Del Taco Restaurants, Inc.
Q3 2018 Earnings Call Transcript

Published: 17 Oct 2018

[Operator:]

Thank you for standing by, and welcome to the Fiscal Third Quarter 2018 Conference Call and Webcast for Del Taco Restaurants Incorporated. I’d 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 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 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 all for joining the call today. Overall, I would characterize our Q3 results as decidedly mixed with our strategic progress and effective cost management being tempered by soft comparable restaurant sales trends at company restaurants. In the quarter, we successfully rolled out elevated combined solutions, designed to further our mission to be the leader in the value-oriented QSR+ segment, which has been a driver of our success today, and we believe we’ll continue to pay dividends over the long-term. We again experienced strong franchise comparable restaurant sales trends, demonstrating our strengthening franchise systems and brand portability. We remain focused on further strengthening our great culture with a launch of our company values and our new advertising campaign centered on real employees, and we executed against our margin management plan by achieving restaurant contribution margin expansion during the quarter to elevated pricing and effective cost management even after adjusting for the favorable timing of advertising expenses. This last point is especially important, given the softer company-operated comparable restaurant sales. Still in light of our recent performance and more cautious view on Q4, we have updated our annual guidance as reflected in our earnings press release. Looking at sales, system-wide comparable restaurant sales grew 1.4%, or 5.5% on a two-year basis, driven by franchise comparable restaurant sales growth of 3% and company-operated comparable restaurant sales growth of 0.3%. These results extend our streak of system and company comparable restaurant sales gains to 20 and 25 consecutive quarters, respectively. We continue to believe our franchise outperformance reflects our strength in franchise systems and relevance across a diverse geographic footprint and surge to stimulate development interest across existing and new franchisees, supporting our brand’s ability to expand its reach. In Q3, we opened two new company-operated restaurants and three new franchise restaurants, and recently opened two additional company-operated restaurants, bringing our 2018 new system-wide openings to 12 new restaurants. We currently have 17 restaurants under construction, including six company-operated and 11 franchise. We expect 13 to 16 of these restaurants to open this year and our 2018 openings will reflect a nearly even split between company and franchise. We are very pleased with the momentum we are seeing with our franchisees, as the brand expects to open restaurants in a 11 total states this year, which positions us well for future growth. We also opportunistically acquired three restaurants from franchisees during the third quarter. As I noted a moment ago, we launched elevated combined solutions, the latest iteration of our brand’s strategy at the onset of Q3. It included brand catalyst and operational improvements designed to further elevate our brand positioning to a deeper focus on our freshness and quality attributes. As part of this strategy, we made improvements inside the restaurants to enhance our focus on fresh preparation and to elevate our hospitality. We also launched the new advertising campaign, highlighting our freshly prepared ingredients and QSR+ positioning by Celebrating the Hardest Working Hands in Fast Food. These brand building strategies were paired with the launch of the new $1 Chicken Quesadilla Snacker on the Buck & Under menu as a consumer catalyst intended to drive guest into our restaurants to experience the changes. Although the $1 Chicken Quesadilla Snacker was a record-breaking new product in terms of units sold and helped to reinforce our strong value and affordability perceptions, its high mix caused negative check mix trends without any improvement in transactions. Therefore, we quickly pivoted our messaging to focus on Epic Burritos and ended the quarter with a $2 for $5 Classic Burrito Mix and Match promotion. This shift immediately restored healthy check trends, including positive menu mix in the second-half of Q3, however, transaction trends continue to soften. Ultimately, although we used innovation to launch a high-demand value product, it did not have the desired effect on transactions. We believe this outcome and part maybe a reflection of the current environment, as we are all well into the third year of heavy competitive value promotions and discounting. The value-driven consumer has many options, which perhaps diluted our ability to use the new dollar Snacker as Quesadilla action. Looking forward, our plan to generate transaction momentum is underway. First, we will continue to execute against our Elevated Combined Solutions game plan, designed to drive frequency through brand and guest experience initiatives. Second, we’re focused on demonstrating value across our barbell menu strategy, driving new occasions with an emphasis on new mid-tier and premium products. And third, we will be expanding points of access for guests through the launch of key digital initiatives intended to drive both frequency and trial. Now let me take you through the detail. During Q4, we are using menu innovation to spur consumer interest beginning with the return of a fan-favorite premium LTO protein, Shredded Beef, which hasn’t been on the menu since 2012, and will run through the end of the year. Shredded Beef has mid-tier and premium products that provide great value for the money and quality food experience designed to elevate the brand. Later this month, we’ll pair our Shredded Beef LTO with additional new product news around Epic Burritos with a launch of the new Triple Meat Epic Burrito, featuring freshly grilled steak, chicken and bacon. We expect these promotions to drive a healthy check average and improved transaction trends compared to Q3. So far, the Shredded Beef promotion is off to a strong start, achieving high single-digit sales mix in its first two weeks, and since its launch in the third week of fiscal Q4, our same-store sales trends have improved sequentially. I also have some exciting updates around how we will position the brand to grow sales and transactions by expanding points of access through digital initiatives. in November, we expect to launch the Del Taco mobile app, featuring enhanced marketing capabilities, including targeted promotional offers to drive guest frequency and the ability to support a future of loyalty program. Our guests have been eagerly awaiting the launch of our app, and we believe this will help us limit any impact from deep discounts many competitors are offering on their own apps as we build our consumer database over time. In addition, we expect to expand our third-party delivery offering to the entire Los Angeles market next month through our partner GrubHub, followed by a system-wide launch in 2019. We have also signed partnership agreements with Postmates and DoorDash and plan to expand with both during 2019. We believe moving toward a multiple DSP approach will position us to optimize driver coverage and maximize consumer demand across trade areas, as our testing to date indicates a significant increase in delivery occasions upon adding an additional DSP. Our test and learn approach allowed us to optimize all aspects of our delivery program and we are now in a position to successfully provide another convenient channel to attract new guests. In summary, we continue to believe that we are in the early stages of our journey at Del Taco. Our focus remains on building a strong people-driven culture, strengthening our brand position, driving comparable restaurant sales growth, optimizing restaurant level margins and growing our restaurant base. We made strategic progress during Q3 and our nimble approach allowed us to swiftly leverage mid-tier and premium innovation to immediately improve check trends, and our plan to drive transaction momentum is underway. I would now like to hand it over to Steve Brake, who will cover our financial results.

