Del Taco Restaurants, Inc.
Q1 2021 Earnings Call Transcript

Published: 2 May 2021

[Operator:]

Thank you for standing by, and welcome to the fiscal first quarter 2021 conference call and webcast for Del Taco Restaurants, Inc. I would now like to turn the call over to Mr. Raphael Gross, Managing Director at ICR to begin.

[Raphael Gross:]

Thank you, operator, and thank you all for joining us today. On the call with me is John Cappasola, President and Chief Executive Officer; and Steve Brake, Chief Financial Officer. After we deliver our prepared remarks, we will open the lines for your questions. But first, let me remind everyone that part of our discussion today will include forward-looking statements. These statements are not guarantees of future performance and therefore, undue reliance should not be placed upon them. We do not undertake to update these forward-looking statements at a later date and refer you to today's earnings press release and our SEC filings for a more detailed discussion of the risks that could impact Del Taco's future operating results and financial condition.

[John Cappasola:]

Thank you, Raphael, and we appreciate everyone joining us today. We're pleased to have delivered a very strong first quarter that sets us up for a great year at Del Taco. Although the operating environment remains very difficult due to continued COVID-related impacts and very challenging labor availability, our team is doing an outstanding job growing sales by serving guests through our drive-thru, takeout and delivery channels while managing costs effectively. This resulted in significant first quarter restaurant contribution and adjusted EBITDA growth and margin expansion. First, let's review our first quarter performance and highlights. Following positive company and franchise same-store sales trends through the first 10 weeks of the quarter, which sequentially improved compared to the fourth quarter, we experienced accelerated sales growth in the final 2 weeks of the quarter as we cycled over the onset of COVID-19 last year. This resulted in first quarter system-wide comparable restaurant sales growth of 9.1%, consisting of a 14% increase at franchised restaurants and a 4.9% increase at company-operated restaurants. Our sales trends continue to be a geographic story as our non-California restaurants, which are primarily franchise operated, drove impressive comparable restaurant sales growth of 12% during the first 10 weeks prior to lapping the pandemic, which accelerated to growth of over 16% during the full 12-week fiscal first quarter. Restaurant contribution margin increased by 330 basis points to 16% due primarily to strong comparable restaurant sales, including 4% menu price coupled with food deflation and labor efficiencies. In terms of profit, adjusted EBITDA increased $2.9 million or over 33% to $11.6 million from $8.7 million while adjusted net income per diluted share increased to $0.07 from adjusted net loss per diluted share of $0.01 last year. Finally, while our net debt remained relatively consistent with Q4 last year, our adjusted EBITDA growth reduced our net-debt-to-adjusted EBITDA leverage ratio to approximately 1.87x from 1.96x.

[Steven Brake:]

Thank you, John. During our 12-week fiscal first quarter, total revenue increased 5.2% to $115.5 million from $109.8 million in the year-ago first quarter. Company restaurant sales increased 3.2% to $103.6 million from $100.3 million in the year-ago period. This growth was primarily driven by the positive comparable restaurant sales.

[Operator:]

. Our first question comes from the line of Alex Slagle with Jefferies.

[Alex Slagle:]

Good to see everything accelerating here. I had a question on development. I know you picked up the pace of conversations with new and existing franchisees about signed development agreements. So just curious what these conversations have been like, sort of the reaction to the new prototype and the performance of your existing franchise base and if you've had any evolution in the composition of those interested parties and maybe their preferences. It used to be that buy and hold was the strategy, but I just wonder how that's evolved.

[John Cappasola:]

Yes. Alex, so first off, definitely continue the theme from the last call, which is the combination of the launch of the Fresh Flex prototype, which really creates nice opportunity for any active developer as they think about growing Del Taco, that's definitely a piece of the puzzle as we think about the kind of flexibility you need to access real estate; and then also the -- obviously, having the tech integration to be able to meet consumer demand. So really getting lots of positives on Fresh Flex and feel really great about moving that prototype forward. In addition, as we've been trumpeting here for a bit, the 8th consecutive year of positive same-store sales growth on the franchise business has been a big deal, and it's been nice to be able to really kind of actively talk about that 2 prospects. And so those are probably the 2 big things that are going in our favor right now and causing a real influx of conversations to occur, especially in the territories that we're looking to grow and underserved or underpenetrated territories. And that obviously culminated to a couple of deals getting signed here recently, and there's many more conversations kind of happening. And how many of those come through to actual deals, we'll see, but we certainly have momentum in this area. And I'd say, in regards to the quality of the candidate, yes, we're seeing a really nice quality candidate coming to the table that wants to grow from restaurant 1 and doesn't necessarily want to build, but that -- or want to buy. But that buy dynamic is still out there and we hear that from time to time. But I'd say, right now, we're hearing a nice -- a bit of a mixture on that right now that's allowing for probably more meaty conversations across the board. So we feel good about the progress we've made on that front.

