Del Taco Restaurants, Inc.
Q2 2018 Earnings Call Transcript

Published: 27 Jul 2018

[Operator:]

Thank you for standing by and welcome to the Fiscal Second Quarter 2018 Conference Call and Webcast for Del Taco Restaurants, Inc. I would now like to turn the call over to Mr. Raphael Gross to 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 Inc. for a more detailed discussion of the risks that could impact future operating results and financial condition. Today's earnings press release also includes some non-GAAP financial measures such as adjusted net income, adjusted EBITDA, and restaurant contribution. These 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. During Q2, we were proud to achieve our trailing 12-month company annual unit volume goal of $1.5 dollars. You may recall that this milestone was something we first guided to following our entrance to the public markets several years ago and we are very pleased to achieve this elevated AUV. Since fiscal 2013, our company and franchise AUVs each grown by more than 25%. This growth has helped us achieve a solid foundation with a relevant and differentiated brand positioning as well as enhanced unit economics that are enabling company and franchise growth opportunities. System-wide comparable restaurant sales rose 3.3% in Q2 or 10.4% on a two-year basis. We extended our streak of company and system comparable restaurant sales gains to 24 and 19 consecutive quarters, respectively, with company-operated comparable restaurant sales growth of 2.5% and franchise comparable restaurant sales growth of 4.2%. We believe the continued franchise outperformance reflects our brand strength across diverse geographies which helps stimulate development interest among existing and future franchisees and supports the brand's ability to continue to achieve scale across a broadened geographic footprint. During the quarter, we opened one new company-operated restaurant and one new franchised restaurant. Our people, process, and pipeline investments have put our development efforts in a much better position compared to 2017. We now have 22 restaurants either open or under construction and remain on track to open 25 to 28 new units system-wide in 2018. From a marketing standpoint, Q2 continued to leverage our brand strengths in new product innovation, quality food platforms, and of course, value. We executed on our strategy to expand our mid-tier menu segment by promoting two for $5 mix and match our popular classic burritos. And launching our new late night bites menu with highly cravable and indulgent mid-tier products positioned and branded to drive our late night sub-brand. This also provides an ongoing late night platform for continued innovation and marketing. In May, our Carnitas LTO returned to the menu with mid-tier premium offerings that drove very high guest satisfaction scores and favorable menu mix trends. Carnitas will continue on our menu through summer. Turning to Q3. At the start of the quarter, we launch Elevated Combined Solutions, the latest iteration of our pivotal brand strategy. Elevated Combined Solutions includes brand catalysts and operational improvements designed to further our mission to be the category leader in the value-oriented QSR-plus segment. On the brand side, we launched a new advertising campaign that accentuates our freshly prepared ingredients and QSR-plus positioning by celebrating the hardest working hands in fast food. The campaign features real team members, and along with being well-received by guests, has created significant team pride. Improvements inside the restaurants enhance our focus on fresh prep through newly designed menu boards, refreshed artwork, updated uniforms, and a new fresh ingredient chalkboard, which features one of our fresh items each day, showing where the ingredient was formed, when it was picked, and which team member prepared it that day. To complement our brand catalysts, our operators are elevating restaurant hospitality. With Elevated Combined Solutions, the operational focus is on creating more genuine guest greetings and good-bye, or what we like to call 4G hospitality. For example, in the drive-thru, our cashiers are now introducing themselves by name. And in the dining room, instead of calling out order numbers, we are calling our guest by name as well. Both moves create a more personal connection with guests. Our research shows this type of connection has a big influence on overall guest satisfaction and our goal is to make hospitality and service another point of differentiation for the brand. I am confident our 4G hospitality will help take our service to the next level. These marketing and hospitality strategies are brand building foundational elements of the elevated launch that will further differentiate Del Taco over time. They will be paired with a series of consumer catalysts to drive guests into our restaurants to experience the changes. The first catalyst is a New Dollar Chicken Quesadilla Snacker on the Buck & Under menu. Based on early results, the Chicken Quesadilla Snacker is a record breaking new product in terms of units sold. With an introductory price of $1, we designed this product to drive consumer demand and to reinforce value and affordability perceptions as it coincides with our recent price increase which includes select Buck & Under items as part of our Buck & Change menu expansion. Initial guest feedback on our Elevated Combined Solutions enhancements has been favorable. Although through the first five weeks of Q3, our system-wide same-store sales are trending slightly below our annual same-store sales guidance range with continued franchise outperformance. This sequential slowing compared to the second quarter reflects a negative menu mix due to a very high mix on the New Dollar Chicken Quesadilla Snacker, while negative transaction trends remain similar to Q2. Looking ahead, we recently shifted our primary promotion and external communications to a premium message and for the balance of the year; we expect our focus to remain on mid-tier and premium products. These include new news around Epic Burritos and an exciting new premium LTO protein to complement the New Dollar Chicken Quesadilla Snacker. We expect this focus will strengthen our check average trend and when paired with our Elevated Combined Solutions elements, should also help drive improved transaction trends as the year progresses. We also remain focused on our margin management plan designed to achieve additional menu pricing, lower food cost inflation net of supply chain strategies, and optimize labor to drive improved restaurant contribution dollar and margin trends. This focus was evident in our second quarter results as sequentially higher menu price in the high 2% area and sequentially lower food inflation slightly below 1% helped limit restaurant contribution margin contraction to only 10 basis points when adjusted for the timing of advertising. Moving forward, menu pricing in the low to mid 3% area during the third quarter, continued progress on supply chain strategies, enhanced labor scheduling techniques, and the launch of new prep equipment at the end of Q3 to enhance ingredient quality while reducing labor hours, will provide structural enhancements to help optimize restaurant contribution performance. In addition we plan to expand or third-party delivery offering and launch the Del Taco mobile app later this year. The mobile app will feature enhanced marketing capabilities including the use of targeted promotional offers to drive guest frequency and the capability to support future loyalty program, which we believe will be a powerful marketing tool going forward. To conclude, Del Taco remains in the early stages of our journey and Elevated Combined Solutions is designed to further strengthen and differentiate us in a crowded QSR and fast casual landscape. Elevated Combined Solutions coupled with our margin management focus positions us to drive sales momentum and restaurant contribution performance that we expect will serve as a catalyst for continued company and franchise unit growth. With that, I'll turn the call over to Steve to review our quarterly results in detail.

