$
450,226

Liabilities and Stockholders' Equity
 

 
 

Current liabilities:
 

 
 

Current portion of obligations under finance leases
$
32

 
$
68

Current portion of obligations under operating leases
17,904

 

Accounts payable
9,811

 
9,564

Accrued salaries and vacation
9,833

 
7,574

Accrued insurance
8,939

 
7,076

Accrued income taxes payable
174

 
71

Accrued interest
364

 
149

Current portion of income tax receivable agreement payable
5,708

 
6,637

Other accrued expenses and current liabilities
27,594

 
51,764

Total current liabilities
80,359

 
82,903

Revolver loan
101,000

 
74,000

Obligations under finance leases, net of current portion
92

 
116

Obligations under operating leases, net of current portion
198,849

 

Deferred taxes
1,216

 

Other intangible liabilities, net

 
642

Income tax receivable agreement payable, net of current portion
8,114

 
7,305

Other noncurrent liabilities
5,784

 
20,024

Total liabilities
395,414

 
184,990

Commitments and contingencies

 

Stockholders' Equity
 

 
 

Preferred stock, $0.01 par value, 100,000,000 shares authorized; none issued or
   outstanding

 

Common stock, $0.01 par value—200,000,000 shares authorized; 34,893,716
   and 39,004,451 shares issued and outstanding
349

 
390

Additional paid-in-capital
329,047

 
375,734

Accumulated deficit
(89,486
)
 
(110,888
)
Accumulated other comprehensive income
104

 

Total stockholders' equity
240,014

 
265,236

Total liabilities and stockholders' equity
$
635,428

 
$
450,226

 
See notes to condensed consolidated financial statements (unaudited).

5



EL POLLO LOCO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(Amounts in thousands, except share data)
 
Thirteen Weeks Ended
 
Thirty-Nine Weeks Ended
 
September 25, 2019
 
September 26, 2018
 
September 25, 2019
 
September 26, 2018
Revenue
 
 
 
 
 
 
 
Company-operated restaurant revenue
$
99,052

 
$
100,024

 
$
296,341

 
$
294,204

Franchise revenue
7,273

 
6,665

 
21,635

 
19,324

Franchise advertising fee revenue
5,742

 
5,489

 
16,808

 
16,039

Total revenue
112,067

 
112,178

 
334,784

 
329,567

Cost of operations
 

 
 

 
 

 
 

Food and paper cost
27,512

 
28,349

 
82,550

 
84,265

Labor and related expenses
29,292

 
29,164

 
88,140

 
84,682

Occupancy and other operating expenses
23,844

 
24,187

 
70,103

 
69,019

Company restaurant expenses
80,648

 
81,700

 
240,793

 
237,966

General and administrative expenses
9,539

 
12,186

 
30,235

 
37,862

Franchise expenses
7,006

 
6,342

 
20,692

 
18,424

Depreciation and amortization
4,343

 
4,507

 
13,558

 
13,063

Loss on disposal of assets
35

 
140

 
213

 
193

Recovery of securities lawsuits related legal expenses

 
(2,036
)
 
(10,000
)
 
(6,099
)
Asset impairment and closed-store reserves
367

 
(153
)
 
1,241

 
6,629

Loss on disposition of restaurants
11

 

 
5,062

 

Total expenses
101,949


102,686


301,794

 
308,038

Income from operations
10,118

 
9,492

 
32,990

 
21,529

Interest expense, net
973

 
840

 
2,754

 
2,688

Income tax receivable agreement income
(197
)
 
(571
)
 
(120
)
 
(777
)
Income before provision for income taxes
9,342

 
9,223

 
30,356

 
19,618

Provision for income taxes
2,940

 
2,388

 
8,954

 
5,202

Net income
$
6,402

 
$
6,835

 
$
21,402

 
$
14,416

Net income per share
 

 
 

 
 

 
 

Basic
$
0.18

 
$
0.18

 
$
0.57

 
$
0.37

Diluted
$
0.18

 
$
0.17

 
$
0.56

 
$
0.37

Weighted-average shares used in computing net income per share
 

 
 

 
 

 
 

Basic
35,859,502

 
38,602,658

 
37,484,372

 
38,516,792

Diluted
36,397,368

 
39,205,090

 
38,173,097

 
39,102,130

 
See notes to condensed consolidated financial statements (unaudited).

6



EL POLLO LOCO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(Amounts in thousands, except share data)

 
Thirteen Weeks Ended
 
Thirty-Nine Weeks Ended
 
September 25, 2019
 
September 26, 2018
 
September 25, 2019
 
September 26, 2018
Net income
$
6,402

 
$
6,835

 
$
21,402

 
$
14,416

Other comprehensive income
 
 
 
 
 
 
 
Changes in derivative instruments
 
 
 
 
 
 
 
Unrealized gains arising during the period from interest rate swap
171

 

 
171

 

Reclassifications of gains into net income
(29
)
 

 
(29
)
 

Income tax
(38
)
 

 
(38
)
 

Other comprehensive income, net of taxes
104

 

 
104

 

Comprehensive income
$
6,506

 
$
6,835

 
$
21,506

 
$
14,416




7



EL POLLO LOCO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
(Amounts in thousands, except share data)
Thirteen Weeks Ended September 25, 2019
 
Common Stock
 
Additional
Paid-in Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income
 
Total
Stockholders’ Equity
 
Shares
 
Amount
 
 
 
 
Balance, June 26, 2019
37,732,948

 
$
377

 
$
358,335

 
$
(95,888
)
 
$

 
$
262,824

Stock-based compensation

 

 
668

 

 

 
668

Shares repurchased for employee tax withholdings
(4,176
)
 

 
(46
)
 

 

 
(46
)
Forfeiture of common stock related to restricted shares
(9,160
)
 

 

 

 

 

Repurchase of common stock
(2,825,896
)
 
(28
)
 
(29,910
)
 

 

 
(29,938
)
Other comprehensive income, net of tax

 

 

 

 
104

 
104

Net income

 

 

 
6,402

 

 
6,402

Balance, September 25, 2019
34,893,716

 
$
349

 
$
329,047

 
$
(89,486
)
 
$
104

 
$
240,014

Thirteen Weeks Ended September 26, 2018
 
Common Stock
 
Additional
Paid-in Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income
 
Total
Stockholders’ Equity
 
Shares
 
Amount
 
 
 
 
Balance, June 27, 2018
38,608,810

 
$
387

 
$
374,081

 
$
(94,340
)
 
$

 
$
280,128

Stock-based compensation

 

 
377

 

 

 
377

Issuance of common stock related to restricted shares
211,060

 
2

 
1,707

 

 

 
1,709

Issuance of common stock upon exercise of stock options
249,091

 
2

 
(2
)
 

 

 

Shares repurchased for employee tax withholdings
736

 

 

 

 

 

Forfeiture of common stock related to restricted shares
(2,961
)
 

 

 

 

 

Net income

 

 

 
6,835

 

 
6,835

Balance, September 26, 2018
39,066,736

 
$
391

 
$
376,163

 
$
(87,505
)
 
$

 
$
289,049


8



Thirty-Nine Weeks Ended September 25, 2019
 
Common Stock
 
Additional
Paid-in Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income
 
Total
Stockholders’ Equity
 
Shares
 
Amount
 
 
 
 
Balance, December 26, 2018
39,009,451

 
$
390

 
$
375,734

 
$
(110,888
)
 
$

 
$
265,236

Stock-based compensation

 

 
1,797

 

 

 
1,797

Issuance of common stock related to restricted shares, net
292,211

 
3

 
(3
)
 

 

 

Issuance of common stock upon exercise of stock options
6,709

 

 
34

 

 

 
34

Shares repurchased for employee tax withholdings
(29,923
)
 
(1
)
 
(294
)
 

 

 
(295
)
Repurchase of common stock
(4,384,732
)
 
(43
)
 
(48,221
)
 

 

 
(48,264
)
Other comprehensive income, net of tax

 

 

 

 
104

 
104

Net income

 

 

 
21,402

 

 
21,402

Balance, September 25, 2019
34,893,716

 
$
349

 
$
329,047

 
$
(89,486
)
 
$
104

 
$
240,014

Thirty-Nine Weeks Ended September 26, 2018
 
Common Stock
 
Additional
Paid-in Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income
 
Total
Stockholders’ Equity
 
Shares
 
Amount
 
 
 
 
Balance, December 27, 2017
38,661,850

 
$
387

 
$
372,990

 
$
(98,427
)
 
$

 
$
274,950

Cumulative effect of accounting change (See Note 10)

 

 

 
(3,494
)
 

 
(3,494
)
Stock-based compensation

 

 
1,547

 

 

 
1,547

Issuance of common stock related to restricted shares
211,060

 
2

 
1,707

 

 

 
1,709

Issuance of common stock upon exercise of stock options
249,091

 
2

 
(2
)
 

 

 

Shares repurchased for employee tax withholdings
(7,730
)
 

 
(79
)
 

 

 
(79
)
Forfeiture of common stock related to restricted shares
(47,535
)
 

 

 

 

 

Net income

 

 

 
14,416

 

 
14,416

Balance, September 26, 2018
39,066,736

 
$
391

 
$
376,163

 
$
(87,505
)
 
$

 
$
289,049




9



EL POLLO LOCO HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Amounts in thousands)
 
Thirty-Nine Weeks Ended
 
September 25, 2019
 
September 26, 2018
Cash flows from operating activities:
 

 
 

Net income
$
21,402

 
$
14,416

Adjustments to reconcile net income to net cash flows provided by operating
   activities:
 

 
 

Depreciation and amortization
13,558

 
13,063

Stock-based compensation expense
1,797

 
1,547

Income tax receivable agreement income
(120
)
 
(777
)
Loss on disposition of restaurants
5,062

 

Loss on disposal of assets
213

 
193

Impairment of property and equipment
283

 
1,791

Closed-store reserve expense

 
4,838

Amortization of deferred financing costs
189

 
217

Amortization of favorable and unfavorable leases, net
(362
)
 
(37
)
Deferred income taxes, net
8,583

 
3,825

Changes in operating assets and liabilities:
 

 
 

Accounts and other receivables, net
(1,257
)
 
(1,675
)
Inventories
261

 
46

Prepaid expenses and other current assets
868

 
229

Other assets
(118
)
 
113

Accounts payable
(1,657
)
 
(2,206
)
Accrued salaries and vacation
2,259

 
2,560

Accrued insurance
1,863

 
895

Income taxes payable
102

 
(33
)
Other accrued expenses and liabilities
(21,031
)
 
2,596

Net cash flows provided by operating activities
31,895

 
41,601

Cash flows from investing activities:
 

 
 

Proceeds from disposition of restaurants
4,770

 

Purchase of property and equipment
(10,848
)
 
(20,711
)
Net cash flows used in investing activities
(6,078
)
 
(20,711
)
Cash flows from financing activities:
 

 
 

Minimum tax withholdings related to net share settlements
(341
)
 
(79
)
Payments on revolver and swingline loan
(15,000
)
 
(29,000
)
Borrowings on revolver and swingline loan
42,000

 
6,307

Deferred financing costs on revolver loan


 
(138
)
Proceeds from issuance of common stock upon exercise of stock options, net of expenses
80

 
1,710

Payment of obligations under finance leases
(61
)
 
(98
)
Stock buybacks
(47,395
)
 

Net cash flows used in financing activities
(20,717
)
 
(21,298
)
Increase (decrease) in cash and cash equivalents
5,100

 
(408
)
Cash and cash equivalents, beginning of period
6,969

 
8,550

Cash and cash equivalents, end of period
$
12,069

 
$
8,142


10



 
Thirty-Nine Weeks Ended
Supplemental cash flow information
September 25, 2019
 
September 26, 2018
Cash paid during the period for interest
$
2,400

 
$
2,623

Cash paid during the period for income taxes
$
268

 
$
125

Unpaid purchases of property and equipment
$
2,577

 
$
1,449

Unpaid stock buybacks
$
1,004

 
$

 
 
 
 
Schedule of Non-cash Transactions
 
 
 
Borrowing on Revolver for Financing Fees
$

 
$
693

 
See notes to the condensed consolidated financial statements (unaudited).