[Alex Slagle:]

Great. And then the delivery pricing that you took in the third quarter, I mean, it sounds like not a whole lot of pushback now that it's gone up to 7% of sales. But just kind of interested in what the reaction has been. And I guess some of that is the price in that mix, but any thoughts on what the reaction has been?

[Steven Brake:]

Sure, Alex. It's Steve. We did take that price increase up to 20% early Q3 last year. That followed a lengthy test of that during the first half of 2020, and certainly, during that test, we did not sense or detect any notable elasticity, which enabled us to make the move. And clearly, delivery kind of held and has since accelerated sequentially as we moved into the new year. So we feel really good about that pricing level that we've enacted, definitely goes a long way towards managing margins. So overall, we feel good about the model that we've created. We're at the point where we're limiting the impact on margins and we're getting a similar penny profit/dollar, if you will, flow-through on delivery that we'd see at a restaurant transaction. That flow-through might be a little smaller on a percent basis that could pressure margins, but really, we also believe a good amount of this delivery is incremental, which, as you know, creates leverage in other areas of the P&L. So overall, the strategy, the 20%, we think it really neutralizes any overall restaurant margin pressure and probably puts us at the point where we're generally agnostic between a delivery transaction with a much higher check that we continue to see versus something at stores. So we feel good about that.

[Operator:]

Our next question comes from the line of Nick Setyan with Wedbush Securities.

[Nerses Setyan:]

Congratulations on some really great results. It's great to hear the quarter-to-date trends as well. Steve, just given the top line trends, particularly the stepped-up trends in April here on the company-owned stores, is there any chance you can maybe bracket the 4-wall margin guidance a little bit more than modest improvements? It seems like the food cost inflation guidance is pretty much the same. The marketing expense through the year was already known. Any chance you could help us maybe bracket that a little bit more than modest improvement year-over-year?

[Steven Brake:]

Yes. We certainly feel pretty good about Q2. It's more of a normalized outcome. Also pointing out that Q4 was more of a normalized margin. The one little deviation a year ago, Q3 was very strong, came in at 18% that quarter. Each of food, labor and OpEx ran the lowest all year on a percent basis among the 4 quarters. So Q3 will certainly be the challenging quarter in terms of margin performance, but I feel otherwise -- particularly good about Q2. On the food line, overall, incredible outcome, sub 26% in the first quarter. We mentioned that, that will move to some slight inflation from deflation as we get into Q2, with second half having more notable, modest inflation on the food line. So overall, that's a little more color on the food line. Then labor and OpEx, those 2 line items, as we move seasonally out of Q1 that historically has lower AUVs into higher seasonality quarters, certainly, those 2 lines sequentially will lever as we move forward. And really, as we especially think about second half, notably, we're going over a great second half last year. Company was up low single digits, a nice strong 2% in Q3. And franchise also -- great performance for them as well. The New Crispy Chicken launch kind of was really the catalyst that drove some of those sales. And notably, as sales recovered last year, a lot of strong labor and other operating efficiencies were kicking in. So we had some pretty good performance second half. So as we look at back half this year, where sales are in terms of magnitude of sales growth is going to heavily inform what that margin looks like in the second half. So it's a little early to put a finite color on that. We are still inching our way out of a pandemic, but feel really good. Everything John touched on, the brand is well positioned. We feel great about the sales line, which will lead the comfort on the margin line. But naturally, things have to play out. And hopefully, that's a little added color for you.

