Del Taco Restaurants, Inc.
Q1 2018 Earnings Call Transcript

Published: 4 May 2018

[Operator:]

Greetings and welcome to the Fiscal First Quarter 2018 conference call and Webcast for Del Taco Restaurants, Inc. [Operator Instructions]. It is now my pleasure to introduce your host, Raphael Gross with ICR. Thank you Mr. Gross, you may begin.

[Raphael Gross:]

Thank you, operator, and thank you all for joining us today. On the call with me are John Cappasola, President and Chief Executive Officer and Steve Brake, Executive Vice President and Chief Financial Officer. After John and Steve deliver their prepared remarks, we will open the lines for your questions. Before we begin, I'd like to remind everyone that part of our discussion today will include some 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 the SEC filings filed by Del Taco Restaurants Incorporated for a more detailed discussion of the risks that could impact future operating results and financial condition. Today's earnings press release also includes non-GAAP financial measures such as adjusted EBITDA and restaurant contribution. Non-GAAP financial measures should not be considered as alternatives to GAAP measures such as net income, operating income, net cash flows provided by operating activities or any other GAAP measure of liquidity or financial performance. We refer you to today's earnings press release, which includes the reconciliations of the non-GAAP measures to the nearest GAAP measures. I would now like to turn the call over to John Cappasola, Chief Executive Officer.

[John Cappasola:]

Thank you Raphael. Good afternoon everyone and thank you for joining the call today. Restaurant results in the first quarter were generally in line with our expectations demonstrating the power of our everyday value in barbell menu strategy in what remains a highly competitive environment. We are pleased to reaffirm our annual guidance as we remain focused on strengthening Del Tacos brand position, driving same store sales growth and optimizing restaurant level margins. We believe our late June launch of Elevated Combined Solutions will help achieve these objectives. System-wide comparable restaurant sales growth was 3.7% or 7.9% on a two-year basis consisting of company operated comparable restaurant sales growth of 2.6% and franchise comparable restaurant sales growth of 5.2%, extending our streak of company and system comparable restaurant sales gains to 23 and 18 consecutive quarters respectively. The gap between company and franchise comparable restaurant sales performance was driven by average check growth from elevated franchise price increases as well as transaction growth. The transaction growth difference includes the transfer of existing restaurants to more engaged franchise owners in recent years and franchisees embedding speed of service and guest experience initiatives. As you know, the company has been leading the way with best practices in these areas and we're pleased our franchise supports strategy over the last couple of years is yielding great results across markets. In addition, the very cold and wet weather in California the last two weeks of Q1 caused our system-wide same-store sales to erode slightly below the 4% achieved through ten weeks. This also disproportionally impacted company restaurants due to our 80% plus California footprint while franchise restaurants sustained a mid-single digit same store sales trend during the same two weeks. The first quarter began with a strong value focus led by Buck & Under through the launch of our new dollar Salsa Chicken Taco. Buck & Under is a unique platform with up to 15 items for a dollar or less and continues to be a key component of our everyday value strategy. Buck & Under allows us to promote value without sacrificing margins and is integral to driving our value and affordability perceptions. Our Buck & Under focus was followed by our seafood promotion including our popular jumbo shrimp in advance of Lent which began two weeks earlier this year. The guest response was very positive with the seafood mix achieving approximately 10% while our operations team drove continued year-over-year improvement in guest satisfaction and throughput at key dayparts. We were particularly pleased with our Q1 restaurant contribution margin which reflected a modest 50 BIP's of deleverage after adjusting for the timing of advertising. This is in with our belief that Q1 will have the lowest level of menu price coupled with the highest level of expected food inflation this year. We are confident our margin management plan will position us to achieve additional menu pricing, lower food cost inflation net of supply chain strategies and optimized labor to help deliver improved restaurant contribution dollar and margin trends compared to Q1. We believe these structural enhancements will position us to deliver on our guidance for 2018 and continue our track record of near 20% restaurant contribution margins since Fiscal 2015. Regarding menu price, after carrying 2.5% during Q1, our summer and fall increases are expected to drive menu price of nearly 3% during Q2, nearly 3.5% during Q3 and up to 4% during Q4. We plan to expand the Buck & Change section of the Buck & Under menu to nearly all system restaurants as part of this incremental menu price. Buck & Change is a part of our strategic approach to evolve our value platform and expand the mid-tier of our menu. Buck & Change will complement the Buck & Under menu and represents a path to migrate select products beyond a dollar price point over time. Buck & Change is a proven concept that has been used within the Buck & Under menu in most system restaurants with strong performance. To be clear, Buck & Under will not go away; rather, we will continue to leverage Buck & Under with ongoing innovation. For instance, upon the launch late June of Elevated Combined Solutions, we will expand Buck & Change and launch a new dollar grilled chicken quesadilla snacker on the Buck & Under menu in all restaurants to help drive transactions and maintain strong value perceptions. We believe this approach and the compelling value offered across our barbell menu will help achieve elevated pricing with a limited adverse impact on transactions. On the cost management front, we continue to make progress on supply chain strategies including portion optimization on select items that do not adversely impact guest experience. Within the restaurants we plan to roll out new prep equipment in Q3 to enhance quality and reduce labor hours and also leverage enhanced labor scheduling techniques to optimize labor. As we look ahead to the second half of the year, we're excited about the launch of our next generation Combined Solution Strategy. Elevated Combined Solutions is set to roll out at the start of Fiscal Q3 and includes brand catalysts and operational improvements designed to further elevate our brand position through a deeper understanding of our quality and freshness attributes while maintaining focus on our value and speed brand strengths. On the brand side we will launch a new advertising campaign highlighting our Fresh Prep, refresh all of our menus and marketing communications and introduce new Buck & Under, mid-tier and premium products throughout the back half of the year including a new Del Taco Plato. Additionally, during the second half we will expand our third party delivery offering and launch the Del Taco mobile app with enhanced marketing capabilities including the use of targeted promotional offers to drive guest frequency. The platform can also support a future loyalty program which we believe will be a powerful marketing tool in the future. Operations has been preparing for the launch of Elevated Combined Solutions with our spring general manager leadership academies focusing on best practices from high performing restaurant leaders, training enhancements through an updated eLearning platform and elevating our hospitality overall at Del Taco. We continue to believe that we are in the early stages of this journey and Elevated Combined Solutions will further strengthen our brand, drive same-store sales growth and facilitate restaurant contribution margin optimization. Entering Q2, we launched a successful two for $5.00 promotion that allowed guests to mix and match our popular classic burritos and we recently launched Carnitas as an LTO. Carnitas is a fan favorite with premium positioning and pricing which we expect to drive improved traffic and mix trends during the balance of Q2. Through the first five weeks of Fiscal Q2 company and franchise comparable restaurant sales are up over 1% and over 3% respectively. While each lap, our most challenging prior year comparisons over 8% during the same five weeks resulting in strong two-year trends thus far during the quarter. We are very pleased with the continued strength within our franchise base which spans 13 total states and we believe the continued AUV growth is exactly why we are seeing increased traction on franchise development across the country from both existing and new franchisees. This increased franchise development activity along with the recently announced seven-unit development agreement with a new franchisee in Atlanta, bolsters our confidence that franchise development will play an important role in our future system-wide unit growth. During the first quarter we opened three company-operated restaurants while one franchise restaurant closed. Looking ahead, we remain on track to open 25 to 28 units system-wide in 2018. As we make progress on our margin management initiatives, menu price and food inflation are both expected to sequentially move in our favor and prior year same-store sales comparisons ease. We believe these trends coupled with the upcoming launch of Elevated Combined Solutions with enhanced marketing and advertising, menu innovation and operational initiatives has us well positioned to drive sales momentum and improved restaurant contribution performance in the second half of the year and beyond. With that, I'll turn the call over Steve to review our quarterly results in detail.