11



EL POLLO LOCO HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Overview
El Pollo Loco Holdings, Inc. (“Holdings”) is a Delaware corporation headquartered in Costa Mesa, California. Holdings and its direct and indirect subsidiaries are collectively referred to herein “we,” “us” or the “Company.” The Company’s activities are conducted principally through its indirect wholly-owned subsidiary, El Pollo Loco, Inc. (“EPL”), which develops, franchises, licenses, and operates quick-service restaurants under the name El Pollo Loco® and operates under one operating segment. At September 25, 2019, the Company operated 201 and franchised 284 El Pollo Loco restaurants.
On August 2, 2018, the Company announced that the Board of Directors had authorized a stock repurchase program. The Company entered into a stock repurchase plan on August 28, 2018 (the “2018 Stock Repurchase Plan”), which allowed for the repurchase of up to $20.0 million of the Company’s common stock. The 2018 Stock Repurchase Plan commenced on November 6, 2018 and terminated on June 26, 2019.
On April 30, 2019, as part of the Company’s focus on stockholder returns, the Board of Directors approved a new stock repurchase program. The Company entered into a stock repurchase plan May 17, 2019 (the “2019 Stock Repurchase Plan”), which allowed for the repurchase up to $30.0 million of the Company's common stock. The 2019 Stock Repurchase Plan commenced on June 27, 2019, and will terminate on March 25, 2020, if not exhausted or terminated sooner pursuant to the provisions of the 2019 Stock Repurchase Plan.
Under the 2019 Stock Repurchase Plan, the Company may repurchase its common stock from time to time, in amounts and at prices that the Company deems appropriate, subject to market conditions and other considerations. The Company’s repurchases may be executed using open market purchases, including pursuant to Rule 10b5-1 trading plans, and/or through privately negotiated transactions.
For the thirteen weeks ended September 25, 2019, the Company repurchased 2,825,896 shares of common stock under the 2019 Stock Repurchase Plan, using open market purchases, for total consideration of approximately $29.9 million. For the thirty-nine weeks ended September 25, 2019, the Company repurchased 1,558,836 shares of common stock under the 2018 Stock Repurchase Plan and 2,825,896 shares of common stock under the 2019 Stock Repurchase Plan, using open market purchases, for total consideration of approximately $48.3 million. The common stock repurchased under both the 2018 Stock Repurchase Plan and the 2019 Stock Repurchase Plan was retired upon repurchase.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial statements and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments consisting of normal recurring adjustments necessary for a fair presentation of the Company’s consolidated financial position and results of operations and cash flows for the periods presented. Interim results of operations are not necessarily indicative of the results that may be achieved for the full year. The condensed consolidated financial statements and related notes do not include all information and footnotes required by GAAP for annual reports. This quarterly report should be read in conjunction with the consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended December 26, 2018.
The Company uses a 52- or 53-week fiscal year ending on the last Wednesday of the calendar year. In a 52-week fiscal year, each quarter includes 13 weeks of operations; in a 53-week fiscal year, the first, second and third quarters each include 13 weeks of operations, and the fourth quarter includes 14 weeks of operations. Every six or seven years, a 53-week fiscal year occurs. Fiscal 2019 and 2018 are both 52-week years, ending on December 25, 2019 and December 26, 2018, respectively. Revenues, expenses, and other financial and operational figures may be elevated in a 53-week year.
Holdings has no material assets or operations. Holdings and Holdings’ direct subsidiary, EPL Intermediate, Inc. (“Intermediate”), guarantee EPL’s 2018 Revolver (as defined below) on a full and unconditional basis (see Note 4), 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, subject to the terms of the 2018 Revolver.
 

12



Principles of Consolidation
The accompanying condensed consolidated financial statements include the accounts of Holdings and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and revenue and expenses during the periods reported. Actual results could materially differ from those estimates. The Company’s significant estimates include estimates for impairment of goodwill, intangible assets and property and equipment, insurance reserves, lease accounting matters, closed-store reserves, stock-based compensation, income tax receivable agreement liability, contingent liabilities and income tax valuation allowances.
Cash and Cash Equivalents
The Company considers all highly-liquid instruments with an original maturity of three months or less at the date of purchase to be cash equivalents.
Liquidity
The Company’s principal liquidity and capital requirements are new restaurants, existing restaurant capital investments (remodels and maintenance), interest payments on our debt, lease obligations and working capital and general corporate needs. At September 25, 2019, the Company’s total debt was $101.0 million. The Company’s ability to make payments on its indebtedness and to fund planned capital expenditures depends on available cash and its ability to generate adequate cash flows in the future, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory, and other factors that are beyond the Company’s control. Based on current operations, the Company believes that its cash flow from operations, available cash of $12.1 million at September 25, 2019, and available borrowings under the 2018 Revolver (see Note 4) will be adequate to meet the Company’s liquidity needs for the next twelve months from the filing of these condensed consolidated financial statements.

Recovery of Securities Class Action Legal Expense
During the thirty-nine weeks ended September 25, 2019, the Company received insurance proceeds of $10.0 million related to the settlement of a securities class action lawsuit. During the thirteen and thirty-nine weeks ended September 26, 2018, the Company received insurance proceeds of $2.0 million and $6.1 million, respectively, related to the reimbursement of certain legal expenses paid in prior years for the defense of securities lawsuits. See Note 7, Commitments and Contingencies, Legal Matters.

Loss on Disposition of Restaurants
During the thirty-nine weeks ended September 25, 2019, the Company 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. The Company has determined that these restaurant dispositions represent multiple element arrangements, and as a result, the cash consideration received was allocated to the separate elements based on their relative selling price. Cash proceeds included upfront consideration for the sale of the restaurants and franchise fees, as well as future cash consideration for royalties and lease payments. The Company 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. The Company initially defers and subsequently recognizes the franchise fees over the term of the franchise agreement. Future royalty income is also recognized in revenue as earned.
These sales resulted in cash proceeds of $4.8 million and a net loss on sale of restaurants of $5.1 million for the thirty-nine weeks ended September 25, 2019. These restaurants are now included in the total number of franchised El Pollo Loco restaurants.
Recently Adopted Accounting Pronouncements
In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, “Disclosure Update and Simplification, amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded.  In addition,

13



the amendments expanded the disclosure requirements on the analysis of stockholders' equity for interim financial statements.  Under the amendments, an analysis of changes in each caption of stockholders' equity presented in the balance sheet must be provided in a note or separate statement.  The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed.  The Company adopted SEC Release No. 33-10532 as of December 27, 2018. See “Condensed Consolidated Statements of Changes in Stockholders’ Equity” above.
In June 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-07, “Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting”, (“ASU 2018-07”) which expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from non-employees. ASU 2018-07 is effective for financial statements issued for annual periods beginning after December 15, 2018, and for the interim periods therein. The Company adopted ASU 2018-07 as of December 27, 2018 and it did not have a significant impact on the Company’s consolidated financial position or results of operations.

In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging," which refines and expands existing hedge accounting guidance. The Company adopted ASU 2017-12 as of December 27, 2019. The adoption of this standard did not have a material impact on the condensed consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases”, (“Topic 842”). Topic 842 establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU Asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard was effective for fiscal years beginning after December 15, 2018, including interim periods therein. In July 2018, the FASB issued ASU No. 2018-11, which provides an alternative transition method that allows entities to apply the new leases standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company adopted Topic 842, and all related ASU’s as of December 27, 2018. See “Changes in Accounting Policies” below for further details.
Subsequent Events
Subsequent to September 25, 2019, the Company completed the sale of five company-operated restaurants within the Dallas area to an existing franchisee. This sale did not result in any cash proceeds or gain or loss on sale of restaurants, as the fixed assets of all five locations were fully impaired in prior periods. Additionally, the Company closed one restaurant in Texas, which is expected to result in closed-store reserve expense of $0.8 million.
The Company evaluated subsequent events that have occurred after September 25, 2019, and determined that there were no other events or transactions occurring during this reporting period that require recognition or disclosure in the condensed consolidated financial statements.
Concentration of Risk
Cash and cash equivalents are maintained at financial institutions and, at times, these balances may exceed federally-insured limits. The Company has never experienced any losses related to these balances.
The Company had two suppliers for which amounts due totaled 14.6% and 10.2% of the Company’s accounts payable at September 25, 2019. As of December 26, 2018, the Company had one supplier for which amounts due totaled 36.0% of the Company’s accounts payable. Purchases from the Company’s largest supplier totaled 29.0% and 28.9% of total expenses for the thirteen and thirty-nine weeks ended September 25, 2019, respectively, and 29.4% and 28.8% of total expenses for the thirteen and thirty-nine weeks ended September 26, 2018, respectively.
Company-operated and franchised restaurants in the greater Los Angeles area generated, in the aggregate, approximately 71.5% and 70.0% of total revenue for the thirteen and thirty-nine weeks ended September 25, 2019, respectively, and 69.3% and 69.0% for the thirteen and thirty-nine weeks ended September 26, 2018.
Revenue Recognition
In the first quarter of 2018 the Company implemented Topic 606 "Revenue from Contracts with Customers". Revenue is measured based on a consideration specified in a contract with a customer. The Company recognizes revenue when it satisfies a performance obligation by transferring control over a product or service to a customer. Topic 606 defines a five-step process to achieve this core principle. Refer to Note 10, “Revenue From Contracts With Customers” for further details on the Company’s revenue recognition policy.
Goodwill and Indefinite Lived Intangible Assets