[Steven Brake:]

Thanks, John. Total third quarter revenue was $117.8 million, an increase of 6.2% from the $111 million in the year-ago third quarter, and included $3.2 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 3.1%. System-wide comparable restaurant sales increased 1.4% and lapped system-wide comparable restaurant sales of 4.1% during Q3 2017, resulting in a two-year trend of 5.5%. The Del Taco system has now generated 20 consecutive quarters of positive same-store sales. Third quarter company restaurant sales increased 3.1% year-over-year to $109.6 million from $106.3 million in the year-ago period. This increase was driven by company-operated comparable restaurant sales growth of 0.3%, along with contributions from additional company-operated stores as compared to the third quarter of last year. Third quarter company-operated comparable restaurant sales growth represents the 25th consecutive quarter of gains, and was comprised of a 2.9% increase in check, including slightly negative menu mix, partially offset by a 2.6% decline in transactions. Franchise revenue increased 8.3% year-over-year to $4.3 million from $4.0 million last year. The increase was primarily driven by franchise comparable restaurant sales growth of 3% and other franchise revenue related to the adoption of the new revenue recognition rules. Moving on to expenses. Food and paper cost as a percentage of company restaurant sales decreased approximately 90 basis points year-over-year to 27.0% from 27.9%, due to the impact of menu price increases and slight food deflation during the quarter. Looking ahead, we expect net food inflation of up to 1% during the fourth quarter as a new agreement with our distributor is expected to increase distribution costs. Our food inflation estimate for the full fiscal 2018 year remains at approximately 1%. The fourth quarter food and paper percentage will also face slight pressure from our Shredded Beef and Epic Triple Meat products, which each drive a strong margin dollar contribution, but with a slightly lower than typical margin percentage. Labor and related expenses as a percentage of company restaurant sales increased approximately 60 basis points to 32.2% from 31.6%. This increase was primarily driven by the January 1, 2018 California minimum wage increase to $11 an hour in the Los Angeles County and Pasadena escalations to $12 an hour on July 1, 2018, as well as a loss of leverage due to the negative transactions and modest same-store sales during the third quarter. This wage inflation was partially 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 decreased by approximately 40 basis points to 20.9% from 21.3% last year. This decrease was from lower advertising expense based on the timing of advertising. Excluding the advertising timing impact, operating expenses increased 20 basis points year-over-year, as operating expense inflation slightly outpaced company restaurant sales growth. Based on this performance, restaurant contribution was $21.8 million, compared to $20.4 million in the prior year, an increase of 6.9%. Restaurant contribution margin increased approximately 70 basis points to 19.9% from 19.2%. And excluding the timing of advertising, our restaurant contribution margin expanded 10 basis points despite the modest same-store sales during the third quarter. General and administrative expense were at $9.6 million, and as a percentage of total revenue increased by approximately 30 basis points year-over-year to 8.2%. This increase was driven by 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 reported on a gross basis, as well as lower than expected revenues, which magnify the percentage. Adjusted EBITDA increased 6.4% to $17.7 million from $16.6 million last year. As a percentage of total revenue, adjusted EBITDA remained at 15.0% consistent with last year. Deprecation and amortization expense increased 6.0% to $5.9 million, compared to $5.5 million million last year. As a percentage of total revenue, depreciation and amortization remained at 5.0% in line with last year. Interest expense was $2.1 million, compared to $1.6 million last year. The increase was due to an increase to one-month LIBOR rate and a slightly higher average outstanding revolver balance compared to the third quarter of 2017. As previously discussed, we expect the increased year-over-year trend to continue due to the rising interest rate environment. As of the end of the third quarter, we had $152 million outstanding under our all revolver credit facility, while our applicable margin for LIBOR loans remained at 1.75%. Income tax expense was $1.8 million during the third quarter for an effective tax rate of 23.3%, as compared to a $2.8 million expense for a 35.5% effective tax rate during the same period last year. The reduction in an effective tax rate is due to the impact of the recent tax reform and a benefit from a favorable permanent difference for stock-based compensation expense from restricted stock awards that vested during the fiscal third quarter. Net income for the third quarter was $5.9 million, or $0.15 per diluted share, compared to $5.1 million, or $0.13 per diluted share last year. In addition, we are reporting adjusted net income, which excludes restaurant closure charges and other income related to the write-off of unfavorable lease liabilities. Adjusted net income in the quarter was $6.0 million, or $0.15 per diluted share. Turning to our repurchase program, covering the common stock and warrants. During the quarter, we repurchased 235,041 shares of common stock at an average price of $12.74 per share and 5,972 warrants at an average price per warrant of $3.07. As of the end of the fiscal third quarter, approximately $38.1 million remained under the $75 million authorization. As John indicated, our recent performance and more conservative expectations for a 16-week fourth quarter has led us to update our fiscal 2018 annual guidance. Please refer to these earning release for the details on our outlook and note that our guidance system-wide same-store sales growth of approximately 3% contemplates company-operated same-store sales growth of approximately 2%. Looking ahead to next year, we thought it would be timely to directionally call out some key items to consider when evaluating our business. First, as I noted, a new agreement with our distributor is expected to increase our distribution costs. Although it is premature to identify an exact range of food inflation until we finalize coverage on many key ingredients, we do expect increased fiscal 2019 food inflation compared to the 1% inflation estimated for this year. Second, we expect labor and related inflation of approximately 6%, primarily driven by a $1 increase in California minimum wage from $11 to $12, which takes effect in January 2019, compared to a $0.50 hourly increases past January 2018. Third, although our pricing strategy will remain nimble, as we continuously evaluate consumer, competitive and macroeconomic trends, we currently expect elevated fiscal 2019 menu pricing of up to 4%, compared to approximately 3% during fiscal 2018. Finally, gross system-wide new unit openings are expected to be similar to our fiscal 2018 openings, again, with an estimated 1% system-wide closure rate. Our use of company capital for new unit development will continue on a selective basis due to the inflationary construction cost and real estate environments, and we’re pleased that slightly more than half of our 2019 openings are expected to be franchised restaurants. In conclusion, as we maintain our current focus on restoring improved transaction trends, we are pleased with the early results from the Shredded Beef promotion and look forward to pairing it with our new Triple Meat Epic Burrito as we finish 2018 and move into 2019. Thank you for your interest in Del Taco, and we’re happy to answer any questions.