[Steven Brake:]

Thanks John. Total first quarter revenue was $112.6 million, an increase of 6.8% from the $105.3 million in the year-ago first quarter and included $2.9 million of franchise advertising contributions and $0.2 million of other franchise revenue related to the adoption of the new revenue recognition rules. Excluding these revenue recognition impacts, total revenue grew by approximately 3.9%. System-wide comparable restaurant sales increased 3.7% and lapped system-wide comparable restaurant sales of 4.2% during the first quarter of 2017 resulting in a strong 7.9% two-year trend. The Del Taco system has now generated 18 consecutive quarters of positive same-store sales. First quarter, company restaurant sales increased 3.8% year-over-year to $105.1 million from $101.2 million in the year-ago period. The increase was driven by company operated comparable restaurant sales growth of 2.6% along with contributions from additional company operated stores as compared to the first quarter of last year. The first quarter company operated comparable restaurant sales growth represents the 23rd consecutive quarter of gains. Comparable restaurant sales growth was comprised of a 2.6% increase in check resulting primarily for menu price increases and flat transactions. Franchise revenue increased 5.0% year-over-year to $3.8 million from $3.6 million last year. The increase was driven by strong franchise comparable restaurant sales growth with 5.2%, additional franchise restaurants compared to the first quarter last year and other franchise revenue related to the adoption of a new revenue recognition rules partially offset by reduced initial fees. Moving on to expenses. Food and paper costs as a percentage of company restaurant sales were unchanged year-over-year at 27.6% as food inflation was approximately offset by the impact in menu price increases. Looking ahead, we expect net food inflation at or under 1% in each of the next three quarters and continue to expect annual 2018 net food basket inflation of approximately 1%. Labor and related expenses as a percentage of company restaurant sales increased approximately 30 basis points to 33.1% from 32.8%. This increase was primarily driven by the January 1, 2018 California minimum wage increase to $11.00 an hour and the Los Angeles County and Pasadena escalations to $12.00 an hour on July 1, 2017 which impacted 27 company restaurants. This wage inflation was mostly offset by the impact of menu price increases and reductions in workers compensation expense based on underlying claims activity. Occupancy and other operating expenses as a percentage of company restaurant sales increased by approximately 40 basis points to 20.9% from 20.5% last year. Half of the increase was from higher advertising expense based on the timing of advertising with a balance due to increase repair, maintenance, credit card fee and occupancy expenses as a percentage of company restaurant sales. We expect continued operating expense inflation which may impact our offering expense as a percent of restaurant sales depending on the strength of same-store sales growth. Based on this performance, restaurant contribution dollars were about flat at $19.3 million compared to $19.4 million in the prior year. Restaurant contribution margin decreased approximately 70 basis points to 18.4% from 19.1% including 20 basis points of pressure due to the timing of advertising. General and administrative expenses were $10.4 million and as a percentage of total revenue increased by approximately 50 basis points year-over-year to 9.3%. This increase was driven by increased legal and related expenses, increased stock-based compensation expense, incremental SOX 404(b) compliance costs and expense side of the other franchise revenue that is now reported on a gross basis partially offset by reduced performance based management incentive compensation. Although the timing of our G&A resulted in a level of front loading this year, looking ahead, we believe we are on track to meet our full year G&A guidance. Adjusted EBITDA decreased 4.8% for $13.9 million from $14.6 million last year. As a percentage of total revenues, adjusted EBITDA was 12.4%, down 150 basis points from 13.9% last year. Depreciation and amortization expense in the first quarter was $5.9 million, an increase of 15.9% compared to $5.1 million last year. As a percentage of total revenue, depreciation and amortization was 5.3% compared to 4.8% last year. The increase was driven by the addition of new assets and the write-off of the franchise right asset related to the franchise restaurant that closed in the first quarter. Interest expense was $1.9 million compared to $1.5 million in the prior year. The increase was due to an increased one month LIBOR rate and increased average outstanding total indebtedness compared to the first quarter of 2017 and we expect an increased year-over-year trend to continue due to the rising interest rate environment. As of the end of the first quarter, $154 million was outstanding under our all revolving credit facility while our applicable margin for LIBOR loans remained at 1.75%. In addition, during the quarter we recorded a $0.1 million net loss on disposal of assets related to two temporary closures mostly offset by insurance recovery and a gain on disposal of assets. The two temporary closures were related to a fire at one restaurant and a construction defect matter at another restaurant. We expect to record future gains related to additional insurance proceeds and legal recoveries. Please note the temporary closures will impact per week operating results until the restaurants reopen in the fourth quarter of 2018 or first half of 2019. Income tax expense was $1.2 million during the fiscal first quarter for an effective tax rate of 27.1% as compared to a $2.8 million expense for a 40.1% effective tax rate during the same period last year. The reduction in effective tax rate is due to the impact of the recent tax reform. Net income for the first quarter was $3.2 million or $0.08 per diluted share compared to $4.2 million or $0.10 per diluted share during the prior year period. Finally, we are reaffirming our guidance for the 52-week period ended January 1, 2019. Please refer to today's earnings release for the details on our outlook. In summary, as John indicated, 2018 is off to a good start as we continue our long track record of positive same-store sales. We believe our upcoming launch of Elevated Combined Solutions in tandem with our margin management strategies has us poised to deliver strong same-stores sales and restaurant contribution trends as the year progresses; particularly during the second half as our prior year same-store sales comparisons ease and elevated menu pricing is achieved. Thank you for your interest in Del Taco and we're happy to answer any questions.