14



The Company’s indefinite-lived intangible assets consist of trademarks. Goodwill represents the excess of cost over fair value of net identified assets acquired in business combinations accounted for under the purchase method. The Company does not amortize its goodwill and indefinite-lived intangible assets. Goodwill resulted from the acquisition of certain franchise locations.
Upon the sale or closure of a restaurant, the Company evaluates whether there is a decrement of goodwill. The amount of goodwill included in the cost basis of the asset sold is determined based on the relative fair value of the portion of the reporting unit disposed of compared to the fair value of the reporting unit retained. The Company determined there was no decrement of goodwill related to the disposition of restaurants during the thirty-nine weeks ended September 25, 2019.
The Company performs annual impairment tests for goodwill during the fourth fiscal quarter of each year, or more frequently if impairment indicators arise.
The Company reviews goodwill for impairment utilizing either a qualitative assessment or a fair value test by comparing the fair value of a reporting unit with its carrying amount. If the Company decides that it is appropriate to perform a qualitative assessment and concludes that the fair value of a reporting unit more likely than not exceeds its carrying value, no further evaluation is necessary. If the Company performs the fair value test, the Company will compare the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired. If the carrying amount of a reporting unit exceeds its fair value, the Company will recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized cannot exceed the total amount of goodwill allocated to that reporting unit.
The Company performs annual impairment tests 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 recognized as an impairment loss.
The assumptions used in the estimate of fair value are generally consistent with the past performance of the Company’s reporting segment and are also consistent with the projections and assumptions that are used in current operating plans. These assumptions are subject to change as a result of changing economic and competitive conditions.
The Company did not identify any indicators of potential impairment of its goodwill or indefinite-lived intangible assets during the thirteen and thirty-nine weeks ended September 25, 2019 or September 26, 2018, and therefore did not record any impairment during the respective periods.
Fair Value Measurements
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:
Level 1: Quoted prices for identical instruments in active markets.
Level 2: Observable prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs or significant value drivers are observable.
Level 3: Unobservable inputs used when little or no market data is available.
During the thirteen and thirty-nine weeks ended September 25, 2019, the Company entered into an interest rate swap, which is required to be measured at fair value on a recurring basis. The fair value was determined based on Level 2 inputs, which include valuation models, as reported by the Company's counterparty. These valuation models use a discounted cash flow analysis on the cash flows of the derivative. The key inputs for the valuation models are observable market prices, discount rates, and forward yield curves. See Note 4 for further discussion regarding our interest rate swaps. The following table presents fair value for the interest rate swap at September 25, 2019 (in thousands):
 
 
 
Fair Value Measurements Using
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Other assets - Interest rate swap
$
171

 
$

 
$
171

 
$

The Company had no assets or liabilities required to be measured at fair value on a recurring basis as of December 26, 2018 or any prior interim period.

15



Certain assets and liabilities are measured at fair value on a nonrecurring basis. In other words, the instruments are not measured at fair value on an ongoing basis, but are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment).
The following non-financial instruments were measured at fair value, on a nonrecurring basis, as of and for the thirteen and thirty-nine weeks ended September 25, 2019, reflecting certain property and equipment assets for which an impairment loss was recognized during the corresponding periods, as discussed immediately below under "Impairment of Long-Lived Assets." Amounts in the table below are presented in thousands.
 
 
 
Fair Value Measurements at September 25, 2019 Using
 
Thirteen Weeks Ended September 25, 2019
 
Thirty-Nine Weeks Ended September 25, 2019
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Impairment Losses
 
Impairment Losses
Property and equipment owned, net
$

 
$

 
$

 
$

 
$
56

 
$
283


The following non-financial instruments were measured at fair value on a nonrecurring basis as of and for the thirteen and thirty-nine weeks ended September 26, 2018, reflecting certain property and equipment assets for which an impairment loss was recognized during the corresponding periods, as discussed immediately below under "Impairment of Long-Lived Assets." Amounts in the table below are presented in thousands.
 
 
 
Fair Value Measurements at June 27,2018 Using
 
Thirteen Weeks Ended September 26, 2018
 
Thirty-Nine Weeks Ended September 26, 2018
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Impairment Losses
 
Impairment Losses
Property and equipment owned, net
$

 
$

 
$

 
$

 
$
84

 
$
1,791

Impairment of Long-Lived Assets
The Company reviews its long-lived assets for impairment on a restaurant-by-restaurant basis whenever events or changes in circumstances indicate that the carrying value of certain assets may not be recoverable. 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 loss 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 the Company’s impairment review analysis, which requires the use of estimates and assumptions. If actual performance does not achieve the projections, or if the estimates and assumptions used change in the future, the Company may be required to recognize impairment charges in future periods, and such charges could be material. Based on the results of the analysis, the Company recorded a non-cash impairment charge of $0.1 million and $0.3 million for the thirteen and thirty-nine weeks ended September 25, 2019, respectively, primarily related to the carrying value of the assets of one restaurant in California. The Company recorded a non-cash impairment charge of $0.1 million and $1.8 million for the thirteen and thirty-nine weeks ended September 26, 2018, respectively, primarily related to the carrying value of the assets of one restaurant in Arizona. Given the difficulty in projecting results for newer restaurants in newer markets, we are monitoring the recoverability of the carrying value of the assets of several restaurants on an ongoing basis. For these restaurants, if expected performance improvements are not realized, an impairment charge may be recognized in future periods, and such charge could be material.

16



Closed-Store Reserves
Prior to the adoption of Topic 842 “Leases,” when the Company closed a restaurant, it reviewed the future minimum lease payments and related ancillary costs from the date of the restaurant closure to the end of the remaining lease term and recorded a lease charge for the lease liabilities to be incurred, net of any estimated sublease recoveries. The estimates of future closed-store reserves were re-evaluated and adjusted each period based on information available as of the period. In addition, an impairment charge was recognized for any remaining carrying value of certain restaurant assets. During the thirteen weeks ended September 26, 2018, the Company closed one restaurant in California and one restaurant in Arizona. During the thirty-nine weeks ended September 26, 2018, the Company closed six restaurants, including four locations in Texas, one in California and one in Arizona, and decided not to move forward with the development of a third location in Texas.  All four Texas locations were previously impaired during the third quarter of 2017. This resulted in a closed-store reserve recovery expense of $0.2 million for the thirteen weeks ended September 26, 2018 and $4.8 million for the thirty-nine weeks ended September 26, 2018.
Subsequent to 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 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 the thirty-nine weeks ended September 25, 2019, the Company closed one restaurant in California and one in Texas and recognized $0.3 million and $1.0 million of closed-store reserve expense for the thirteen and thirty-nine weeks ended September 25, 2019, respectively, primarily related to the amortization of ROU Assets for the two closed stores.
Derivative Financial Instruments
The Company uses an interest rate swap, a derivative instrument, to hedge interest rate risk and are not used for trading purposes. The derivative contract is entered into with financial institutions.
The Company records the derivative instrument on its condensed consolidated balance sheet at fair value. 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 reclassed to earnings immediately.

As a result of the use of an interest rate swap, the Company is exposed to risk that the counterparty will fail to meet their contractual obligations. To mitigate the counterparty credit risk, the Company 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 September 25, 2019, the counterparty to the Company's interest rate swap has performed in accordance with their contractual obligation.
Income Taxes
The provision for income taxes, income taxes payable and deferred income taxes is determined using the asset and liability method. Deferred tax assets and liabilities are determined based on temporary differences between the financial carrying amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which the temporary differences are expected to reverse. On a periodic basis, the Company assesses the probability that its net deferred tax assets, if any, will be recovered. If, after evaluating all of the positive and negative evidence, a conclusion is made that it is more likely than not that some portion or all of the net deferred tax assets will not be recovered, a valuation allowance is provided by charging to tax expense to reserve the portion of deferred tax assets which are not expected to be realized.
The Company reviews its filing positions for all open tax years in all U.S. federal and state jurisdictions where the Company is required to file.
When there are uncertainties related to potential income tax benefits, in order to qualify for recognition, the position the Company takes has to have at least a “more likely than not” chance of being sustained (based on the position’s technical merits) upon challenge by the respective authorities. The term “more likely than not” means a likelihood of more than 50 percent. Otherwise, the Company may not recognize any of the potential tax benefit associated with the position. The Company recognizes a benefit for a tax position that meets the “more likely than not” criterion at the largest amount of tax benefit that is greater than 50 percent likely of being realized upon its effective resolution. Unrecognized tax benefits involve management’s judgment regarding the likelihood of the benefit being sustained. The final resolution of uncertain tax positions could result in

17



adjustments to recorded amounts and may affect the Company’s consolidated financial position, results of operations, and cash flows.
The Company’s policy is to recognize interest and penalties related to income tax matters in income tax expense. The Company had no accrual for interest or penalties at September 25, 2019 or at December 26, 2018, and did not recognize interest or penalties during the thirteen or thirty-nine weeks ended September 25, 2019 or September 26, 2018, since there were no material unrecognized tax benefits. Management believes no material changes to the amount of unrecognized tax benefits will occur within the next twelve months.
On July 30, 2014, the Company entered into the income tax receivable agreement (the "TRA"), which calls for the Company to pay to its pre-IPO stockholders 85% of the savings in cash that the Company realizes in its income taxes as a result of utilizing its net operating losses and other tax attributes attributable to preceding periods. For the thirteen and thirty-nine weeks ended September 25, 2019, the Company recorded income tax receivable agreement income of $0.2 million and $0.1 million, respectively, and for the thirteen and thirty-nine weeks ended September 26, 2018, we recorded income tax receivable agreement income of $0.6 million and $0.8 million, respectively, related to the amortization of interest expense related to our total expected TRA payments and changes in estimates for actual tax returns filed and future forecasted taxable income.

Changes in Accounting Policies
Except for the changes below, the Company has consistently applied the accounting policies to all periods presented in these condensed consolidated financial statements.
The Company adopted Topic 842 with a date of initial application of December 27, 2018. As a result, the Company has changed its accounting policy for leases as detailed below.
The Company’s operations utilize property, facilities, equipment and vehicles owned by the Company or leased from others, the majority of which are operating leases. Additionally, the Company has various contracts with vendors that have been determined to contain an embedded lease in accordance with Topic 842. As of the date of adoption, the Company recognized a ROU Asset and lease liability equal to the present value of these leases within its consolidated balance sheet for any leases with terms longer than 12 months. The Company also has three finance leases, subleases facilities to certain franchises and is the lessor for certain property, facilities and equipment owned by the Company. The adoption of Topic 842 did not have an impact on our current accounting policies for these items. Furthermore, the adoption of this standard did not have any impact on the Company’s consolidated statement of operations or the consolidated statement of cash flows.
The Company applied Topic 842 using the effective date method, which allowed the Company to apply the standard as of the adoption date, and to recognize the cumulative effect of initially applying Topic 842 as an adjustment to retained earnings at December 27, 2018, if applicable. Therefore, the comparative information has not been adjusted and continues to be reported under Topic 840. However, the Company did not have any impact to its retained earnings.

