(EDGAR Online via COMTEX) -- 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
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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.
While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors, and it is impossible for us to anticipate all factors that could affect our actual results. All forward-looking statements are expressly qualified in their entirety by these cautionary statements. You should evaluate all forward-looking statements made in this report in the context of the factors that could cause outcomes to differ materially from our expectations. These factors include, but are not limited to:
the impacts of the COVID-19 pandemic on our company, our employees, our ? customers, our partners, our industry and the economy as a whole, as well as our franchisees' ability to maintain operations in their individual restaurants;
? our ability to open new restaurants in new and existing markets, including difficulty in finding sites and in negotiating acceptable leases;
? our ability to compete successfully with other quick-service and fast casual restaurants;
? vulnerability to changes in consumer preferences and economic conditions;
? vulnerability to political and social factors, including regarding trade, immigration or customer preferences;
? 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;
? the possibility that we may continue to incur significant impairment of certain of our assets, in particular in our new markets;
? changes to food and supply costs, especially for chicken;
? social media and negative publicity, whether or not valid, and our ability to respond to and effectively manage the accelerated impact of social media;
? our ability to continue to expand our digital business, delivery orders and catering;
? concerns about food safety and quality and about food-borne illness, particularly avian flu;
dependence on frequent and timely deliveries of food and supplies and our ? dependence on a single supplier to distribute substantially all of our products to our restaurants;
? our ability to service our level of indebtedness;
? uncertainty related to the success of our marketing programs, new menu items, advertising campaigns and restaurant designs and remodels;
our reliance on our franchisees, who may incur financial hardships, lose access ? to credit, close restaurants, or declare bankruptcy, and our limited control over our franchisees and potential liability for their acts;
? potential exposure to unexpected costs and losses from our self-insurance programs;
? potential obligations under long-term and non-cancelable leases, and our ability to renew leases at the end of their terms;
? the impact of any failure of our information technology system or any breach of our network security;
the impact of any security breaches of confidential customer data or personal ? information in connection with our electronic process of credit and debit card transactions;
? our ability to enforce and maintain our trademarks and protect our other proprietary intellectual property;
? risks related to government regulation and litigation, including employment and labor laws; 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 30, 2020, which filings are available online at www.sec.gov .
We caution you that the important factors referenced above may not contain all of the factors that are important to you. In addition, we cannot assure you that we will realize the results or developments we expect or anticipate or, even if substantially realized, that they will result in the consequences we anticipate or affect us or our operations in the ways that we expect. The forward-looking statements included in this report are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as required by law. If we do update one or more forward-looking statements, no inference should be made that we will make additional updates with respect to those or other forward-looking statements. We qualify all of our forward-looking statements by these cautionary statements.
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El Pollo Loco is a differentiated and growing restaurant concept that specializes in fire-grilling citrus-marinated chicken and operates in the limited service restaurant ("LSR") segment. We strive to offer food that integrates the culinary traditions of Mexico with the healthier lifestyle of Los Angeles, a combination that we call "LA-Mex." Our distinctive menu features our signature product--citrus-marinated fire-grilled chicken--and a variety of Mexican and LA-inspired entrees that we create from our chicken. We serve individual and family-sized chicken meals, a variety of Mexican and LA-inspired entrees, and sides, and, throughout the year, on a limited-time basis, additional proteins like shrimp. Our entrees include favorites such as our Chicken Avocado Burrito, Pollo Fit entrees, chicken tostada salads, and Pollo Bowls. Our famous Creamy Cilantro dressings and salsas are prepared fresh daily, allowing our customers to create their favorite flavor profiles to enhance their culinary experience. Our distinctive menu with better for you and more affordable alternatives appeals to consumers across a wide variety of socio-economic backgrounds and drives our balanced composition of sales throughout the day (our "day-part mix"), including at lunch and dinner.
During the COVID-19 pandemic, we have experienced periods of significant disruption to our restaurant operations. Following the pandemic declaration in March 2020, federal, state and local governments have periodically responded to the public health crisis by requiring social distancing, issuing "stay at home" directives, and implementing restaurant restrictions - including government-mandated dining room closures - that limited business to off-premise services only (take-out, drive-thru and delivery). Many state and local governments continue to periodically implement certain restrictions to try and contain the spread of the virus. As of September 29, 2021, all of our restaurants have dining rooms open at full capacity and continue to maintain take-away, mobile pick-up, delivery, and drive-thru operations where available. We continue to experience staffing challenges which resulted in reduced operating hours and service channels. Further, there have been inflationary pressures due to supply chain disruptions that have impacted our business and results of operations during the thirteen and thirty-nine weeks ended September 29, 2021.
During the thirteen and thirty-nine weeks ended September 29, 2021, we incurred $0.5 million and $3.5 million, respectively, in COVID-19 related expenses, primarily due to leaves of absence and overtime pay. During the thirteen and thirty-nine weeks ended September 23, 2020, the Company incurred $0.9 million and $2.0 million, respectively, in COVID-19 related expenses, primarily due to leaves of absence and overtime pay.