[Operator:]

[Operator Instructions]. Our first question comes from the line of Joshua Long with Piper Jaffray, please proceed with your question.

[Joshua Long:]

Great, thank you for the -- taking my question today. Wanted to circle back to 1Q trends. John, it sounded like you mentioned some falloff there in March with some of the cold rainy weather. I was curious if after you moved away from that if you felt like the underlying traffic trends were getting back to normal and then kind of any sort of commentary you could provide in terms of as we lap over last years strong comp trends and how those trended through 2Q of 2017?

[Steven Brake:]

Hey Josh, it's Steve. Yeah, as we noted, the tail end of Q1 was dampered by wet and cold weather. Moving into Q2 we started Q2, important to recall that there is the two week Lent shift that did somewhat aid the first quarter but works against us the first two weeks of the second quarter. So we have now favorably lapped those first two weeks with positive sales and as we sit here five weeks in, we've now lapped by far our most difficult prior year comparisons of over 8% both for company and franchise. And we sit here at the five-week mark, companies up, comfortably over 1%, franchise is up actually closer to 4%, so feel really good about having lapped by far the toughest stretch of the year in terms of prior year compares and naturally baked in there is a very strong acceleration of our two-year same-store sales trend, you know, company now in that mid-9% area on a two-year basis through those five weeks, franchise up near 12% through the same first five weeks on a two-year basis. On top of that, as we look forward for the balance of the quarter, less than two weeks ago Carnitas returned into the business showing a lot of strength as we expect it to, in fact that first week mixed stronger than it did last summer in it's first week which is a great sign of consumer demand. So we think Carnitas is off to a great start for us and we have even seen a nice bit of an uptick in our one-year same-store sales trends since we launched Carnitas. So we feel good about that then looking ahead to round out this quarter. You know, the compares do ease, we're going up over about 6% last year for company and about 7% for franchisees the next seven weeks to round out Q2. So, those are easier compares, yet still difficult compares naturally but we feel great about the positioning and Carnitas in particular, it's going to play a good role in the balance of Q2.

[Joshua Long:]

Great, thank you for that color. That's very helpful. I wanted to kind of shift over to the discussion you provided around the Buck & Change menu and maybe get some added context in terms of how you had experience with kind of introducing these new platforms historically. It sounds like you're going to do kind of a one-two punch in terms of rolling out this new menu platform but then also supplementing the Buck & Under to kind of maintain that mix and not alienate anybody but just curious on the thought process there and maybe any historical experience you've had with rolling out these new menu platforms and kind of making sure that they go as smoothly as you'd like them to.