[Steven Brake:]

Thanks John. Total second quarter revenue was $117.8 million, an increase of 8.5% from the $108.6 million in the year ago second quarter and included $3.1 million to 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 5.4%. System-wide comparable restaurant sales increase 3.3% and lapped system-wide computer will restaurant sales of 7.1% during Q2 of 2017, resulting in a strong 10.4% two-year trend. The Del Taco System has now generated 19 consecutive quarters of positive same-store sales. Second quarter company restaurant sales increased 5.6% year-over-year to $109.8 million from $104.0 million in the year ago period. This increase was driven by company-operated comparable restaurant sales growth of 2.5% along with contributions from additional company-operated stores as compared to the second quarter last year. Second quarter company-operated comparable restaurant sales growth represents the 24th consecutive quarter of gains and was comprised of the 3.7% increase in check, including approximately 1% of menu mix, partially offset by a 1.2% decline in transactions. Franchise revenue increased 6.3% year-over-year to $4.1 million from $3.9 million last year. The increase was primarily driven by franchise comparable restaurant sales growth of 4.2% and other franchise revenue related to the adoption of the new revenue recognition rules, partially offset by reduced initial fees. Moving onto expenses. Food and paper costs as a percentage of company restaurant sales decreased approximately 30 basis points year-over-year to 27.4% from 27.7% as the impact of menu price increases more than offset the impact of food inflation that ran slightly below 1% as well as impact from Carnitas which drives a strong margin dollar contribution, but with a slightly lower than typical margin percentage. Looking ahead, we continue to expect net food inflation at or under 1% during the second half of the year and annual 2018 net food basket inflation of approximately 1%. Labor and related expenses as a percentage of company restaurant sales increased approximately 40 basis points to 32.3% from 31.9%. This increase was primarily driven by the January 1st, 2018 California minimum wage increase to $11 an hour and the Los Angeles County and Pasadena escalations to $12 an hour on July 1st, 2017, which impacted 27 company restaurants. This wage inflation was mostly offset by the impact of menu price increases and reductions of workers' compensation expense based on underlying claims activity. Occupancy and other operating expenses as a percentage of company restaurant sales increased by approximately 50 basis points to 20.6% from 20.1% last year. This increase was from higher advertising expense based on the timing of advertising as operating expense inflation was otherwise in line with second quarter of company restaurant sales growth. Based on this performance, restaurant contribution was $21.7 million compared to $21.1 million in the prior year. Restaurant contribution margin decreased approximately 60 basis points to 19.7% from 20.3% including 50 basis points of deleverage due to the timing of advertising. General and administrative expenses were $10.3 million and as a percentage of total revenue increased by approximately 50 basis points year-over-year to 8.8%. This increase was driven by an increased legal and related expenses, increased stock-based compensation expense, incremental SOX 404(b) compliance costs, and the expense side of the other franchise revenue that is now reported on a gross basis, partially offset by reduced performance based management incentive compensation. Adjusted EBITDA decreased 1.1% to $16.8 million from $17.0 million last year. As a percentage of total revenues, adjusted EBITDA was 14.3%, down 130 basis points from 15.6% last year. Depreciation and amortization expense increased 10.8% to $5.8 million compared to $5.3 million last year. As a percentage of total revenue, depreciation and amortization was 5.0% compared to 4.9% last year. The increase was driven by the addition of new assets. Interest expense was $2.0 million compared to $1.6 million in the prior year second quarter. The increase was due to an increase to one month LIBOR rate compared to the prior year. As previously discussed, we expect the increase year-over-year trend to continue due to the rising interest rate environment. As of the end of the second quarter, $153 million was outstanding under our all-revolver credit facility, while our applicable margin for LIBOR loans remained at 1.75%. Income tax expense was $1.6 million during the second quarter for an effective tax rate of 27.3% as compared with $3.3 million expense or a 38.4% 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 second quarter was $4.2 million or $0.11 per diluted share compared to $5.3 million or $0.13 per diluted share of last year. In addition, we reported an adjusted net income which excludes impairment of long lived assets net of tax resulting in $5.4 million or $0.14 per diluted share. Turning to our repurchase program, covering common stock and warrants, the Board of Directors increased our repurchase authorization to $75 million from $50 million. The increased authorization will expire upon completion of the repurchase program unless terminated earlier by the Board of Directors. During the second quarter, we repurchased 407,821 shares of common stock at an average price of $11.57 per share to a total of $4.7 million and repurchased 11,132 warrants at an average price per warrant of $2.68. Approximately $41.2 million currently remains under the $75 million authorization. In summary, as John indicated, our first half performance was in line with our expectations and we are reaffirming our guidance for the 52-week period in January 1st, 2019. Please refer to today's earnings release for the details and our outlook. Note, however, that our net income per diluted share guidance is now on an adjusted basis. Thank you for your interest in Del Taco. And we are happy to answer any questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Alex Slagle with Jefferies. Please go ahead.