Growth Strategies and Outlook
As of September 29, 2021, we had 480 locations in six states. In fiscal 2020, we opened one new company-operated restaurant in Nevada, which was in process prior to the COVID-19 pandemic and our franchisees opened three new restaurants, two in California and one in Arizona. For the thirty-nine weeks ended September 29, 2021, two new company-operated restaurants were opened, one in Nevada and one in California, and no new franchised restaurants were opened, although we sold eight of our company-owned restaurants to a franchisee during the thirteen and thirty-six weeks ended September 29, 2021.
We plan to continue to expand our business, drive restaurant sales growth, and enhance our competitive positioning, by executing the following strategies:
? expand our restaurant base;
? increase our comparable restaurant sales; and
? enhance operations and leverage our infrastructure.
To increase comparable restaurant sales, we plan to increase customer frequency, attract new customers, and improve per-person spend. Success of these growth plans is not guaranteed.
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Highlights and Trends
Comparable Restaurant Sales
For the thirteen and thirty-nine weeks ended September 29, 2021, system-wide comparable restaurant sales increased by 9.3% and 12.5%, respectively, from the comparable period in the prior year. For company-operated restaurants, comparable restaurant sales for the thirteen and thirty-nine weeks ended September 29, 2021 increased by 4.8% and 8.1%, respectively. For company-operated restaurants, the quarter's change in comparable restaurant sales consisted of an approximately 3.5% increase in average check size and an increase in transactions of 1.2% and the year-to-date change in comparable restaurant sales consisted of a 6.6% increase in average check size and a 1.4% increase in transactions. For franchised restaurants, comparable restaurant sales increased 12.6% and 15.7% for the thirteen and thirty-nine weeks ended September 29, 2021, respectively. Refer to Comparable Restaurant Sales definition in "Key Performance Indicators" section below.
Restaurant Development Our restaurant counts at the beginning and end of each of the last three fiscal years and the thirty-nine weeks ended September 29, 2021, were as follows: Thirty-Nine Weeks Ended Fiscal Year Ended September 29, 2021 2020 2019 2018 Company-operated restaurant activity: Beginning of period 196 195 213 212 Openings 2 1 2 8 Restaurant sale to franchisee (8) - (16) - Closures - - (4) (7) Restaurants at end of period 190 196 195 213 Franchised restaurant activity: Beginning of period 283 287 271 265 Openings - 3 2 9 Restaurant sale to franchisee 8 - 16 - Closures (1) (7) (2) (3) Restaurants at end of period 290 283 287 271 System-wide restaurant activity: Beginning of period 479 482 484 477 Openings 2 4 4 17 Closures (1) (7) (6) (10) Restaurants at end of period 480 479 482 484
In 2020, we finalized a new restaurant design that we believe will clearly differentiate and communicate our brand, both on the exterior and interior. We believe that our remodels using this new design will result in higher restaurant revenue and a strengthened brand. As of September 29, 2021 we have completed 12 remodels using the new asset design including 10 this year. In fiscal 2021, we plan to complete a total of 10-12 company and 5-7 franchise remodels using the new design.
During the second quarter of 2017, we introduced a new loyalty rewards points program in an effort to increase sales and loyalty among our customers, by offering rewards that incentivize customers to visit our restaurants more often each month. Customers earn points for each dollar spent and as of August 4, 2020, 50 points can be redeemed for a $5 reward to be used for a future purchase. Prior to August 4, 2020, 100 points could be redeemed for a $10 reward. If a customer does not earn or use points within a one-year period, their account is deactivated and all points expire. Additionally, if a reward is not used within six months, it expires. When a customer is part of the rewards program, the obligation to provide future discounts related to points earned is considered a separate performance obligation, to which a portion of the transaction price is allocated. The performance obligation related to loyalty points is deemed to have
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been satisfied, and the amount deferred in the balance sheet is recognized as revenue, when the points are transferred to a reward and redeemed, the reward or points have expired, or the likelihood of redemption is remote. A portion of the transaction price is allocated to loyalty points on a pro-rata basis, based on stand-alone selling price, as determined by menu pricing and loyalty point's terms.
In addition, customers can earn additional points and free entrees for a variety of engagement activities. As points are available for redemption past the quarter earned, a portion of the revenue associated with the earned points will be deferred until redemption or expiration. As of September 29, 2021 and December 30, 2020, the revenue allocated to loyalty points that had not been redeemed was $0.7 million and $0.9 million, respectively, which is reflected in the Company's accompanying condensed consolidated balance sheets within other accrued expenses and current liabilities. The Company had over 2.5 million loyalty program members as of September 29, 2021.