[John Cappasola:]

Sure, yes Josh. Well Buck & Change today is actually being used in approximately 200 franchise restaurants as our franchisees have implemented it with support of the brand as a component of the Buck & Under menu at an increasing rate over the past several years, you know, in order to provide them some price flexibility within Buck & Under of course. And as you know, as we've described on the call today, our franchise same store sales have remained fairly strong boosting mid-single digit same-store sales trends in the last several years, 2015, 2016 and 2017 and again here, what we've seen thus far in Q1 2018. So these trends certainly help validate the effectiveness of Buck & Change within the Buck & Under menu and today also to note, we actually have near like 200 company restaurants who have Buck & Change and whose same-store sales trends to date are very similar to other restaurants that don't have Buck & Change. So we're in a pretty good position there feeling strong about the platform, what it does for us relative to our strategy to expand the mid-tier section of our value platform and our data and our market experience suggests that we'll be able to flow through some price increases on the Buck & Under menu at a fairly high percentage rate with minimal risk to traffic but of course as you mentioned, a key part of our approach, that one, two punch if you will, is continuing to leverage Buck & Under and we'll do that concurrently with this increase and with the elevated combined solutions launch when we launch the new dollar Chicken Quesadilla Snacker onto the Buck & Under menu and that will be part of our advertising in order to manage value perceptions and obviously do our best to limit that traffic impact of the Buck & Change move. So we think that historically to your question, this has been the one, two punch we've used on pricing typically pricing across the menu that will occur and then we use Buck & Under to manage those value perceptions with either new news or just a heavy marketing push against Buck & Under so very similar approach here but we feel good about the strategy to enabling some elevated pricing and plus we get new news, value oriented new news, into the marketplace to kick off Q3.

[Joshua Long:]

Great, thank you for that color as well. And then kind of a -- maybe more of a housekeeping item as we start breaking out the franchise advertising contributions into the P&L, you -- it was nice to see the last year's number, but just curious, any sort of seasonality or kind of pushes and pulls on that line item that might happen over the course of the year as we just try to dial that in and then any sort of kind of perspective on it, be able to provide how that line tends to grow over time?

[Steven Brake:]

Sure, Josh. So that $2.9 million that very overtly is now part of our revenues due to the revenue recognition changes, that's the made up of 4% of sales contributions that substantiate all franchise restaurants contributes. So it's basically perfectly correlated to restaurant sales that the franchise restaurants so if you're to look at probably company or total revenue trends as they cadence on a seasonal basis throughout the year, quarter to quarter, that would probably be a good, you know, indexing guide to follow and then you of course this year versus a year ago, you know, kind of kick it up commensurate with the growth we're expecting to drive. So this first 12-week metrics kind of data 0.1 so if you want to evolve that pursuant to trends last year by quarter plus some growth thereon, that would probably be the right way to think about it.

[Joshua Long:]

Got it, thank you.

[Operator:]

Our next question comes from the line of Alex Slagle with Jeffries, please proceed with your question.

[Alexander Slagle:]

Thanks. Hey guys. Wanted to follow-up on the Buck & Change thoughts and the new product introductions and do you expect to remove some items from the menu as you roll out the new products and keep the menu simple, try to limit the SKU's and complexity? Is that part of the process on return?

[John Cappasola:]

Well you know Alex, we're always calling the menu as performance dictates. So there are individual items that don't perform quite as well as others and those will be removed as we add items to that as an ongoing part of our thought process. Overall reducing the number of items on the Buck & Under end and/or significantly increasing the number of items on the Buck & Change menu isn't really a core part of the strategy right now. We still look at it very holistically as our value platform and it is Buck & Under. Buck & Change is a mere component of that, it gives us some pricing flexibility. So I think right now Buck & Under is up to 15 items, you know, we could simplify that over time if performance dictates it or if we got more bullish in regards to some of the mid-tier moves around Buck & Change and we would expect the value platform over time will continue to evolve. But right now we're happy with what Buck & Under does for us out there in the market from a brand perception and value perception perspective and we think this nuance around Buck & Change can create some nice upside on the pricing and margin front.

[Alexander Slagle:]

Got it and then the same-store sales by dayparts. I mean, are there any interesting daypart trends you've seen due the first quarter or into the second quarter, recall you had pretty good trends at dinner and had some good momentum at breakfast. Has that continued?

[John Cappasola:]

Yes, so you know our focus on the daypart side has been dinner, breakfast and late night fairly consistently and we think there's a lot of same-store sales growth opportunities in those dayparts and that's why we're continuing to innovate but also sequence them and pace them and toggle them back and forth from one another so we can remain focused. We really use seasonality as the driver of that. So dinner has been one that you mentioned that we've seen some great performance on over the last year and a half; 2017 it was a top performing daypart for us and we'll do some new news against Platos this year to help to just continue to remind and drive awareness of that daypart with the Del Taco Plato that I mentioned which has brought appeal and we think it's going to bring even more appeal to the platform and usage. Breakfast was another one that we have been very focused on and in the first half of the year breakfast has been actually our top performing daypart. So, in Q1 we launched the Break Fiesta promotion which was starting at $2.49 kind of a bundle offer at breakfast with a very decent margin and we've seen the breakfast daypart be the top performer thus far in 2018 and Q1. So we're going to continue to use that and spot seasonally as it makes sense. We like what breakfast does to same-store sales when we focus on it so that will be an ongoing focus in the fall will be the next window that we do that and then as we think about the next daypart that we need to focus on as you can probably imagine, late night deserves its turn this year and we're about to pivot to late night as a focus over summer seasonality to take advantage of those longer days. It's great seasonality for late night. So we'll be launching a new late night menu actually with some pretty highly cravable and as [indiscernible] would say, Instagramable items like the Churro Dipper Shake that we're about to launch. So we think we've got some comp upside and some same-store sales upside from late night over the summer months as well. So hopefully I know a comprehensive answer but hopefully that answers all your questions about how we're thinking about some of those incremental dayparts.