[Nerses Setyan:]

And then, obviously, marketing spend this year should be a lot of ammunition just year-over-year in terms of the normalization even as we kind of go over second half. Any chance you could kind of -- even if you don't tell us the exact number of spending, but at least just directionally, Q2, Q3, Q4, if there's certain quarters where marketing is maybe more concentrated than others.

[Steven Brake:]

Where we are right now, overall, our model is to deploy 4% in a given fiscal year. Notably, last year, due to some reduction in advertising during the height of the pandemic, 2020, we spent 3.7%. So right there, we'll have a 30 basis point headwind on the margin line just due to that. So notably, when we talk about modest restaurant margin expansion, that includes absorbing that 30 bps. So as far as where we sit right now, we spent a little under 4% during the first quarter. In general, the next few quarters will be in that 4% area. Likely Q3 will be a bit higher. That's our toughest sales comparisons. We want to really have strong advertising deployment that quarter to help sustain our sales trends. And what we're lapping -- Q2 and Q3, those were the 2 quarters where a year ago, we deployed around 3%. So that right there suggests you're looking at a full percentage plus of headwind in each of those quarters. And then the fourth quarter, probably more level in that kind of 4% area. So that's a little bit of color on the cadence of our advertising line. That is inside operating expense, as most of you know.

[Nerses Setyan:]

Got it. And then just lastly, any chance we could see further price increases on delivery going forward, just given the trend across the industry seems to be that there's very little pushback on further increases?

[Steven Brake:]

Yes. Good question. Very topical, top of mind here. We are currently testing 25%. So that test is underway and will lead to a decision down the road here.

[Operator:]

Our next question comes from the line of Joshua Long with Piper Sandler.

[Joshua Long:]

I wanted to follow up on that last point on the testing of the 25% menu price and then some of your earlier comments, Steve, in terms of being able to mitigate some of that margin pressure with the 20% increase. And maybe really just summarizing, the question is does 25% really get you to where you're fully agnostic? Does that just narrow that gap a little bit more? Just trying to get a sense of where we are in that ultimate long-run potential of being truly agnostic between in-store and delivery.

[Steven Brake:]

I would say due to the 1.85x area average elevated check we're seeing on delivery, with today's 20% premium, the dollar flow-through on a delivery transaction truly is lined up with what we see at the restaurant on a more normalized check average. So we're kind of already there. So I mentioned that on a margin percent basis, maybe a slight drag. But if we indeed prove out and move to 25%, I would say we're clearly agnostic certainly on the dollar flow-through line item and even on the margin point, where we might even be agnostic, skewing towards very much fine with delivery. I mean it's definitely a proven meaningful channel. That's not going to change. So naturally, our view is to continue to nurture that. And it goes back to ultimate convenience, making sure the guests can use us how, when and where they want to use us. So that will remain core to our strategy.

[Joshua Long:]

Understood. Very helpful color there. And then thinking back to maybe John's comments on the geographic story and how this is playing out. We've been talking about this for a while, and so that definitely makes sense. And I was curious if we could dig deeper into understanding some of the consumer behavior beneath that trend. When you think about or look at the transaction data and think about your consumers in those various markets, are they acting differently above and beyond just the restrictions and maybe the changes in kind of behavioral patterns in terms of going to the office or having area restrictions in terms of daytimes? Anything else you can glean in terms of how the consumer is using and engaging with your concept across those various geographies that's worth noting?

[John Cappasola:]

Yes, sure. I think first off, I think the good news on this is that -- those 3 counties that we've been highlighting for a few calls now, L.A., Orange and Clark, could have really lagged relative to the other company markets, which have all generally been positive. I guess the good news is we're starting to see some positive trends in those markets from a perspective of they're moving in the right direction, right? They're progressing. So although they're not all where we want them to be just yet, we definitely see that a combination of kind of factors are happening. When you look at a couple of the markets, I think it's a, L.A. County and Clark in particular, they had significant unemployment headwinds as well relative to national trends and what we were seeing. So good news is some of those trends have started to improve with progress over the last few periods, Josh. So we think that will help those particular counties as unemployment kind of normalizes there a bit more. And then the other dynamic, you kind of hit the nail on the head, which is a few of these counties -- Orange County is a great example. Lots of inflow into Orange County from other counties for daytime employment and many more kind of white collar jobs in Orange County, more office buildings, things of that nature that have been very virtual, as we all know. So as some of that starts to come back, we expect a county like Orange to start to normalize a bit more relative to the type of occasions that we serve during the day. So those are some of the things relative to those 3 counties. But I think Steve and I sitting here today, we feel pretty good about the fact that they're moving in the right direction. They're not exactly where we want them, but over time, we do believe that we'll get back to more normalized behavior in those counties, which will certainly help the company trend because as we've noted, it's a high concentration of company stores coming out of those counties.