Critical Accounting Policies and Use of Estimates
The preparation of our condensed consolidated financial statements in accordance with GAAP requires us to make estimates and judgments that affect our reported amounts of assets, liabilities, revenue, and expenses, and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under current circumstances in making judgments about the carrying value of assets and liabilities that are not readily available from other sources. We evaluate our estimates on an on-going basis. Actual results may differ from these estimates under different assumptions or conditions.
Accounting policies are an integral part of our condensed consolidated financial statements. A thorough understanding of these accounting policies is essential when reviewing our reported results of operations and our financial position. Management believes that the critical accounting policies and estimates discussed below involve the most difficult management judgments, due to the sensitivity of the methods and assumptions used. For a summary of our critical accounting policies and a discussion of our use of estimates, see "Critical Accounting Policies and Use of Estimates" in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our annual report on Form 10-K for the year ended December 30, 2020.
There have been no material changes to our critical accounting policies or uses of estimates since our annual report on Form 10-K.
Recent Accounting Pronouncements
Recent accounting pronouncements are described in Note 1, "Basis of Presentation and Summary of Significant Accounting Policies" in the Notes to Condensed Consolidated Financial Statements above.
Key Financial Definitions
Our revenue is derived from three primary sources: company-operated restaurant revenue, franchise revenue, which is comprised primarily of franchise royalties and, to a lesser extent, franchise fees and sublease rental income, and franchise advertising fee revenue. See Note 10, "Revenue from Contracts with Customers" in the Notes to Condensed Consolidated Financial Statements above for further details regarding our revenue recognition policy.
Food and Paper Costs
Food and paper costs include the direct costs associated with food, beverage and packaging of our menu items. The components of food and paper costs are variable in nature, change with sales volume, are impacted by menu mix, and are subject to increases or decreases in commodity costs.
Labor and Related Expenses
Labor and related expenses include wages, payroll taxes, workers' compensation expense, benefits, and bonuses paid to our restaurant management teams. Like other expense items, we expect labor costs to grow proportionately as our
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restaurant revenue grows. Factors that influence labor costs include minimum wage and payroll tax legislation, overtime, the frequency and severity of workers' compensation claims, health care costs, and the performance of our restaurants.
Occupancy Costs and Other Operating Expenses
Occupancy costs include rent, CAM, and real estate taxes. Other restaurant operating expenses include the costs of utilities, advertising, credit card processing fees, restaurant supplies, repairs and maintenance, and other restaurant operating costs.
General and Administrative Expenses
General and administrative expenses are comprised of expenses associated with corporate and administrative functions that support the development and operations of our restaurants, including compensation and benefits, travel expenses, stock compensation costs, legal and professional fees, and other related corporate costs. Also included are pre-opening costs, and expenses above the restaurant level, including salaries for field management, such as area and regional managers, and franchise field operational support.
Legal settlements include expenses such as judgments or settlements related to legal matters, legal claims and class action lawsuits.
Franchise expenses are primarily comprised of rent expenses incurred on properties leased by us and then sublet to franchisees, expenses incurred in support of franchisee information technology systems, and the franchisee's portion of advertising expenses.
Depreciation and Amortization
Depreciation and amortization primarily consists of the depreciation of property and equipment, including leasehold improvements and equipment.
Loss on Disposal of Assets
Loss on disposal of assets includes the loss on disposal of assets related to retirements and replacement or write-off of leasehold improvements or equipment.
Impairment and Closed-Store Reserves
We review long-lived assets such as property, equipment, and intangibles on a unit-by-unit basis for impairment when events or circumstances indicate a carrying value of the assets that may not be recoverable. We determine if there is impairment at the restaurant level by comparing undiscounted future cash flows from the related long-lived assets to their respective carrying values and record an impairment charge when appropriate. In determining future cash flows, significant estimates are made by us with respect to future operating results of each restaurant over its remaining lease term, including sales trends, labor rates, commodity costs and other operating cost assumptions. If assets are determined to be impaired, the impairment charge is measured by calculating the amount by which the asset carrying amount exceeds its fair value. This process of assessing fair values requires the use of estimates and assumptions, including our ability to sell or reuse the related assets and market conditions, which are subject to a high degree of judgment. If these assumptions change in the future, we may be required to record impairment charges for these assets and these charges could be material.
When the Company closes a restaurant, it will evaluate the ROU asset for impairment, based on anticipated sublease recoveries. The remaining value of the ROU asset is amortized on a straight-line basis, with the expense recognized in closed-store reserve expense, in addition to property tax and CAM charges for closed restaurants.
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Interest Expense, Net
Interest expense, net, consists primarily of interest on our outstanding debt. Debt issuance costs are amortized at cost over the life of the related debt.
Provision for Income Taxes
Provision for income taxes consists of federal and state taxes on our income.
Comparison of Results of Operations
Our operating results for the thirteen and thirty-nine weeks ended September 29, 2021 and September 23, 2020 and expressed as percentages of total revenue, with the exception of cost of operations and company restaurant expenses, which are expressed as a percentage of company-operated restaurant revenue, are compared in the tables below.
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