Additionally, the Company elected to apply the package of practical expedients, which allowed for carryforwards of 1) historical lease classifications, 2) determination of whether a contract contains a lease under the new definition of a lease and 3) whether previously capitalized initial direct costs qualify for capitalization. See Note 11, "Leases," for further details.


2. PROPERTY AND EQUIPMENT
The costs and related accumulated depreciation and amortization of major classes of property and equipment are as follows (in thousands):
 
September 25, 2019
 
December 26, 2018
Land
$
12,323

 
$
12,323

Buildings and improvements
149,474

 
156,806

Other property and equipment
75,416

 
76,061

Construction in progress
6,227

 
2,989

 
243,440

 
248,179

Less: accumulated depreciation and amortization
(150,076
)
 
(144,034
)
 
$
93,364

 
$
104,145

 

18



Depreciation expense was $4.3 million and $4.5 million for the thirteen weeks ended September 25, 2019 and September 26, 2018, respectively, and $13.6 million and $13.1 million for the thirty-nine weeks ended September 25, 2019 and September 26, 2018, respectively.

Based on the Company's review of its long-lived assets for impairment, the Company recorded non-cash impairment charges of $0.1 million and $0.3 million for the thirteen and thirty-nine weeks ended September 25, 2019, respectively, and $0.1 million and $1.8 million for the thirteen and thirty-nine weeks ended September 26, 2018, respectively.

3. STOCK-BASED COMPENSATION

At September 25, 2019, options to purchase 2,302,225 shares of common stock were outstanding, including 1,746,164 vested and 556,061 unvested. Unvested options vest over time; however, upon a change in control, the board may accelerate vesting. At September 25, 2019, 1,381,010 premium options, options granted above the stock price at date of grant, remained outstanding. A summary of stock option activity as of September 25, 2019 and changes during the thirty-nine weeks ended September 25, 2019 is as follows:

 
Shares
 
Weighted-Average
Exercise Price
Outstanding - December 26, 2018
2,102,404

 
$
7.68

Grants
320,536

 
11.47

Exercised
(6,709
)
 
11.94

Forfeited, cancelled or expired
(114,006
)
 
13.35

Outstanding - September 25, 2019
2,302,225

 
$
7.91

Vested and expected to vest at September 25, 2019
2,289,725

 
$
7.90

Exercisable at September 25, 2019
1,746,164

 
$
6.81


The fair value of each stock option was estimated on the grant date using an exercise price of the closing stock price on the day prior to date of grant and the Black‑Scholes option-pricing model with the following weighted average assumptions:
 
Thirty-Nine Weeks Ended September 25, 2019
 
Thirty-Nine Weeks Ended September 26, 2018
Expected volatility
28.7
%
 
28.4
%
Risk-free interest rate
2.3
%
 
2.9
%
Expected term (years)
6.25

 
6.25

Expected dividends

 


At September 25, 2019, the Company had total unrecognized compensation expense of $1.9 million related to unvested stock options, which it expects to recognize over a weighted-average period of 3.17 years.

A summary of restricted share activity as of September 25, 2019 and changes during the thirty-nine weeks ended September 25, 2019 is as follows:

 
Shares
 
Weighted-Average
Fair Value
Unvested shares at December 26, 2018
490,700

 
$
10.91

Granted
285,996

 
$
11.47

Released
(142,861
)
 
$
10.61

Forfeited, cancelled, or expired
(53,882
)
 
$
11.81

Unvested shares at September 25, 2019
579,953

 
$
11.17

Unvested shares at September 25, 2019, included 455,230 unvested restricted shares, 36,058 unvested performance stock units and 88,665 unvested restricted units.
At September 25, 2019, the Company had unrecognized compensation expense of $4.8 million related to unvested restricted shares, which it expects to recognize over a weighted-average period of 3.00 years, unrecognized compensation expense of

19



$0.1 million related to performance stock units, which it expects to recognize over a weighted-average period of 3.62 years and unrecognized compensation expense of $0.9 million related to unvested restricted units, which it expects to recognize over a weighted-average period of 2.76 years.
Total stock-based compensation expense was $0.7 million and $1.8 million for the thirteen and thirty-nine weeks ended September 25, 2019, respectively, and $0.4 million and $1.5 million for the thirteen and thirty-nine weeks ended September 26, 2018, respectively.

4. LONG-TERM DEBT
On July 13, 2018, the Company refinanced a credit agreement with Bank of America, N.A., initially entered into on December 11, 2014 (the “2014 Revolver”), pursuant to a credit agreement (the “2018 Credit Agreement”) among EPL, as borrower, and the Company and Intermediate, 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 2018 Revolver and 2018 Credit Agreement will mature on July 13, 2023. The obligations under the 2018 Credit Agreement and related loan documents are guaranteed by the Company and Intermediate. The obligations of the Company, EPL and Intermediate under the 2018 Credit Agreement and related loan documents are secured by a first priority lien on substantially all of their respective assets.
Borrowings under the 2018 Credit Agreement (other than any swingline loans) bear interest, at the borrower’s option, at rates based upon either LIBOR or a base rate, plus, for each rate, a margin determined in accordance with a lease-adjusted consolidated leverage ratio-based pricing grid. The base rate is calculated as the highest of (a) the federal funds rate plus 0.50%, (b) the published Bank of America prime rate, or (c) LIBOR plus 1.00%. For LIBOR loans, the margin is in the range of 1.25% to 2.25%, and for base rate loans the margin is in a range of 0.25% to 1.25%. Borrowings under the 2018 Revolver may be repaid and reborrowed. The interest rate range was 3.65% to 3.90% and 3.65% to 6.00% for the thirteen and thirty-nine weeks ended September 25, 2019, respectively, and 3.57% to 3.84% and 3.30% to 3.84% for the thirteen and thirty-nine weeks ended September 26, 2018, respectively.

The 2018 Credit Agreement contains certain financial covenants. The Company was in compliance with the financial covenants as of September 25, 2019.
At September 25, 2019, $8.5 million of letters of credit and $101.0 million in borrowings under the 2018 Revolver were outstanding. The amount available under the 2018 Revolver was $40.5 million at September 25, 2019.
Maturities
During the thirteen and thirty-nine weeks ended September 25, 2019, the Company borrowed $16.0 million and $27.0 million, respectively, net of pay downs of $15.0 million during the thirty-nine week period, on the Company’s 2018 Revolver, primarily to fund settlement payments. See Note 7 for further details regarding the settlement payments. During the thirteen and thirty-nine weeks ended September 26, 2018, the Company elected to pay down $10.0 million and $23.0 million, net of new borrowings of $6.0 million during the thirty-nine week period, of outstanding borrowings on the Company’s 2014 Revolver, respectively. There are no required principal payments prior to maturity for the 2018 Revolver.
Interest Rate Swap
During the thirteen and thirty-nine weeks ended September 25, 2019, the Company entered into a variable-to-fixed interest rate swap agreement with a notional amount of $40.0 million that matures in June 2023. The objective of the interest rate swap is to reduce its exposure to interest rate risk for a portion of its variable-rate interest payments on its borrowings under the 2018 Revolver. Under the terms of the swap agreement, the variable LIBOR-based component of interest payments are converted to a fixed rate of 2.81%. The interest rate swap is designated as a cash flow hedge, as the changes in the future cash flows of the swap are expected to offset changes in expected future interest payments on the related variable-rate debt, in accordance with Accounting Standards Committee ("ASC") 815. There were no interest rate swaps outstanding as of December 26, 2018.

The changes in the fair value of the interest rate swap are not included in earnings, but are included in other comprehensive income (“OCI”). These changes in fair value are subsequently reclassified into net earnings as a component of interest expense as the hedged interest payments are made on the variable rate borrowings.
For the thirteen and thirty-nine weeks ended September 25, 2019, the swap was a highly effective cash flow hedge.

20




As of September 25, 2019, the estimated net gain included in AOCI related to the Company's cash flow hedge that will be reclassified into earnings in the next 12 months is $0.3 million, based on current LIBOR interest rates.

The following table shows the financial statement line item and amount of the Company's cash flow hedge accounting on the condensed consolidated balance sheet (in thousands):
 
September 25, 2019
 
Notional
 
Fair value
Other Assets - Interest rate swap
40,000

 
171


The following table summarizes the effect of the Company's cash flow hedge accounting on the condensed consolidated statements of income (in thousands):
 
Thirteen Weeks Ended
 
Thirty-Nine Weeks Ended
 
September 25, 2019
 
September 26, 2018
 
September 25, 2019
 
September 26, 2018
Interest expense on hedged portion of debt
122

 

 
122

 

Interest income on interest rate swap
(29
)
 

 
(29
)
 

Interest expense on debt and derivatives, net
$
93

 
$

 
$
93

 
$


The following table summarizes the effect of the Company's cash flow hedge accounting on AOCI for the thirteen and thirty-nine weeks ended September 25, 2019 and September 26, 2018 (in thousands):
 
Thirteen Weeks Ended
 
Thirty-Nine Weeks Ended
 
Gain Recognized in OCI
 
(Gain) Reclassified from AOCI into Interest expense
 
Gain Recognized in OCI
 
(Gain) Reclassified from AOCI into Interest expense
 
September 25, 2019
 
September 26, 2018
 
September 25, 2019
 
September 26, 2018
 
September 25, 2019
 
September 26, 2018
 
September 25, 2019
 
September 26, 2018
Interest rate swap
$
171

 

 
$
(29
)
 

 
$
171

 

 
$
(29
)
 


See Note 1 for the fair value of our derivative asset.

5. OTHER ACCRUED EXPENSES AND CURRENT LIABILITIES
Other accrued expenses and current liabilities consist of the following (in thousands):
 
September 25, 2019
 
December 26, 2018
Accrued sales and property taxes
$
5,657

 
$
5,016

Gift card liability
2,322

 
2,512

Accrued legal settlements and professional fees
16,569

 
38,639

Other (1)
3,046

 
5,597

Total other accrued expenses and current liabilities
$
27,594

 
$
51,764


(1) The Company previously included the short-term portion deferred rent, tenant improvement allowance and lease escalation liabilities within “Other accrued expenses and current liabilities.” Upon its adoption of Topic 842 “Leases,” these balances were netted with the ROU Asset for the respective operating lease. See “Change in accounting policies" in Note 1 and Note 11 “Leases” for further details of the Company’s adoption of Topic 842. 

6. OTHER NONCURRENT LIABILITIES
Other noncurrent liabilities consist of the following (in thousands):

21



 
September 25, 2019
 
December 26, 2018
Deferred rent (1)
$

 
$
10,660

Deferred franchise and development fees
5,717

 
5,224

Other (2)
67

 
4,140

Total other noncurrent liabilities
$
5,784

 
$
20,024


(1) In accordance with the Company’s adoption of Topic 842 “Leases” all deferred rent balances are now included with in the Company’s ROU Asset. Refer to “Change in accounting policies” in Note 1 and Note 11 “Leases” for further details of the Company’s adoption of Topic 842. 
(2) The Company previously included the non-current portion tenant improvement allowance and lease escalation liabilities within “Other noncurrent liabilities.” Upon its adoption of Topic 842 “Leases,” these balances were netted with the ROU Asset for the respective operating lease. See “Change in accounting policies” in Note 1 and Note 11 “Leases” for further details of the Company’s adoption of Topic 842. 