[Joshua Long:]

Understood. And my last question was circling back to your comments around the labor approach and how you were both working bottoms up and then kind of widening your funnel. And I'm curious to understand more about that and what you've learned to date or what maybe some of the early wins have been in terms of really being able to try to maybe outmaneuver some of that -- I wouldn't call it labor shortage, but some of the pressure just on really refilling that or building that human capital pipeline, which is a crucial piece to both the brand and your historical successes.

[John Cappasola:]

Yes. Let me give you more color on that. So on a system-wide basis, so on a national basis for us, for Del Taco, we've definitely seen applicant flow slow down, right? So that's an early indicator. That's an important one to recognize. But turnover has been very stable in Q1 and so far in Q2. And then when you look at the operations further, you're seeing the fact that there hasn't been a major impact on our business just yet. As I noted on the call, our operating guest metrics have been stable and improving. You heard that guest OSAT increased by 3.6% in Q1 and then lunch drive-thru speed was better by 3%. So it's safe to say that our system-wide same-store sales are not being materially impacted at this point. However, there are pockets of stores being affected. And the big key here is we need to stay ahead of the applicant flow and stay focused on maintaining strong staffing levels system-wide so this doesn't become a problem for Del Taco, and that's what we're doing. I mean that's my comments on best practice sharing. We're doing that with franchise owners. We're doing that with our operators. And then we've got the addition of new recruiting tactics, including an enhanced employee referral program that we're rolling out, and then our franchisees have decided to do that as well. So it's both company and some franchise momentum in that. We've also got new and improved restaurant signage that has gone up that includes starting wage in the stores that really need to kind of talk about that and make that top of mind for consumers coming in because sometimes those best consumers can turn into your best employees. And then we've got some new instant interview -- a new instant interview process to quickly connect with potential applicants. So that's about speed, just getting them through the application very quickly and hired very quickly so we don't miss the opportunity. So again, not an issue that we're seeing in regards to business performance right now but definitely some early indicators in regards to applicant flow that we are trying to stay ahead of.

[Joshua Long:]

Understood. And then just one point of clarification on that. Are these relatively new initiatives here, say, in 2021 or first quarter? Or have we been -- have you been layering in some of these over time? Just trying to get a sense of the timing of these pieces.

[John Cappasola:]

Combination. There's some that we're layering in, and there are some that we're just reinforcing or refreshing, if you will.

[Operator:]

. Our next question comes from the line of Todd Brooks with CL King & Associates.

[Todd Brooks:]

Congratulations on the great momentum we're seeing in the business, really great to see. So if we can talk first about kind of that pipeline of active discussions on the potential franchisee partner side, 2 announced deals, nice size in the Southeast. Obviously, you said multi-branded, other QSR operator, so it seems like the type of franchisees that you want to be bringing into the fold. If you look at the pipeline of discussions, are they skewing to the Southeast just from the development opportunity, where I think you think that could be a couple of hundred store market? Or what's the breadth of where you're seeing kind of that best, most intense level of franchisee interest?

[John Cappasola:]

Yes. It's really over the breadth of our operating geographies and some new territories that folks are interested in. I mean the reality is you've got a lot of underpenetrated markets in the Western third, where we currently operate in, and we're seeing interest there and also seeing existing franchisees really excited about Fresh Flex. And then obviously, the Southeast has been a priority market for us, and we've been doing a lot of work down there to grow our presence. So good news there is both of these deals, obviously, are in the Southeast, and there's more conversations happening in the Southeast because of the presence and how the brand is building down there. I think that gives folks more confidence in regards to the brand's ability to perform, and that causes more material conversations to happen. So that certainly happened in the Southeast. And then we're getting approached from a new market perspective, folks that want to go in, in Greenfield, a new market that they feel like they can be first mover. And so there's a few of those conversations happening, Todd. So definitely, the Southeast is a priority and we're all over the Southeast, but there's more conversations going on right now than just the Southeast.