[Steven Brake:]

And I would just say that all six dayparts were positive in the first quarter.

[Alexander Slagle:]

That's great. Thank you. Helpful.

[Operator:]

Our next question comes from the line of Nick Setyan, from Wedbush Securities, please proceed with your question.

[James Feldman:]

Thank you. The difference between the franchise comp and the company owned comp, I think you kind of touched about it, was it mainly price or are there some other things going on as well?

[John Cappasola:]

Yes, it's a combination of the two things. But let me -- Nick, let me step back a little bit on this and just talk and give some color about the approach that we've been taking on franchise and I'll let Steve add some financial context here. But, you know, as you've seen historically we've actually observed a fairly tight same-store sales performance dynamic between company and franchise. However, franchise has held a slight edge on same store sales growth over the company for eight of the nine past quarters going back to Q1 2016. So we've seen some momentum, albeit not quite as pronounced as we saw in Q1 this year, we think this momentum is mainly attributable to a few key elements of our strategy to really improve franchise performance. One, we definitely provided better support over the last several years. We've added edge to reduce span and control among our franchise business consultants making them much more visible and accessible so they're with our franchisees much more often to help them drive their business plans. Better data is another component, most of our franchisees have finished their migration to a common POS and back office with the company. So, we have the ability to provide them better reporting and more detail on their businesses. Better training is another piece we've talked a lot about the enhanced enhancements we've made with training and we've also added hedge to training to help support franchising so more frequent training, better reporting on compliance through our eLearning platform and then lastly I'd say better marketing. I mean, we have aided our much improved franchise operations with smart local store marketing strategies and digital marketing has really led the way in some of these markets that don't have the full complement of advertising because they're not quite as mature yet. And that's really been an effort that we've seen gaining traction as well. So, you know, these are just a few examples of the type of focus and detail that we're putting against our -- building a strong franchise culture. Let me let Steve speak to the numbers a little bit here.

[Steven Brake:]

Yes, and John listed a lot of very relevant dynamics there; naturally we can't itemize the spread amongst all of those important initiatives. That's one that we can't itemize or quantify if you will would be -- we touched on some changes in ownership so over the last several years about 30 franchise restaurants have come under new ownership, folks who are much more focused than the prior owner operator and basically Q1 those units outperformed the balance of the franchise restaurants by more than a little bit. So that has -- you know, fairly small but definitely quantifiable impact on that spread which certainly played a role among the other things John noted during the first quarter.

[James Feldman:]

Got it. On labor, actually a lot less deleveraged than I thought there would be. On the workers comp piece, is that something that might reverse as we kind of think about the year-over-year comparisons going forward, anything we should watch out for in terms of the quarter-to-quarter or how we think about the quarter-to-quarter comparisons going forward? Yeah, I mean it sounds like given the price increases, maybe we can actually maintain this level of deleverage as opposed to being bigger or maybe even a little less deleverage?

[Steven Brake:]

So as it relates to workers comp, it was a favorable, you know, good guy that we called out fourth quarter. The first quarter had some favorability there. You know, we're having some much improved underlying trends in our open claim. So we're happy about that. As I look forward, I feel pretty good about those claim trends. I don't seem them marching the other way, you know, biting us in the wrong direction to what extent we'll continue to have a bit less expense year-over-year, time will tell but overall I don't see that becoming a threat. Naturally labor, hours drive the bulk of that line item but certainly workers comp among other lines of insurance for health can play a role in that ultimate level of deleverage and obviously the first quarter we felt very good about controlling that deleverage to only 30 BIP's and by the way, the first quarter will definitely carry the least amount of menu price and we touched on our plan to elevate menu price as the year progresses. So, lastly, traffic and mix and strength of comp plays some role in what the ultimate leverage or deleverage will shake out but we feel good about management of that line and keeping it absolutely in check for the balance of the year.

[James Feldman:]

And in terms of the marketing shift, do we get that back in Q2 or is that more spread out?

[Steven Brake:]

It'll spread out. You know, every year without exception we will spend 4.0% of sales, you know, naturally in a given quarter there may be pressure or good guys so we try to call that out as more or less a tiny difference but for a full fiscal year it will always be even on a percent of sales basis.

[James Feldman:]

Got it and just last question on the buybacks, you know, you guys bought back some warrants, didn't buyback any shares. I guess how -- what was your thinking there and how are we thinking about that going forward?

[Steven Brake:]

Overall it's the very important and very long-term program. We use a combination of open windows or 10b5-1's set at various points in time during the recent year-to-date period nothing transacted. That absolutely remains the important part of our go-forward strategy, how we deploy free cash flow, we think done in the right manner it would, again, as we've always said with a bit of an opportunistic bias on -- we think it will continue to be an important lever that helps create long-term value here. So, you know, certainly we'd expect to see more activity as we move forward from here.

[James Feldman:]

Thank you.

[Operator:]

[Operator Instructions]. Our next question comes from the line of Steven Anderson with Maxim Group, please proceed with your question.