7. COMMITMENTS AND CONTINGENCIES
Legal Matters
On or about February 24, 2014, a former employee filed a class action in the Superior Court of the State of California, County of Orange, under the caption Elliott Olvera, et al v. El Pollo Loco, Inc., et al (Case No. 30-2014-00707367-CU-OE-CXC) (the “Olvera Action”) on behalf of all putative class members (all hourly employees from 2010 to the present) alleging certain violations of California labor laws, including failure to pay overtime compensation, failure to provide meal periods and rest breaks, and failure to provide itemized wage statements. The putative lead plaintiff’s requested remedies include compensatory and punitive damages, injunctive relief, disgorgement of profits, and reasonable attorneys’ fees and costs. No specific amount of damages sought was specified in the complaint. The parties reached a settlement in principle on January 24, 2019 of all claims brought on behalf of approximately 32,000 putative class members in the Olvera Action, as well as all claims for failure to pay overtime compensation, failure to provide meal periods and rest breaks, and failure to provide itemized wage statements brought in the class actions captioned Martha Perez v. El Pollo Loco, Inc. (Los Angeles Superior Court Case No. BC624001) (the “Perez Action”), Maria Vega, et al. v. El Pollo Loco, Inc. (Los Angeles Superior Court Case No. BC649719 (the “Vega Action”), and Gonzalez v. El Pollo Loco, Inc. (Los Angeles Superior Court Case No. BC712867) (the “Gonzalez Action”) and codified such settlement on April 26, 2019. The settlement reached in the Olvera Action, Perez Action, Vega Action, and Gonzalez Action resolves all potential claims from April 12, 2010 through April 1, 2019 that the Company’s California based restaurant employees may have against El Pollo Loco for the failure to pay all compensation owed, failure to pay overtime compensation, failure to provide meal periods and rest breaks and failure to provide itemized wage statements, among other wage and hour related claims. It is anticipated that the settlement will be approved by the Court in the first quarter of 2020. A $16.3 million accrual of an expected settlement amount related to this matter was recorded as of December 26, 2018. Purported class actions alleging wage and hour violations are commonly filed against California employers. The Company fully expects to have to defend against similar lawsuits in the future.
Daniel Turocy, et al. v. El Pollo Loco Holdings, Inc., et al. (Case No. 8:15-cv-01343) was filed in the United States District Court for the Central District of California on August 24, 2015, and Ron Huston, et al. v. El Pollo Loco Holdings, Inc., et al. (Case No. 8:15-cv-01710) was filed in the United States District Court for the Central District of California on October 22, 2015. The two lawsuits have been consolidated, with co-lead plaintiffs and class counsel.  A consolidated complaint was filed on January 29, 2016, on behalf of co-lead plaintiffs and others similarly situated, alleging violations of federal securities laws in connection with Holdings common stock purchased or otherwise acquired and the purchase of call options or the sale of put options, between May 1, 2015 and August 13, 2015 (the “Class Period”). The named defendants are Holdings; Stephen J. Sather, Laurance Roberts, and Edward J. Valle (collectively, the “Individual Defendants”); and Trimaran Pollo Partners, LLC, Trimaran Capital Partners, and Freeman Spogli & Co. (collectively, the “Controlling Shareholder Defendants”). Among other things, Plaintiffs allege that, in 2014 and early 2015, Holdings suffered losses due to rising labor costs in California and, in an attempt to mitigate the effects of such rising costs, removed a $5 value option from the Company’s menu, which resulted in a decrease in traffic from value-conscious consumers. Plaintiffs further allege that during the Class Period, Holdings and the Individual Defendants made a series of materially false and misleading statements that concealed the effect that these factors were having on store sales growth, resulting in Holdings stock continuing to be traded at artificially inflated prices. As a result, Plaintiffs and other members of the putative class allegedly suffered damages in connection with their purchase of Holdings’ stock during the Class Period. In addition, Plaintiffs allege that the Individual Defendants and Controlling Shareholder Defendants had direct involvement in, and responsibility over, the operations of Holdings, and are presumed to have had, among other things, the power to control or influence the transactions giving rise to the alleged securities law violations. In both cases, Plaintiffs seek an unspecified amount of damages, as well as costs and expenses (including attorneys’ fees).

22



On July 25, 2016, the Court issued an order granting, without prejudice, Defendants’ Motion to Dismiss plaintiff’s complaint for failure to state a claim. Plaintiffs were granted leave to amend their complaint, and filed an amended complaint on August 22, 2016. Defendants moved to dismiss the amended complaint, and on March 20, 2017, the Court dismissed the amended complaint and granted Plaintiffs leave to file another amended complaint.  Plaintiffs filed another amended complaint on April 17, 2017. Defendants filed a motion to dismiss the amended complaint on or about May 17, 2017. The Court denied Defendants' motion to dismiss the third amended complaint on August 4, 2017. On December 8, 2017, Plaintiffs filed a motion for class certification, and on July 3, 2018, the Court granted Plaintiffs’ motion and certified a class as to all of Plaintiffs’ claims. Defendants filed a petition for appellate review of a portion of the Court’s July 3, 2018 class certification order.  On October 19, 2018 the Ninth Circuit Court of Appeals denied the petition.
On January 23, 2019, the parties filed a Notice of Settlement and Joint Request for Order to Stay Proceedings, stating the parties have reached an agreement in principle to settle the claims and allegations in the action and are negotiating the terms of a Stipulation of Settlement.  On January 24, 2019, the Court ordered that all proceedings in the action be stayed until April 3, 2019, on or before which the parties were to file a Stipulation of Settlement and a motion for preliminary approval of the settlement. On April 3, 2019, Plaintiffs filed the Stipulation of Settlement and a Motion for Preliminary Approval of the
Settlement. On May 13, 2019, the Court granted preliminary approval of the settlement. On July 17, 2019, Plaintiffs filed the Motion for Final Approval of Class Action Settlement and Approval of Plan of Allocation and the Motion for an Award of Attorneys’ Fees and Expenses and Awards to Lead Plaintiffs Pursuant to 15 U.S.C. §78u-4(a)(4), which was granted by the Court on August 26, 2019. A $20.0 million accrual of an expected settlement amount related to this matter was recorded as of December 26, 2018 and all settlement payments were made during the thirty-nine weeks ended September 25, 2019
On or about November 5, 2015, a purported Holdings shareholder filed a derivative complaint on behalf of Holdings in the Court of Chancery of the State of Delaware against certain Holdings officers, directors and Trimaran Pollo Partners, L.L.C., under the caption Armen Galustyan v. Sather, et al. (Case No. 11676-VCL). The derivative complaint alleges that these defendants breached their fiduciary duties to Holdings and were unjustly enriched when they sold shares of Holdings at artificially inflated prices due to alleged misrepresentations and omissions regarding EPL’s comparable store sales in the second quarter of 2015. The Holdings shareholder’s requested remedies include an award of compensatory damages to Holdings, as well as a court order to improve corporate governance by putting forward for stockholder vote certain resolutions for amendments to Holdings’ Bylaws or Certificate of Incorporation. The parties have stipulated to, which the court has ordered, a stay of these proceedings pending the outcome of Turocy v. El Pollo Loco Holdings, Inc., discussed above. A second purported Holdings shareholder filed a derivative complaint on or about September 23, 2016, under the caption Diep v. Sather, CA 12760-VCL in the Delaware Court of Chancery. The Diep action is also purportedly brought on behalf of Holdings, names the same defendants and asserts substantially the same claims on substantially the same alleged facts as does Galustyan. Defendants moved to stay or dismiss the Diep action.
On March 17, 2017, the Delaware court granted in part, and denied in part, the motion to stay the Diep action.  The court denied defendants' motion to dismiss the complaint for failure to state a claim. On January 17, 2018, the court entered an order granting the parties’ stipulation staying all proceedings in the Diep action for five months or until the completion of an investigation of the allegations in the action by a special litigation committee of the Holdings board of directors (the "SLC"). On February 13, 2019, after concluding its investigation, the SLC filed a motion to dismiss the Diep action.  The SLC filed its investigative report under seal as an exhibit to the motion to dismiss.
Janice P. Handlers-Bryman and Michael D. Bryman v. El Pollo Loco, Inc., Los Angeles Superior Court (Case No. MC026045) (the “Lancaster Lawsuit”) was filed on February 9, 2016.   Existing El Pollo Loco franchisees, Janice P. Handlers-Bryman and Michael D. Bryman, as individuals and in their capacities as trustees of the Handlers Bryman Trust (collectively, “Plaintiffs”), filed suit against us alleging, among other things, that we “imposed unreasonable time limitations” on their development of additional restaurant locations in Lancaster, California, and that we thereafter developed  company-operated El Pollo Loco restaurants in the “market area” of Plaintiffs’ existing El Pollo Loco restaurant in Lancaster. Plaintiffs asserted claims against us for, among other things, (i) breach of the implied covenant of good faith and fair dealing, (ii) intentional interference with prospective business, and (iii) unfair business practices. In addition to an unspecified amount of damages and costs of the lawsuit, Plaintiffs sought reformation of the contract, declaratory relief, disgorgement of alleged revenues and profits, injunctive relief, and a judicial mandate requiring us to either transfer the company-operated locations to Plaintiffs or to continuously disgorge to Plaintiffs the unjust enrichment allegedly obtained by us through the operation of the company-operated restaurants in Lancaster. We denied Plaintiffs’ allegations as the franchise agreement did not grant Plaintiffs any exclusive territorial rights and, instead, expressly reserved for us the right to open and operate - and the right to grant others the right to open and operate - El Pollo Loco restaurants “in the immediate vicinity of or adjacent to” Plaintiffs’ restaurant in Lancaster. On June 7, 2016, we filed a cross-complaint against Plaintiffs for breach of the franchise agreement due to Plaintiffs’ failure to pay to us liquidated damages provided for in the franchise agreement in connection with their solicitation and/or hiring of our general manager. This counterclaim was voluntarily dismissed by us, without prejudice, on February 27, 2017 and a related action before the San Bernardino Superior Court, titled El Pollo Loco, Inc. v. EPL 3766, Inc., was dismissed on April