[Operator:]

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Alex Slagle from Jefferies. Please proceed with your question.

[Alexander Slagle:]

Hey, guys, thanks for the question. We’ve seen some softer trends in California recently and realized some of your softness is promotion-related. But is there any more color you can provide on what you’ve seen in a region or thoughts on what might be driving that?

[John Cappasola:]

Yes, Alex, sure, this is John. Listen, overall, you’re – what you picked up on is right. I mean, we see as we launched elevated and moved through Q3, we saw actually many of our markets performing fairly well and outperforming the category in some cases, relative to traffic. So, when you look at that franchise same-store sales comp, which was 2.7% ahead of the company in Q3, the majority of that difference is really traffic. So it’s absolutely something that was isolated to some markets. And in these softer markets, what we saw was the $1 Chicken Quesadilla Snacker, as I said, just did not have the desired effect as a traffic catalyst and obviously, its ability to kind of offset the check pressure was not there. And we think, as I said, that, that was heavily due to just the value discount-driven environment that we’ve been in and perhaps the consumer just having too many options out there. The good news is that what we’ve proven to do over time is have the ability to drive healthy same-store sales, including traffic with mid-tier and premium products, and we like that, because strategically, it further differentiates the brand from Taco Bell and that’s why we pivoted in that direction, especially here in early part of Q4 and we’re seeing some success in the early part of Q4. I think, the other dynamic that maybe playing out more in a market like Los Angeles is the early adoption of technology, which we really see starting to take shape and where we see things like heavy competitor discounting via mobile apps, as consumers are using mobile apps more and more in QSR environments and then, of course, the emergence of delivery, which has been well documented. So on both of those fronts, we’re getting in the game. We’re through our testing development phases and moving into roll out. So if there is a headwind in some certain markets related to that, because of our careful adoption of these programs, it’s going to be removed here over the next few quarters.

[Alexander Slagle:]

Got it. And then pricing plans for the rest of this year and into 2019, I mean, if you could just talk a little bit more about your continued comfort and staying at that higher level of pricing, even though we’ve seen this competitive environment still pretty hot and value focused and the traffic being tougher to come by?