[Todd Brooks:]

That's helpful. Second, kind of following up on some of Josh's questions about labor. If you look at -- the way that you characterized it, that it's not a constraint yet but the front end of the pipeline has slowed so you want to bolster the applicant pipeline. If you look at areas of the business that are coming back, and I'm thinking specifically graveyard, is the labor pinch being felt with staffing that daypart or maybe reopening that daypart in some of the units because you're having challenges staffing up for that? And is that an opportunity, once we get over this staffing challenge, for even better same-store sales results than what you're reporting now?

[John Cappasola:]

Yes. So we're not seeing that just yet outside of just a few -- obviously, a few restaurants that are those pockets of opportunities that we're seeing and I'm sure many other brands are seeing. So just not yet in regards to the trends. Now hours of operations have been a piece of the shoulder dayparts for us over the last year or so. As you recall, we've culled some hours here and there to optimize profitability, and we're not fully back to pre-COVID level hours of operations across the system just yet, although we're building our way back there. So -- and that's part of the tailwind that we're seeing at late night, certainly part of some of what we may see at breakfast over time here over the coming quarters. It's not material enough to have affected our Q1 same-store sales, but obviously, the daypart -- in a vacuum from a percentage standpoint, it's going to help the daypart as you have more hours of operations. So I think the balance that we're striking right now is where we have those issues, we're probably not adding those hours back just quite as quickly, which isn't in a lot of restaurants and in a lot of markets just yet. And in the other markets or restaurants where we're not having the issue quite as bad on the staffing front, we're probably still not quite where we were pre COVID in regards to hours of operation. So it's a balancing act that we're playing right now in regards to the staffing and dayparts. But like I said, the key for us right now across the system is staying very focused on this applicant funnel and staying ahead of the game here. I mean we expect to have a few issues here and there, but we do not expect for this to be a system-wide brand issue because we are actively and vigorously managing it.

[Todd Brooks:]

That's very helpful. And then final one for me. You talked, I believe it was on the last conference call, about the possibility of a couple of new platforms, product platforms this year. You just talked about breakfast with the late summer launch, timing it for kind of an early fall, hopefully, return-to-office type of scenario. With the rebound that you're seeing in graveyard currently, would that support pivoting that way from a platform or product newness standpoint? Or does it recovering on its own actually gets you to pivot towards more of the core dayparts as far as a potential new platform?

[John Cappasola:]

Yes. Let me -- platforms are going to continue to be -- let me just hit that first. Product platforms in particular are going to continue to be something that we will actively be developing against and innovating against. And every year, you'll likely see us deploy some level of product platform to keep our news fresh and interesting. And then, obviously, developing products against those platforms are really key as well. So excited about what's happening with breakfast. I think we've got a great platform to deploy that represents value in mid-tier really well, and the consumer is going to love it. And we'll see what it does for the daypart. Some of that is definitely macro, but we do expect to start to see more normalized behavior, especially as we move into the fall. So we're anticipating that, and we want to try to get ahead of that with some new products and some new exciting news from Del Taco at that daypart. In regards to late night, our late night and graveyard business have really been heavily influenced by the delivery channel, both over-indexed from a percent of sales perspective compared to other dayparts. So as you heard, we're running higher so far this year from a delivery perspective both quarter-to-quarter, Q4 to Q1, as well as year-on-year. So that extra momentum we're feeling on delivery with that over-indexing that's happening with graveyard and really late night behavior is definitely translating into those later dayparts. So it feels like, Todd, to me, that the good play right now or the right play right now for us, given that we're seeing that kind of momentum is to continue to harness delivery, continue to leverage the fact that maybe more folks are out and about again with more normalized evening activity. That will continue to build, we believe, through the summer. And we probably don't need to go the route of a product platform just yet at late night, just really operate well, do delivery well and make sure we take advantage of the added traffic that may be in the marketplace in the evening over the summer. So that's how we're thinking about it right now.

[Operator:]

We have reached the end of our question-and-answer session and the conclusion of today's call. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.