23



6, 2017.  On April 24, 2017, four days before the commencement of trial, Plaintiffs filed a voluntary dismissal, without prejudice, of the Lancaster Lawsuit without any payment or other concession by us. The corresponding dismissal was entered by the court on April 25, 2017. On May 22, 2017, Plaintiffs filed a motion for relief from the dismissal which was granted by the court on June 29, 2017.  The trial in the case was bifurcated between the liability and damages phases.  The liability phase commenced on November 16, 2017.  The only cause of action that the court allowed to go to the jury was the cause of action for breach of the covenant of good faith and fair dealing. The court elected not to present the cause of action for intentional interference with prospective business to the jury.  (The causes of action for reformation due to mistake and unconscionability, unfair business practices under California Business & Professions Code §17200 et seq., and declaratory relief were not presented to the jury as these types of equitable claims are to be decided by the court as a matter of law.) On December 11, 2017, the jury returned a verdict in favor of Plaintiffs finding that the Company breached the implied covenant of good faith and fair dealing by (1) constructing the two new company-operated El Pollo Loco restaurants in Lancaster, and (2) not offering the two new company-operated El Pollo Loco restaurants in Lancaster to Plaintiffs. Because the trial was bifurcated, the December 11, 2017 verdict did not include a determination of damages.
The damages phase of the trial commenced on April 20, 2018. On May 1, 2018, the jury returned a verdict on damages in favor of Plaintiffs in the following amounts: (1) $4,356,600 in “impact damages” arising out of our construction of the two new company-owned El Pollo Loco restaurants in Lancaster, and (2) $4,481,206 in “lost opportunity damages” arising out of our failure to offer the two new company-owned El Pollo Loco restaurants in Lancaster to Plaintiffs. On August 1, 2018, the court issued a final judgment and decision on the unfair business practices claim under California Business & Professions Code § 17200 et seq. As part of the final judgment, the court found El Pollo Loco liable and issued injunctive relief requiring El Pollo Loco to revise its franchise disclosure document and franchise agreement. The court also awarded Plaintiffs restitution of $4,356,600 for “impact damages” arising out of our construction of the two new company-operated El Pollo Loco restaurants in Lancaster. The court, reversing its previous position, held that these damages could be awarded in addition to the "lost opportunity damages" awarded by the jury. Thus, the court entered a total monetary judgment of $8,837,806. There has been no ruling on the causes of action for reformation due to mistake and unconscionability, and declaratory relief.
On August 16, 2018, the Company filed a motion challenging the verdicts and a motion for new trial (both the liability phase and damages phase) and on September 2, 2018, the court denied those motions. On August 27, 2018, the Company filed a notice of appeal as to the entire judgment, and on October 5, 2018, the Company filed a second notice of appeal challenging the court’s denial of the post-trial motions. On September 5, 2018, we filed a motion to strike several of the costs of suit requested by the Plaintiffs, and on September 28, 2018, the Plaintiffs filed a motion for an award of attorneys’ fees. The court ruled on these motions on October 30, 2018, reducing many of the costs requested by the Plaintiffs and awarding $1,391,703 to the Plaintiffs for attorneys’ fees. We filed a notice of appeal relating to the trial court’s order relating to our motion to strike the costs and the Plaintiff’s motion for attorneys’ fees on November 6, 2018. The Company also filed motions to stay the injunctive part of the judgment pending the appeal, but both the trial court and the California Court of Appeal denied those motions. We filed a petition for review of these denials with the California Supreme Court, but the California Supreme Court denied our petition for review on November 14, 2018. The Company disputes liability and has filed an appeal of the trial court's judgment. The appeal on the merits is currently pending, with appellant’s opening brief due December 2, 2019. Briefing on the merits has not yet occurred in the appellate court. Based on the assessment by Management, together with our legal trial and appellate counsel, the Company believes that the loss is currently not probable under ASC 450 and as of September 25, 2019, no accrual has been made with regard to the verdict.
The Company is also involved in various other claims and legal actions that arise in the ordinary course of business. The Company does not believe that the ultimate resolution of these other actions will have a material adverse effect on its financial position, results of operations, liquidity, or capital resources. A significant increase in the number of claims, or an increase in amounts owing under successful claims, could materially and adversely affect its business, consolidated financial condition, results of operations, and cash flows.
Purchasing Commitments
The Company has long-term beverage supply agreements with certain major beverage vendors. Pursuant to the terms of these arrangements, marketing rebates are provided to the Company and its franchisees from the beverage vendors based upon the dollar volume of purchases for system-wide restaurants which will vary according to their demand for beverage syrup and fluctuations in the market rates for beverage syrup. These contracts have terms extending through the end of 2024.
At September 25, 2019, the Company’s total estimated commitment to purchase chicken was $4.2 million.
Contingent Lease Obligations
As a result of assigning the Company’s interest in obligations under real estate leases in connection with the sale of company-operated restaurants to some of the Company’s franchisees, the Company is contingently liable on five lease agreements. These

24



leases have various terms, the latest of which expires in 2036. As of September 25, 2019, the potential amount of undiscounted payments the Company could be required to make in the event of non-payment by the primary lessee was $2.1 million. The present value of these potential payments discounted at the Company’s estimated pre-tax cost of debt at September 25, 2019 was $1.8 million. The Company’s franchisees are primarily liable on the leases. The Company has cross-default provisions with these franchisees that would put them in default of their franchise agreements in the event of non-payment under the leases. The Company believes that these cross-default provisions reduce the risk that payments will be required to be made under these leases. Accordingly, no liability has been recorded in the Company’s condensed consolidated financial statements related to these contingent liabilities.
Employment Agreements
The Company has employment agreements with four of the officers of the Company. These agreements provide for minimum salary levels, possible annual adjustments for cost-of-living changes, and incentive bonuses that are payable under certain business conditions. The Company incurred $0.1 million and $0.5 million of expenses related to employment agreements for the thirteen and thirty-nine weeks ended September 25, 2019, respectively, and incurred $0.8 million of expenses related to employment agreements for the thirty-nine weeks ended September 26, 2018.
Indemnification Agreements
The Company has entered into indemnification agreements with each of its current directors and officers. These agreements require the Company to indemnify these individuals to the fullest extent permitted under Delaware law against liabilities that may arise by reason of their service to the Company and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified. The Company also intends to enter into indemnification agreements with future directors and officers.

8. NET INCOME PER SHARE
Basic earnings per share (“EPS”) is calculated using the weighted-average number of shares of common stock outstanding during the thirteen and thirty-nine weeks ended September 25, 2019 and September 26, 2018. Diluted EPS is calculated using the weighted-average number of shares of common stock outstanding and potentially dilutive during the period, using the treasury stock method.
Below are basic and diluted EPS data for the periods indicated, which are in thousands except for per share data:  
 
Thirteen Weeks Ended
 
Thirty-Nine Weeks Ended
 
9/25/2019
 
9/26/2018
 
9/25/2019
 
9/26/2018
Numerator:
 

 
 

 
 

 
 

Net income
$
6,402

 
$
6,835

 
$
21,402

 
$
14,416

Denominator:
 

 
 

 
 

 
 

Weighted-average shares
   outstanding—basic
35,859,502

 
38,602,658

 
37,484,372

 
38,516,792

Weighted-average shares
   outstanding—diluted
36,397,368

 
39,205,090

 
38,173,097

 
39,102,130

Net income per share—basic
$
0.18

 
$
0.18

 
$
0.57

 
$
0.37

Net income per share—diluted
$
0.18

 
$
0.17

 
$
0.56

 
$
0.37

Anti-dilutive securities not considered in
   diluted EPS calculation
882,253

 
557,300

 
636,099

 
671,565


Below is a reconciliation of basic and diluted share counts:

25



 
Thirteen Weeks Ended
 
Thirty-Nine Weeks Ended
 
9/25/2019
 
9/26/2018
 
9/25/2019
 
9/26/2018
Weighted-average shares outstanding—basic
35,859,502

 
38,602,658

 
37,484,372

 
38,516,792

Dilutive effect of stock options and restricted shares
537,866

 
602,432

 
688,725

 
585,338

Weighted-average shares outstanding—diluted
36,397,368

 
39,205,090

 
38,173,097

 
39,102,130



9. RELATED PARTY TRANSACTIONS
Trimaran Pollo Partners, L.L.C. (“LLC”) owns approximately 48.0% of the Company’s outstanding common stock. This large position means that LLC and its majority owners—predecessors and affiliates of, and certain funds managed by, Trimaran Capital Partners and Freeman Spogli & Co. (collectively, “Trimaran” and “Freeman Spogli,” respectively)—possess significant influence when stockholders vote on matters such as election of directors, mergers, consolidations and acquisitions, the sale of all or substantially all of the Company’s assets, decisions affecting the Company’s capital structure, amendments to the Company’s amended and restated certificate of incorporation or amended and restated by-laws, and the Company’s winding up and dissolution. The Company’s amended and restated certificate of incorporation provides that (i) so long as LLC beneficially owns, directly or indirectly, more than 40% of the Company's common stock any member of the board of directors or the entire board of directors may be removed from office at any time with or without cause by the affirmative vote of a majority of the Company’s common stock, and (ii) prior to the date the LLC ceases to beneficially own, directly or indirectly, 40% or more of the Company’s common stock, stockholders representing at least 40% of the Company's common stock may call a special meeting of the Company's stockholders.


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10. REVENUE FROM CONTRACTS WITH CUSTOMERS
Adoption of Topic 606, “Revenue from Contracts with Customers”

On December 28, 2017, the Company adopted Topic 606 using the modified retrospective method applied to those contracts, which were not fully satisfied as of December 28, 2017. Results for reporting periods beginning after December 28, 2017, are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

The cumulative catch-up adjustment recorded to accumulated deficit, as of December 28, 2017, was approximately $3.5 million, net of taxes, related to franchise and development fees.

Revenue Recognition

Nature of products and services
The Company has two revenue streams, company-operated restaurant revenue and franchise related revenue.

Company-operated restaurant revenue
Revenues from the operation of company-operated restaurants are recognized as food and beverage products are delivered to customers and payment is tendered at the time of sale. The Company presents sales, net of sales-related taxes and promotional allowances.
The Company offers a loyalty rewards program, which awards a customer one point for every $1 spent. When 100 points are accumulated a $10 reward to be used on future purchases is earned. 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 $10 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 $10 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. As of September 25, 2019 and December 26, 2018, the revenue allocated to loyalty points that have not been redeemed are $0.9 million and $1.0 million, respectively, which are reflected in the Company’s accompanying condensed consolidated balance sheets within other accrued expenses and current liabilities. The Company expects the loyalty points to be redeemed and recognized over a one-year period.
The Company sells gift cards to its customers in the restaurants and through selected third parties. The gift cards sold to customers have no stated expiration dates and are subject to actual and/or potential escheatment rights in several of the jurisdictions in which the Company operates. Furthermore, due to these escheatment rights, the Company does not recognize breakage related to the sale of gift cards due to the immateriality of the amount remaining after escheatment. The Company recognizes income from gift cards when redeemed by the customer.