[Steven Brake:]

Sure, Alex, it’s Steve. So as we move through this year, we had low to mid 3% menu price in effect during fiscal Q3, that will tick up slightly to a little bit over 3.5% during fiscal Q4 to leave us at the end of the year carrying kind of the net mid, high 3% area. So as we’ve covered before, part of our margin management plan, it certainly elevated menu pricing, aimed at enhancing restaurant contribution performance with a limited adverse impact on traffic. Every single price move we make we internally and with our econometric modeling firm analyze the heck out of it. The nice thing about price is that it’s fluid as you move forward into time and along with our internal and third-party analysis, we’re going to be reading the consumer, the competitive and the macro very carefully and all of that is going to inform future price increases. All that said, although it’s early to put a tight color on 2019, we do expect to carry more price next year compared to the 3% we carried this year. Right now, we’ll call that up to 4%. We definitely believe price is a very powerful lever that can help margin management to say the least. And we’re also going to be very cautious and mindful as to how we deploy that and lastly, noting that it is a very level playing field when it comes to price, particularly in California, where most of our stores in the company side reside. We’re certainly observing most, if not, all of our direct peers also take elevated menu pricing currently, and we expect that to continue going forward.

[Alexander Slagle:]

Great. Thanks for the color.

[Operator:]

Our next question comes from the line of Greg Badishkanian from Citigroup Incorporated. Please proceed with your question.

[Frederick Wightman:]

Hey, guys, it’s actually Fred Wightman on for Greg. I was just hoping you could dig into the traffic declines in the quarter a little bit more,. I mean, I understand the Snacker didn’t work out quite the way that you had hoped for. But is this – is it really just a story of product launch sort of gone awry? How much of it’s due to that value environment you talked about, or is there something else going on?

[John Cappasola:]

Yes. I think the best way to answer that is to just say that, it’s probably a bit of all of the above when you think about the current marketplace in the environment with the consumer and restaurants. And as we think about moving the brand forward and providing the opportunity to put more momentum into our traffic, as I outlined on the call, I think we’ve got a solid foundation with what we’re doing at the restaurants to improve experience and improve frequency through elevated combined solutions will continue to nuance that and execute against that as we move through time. We think that, that is something that could be a big differentiator for us relative to the marketplace. Consumers are always looking for value, but they’re also looking for better experiences. We see that in the data. Obviously, we talked about wanting to put a bit of a focus on mid-tier and premium innovation. But I just wanted to caveat that by saying that, it does not mean we’re walking away from Buck & Under and Buck & Change in these markets. It is going to be marketed from a secondary standpoint. It’ll be front center on our menu board like it has been over the last several years. So that we continue to remind consumers about the everyday value and affordability at Del Taco. And then obviously, the last point on the digital expansion, we do think is a bit disruptive out in the marketplace right now and something that we absolutely have gotten our hands around and we’re ready to tackle and that’s going to put us in a good position relative to traffic in some of the softer markets moving forward.

[Frederick Wightman:]

Great. And then just looking at the 4Q unit openings, is there sort of how you guys were thinking the year would plan out from a cadence perspective, or did something sort of move around in the back-half of the year, or anything else would be helpful?

[John Cappasola:]

Yes. This is around what we were thanking. I mean, it’s a little bit more back-end loaded, which is kind of the function of development these days. There definitely is a longer lead times and we’ve seen historically happening out there in the marketplace and that’s happening kind of across geographies right now. So a little bit more of a lag than we’d like, but certainly we’re as diligent as ever as getting these units under construction and then getting them built to get them open to start generating revenue for both of our company operations, as well as franchisees.

[Frederick Wightman:]

Great. Thanks.

[Operator:]

Our next question comes from the line of Nicole Miller from Piper Jaffray. Please proceed with your question.

[Nicole Miller Regan:]

Thank you. Good afternoon. The first one, I just want to make sure I understand price was 3% in the quarter, so was mix down 60 basis points?

[Steven Brake:]

Pricing was in the low to mid-3%, so with check at 2.9%. Mix was negative less than 50 bps.

[Nicole Miller Regan:]

Okay. And when you talked about current same-store sales improved sequentially, and I think I heard you say the guidance implies the 2% company comp. Did I hear that correctly? And is that for 4Q or for the year?

[Steven Brake:]

For the year, we expect system sales of 3%, with company about 2%, due to the continued franchise outperformance that we’ve seen all year. The implication with the range is a low single-digit type company comps in the fiscal fourth quarter in that 2% area plus or minus is what our range implies.

[Nicole Miller Regan:]

Okay. And then I see the CapEx just picked up slightly. Maybe could you talk through the pieces of the CapEx spend for this year in terms of new growth maintenance or other buckets? And was – is it just pulling units forward or some other type of investment?

[Steven Brake:]

Yes, most of the upward revision was due to new units. That category, combination of factors, a different mix of new units now, meaning, fewer that will open that have meaningful landlord contributions or sale leaseback opportunities, where we can really net down that net investments, more ground leases based on what we’re actually constructing and opening this year, addition to the continued inflationary environments, both in construction costs and in other aspects of our capital needs. Some additional spending versus original expectations on units that will open in the front-half of 2019, which overall is a positives. And then lastly, there was that one construction defect matter we talked about earlier this year that did require us to expend some meaningful capital that is now captured in the revised guidance.