[Alexander Slagle:]

Thanks. Hey guys. Wanted to -- I wonder if you could talk a bit more about the shift, the negative mix in the third quarter comes after a pretty solid second quarter performance. If you can kind of clarify, was that all due to the better-than-expected response to the Chicken Snacker -- the Quesadilla Snacker? Or was there some shift in the Carnitas LTO timing having an impact also?

[John Cappasola:]

Yes, we think the Dollar Chicken Quesadilla Snacker is really the big driver here and we kind of view this as somewhat of a high class problem that we've got here. I mean it's a powerful demand driver for us and those characteristics are evident when we see it ascend to one of the top products on the Buck & Under menu fairly quickly. And we also like it because obviously it supports our category leading value and affordability perceptions, which is what as you know five fiscal years of positive traffic couple that with a tough mix compare year-on-year. And that's where our commentary was from the early part of the quarter. Thus far, I'd say a bigger focus for us is in the near-term, we're going to complement the snacker with some great premium and mid-tier promotion and new products to make sure that we're working towards building back that check average by fully leveraging our barbell strategy. So, specifically, we're going to be bringing back the popular two for $5 mix and match in late August and then we're going to toggle to an exciting new premium LTO in late September as we bring back shredded beef with an even better flavor profile than last time that we had it on our menu in 2012. So, kind of using that playbook that we used on -- with Carnitas back in the summer of 2017 when we cycled Del Taco launch. We think that's a good move for us to make given the success that we're seeing on the low end of the barbell with the Chicken Quesadilla Snacker. We also have another Epic Burrito program that we're planning to put into the business towards the back half of the year, so -- or the back end of the year, I should say. So, we're going to continue to do everything we can to surround the snacker with nice mid-tier and premium news. We think that's the answer right now and we'll continue to innovate against that.

[Alexander Slagle:]

Great. And then it's still early, but any preliminary thoughts on what the pipeline looks like development-wise for 2019? And any kind of initial thoughts on how that might look in terms of the split between company franchise or what markets?

[John Cappasola:]

Specific to 2019?

[Alexander Slagle:]

Yes.

[John Cappasola:]

It is remainder 2018 too. Let me let me hit on both. So, obviously, right now, we're very focused on delivering 2018. And I'll give you some commentary on that in just a moment. At the same time, we're also very focused on building our pipeline and the pipeline is going to be what is critical to fueling 2019 and 2020 obviously. And I'd like to say that we're having some good success and seeing some good momentum within building that pipeline on both the company and the franchise side relative to future years. So, in 2018, we feel really good about the guidance range that we provided. As I said, the 22 units that are either open or under construction, put us in a much better position year-on-year. We feel good about that than where we were prior year and the fact is we're actually working more units as well as you can imagine and we need to be able to hit our guidance range. And incidentally, we have another three units or so that we expect to have under construction in early August. So, and that's with a couple more months of work that's going to be done about -- around getting units under construction just puts us in a good position in 2018. So, it's nice to see that the overall pipeline is strengthening because we've been so focused on it and we do see really good signs in regards to 2018 and being able to deliver on our commitments.

[Alexander Slagle:]

Okay. Thank you.

[Operator:]

[Operator Instructions] This concludes the question-and-answer session. I would like to turn the conference back over to John Cappasola for any closing remarks.

[John Cappasola:]

All right everyone. Well, thank you for your interest in Del Taco and we look forward to sharing our progress on future calls. Have a great day.

[Operator:]

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.