[Stephen Anderson:]

Yes, good afternoon and wanted to look more closely at your occupancy and other lines. It seemed like that -- I wanted to clarify the reason for the larger increase in that. So I know you mentioned that some timing and advertising was part of that but do you think there also may be some increased investments ahead of enhanced Elevated Combined Solutions?

[John Cappasola:]

No, there's no increased investments relative to Combined Solutions or otherwise. You know, the 40 BIP's of year-over-year pressure, half of that was the timing of advertising that we just touched on which will reverse out and neutralize over the course of the fiscal year. You know, the other half was frankly the majority of our stores are comping and when you're comping stores grow 2,6 it's the underlying opex elements inflate more than 2, 6, you have slight deleverage. So that's kind of what happened, the underlying components that run through opex and there's a lot of them from utilities and supplies to repairs and maintenance and rents, you know, those inflated a bit more than our same-store sales growth. So that's what takes you to the modest deleverage that we felt Q1. For some context last year 2017, that line item ran flat back in 2014 and 2015 on strong in MSP comps, each of those years we got 20 BIP's of leverage so end of the day it's contemplation up against strength of the comp so that's kind of what we've seen play out in recent years and we're doing our best to manage it and the strength of the comp tends to rule the day on opex.

[Stephen Anderson:]

Got it, thank you.

[Operator:]

Our next question comes from the line of Craig Bibb with CJS Securities, please proceed with your question.

[Craig Bibb:]

Hey guys. How much did the Easter shift help comps in Q1 and then how much of a hurdle for next quarter?

[Steven Brake:]

It's a dynamic that's hard to precisely quantify because there's always many moving parts in a trend but it was a -- two weeks is not -- it's not a dramatic amount of help for the first quarter or hurt for the second quarter. I mean, it's a -- it was a modest tailwind and it became a modest headwind. You know, likely inside 50 BIP's so it's not a huge swing factor but it is something that we always feel is appropriate to call out because it definitely is a real calendar dynamic.

[Craig Bibb:]

I mean weather would also be kind of -- just the two weeks at the end of the quarter?

[Steven Brake:]

Yes, you know, we are obviously up 4.0% system at the ten-week mark. You know, those last couple of weeks there was very cold and wet weather which, you know, it did have a more pronounced downward impact on the company same-store sales because our companies footprint is more than 80% plus California, franchise are less than 50% California. So, you know, it kind of hit the company more. We mentioned that, you know, franchise actually those same two weeks with a much more varied geographic footprint, they've sustained a mid-single digit trend so that really slowed down the company more than the franchise to end the quarter.

[Craig Bibb:]

Yes, I would also add, you guys did do well with labor in the quarter. You've explained the workers comp. You're facing a bigger step up in hourly labor in 2019. What's the game plan for that, is it scheduling or price or how do you offset?

[Steven Brake:]

It's going to be a variety of items. It's what we refer to broadly as our margin management plan. So, that encompasses brand and cost management strategies. On the brand side, you know, over time incremental yet appropriate levels of menu pricing, thinking about every promotion and every new product making sure that it drives item level margin profiles that are appropriate for the business. You know, of course all of that we bring to life as you know, through our unique barbell menu strategy. So that's kind of the brand side. On the cost side a lot of things have been going on and will continue to be a huge focus. So on the supply chain side, a lot of work has happened and is ongoing on what I'll call portion optimization on select items where we can somewhat, somehow reduce portions, save money with no impact on the guest experience. Also, the ongoing effect of the use of floor coverage trying to make good buys when appropriate to protect our food trend and then also looking at packaging, the packaging itself, the case sizes, freight strategies. A lot of things within supply chain that we have and will continue to look at. On the labor front certainly ongoing journey with what I call enhanced labor scheduling techniques to make sure that we're optimizing the feet on the floor. That varies from -- we know generally each day when the customers arrive and when they start to slow down. So we've got to adjust labor accordingly. Staff when we need to staff, let the staff go when you don't need the staff. You know, also we see some stores with incredible labor performance, others that have opportunities to try and do -- embed and training those best practices at a more rapid pace as another example of labor focus that we have. Then here and there investing some capital to help take pressure off the labor equation. We touched on this new food prep equipment coming out later in Q3. Our goal there is to absolutely speed the process of prep which should allow us to optimize and reduce labor hours to some degree. That uses smart capital to achieve labor saving, that can mean ongoing [indiscernible]. Next week the teams up in Chicago at the NRA looking at all kinds of interesting solutions aimed at reducing labor hours. So that's some of the things that we're thinking about and this will be an ongoing journey so a combination of price, hard cost savings across food and labor. As far as price goes, obviously as you know, we've got a long, strong history of driving favorable traffic and mix. We think this brand remains very well positioned to have healthy traffic and mixed trends and as you know, the ultimate composition and strength of a comp is going to very much inform margin percentage and margin dollar performance as we move forward no matter what minimum wage is doing among other cost threats or cost benefits that we achieve.

[John Cappasola:]

Craig, this is John. I think we're well position on when you think about the three major levers here, AUV growth and the way that we're thinking about driving sustained and enduring AUV growth with our positioning, our occasion based focus and what we think we need to do out in the marketplace over the next several years even with some elevated pricing to balance all of that. And then you've got what's happening on the unit growth side which we are still very positive about and feel good about how we're building our pipelines and thinking about, especially on the franchise side, some of the momentum that we're seeing what that can yield on franchise growth and then the piece that Steve just outlined as our margin management strategy, our margin management plan which, again, we're in the weeds on that right now. So, we're as focused as we've probably ever been on thinking about how we're going to continue to deliver strong four-wall margins and we're going to be maniacal in that area to make sure that we're complimenting the AUV growth strategies. So, I think we're in a good position, we feel good about where we're heading for 2018. It won't be easy over the long-run, we know that, but we certainly have a lot of levers to pull and the leadership team is focused on those that are going to be most meaningful and accretive to the brand.