[Nicole Miller Regan:]

And that’s helpful. Thank you. And just the last question. It’s very helpful to get the color around comps and labor and the price, what that might look like for next year? What comp is required then to hold store level margin flat? I’m just kind of thinking this through and thinking it’s probably prudent to think about deleverage, and I’m just wondering if that’s a fair assessment?

[Steven Brake:]

Ultimately, the comp composition probably carries today more than the absolute comp itself, in particular the level of menu price that can effectively flow through has the most significant impact on maintaining or enhancing margin. So how much price we effectively take to market and flow through is the primary answer to your question, slide cart of that, of course, the strength of traffic and mix, which both flow through at a similar meaningful rate, but have a little less impact on the margins themselves. I’d say overall, we touched on – pluck racing is fluid. We absolutely will continue to lean in on that as a lever. We see the environment doing the same thing and no matter what percent price we take year-over-year. I’ll tell you on an absolute basis, the Del Taco menu and barbell menu strategy has incredible value for our guests. That’s probably one of the most powerful parts of the story in this brand, and we’re going to preserve that as we move forward, whether we’re carrying 3%, 4% or 5% price over time. So that’s very important to note. Beyond that, we feel really good about next year. This mid-tier premium focus is going to be ongoing with continued innovation. We think that should shape up to have a nice contribution overall next year as a driver. So, where that composition of comp and the absolute comp itself shakes out, we’ll very much inform what margin does in 2018 versus this year. So obviously, with our current guidance for this year, if we can deliver that high-end in 19.5% area, that would be very modest contraction from the 19.70% a year ago, that’s obviously what we’re shooting for. And if we do that, that will be the fourth year in a row, where the RC percent right around 20% area, despite the ongoing inflation across the basket and in wage. So we’re remaining very focused on margin management.

[Nicole Miller Regan:]

Excellent. Thank you so much.

[Steven Brake:]

You bet.

[Operator:]

Our next question comes from the line of Jeremy Hamblin from Dougherty & Co. Please proceed with your question.

[Jeremy Hamblin:]

Thank you. I wanted to ask first a question on G&A guidance update, because I think as I’m doing the math here, it looks like your G&A guidance has moved up about $1 million, maybe even a little bit more than that on the low-end. And wanted to get a sense for what’s driving that? Obviously, you’re lowering your EBITDA guidance and sales guidance for the year. I might have thought that, that would have a negative impact on total G&A. But can you give me a sense on why that guidance on an absolute dollar basis has moved higher?

[Steven Brake:]

On an absolute basis, it actually still remains pretty squarely between $43 million and $44 million, that’s using the now 8.6 [ph] on the midpoint of revenues, and really the reduction in revenues for the new guidance has kind of magnified it on a percent basis. That said, throughout the year, we’ve also talked about legal and related expenses, as well as the [indiscernible] costs trending higher than expected. So there is a little bit of pressure there netted down certainly by incentive compensation that goes the other way. Net-net, delivering G&A is kind of right between $43 million and $44 million, really lines up with where we were and where we are now.

[Jeremy Hamblin:]

Okay. And in conjunction with that question, you’ve mentioned that you thought this year was going to be a peak year in terms of percent of sales. With other margin pressures, are you even more focused on how to, maybe control or suck a little bit of cost out of G&A moving forward on next year?

[Steven Brake:]

Yes, we…

[Jeremy Hamblin:]

Is that a priority?

[Steven Brake:]

Yes. We continue to view this as the peak year and are very focused real-time as we go through our planning process for 2019, making sure that as we move forward, we’re looking at plateau and modest leverage long-term to say the least. So, taken a very sharp focus across the business to make sure that, that G&A line is optimized as we move forward that we make sure the percent peaks this year and comes down thereafter, so that is absolutely our focus.

[Jeremy Hamblin:]

Okay. And when you say plateau, just clarifying not next year, right? I’m assuming that you’re going to get leverage on it next year?

[Steven Brake:]

That would be the goal. We’ll have a range on it, which we’ll probably look in the area of plateau to leverage.

[Jeremy Hamblin:]

Okay. And then one other forward-looking question. In terms of – you’ve had some shift in timing here on advertising that has – had an impact on your occupancy and other costs. And it sounds like that’s going to kind of come back on us here in Q4. Is there any color that you can provide in that particular line item for next year? Is it going to more resemble the 2018 version of spender or more like 2017?

[Steven Brake:]

So the good news is advertising for every fiscal year looking back and our expectations going forward, it’s 4.0% of sales. All that said, quarter-to-quarter, it’s going to be what we deploy based on the marketing and promotional calendar and what we think we need to drive the business appropriately. So that’s where – there can be some wild-boar variability year-over-year now. With dust settled this year, I’ll tell you the first two quarters we ran 4.2%, the back two quarters we’re going to run 3.8%, it just so happened that when we lapped a year ago kind of tilted the other way and it caused the pressure we felt in the front-half that’s now largely reversed in the third quarter. So the good news is, really if you look at this year spending 3.8% or 4.2% in every single quarter, it is pretty much in line with our full-year 4%. Every given quarter has a nice meaningful amount of dollars driving the business. So as we get into next year, as we always do, if there’s a notable year-over-year percent shift for the good or the bad, we try to call that out, so folks can have a more – I guess, objective view of the performance.