Franchise and franchise advertising revenue
Franchise revenue consists of franchise royalties, initial franchise fees, license fees due from franchisees, IT support services, and rental income for subleases to franchisees. Franchise advertising revenue consists of advertising contributions received from franchisees. These revenue streams are made up of the following performance obligations:
Franchise license - inclusive of advertising services, development agreements, training, access to plans and help desk services.
Discounted renewal option.
Hardware services.
The Company satisfies the performance obligation related to the franchise license over the term of the franchise agreement, which is typically 20 years. Payment for the franchise license consists of three components, a fixed-fee related to the franchise/development agreement, a sales-based royalty fee and a sales-based advertising fee. The fixed fee, as determined by the signed development and/or franchise agreement, is due at the time the development agreement is entered into, and/or when the franchise agreement is signed, and does not include a finance component.
The sales-based royalty fee and sales-based advertising fee are considered variable consideration and will continue to be recognized as revenue as such sales are earned by the franchisees. Both sales-based fees qualify under the royalty constraint

27



exception, and do not require an estimate of future transaction price. Additionally, the Company is utilizing the practical expedient available under Topic 606 regarding disclosure of the aggregate amount of the transaction price allocated to the performance obligations that are unsatisfied for sales-based royalties.

In certain franchise agreements, the Company offers a discounted renewal to incentivize future renewals after the end of the initial franchise term. As this is considered a separate performance obligation, the Company allocates a portion of the initial franchise fee to this discounted renewal, on a pro-rata basis, assuming a 20-year renewal. This performance obligation is satisfied over the renewal term, typically 10 or 20 years, while payment is fixed and due at the time the renewal is signed.

The Company purchases hardware, such as scanners, printers, cash registers and tablets, from third party vendors, which it then sells to franchisees. As the Company is considered the principal in this relationship, payment for the hardware is considered revenue, and is received upon transfer of the goods from the Company to the franchisee. As of September 25, 2019, there were no performance obligations related to hardware services that were unsatisfied or partially satisfied.

Disaggregated revenue
The following table presents our revenues disaggregated by revenue source and market (in thousands):

 
Thirteen Weeks Ended
 
Thirty-Nine Weeks Ended
 
September 25, 2019
 
September 26, 2018
 
September 25, 2019
 
September 26, 2018
Core Market(1):
 
 
 
 
 
 
 
Company-operated restaurant revenue
$
90,277

 
$
87,634

 
$
264,391

 
$
257,437

Franchise revenue
3,696

 
3,712

 
11,369

 
10,697

Franchise advertising fee revenue
2,809

 
2,801

 
8,332

 
8,179

Total core market
$
96,782

 
$
94,147

 
$
284,092

 
$
276,313

Non-Core Market(2):
 
 
 
 

 

Company-operated restaurant revenue
$
8,775

 
$
12,390

 
$
31,950

 
$
36,767

Franchise revenue
3,577

 
2,953

 
10,266

 
8,627

Franchise advertising fee revenue
2,933

 
2,688

 
8,476

 
7,860

Total non-core market
$
15,285

 
$
18,031

 
$
50,692

 
$
53,254

Total revenue
$
112,067

 
$
112,178

 
$
334,784

 
$
329,567


(1) Core Market includes markets with existing company-operated restaurants at the time of the Company's Initial Public Offering ("IPO") on July 28, 2014.
(2) Non-Core Market includes markets entered into by the Company subsequent to the IPO date.
The following table presents our revenues disaggregated by geographic market:

 
Thirteen Weeks Ended
 
Thirty-Nine Weeks Ended
 
September 25, 2019
 
September 26, 2018
 
September 25, 2019
 
September 26, 2018
Greater Los Angeles area market
71.5
%
 
69.3
%
 
70.0
%
 
69.0
%
Other markets
28.5
%
 
30.7
%
 
30.0
%
 
31.0
%
Total
100
%
 
100
%
 
100
%
 
100
%


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Contract balances
The following table provides information about the change in the franchise contract liability balances during the thirty-nine weeks ended September 25, 2019 and September 26, 2018 (in thousands):

December 26, 2018
$
5,593

Revenue recognized - beginning balance
(283
)
Additional contract liability
1,367

Revenue recognized - additional contract liability
(211
)
September 25, 2019
$
6,466

December 27, 2017
$
5,799

Revenue recognized - beginning balance
(260
)
Additional contract liability
277

Revenue recognized - additional contract liability
(5
)
September 26, 2018
$
5,811



The Company’s franchise contract liability includes development fees, initial franchise and license fees, franchise renewal fees, lease subsidies and royalty discounts and is included within other accrued expenses and current liabilities and other noncurrent liabilities within the accompanying condensed consolidated balance sheets. The Company receives area development fees from franchisees when they execute multi-unit area development agreements. Initial franchise and license fees, or franchise renewal fees, are received from franchisees upon the execution of, or renewal of, a franchise agreement. Revenue is recognized from these agreements as the underlying performance obligation is satisfied, which is over the term of the agreement.

For the thirty-nine weeks ended September 25, 2019, there was an increase to the contract liability balance due to the Company's completion of 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. This resulted in an additional contract liability of $0.7 million, relating to allocation of the transaction price to various performance obligations under the applicable contracts of the sale.

The following table illustrates the estimated revenue to be recognized in future periods related to performance obligations under the applicable contracts that are unsatisfied as of September 25, 2019 (in thousands):

Franchise revenues:
 
2019
$
231

2020
707

2021
495

2022
414

2023
388

Thereafter
4,231

Total
$
6,466


Contract Costs
The Company does not currently incur costs to obtain or fulfill a contract that would be considered contract assets under Topic 606.

11. LEASES
Adoption of Topic 842 "Leases"
On December 26, 2018, the Company adopted Topic 842, using the effective date method, recognizing and measuring all leases that existed as of December 26, 2018. The Company recorded a cumulative-effect adjustment as of December 26, 2018. Comparative periods are presented in accordance with ASC Topic 840 and do not include any retrospective adjustments to

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comparative periods to reflect the adoption of Topic 842. All leases that either (1) commenced, or (2) were modified or re-measured after December 26, 2018 are accounted for under Topic 842.
As a result of Topic 842, the Company recognized a ROU Asset of $205.2 million and a lease liability of $222.3 million on its consolidated balance sheet as of December 27, 2018. However, there was not a material impact on the Company’s consolidated statement of operations or consolidated statement of cash flows.
Nature of leases
The Company’s operations utilize property, facilities, equipment and vehicles owned by the Company or leased from others. Additionally, the Company has various contracts with vendors that have been determined to contain an embedded lease in accordance with Topic 842.
As of September 25, 2019, the Company had no leases that it had entered into, but had not yet commenced. The Company has no involvement with the construction or design of the underlying asset until lease commencement.
Building and facility leases
Buildings and facilities leased from others are primarily for restaurants and support facilities. The majority of the Company’s leases are classified as operating leases; however, the Company currently has one finance lease.
Restaurants are operated under lease arrangements that generally provide for a fixed base rent and, in some instances, contingent rent based on a percentage of gross operating profit or net revenues in excess of a defined amount. Additionally, a number of the Company’s leases have payments, which increase at pre-determined dates based on the change in the consumer price index. For all leases, the Company also reimburses the landlord based on actual common area maintenance, property tax and insurance costs, making them variable consideration and excluding them from the calculations of the ROU Asset and lease liability.
The initial terms of land and restaurant building leases are generally 20 years, exclusive of options to renew. These leases typically have four 5-year renewal options, which have generally been excluded in the calculation of the ROU Asset and lease liability, as they are not considered reasonably certain to be exercised, unless (1) the renewal had already occurred as of the time of adoption of Topic 842, or (2) there have been significant leasehold improvements that have a useful life that extend past the original lease term. Furthermore, there are no residual value guarantees and no restrictions imposed by the lease.
During the thirteen and thirty-nine weeks ended September 25, 2019, the Company reassessed the lease terms on three and six restaurants, respectively. The reassessment was the result of triggering events, such as, the addition of significant leasehold improvements with useful lives that extend past the current lease expiration, the decision to terminate a lease or the decision to renew leases. This resulted in an additional $2.0 million and $3.3 million of ROU Asset and lease liability for the thirteen and thirty-nine weeks ended September 25, 2019, respectively, which will be recognized over the new lease term. The reassessment did not have any impact on the original lease classification. Additionally, as the Company adopted all practical expedients available under Topic 842, no reallocation between lease and non-lease components was necessary.
The Company also subleases facilities to certain franchisees and other non-related parties which are also considered operating leases. Sublease income also includes contingent rental income based on net revenues. The vast majority of these leases have rights to extend terms via fixed rental increases. However, none of these leases have early termination rights, the right to purchase the premises or any residual value guarantees. The Company does not have any related party leases.
Equipment
Leases of equipment primarily consist of restaurant equipment, copiers and vehicles. These leases are fixed payments with no variable component. Additionally, no optional renewal periods have been included in the calculation of the ROU Asset, there are no residual value guarantees and no restrictions imposed.
Significant Assumptions and Judgments
In applying the requirements of Topic 842 the Company made 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 the Company’s contracts contain a lease the Company made assumptions and judgments related to its 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.
The Company also made significant assumptions and judgments in determining an appropriate discount rate for property leases. These included using a consistent discount rate for a portfolio of leases entered into at varying dates, using the full 20-year term

30



of the lease, excluding any options, and using the total minimum lease payments. The Company utilized a third-party valuation firm in determining the discount rate, based on the above assumptions. For all other leases, the Company used the discount rate implicit in the lease, or the Company’s incremental borrowing rate.
As the Company has adopted the practical expedient not to separate lease and non-lease components, no significant assumptions or judgments were necessary in allocating consideration between these components, for all classes of underlying assets.
The following table presents the Company’s total lease cost, disaggregated by underlying asset (in thousands):
 
Thirteen Weeks Ended September 25, 2019
 
Thirty-Nine Weeks Ended September 25, 2019
 
Property Leases
Equipment Leases
Total
 
Property Leases
Equipment Leases
Total
Finance lease cost:
 
 
 
 
 
 
 
Amortization of right-of-use assets
$

$

$

 
$
9

$

$
9

Interest on lease liabilities
9


9

 
24


24

Operating lease cost
6,534

313

6,847

 
19,721

967

20,688

Short-term lease cost

9

9

 

26

26

Variable lease cost  
121

38

159

 
346

136

482

Sublease income
(722
)

(722
)
 
(1,623
)

(1,623
)
Total lease cost
$
5,942

$
360

$
6,302

 
$
18,477

$
1,129

$
19,606


The following table presents the Company’s total lease cost on the condensed consolidated statement of income (in thousands):
 
Thirteen Weeks Ended September 25, 2019
 
Thirty-Nine Weeks Ended September 25, 2019
Lease cost – Occupancy and other operating expenses
$
6,015

 
$
18,675

Lease cost – General & administrative
116

 
348

Lease cost – Depreciation and amortization

 
9

Lease cost – Interest expense
9

 
24

Lease cost - Closed-store reserve
162

 
550

Total lease cost
$
6,302

 
$
19,606


During the thirty-nine weeks ended September 25, 2019, the Company had the following cash and non-cash activities associated with its leases (in thousands):