[Craig Bibb:]

Okay, there John. I'm interested, could you explain Del Taco Platos, Del Taco Plato?

[John Cappasola:]

The Del Taco Platos?

[Craig Bibb:]

Yes.

[John Cappasola:]

I can do I really quickly for you. It's a plato that has two Del Tacos as the entre.

[Craig Bibb:]

That's it?

[John Cappasola:]

It literally is, it's two Del Taco's with beans and rice and the reason why we're doing it is because we want to make sure that we are -- we want to expand the appeal of Plato's beyond just those premium items, the wet burritos, the street tacos that we were doing before and we think that the lower price of entry as well as using one of the top products on our menu could do that and really aid our evolution in the dinner daypart as well as let folks see that you can get premium offerings from the brand. And Steve reminded me, don't forget you can also get free chips and salsa within the Plato's, right, it's part of the package. So, great offering for us and we're going to continue to expand it as we move through time.

[Craig Bibb:]

And I can get Queso on that also?

[John Cappasola:]

You could. Yeah, you could if you'd like to.

[Craig Bibb:]

I would. Okay, thank you guys.

[Operator:]

Our next question comes from the line of Jeremy Hamblin with Dougherty & Company, please proceed with your question.

[Jeremy Hamblin:]

Hey guys, thanks for taking the questions. I wanted to make sure that I captured your commentary on food costs remainder of the year, kind of impressive controls there. Given that you're expecting better menu pricing or higher menu pricing throughout the rest of the year, and I think you said that you're expecting a little bit lower inflation as well, you're able to hold that line item flat. Should we expect a little bit more favorable food costs and kind of positive leverage the remaining three quarters of the year particularly with the comments about the new food prep equipment that might be able to help on labor?

[Steven Brake:]

Hey Jeremy, it's Steve. Yeah, good question. So definitely you're right. First quarter basically the food inflation of over 2% was about perfectly offset by menu pricing in that mid-2% area. So we held food costs flat on a percentage and we actually feel pretty good about that margin excluding the advertising timing. We contracted 50 basis points but remember, that quarter had like far our highest level of expected food inflation, over 2%, and by far our lowest level of menu price in that 2.5% area. So as we look forward sequentially on food, the next three quarters we see that food inflation net of the mitigation efforts that I talked about in that 1% or below area, at the same time we touched on menu price beginning to approach 3% in Q2, beginning to approach 3.5% in Q3 and then up to 4% in Q4. So that certainly sets up the food line item to step down on a percentage basis both sequentially and with some year-over-year improvement. And then as you mentioned definitely the ongoing labor focus on saving hours where we can as well as the impact of price. We feel like it puts us in a very good position as we move forward to have sequential benefits play out on the cost structure but also don't forget Elevated Combined Solutions is only weeks away here and that's with the new ad campaign, a lot of innovation that's going to hit us back half of the year, the refreshed menu boards, launch of the app, expanded delivery. At the same time all of our prior comparisons ease significantly. I mean, we're going over 8% right now here soon in the third quarter we're going over 3.7% and then 2.1% in the year fourth quarter for the company. So, that combination of sequential benefits on price, benefits of run rate cost dynamics and what we think should be a very strong Elevated Combine Solutions lap particularly when cross-referenced against ease and compares, we feel really good about how that's going to play out particularly in the second half of the year as you think about same-store sales performance, margin performance in restaurant contribution and EBITDA dollar performance. So, that's probably a bit more than you asked for but that's really what we love about sitting here today thinking about how the year is going to play out.

[Jeremy Hamblin:]

Yeah, that's very helpful and you definitely have had an impressive start to the quarter lapping 8% compares. I wanted to just add one more quick one in there then. You know, you are lapping some really tough mix in Q2, Q3 in particular, my assumption is that mix would be negative this quarter and potential in Q3 as well even though you guys have really been getting great and positive mixed contribution for the last several years. Are my assumptions correct that I should be kind of planning, mix I think you had 3% in Q2 a year ago, should we be planning for that to be a negative factor the next couple of quarters?

[Steven Brake:]

You're correct, very tough compare for Q2, you know, Q3 is easier on mix. As we sit here today, as I mentioned, Carnitas has come back into the business with very strong mix so far, only a week in, but we feel good about that actually probably being able to improve upon our mixed performance that we posted in Q1. In Q1 we were up about a tenth in menu mix. So we actually do at this point, based on what we know, we do expect to have some level of mix in the second quarter. The third quarter is a little bit harder to call, obviously there's a lot of things going on with Elevated Combined Solutions. We think traffics going to be a big component there. There's the dollar Chicken Quesadilla Snacker, obviously dollar price point but the way it has performed in tests, we think there's a lot of potential there. We always like to think about the aggregation of traffic and mix and making sure it's helping us put up good comps that go along with our menu price but definitely Q2 we actually feel good about mix, Q3 it's going to kind of depend on strength and take rate of Snacker but traffics always a bit of a lever there. I mean, we have the capability to drive both but sometimes there can be a bit of a toggle. But, the aggregation of those two we feel good about our trend as we move forward.