[Jeremy Hamblin:]

Okay, great. Thanks for taking the questions. Good luck.

[Operator:]

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

[Craig Bibb:]

Hi. Let me just make sure I understand, where Q4 same-store sales were looking at about 1% and it’s with the same traffic, but a better mix of 3% price, is that pretty much it?

[Steven Brake:]

The revenue range has a low single-digit range and more of a 1% to 3% color, because there’s $3 million range in the guidance. So, low single-digit is kind of what the implied guide is. You’re out to look into – to deliver that. Certainly, we definitely saw in the third quarter, although, check really started out with negative mix that we talked about on the last call, we mentioned by the time we got the back-half of fiscal Q3, your check had absolutely recovered. We kind of shifted our promotional focus, turned check on a dime and actually ended the back-half of the quarter with a favorable menu mix. Early days in Q4, it’s our long 16-week quarter. But so far, we continue to have a nice check trend in the fourth quarter, particularly with Shredded Beef coming into the business the third week of Q4, which is also had a nice benefit on the check line. Traffic does remain negative in the early days of Q4. So we’re looking for Shredded Beef momentum and the new innovation on Epic Triple Meat to put us in a better position to have further sequential improvement on the traffic line as well, where that nets are in absolute basis, early to call a lot of runway left here, but that’s our focus.

[Craig Bibb:]

Okay. And then you’ve been testing delivery in Sacramento for quite sometime. Can you give us any indication of like where – how that picks up same-store sales or impacts revenue?

[Steven Brake:]

Yes, we’ve been testing delivery in Sacramento, Vegas and a number of stores in the L.A. area for sometime now. We definitely like what we see. Question one, is there consumer demand there? There absolutely is a lot of our efforts have been to make sure that we’re optimizing our program, so that it’s seamless for our operators, so that they can deliver the best possible product and experience. Possible, the other half also involves the economic model. So our testing to date has also included in a variety of price tests, really aimed at measuring guest sensitivity to premium menu pricing for delivery. So far, this testing definitely indicates a relatively low level of sensitivity and that puts us in a position to implement premium pricing for delivery transactions when we launch here soon. So the good news there is that this premium pricing is going to go a long way to help offset potential restaurant margin pressure from the commissions paid to the delivery service providers. So we feel very good about that and that it’s going to be a favorable part of our another channel that’s going to lead to same-store sales potential with appropriate margins.

[Craig Bibb:]

Okay. It’s sounded like you’re using Grubhub in LA., but you’re – longer-term, you’re thinking multiple delivery partners?

[John Cappasola:]

Yes, that’s absolutely right, Craig. We’re going to start here with our partnership in GrubHub, which is fully integrated into our POS to Steve’s point. So we’ll make it seamless for our operators. We’ll expand nationally with GrubHub and then we’ll be moving into expansion with Postmates and DoorDash. We think the multiple DSP approach is the best way to capture and maximize demand through that delivery channel.

[Craig Bibb:]

Okay. And I guess, I’m struggling a little bit with – like it sounded like that high-value $1 Snacker-type product doesn’t drive traffic. It does drive mix within the stores that hurt your mix. Premium is driving traffic or I’m sure…

[Steven Brake:]

Yes. I’d say…

[Craig Bibb:]

…[before they bought lever, or…?] [ph]

[Steven Brake:]

Yes. If you look at our historical and how we view it all, as we continuously look at different windows and different promotions and what the mix looks like and how it drove traffic or check or same-store sales. And ultimately, when we look back historically on premium promotions, whether that be Epic Burritos that we’ve launched, or a program like Carnitas, or even our LTO Shrimp program, which is more premium in the early parts of the year. We absolutely see historically, traffic momentum during those programs. So I think that’s a nice part of our capability that absolutely separates us from other QSR Mexican and that is that we have this ability to leverage that upper-end of our barbell strategy than we’re premium platform because of the quality ingredient platform that we have on our line and that, that positioning that we’re building with QSR+. So absolutely, we think we can get traffic momentum from premium products. We also like it, because it provides a hedge a bit, because you’re typically also getting really nice check and really nice margin out of those products as well.

[Craig Bibb:]

Okay. Last one, is it flat openings next year? I was thinking you guys want to be ramping that up a little bit what’s going on?