31



 
Thirty-Nine Weeks Ended September 25, 2019
 
Property Leases
Equipment Leases
Total
 
 
 
 
Cash paid for amounts included in the measurement of lease liabilities
 
 
 
Operating cash flows used for operating leases
$
18,819

$
970

$
19,789

Financing cash flows used for finance leases
$
61

$

$
61

 
 
 
 
Non-cash investing and financing activities:
 
 
 
Operating lease ROU Assets obtained in exchange for lease liabilities:
 
 
 
Operating lease ROU Assets
$
8,832

$
36

$
8,868

 
 
 
 
Operating lease ROU Assets obtained and liabilities incurred as a result of adoption of ASC 842:
 
 
 
Operating lease ROU Assets
$
200,555

$
4,668

$
205,223

Operating lease liabilities
$
217,615

$
4,668

$
222,283

 
 
 
 
Other Information
 
 
 
Weighted-average remaining lease term—finance leases
3.08


 
Weighted-average remaining lease term—operating leases
12.21

3.08

 
Weighted-average discount rate—finance leases
11.1
%

 
Weighted-average discount rate—operating leases
4.4
%
4.0
%
 

Information regarding the Company’s minimum future lease obligations as of September 25, 2019 is as follows (in thousands):
 
Finance
 
Operating Leases
For the Years Ending
Minimum
Lease
Payments
 
Minimum
Lease
Payments
 
Minimum
Sublease
Income
December 25, 2019
$
14

 
$
8,935

 
$
651

December 30, 2020
54

 
24,619

 
2,612

December 29, 2021
54

 
26,616

 
2,635

December 28, 2022
45

 
25,569

 
2,537

December 28, 2023

 
23,023

 
2,558

Thereafter

 
157,549

 
19,394

Total
$
167

 
$
266,311

 
$
30,387

Less: imputed interest (3.98% - 11.1%)
(43
)
 
(49,558
)
 
 

Present value of lease obligations
124

 
216,753

 
 

Less: current maturities
(32
)
 
(17,904
)
 
 

Noncurrent portion
$
92

 
$
198,849

 
 


Information regarding the Company’s minimum future lease obligations at December 26, 2018 is as follows, under ASC 840 (in thousands):

32



 
Capital Leases
 
Operating Leases
For the Years Ending
Minimum
Lease
Payments
 
Minimum
Lease
Payments
 
Minimum
Sublease
Income
December 25, 2019
$
95

 
$
25,388

 
$
1,443

December 30, 2020
54

 
24,437

 
1,108

December 29, 2021
54

 
23,342

 
1,078

December 28, 2022
45

 
22,338

 
1,001

December 28, 2023

 
20,634

 
989

Thereafter

 
150,342

 
2,612

Total
$
248

 
$
266,481

 
$
8,231

Less: imputed interest (11.0% to 11.1%)
(64
)
 
 

 
 

Present value of capital lease obligations
184

 
 

 
 

Less: current maturities
(68
)
 
 

 
 

Noncurrent portion
$
116

 
 

 
 


Short-Term Leases
The Company has multiple short-term leases, which have terms of less than 12 months, and thus were excluded from the recognition requirements of Topic 842. The Company has recognized these lease payments in its consolidated statement of operations on a straight-line basis over the lease term and variable lease payments in the period in which the obligation for those payments is incurred.
Lessor
The Company is a lessor for certain property, facilities and equipment owned by the Company and leased to others, principally franchisees, under non-cancelable leases with initial terms ranging from three to 20 years. These lease agreements generally provide for a fixed base rent and, in some instances, contingent rent based on a percentage of gross operating profit or net revenues. All leases are considered operating leases.
For the leases in which the Company is the lessor, there are options to extend the lease. However, there are no terms and conditions to terminate the lease, no right to purchase premises and no residual value guarantees. Additionally, there are no related party leases.
For the thirteen and thirty-nine weeks ended September 25, 2019, the Company received $0.1 million and $0.4 million of lease income, respectively, from company-owned locations.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Cautionary Statement Concerning Forward-Looking Statements

This report contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact included in this report are forward-looking statements. Forward-looking statements discuss our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements because they do not relate strictly to historical or current facts. These statements may include words such as “aim,” “anticipate,” “believe,” “estimate,” “expect,” “forecast,” “outlook,” “potential,” “project,” “projection,” “plan,” “intend,” “seek,” “may,” “could,” “would,” “will,” “should,” “can,” “can have,” “likely,” the negatives thereof and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. They appear in a number of places throughout this report and include statements regarding our intentions, beliefs or current expectations concerning, among other things, our results of operations, financial condition, liquidity, prospects, growth, strategies and the industry in which we operate. All forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those that we expected.

33




While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors, and it is impossible for us to anticipate all factors that could affect our actual results. All forward-looking statements are expressly qualified in their entirety by these cautionary statements. You should evaluate all forward-looking statements made in this report in the context of the factors that could cause outcomes to differ materially from our expectations. These factors include, but are not limited to:

the adverse impact of economic conditions on our (i) operating results and financial condition, (ii) ability to comply with the terms and covenants of our debt agreements, and (iii) ability to pay or refinance our existing debt or to obtain additional financing;
vulnerability to changes in consumer preferences and economic conditions;
vulnerability to conditions in the greater Los Angeles area;
vulnerability to natural disasters given the geographic concentration and real estate intensive nature of our business;
ability to open new restaurants in new and existing markets, including difficulty in finding sites and in negotiating acceptable leases;
delayed or canceled future restaurant openings
restaurant closures, due to financial performance or otherwise;
increases in chicken and other input costs;
negative publicity, whether or not valid;
concerns about food safety and quality and about food-borne illness, particularly avian flu;
dependence on frequent and timely deliveries of food and supplies;
problems with our primary distributor;
our history of net losses, including the possibility of future net losses;
our ability to service our level of indebtedness;
our ability to compete successfully with other quick-service and fast casual restaurants;
underperformance of new menu items, advertising campaigns, and restaurant designs and remodeling activity;
our reliance on our franchisees, who may incur financial hardships, lose access to credit, close restaurants, or declare bankruptcy;
our limited control over our franchisees;
potential liability for franchisee acts;
ability to protect our name and logo and other proprietary intellectual property;
loss of the abilities, experience, and knowledge of current directors and officers;
matters relating to employment and labor laws;
impact from litigation such as wage and hour class action lawsuits;
labor shortages and increased labor costs;
our ability and the ability of our franchisees to renew leases at the end of their terms;
status of our relationships with franchisees;
impact from federal, state, and local regulations relating to preparation and sale of food, zoning and building codes, and employee, environmental, taxation and other matters;
impact from our income tax receivable agreement;
conflicts of interest with our largest stockholders;
that El Pollo Loco Holdings, Inc. is a holding company with no operations that relies on its operating subsidiaries to provide it with funds;
timing of our emerging growth company eligibility under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”);
the impact of any security breaches of confidential customer information in connection with our electronic process of credit and debit card transactions;
the impact of any failure of our information technology system or any breach of our network security;
changes in accounting standards; and
other risks set forth in our filings with the SEC from time to time, including under Item 1A, Risk Factors in our annual report on Form 10-K for the year ended December 26, 2018, which such filings are available online at www.sec.gov, at www.elpolloloco.com or upon request from El Pollo Loco.

We caution you that the important factors referenced above may not contain all of the factors that are important to you. In addition, we cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences we anticipate or affect us or our operations in the ways that we expect. The forward-looking statements included in this report are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as required by law. If we

34



do update one or more forward-looking statements, no inference should be made that we will make additional updates with respect to those or other forward-looking statements. We qualify all of our forward-looking statements by these cautionary statements.

Overview
El Pollo Loco is a differentiated and growing restaurant concept that specializes in fire-grilling citrus-marinated chicken and operates in the limited service restaurant (“LSR”) segment. We strive to offer the quality of food and dining experience typical of fast casual restaurants while providing the speed, convenience, and value typical of traditional quick-service restaurants (“QSRs”), a combination that we call “QSR+” and to provide a value-oriented fast casual dining experience. Our distinctive menu features our signature product—citrus-marinated fire-grilled chicken—and a variety of Mexican-inspired entrees that we create from our chicken. We offer our customers healthier alternatives to traditional food on the go, served by our team members in a contemporary restaurant environment. We serve individual and family-sized chicken meals, a variety of Mexican-inspired entrees, and sides. Our entrees include favorites such as our Chicken Avocado Burrito, Under 500 Calorie entrees, Double Pollo Bowl, and Stuffed Chicken Avocado Quesadilla. Our famous Creamy Cilantro dressings and salsas are prepared fresh daily, allowing our customers to create their favorite flavor profiles to enhance their culinary experience. Our distinctive menu with healthier alternatives appeals to consumers across a wide variety of socio-economic backgrounds and drives our balanced composition of sales throughout the day (our "day-part mix"), including lunch and dinner.
Growth Strategies and Outlook
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 September 25, 2019, we had 485 locations in six states. In fiscal 2018, we opened eight new company-operated and nine new franchised restaurants across Arizona, California, Utah, Louisiana and Texas. For the thirty-nine weeks ended September 25, 2019, we opened one new company-operated restaurants and two franchised restaurants in California. In 2019, we intend to open two to three new company-operated and two to three new franchised restaurants. To increase comparable restaurant sales, we plan to increase customer frequency, attract new customers, and improve per-person spend. These growth rates are not guaranteed.
Highlights and Trends
Comparable Restaurant Sales
System-wide, for the thirteen and thirty-nine weeks ended September 25, 2019, comparable restaurant sales increased by 1.1% and 1.4%, respectively, from the comparable periods in the prior year. For company-operated restaurants, comparable restaurant sales, for the thirteen and thirty-nine weeks ended September 25, 2019, increased by 1.6% and 1.2%, respectively. For company-operated restaurants, the quarter’s change in comparable restaurant sales consisted of a 2.0% increase in average check size, and a 0.4% decline in transactions and the year-to-date change in comparable restaurant sales consisted of a 3.3% increase in average check size, and a 2.1% decline in transactions. For franchised restaurants, comparable restaurant sales increased 0.6% and 1.5% for the thirteen and thirty-nine weeks ended September 25, 2019, respectively. Refer to Comparable Restaurant Sales definition in "Key Performance Indicators" section below.

35



Restaurant Development
Our restaurant counts at the beginning and end of each of the last three fiscal years and the thirty-nine weeks ended September 25, 2019, were as follows.  
 
Thirty-Nine Weeks Ended
 
Fiscal Year Ended
 
9/25/2019
 
2018
 
2017
 
2016
Company-operated restaurant activity:
 

 
 

 
 

 
 

Beginning of period
213

 
212

 
201

 
186

Openings
1

 
8

 
16

 
18

Restaurant sale to franchisee
(11
)