[Jeremy Hamblin:]

Okay, awesome. Moving on to G&A, you noted before that FY2018 would likely be a high point of the percent of sales on your G&A expenses and I think if there was a difference in models it probably came on that line item considering your restaurant margins came in better than expected. I wanted to get a sense -- if you're looking at a kind of two or three year target for G&A, what should we be thinking about longer-term of where that number can go to. A few years ago you had it kind of down closer to 7% and now we're looking at kind of mid-8's. What is the kind of multiyear target, two or three year target for where you think that reasonably can go to? Do you see some opportunities to get a little more leverage on that?

[John Cappasola:]

Sure, so this year you're correct. Yeah, we have called out that we expect this year should be the peak G&A percentage and that's largely because this -- 2018 is the year that we finish, if you will, our public company journey in terms of full SOX 404(b) compliance including auditing those internal controls and two and three years ago it is highly irrelevant because we've barely become a public company with little incremental public company costs that had entered the system three years ago. So, really looking at today -- we do believe this will be the peak year on G&A percentage and as we move forward like we said last call, we expect to drive a plateau in modest leverage on a long-term basis. Once you get to that mature level, basically it's the strength of your revenue growth up against what likely will be some level of G&A dollar inflation to make sure we're supporting growth and driving the brand appropriately. We do not want to short-change the upside potential of this brand in terms of the unit growth or same-store sales growth. So, you know, really it's going to be strength of revenue growth that we think we're well positioned through our AUV growth and comp driving capability as well as an emerging growth story to have robust top-line trends, how that compares against inflation that we eventually deem appropriate year-to-year to make sure we're managing the business effectively. That's going to eventually inform what plateau to modest leverage looks like. So, I don't know if that's helpful but that's kind of how we think about it and naturally will want to guide it very specifically on a year-to-year basis.

[Jeremy Hamblin:]

Okay, moving on then. You noted that your franchisee pipeline is getting more attractive, your AUV's I think are approaching $1.5 million which I'm sure is a magic number for some franchisees when you look at it 20% restaurant margin with 1.5 AUV's, that's pretty attractive. In terms of the scope and size of the franchisees that you're talking to today, are you starting to get conversations with what I'd call large scale franchisees, those that are operators of let's say 100 plus units of QSR brands?

[John Cappasola:]

Well, we're certainly putting ourselves out there to do that through our franchise sales and marketing efforts and we're also -- we may not be talking to the hundred plus unit guys just yet Jeremy but we believe that some of those conversations can happen over time as we perform and as we put more news about franchise signings out in the marketplace. So I think what we've done down in the southeast, which has been a pretty strong trickle of development agreements being signed down there, I think we have eight multiunit development agreements in the southeast today and those are obviously mostly representing in five to ten potential unit range per agreement. So the best thing that we can do is continue to highlight those wins when we have them, make sure that we're nuancing the execution of all of these new franchisees so that they're getting into the right real estate, we're supporting them the right way as a brand from an operations and marketing standpoint, giving them the best chance to fulfill the potential of their agreements and we believe that the success in those areas, those small wins will lead to bigger and better things. So, on the efforts there we're absolutely having, you know, a lot of internal conversations and looking at ways to get after some of those bigger groups but no major signings to-date. But I wouldn't count us out just yet. We're going to keep working the execution.

[Jeremy Hamblin:]

Okay, a related question to that. On the company operated side, obviously you're running into the labor costs here of having so much exposure to California. That can't change overnight but as you look forward on company operated locations that you're opening. You know, is there some thought that maybe the skew of openings gets away from those higher cost states like a California or a Colorado and gets into some of the lower cost operator states?

[John Cappasola:]

So those sorts of things could play out given the environment, right, we know that construction and real estate costs are heightened right now and so we're being very pragmatic as we're looking at these deals one-by-one. Not just by geography but trade area by trade area, it can vary, believe it or not. So, we're taking a portfolio approach on the company side to make sure that we're optimizing our returns and there's going to be some deals that we really like that will pay up a little bit for and some deals that we think are too expensive and will slow plan and try to get them to be better deals or we'll walk away from them and move on to the next thing. So, that's inevitably what's happening today given the environment it will continue to happen and that could do what you're suggesting which is push us in the direction of maybe better cost environments and that could naturally happen just through our normal course. So, we haven't set a firm and solid line in the sand on places we don't want to build right now because we're still finding great deals in some of these markets that are kind of inflationary, right? So, we're still doing deals in California and we've got a new unit actually coming in Colorado and these are deals that we're signing that we feel good about the underlying unit economics. So I think we've got to keep our options open and ultimately if we want to get to really strong annualized growth, which we believe we can over time, the geographic -- the more geographic territory that we have to hunt and to build in, the more likely we're going to be able to hit those growth rates that we all expect and want over time.

[Jeremy Hamblin:]

Great, thanks for taking my question guys. Good luck.

[Operator:]

There are no further questions in the queue. I'd like to hand the call back over to management for closing comments.

[John Cappasola:]

Yes, thank you for your interest today in Del Taco. We look forward to sharing our progress on the brand on future calls and we hope you all have a great day.

[Operator:]

Ladies and gentlemen this does conclude today's teleconference. Thank you for your participation, you may disconnect your lines at this time and have a wonderful day.