[Steven Brake:]

Yes. The backdrop here is, as you know, we’ve been building our pipeline on company and franchise, and we feel really good about the momentum that we see within the pipeline. I mean, if you look back 2016, we built 12 restaurants. In 2017, we delivered 20, and we’re saying this year and next year is going to be in that similar kind of mid to high-20 range. So we’re making good progress, while really many others are starting to pull back and why is that happening because of the underlying unit economics. And we want to make sure that we set this up as a long term investment that makes a lot of sense for our company operations, as well as our franchisees. These are long term investments. And the current inflationary environment just makes us be a bit more selective. So, remember, we’ve always said quality over quantity. We want to kind of live that and make sure that we walk the talk there. But despite that, those kind of more challenging conditions, I’d say that, the good news is, “Hey, we’re seeing franchisees that are generally under penetrated in their markets and new franchisees in new markets building pipeline and building restaurants. I mean, we’re building and constructing stores in 11 states this year”. That is – that’s a big statement relative to what the longer-term opportunity looks like for this brand. And I think, I think we’re going to be in great shape in the long run. We just need to move through this environment very carefully.

[Craig Bibb:]

I guess, the 11 states is kind of went really against why it might be a little disappointment you’re going to have flat openings next year, given all the whitespace you have outside of California, which isn’t really true of a lot of your competitors.?

[John Cappasola:]

Right. Remember we are not moving in a lot of different markets at one time. So that quality over quantity approach has been for us, where we’ve been building our hub down in the Southeast and then we’ve been adjacently growing outside of that Atlanta market. So attracting the right franchises down there and the right folks that are willing to get in there and build and build a company – build a franchise operation around us and leverage our infrastructure. So we’ve got those folks coming on Board. I think, we’ve got eight multi-unit development agreements down there. Many of those are five to 10 unit agreements. Remember, we’ve got to make sure that those individuals as they’re building their first stores at the end of this year and next year are having success that we’re helping them to make sure they’re executing properly. So that they’ll build and deliver on those agreements that we’ve agreed to. So that’s kind of part of the dynamic is quality over quantity and being very succinct in the way that we think about expansion. But we’re also looking to attract other franchisees and other territories, where we have the ability to be successful as a brand, maybe where we already have Del Taco Restaurants. So it’s a process and we’re in the middle of that and we’re seeing some success. But we’re clearly – this isn’t something that’s going to move to high single digits anytime soon. We need to kind of walk before we run, get to the net mid single-digit range. I think we’re on pace to get there through our pipeline development and our franchise conversations and that will put the brand in a great position as we get beyond all this inflation eventually.

[Craig Bibb:]

Okay, great, John. Thanks a lot.

[John Cappasola:]

Thank you.

[Operator:]

Our next question comes from the line of Peter Saleh from BTIG. Please proceed with your question.

[Peter Saleh:]

Thanks. Yes, I just wanted to ask about the impact of pricing on traffic. If you could just talk a little bit about what the model suggest the impact is from taking price on traffic, or if there’s any impact at all, or if – and if there is what is the level of resistance on taking this much price?

[Steven Brake:]

Sure. As I noted, the goal of price is to enhance restaurant contribution performance with a limited adverse impact on transactions. We believe some level of consumer elasticity and really tension is going to follow any price increase, particularly in the near-term and we often observe a transaction recovery several purchase cycles after a price increase. So, we think near-term versus long-term price sensitivity dynamics are particularly relevant for Del Taco is, as I said, the value proposition that we offer through our menu and our barbell menu strategy on an absolute pieces is very, very compelling versus our peers, especially in this environment with a heavy California footprint, where the peers are also taking elevated price. So, all that said, our internal analysis and ours third-party econometric modeling analysis continues to indicate that all the recent pricing actions have been accretive overall. I think, that’s evidenced in our Q3 margin performance, even the sequential improvement we talked about more recently during the fourth quarter, I think, also goes to support that notion.

[Peter Saleh:]

Great. And then, Steve, I think you mentioned a agreement for the commodities for 2019 and you’re expecting probably a little bit more food inflation. Can you just tell us, give us a little bit more detail about that agreement? And how would your – is it saving you money on food side? If you didn’t have this agreement in place would your inflation be even higher for next year, how should we be thinking about the benefits and the tradeoffs for this agreement?

[Steven Brake:]

So what I referenced is the renewal of our distribution agreement. So those are typically long-term agreements. Our prior long-term agreements will be expiring and renewing during the fiscal fourth quarter. And in our situation, we’re coming off of what was a fairly attractive case rate on our prior distribution agreements. And currently, the distribution environment has been challenged with very limited capacity, driver shortages and also increase cost pressure on the warehouseman side of their equation. So, that environment has shifted and is much more challenging currently for brands who are going through a similar type of renewal process. So the net of that is distribution cost sets spread across our entire basket of goods will be pressured as we move through this fourth quarter into next year. Beyond that, net itself will have some meaningful inflation. The other puts and takes within our food basket still a lot of work we’re doing, trying to get a little bit more visibility into the food items and where that will take us next year. But all that said, it does feel like we’re going to have higher inflation next year versus this year down the road, will put a tighter color on that.

[Peter Saleh:]

Okay, great. And then I just wanted to circle back to the $1 Chicken Quesadilla. I’m just trying to understand if that didn’t really drive the desired result, how are you thinking about that $1 price point going forward? Are you going to lean on that again? Is it – was it the product that didn’t resonate, was it the price point? How should we be thinking about the strategy going forward? Are you going to focus more on mid-tier premium rather than kind of coming back to this value positioning. Just trying to understand what didn’t work?

[John Cappasola:]

Yes, Peter, it’s a great question. So we absolutely believe there’s still a big place on our menu for what you would call that lower-end part of the barbell menu strategy, which is really the Buck & Change platform that we have. And within – with our Buck & Change platform, we talked a lot about over the last couple of calls, the migration that we’ve been making off Buck & Under. So I think, living in a world, where you’ve got Buck & Under and Buck & Change simultaneously is likely we’re going to be for the time. For the time being, we do think that, given our status as a value brand, that’s got very high affordability perceptions that, that will continue to be that piece of the barbell strategy that differentiates us from other QSR+. Remember, we said we wanted to be a value-oriented QSR+, give ourselves the ability to fight for traffic on the fast food side of the fence, where we have better than average food quality and freshness and a story there to really leverage with the same or similar value and convenience. I think that’s a great proposition for us and we believe there is still traffic and incremental share to go get over there. So a long winded, but I will tell you that it’s going to have a role on our menu moving forward. The focus right now on our innovation is mid-tier and premium. Remember, those are the areas of the menu that we really have the opportunity to build out to bring the plus side of our QSR+ equation to life and that’s what we intend to do. I think it’s got a really good healthy balance there when we think about same-store sales, if we get the right innovation out the door and consumers get excited about it.

[Peter Saleh:]

Got it. Great. And – very helpful. And then just lastly on the delivery side, I know many of your peers within the quick service space have indicated that the average check on delivery tends to be 1.5 times to 2 times higher than the traditional check. Is that something that you guys are seeing as well or at least initially?

[John Cappasola:]

Yes, that’s about right. I mean, that’s about what we’re seeing. I mean, the model that Steve laid out, we’ve gotten very comfortable with a big driver of that model is obviously the average check that we’re seeing, the aggregate profit dollars that actually come out of these transactions. And then further down with the ability to take some pricing, because this is a very convenience driven transaction as we found through our testing and also research that we’ve done with consumers. We believe this can be a very accretive move and we’re excited about the multiple DSP approach, especially in a market like LA. We think we can really, like I said earlier, maximize consumer demand here.

[Peter Saleh:]

All right. Great, thank you very much.

[Operator:]

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

[Nick Setyan:]

Thank you. Just kind of taking a step back bigger picture, Steve, I think, this year guidance calls for low single-digit EBITDA growth. And I think we kind of thought of next year as maybe a low single-digit to potentially mid single-digit type of EBITDA growth here and beyond 2019 that could solidify mid single-digit or even increase above that given the guide down this year on EBITDA and the unit growth commentary on the company-owned being potentially less than 50 of the total unit growth in 2019. How should we think about the cadence there? So this year, we are flat, slightly down EBITDA. How should we think about next year kind of bigger picture and then beyond 2019, how should we think about EBITDA growth algorithm?

[Steven Brake:]

Yes. So with the color provided, somewhat higher food inflation and labor inflation moving to 6%. Obviously, that serves to pressure our P&L, if you will. The good news is, there’s a lot of positive levers in our view that are going to be in play next year. So first, taking more price than the 3% this year certainly up to 4% and it’s fluid. We’re going to read the consumer, the competitor and the macro and make sure we carry the optimal level price next year. So that’s going to be an important lever to help drive restaurant contribution and EBITDA. In addition, as we touched on, this was a tough year on G&A. We had a lot of legal and related hit ups. And we –it’s our year to become 404(b) compliant. There’s a lot of time and effort and expense involved in that. So once we get past this peak year, that G&A headwind, if you will, is going to subside. So that’s definitely a positive as we look ahead. And I would say, even though it’s similar growth next year, the growth we’re going to deliver this year, plus the growth that we put on the Board last year, as it becomes healthier. In fact, to 2018 openings, it’s early, but we’re really liking what we’re seeing out of the 2018 class in particular. We feel like the financial benefits of of disciplined growth well go a lot further down the road next year to drive profit than it did this year. So that’s another positive. Then lastly, traffic and mix. I mean, John told the story very well that we have our QSR+ brand that have delivered innovation consistently for many years now has compelling mid-tier and premium kind of whitespace opportunities with other platforms that we’re working on for down the road. We think traffic and mix, certain, the net of two can shape up to be a healthy year and healthier year next year. So those are a lot of positive things that, in my view, can outstrips the couple directional increased costs that we also talked about. So obviously, we’re going to try to frame that into some meaningful guidance down the road here for 2019 and behind the scenes, we remain very focused on optimizing our plights as we move forward.

[Nick Setyan:]

John, I know in the past, you guys had highlighted some of your cost initiatives thinking about kind of 2019, particularly on labor. Are there some opportunities to maybe mitigate that 6% labor inflation? So maybe the actual labor expense growth is more like 5% or 5.5% not 6%?

[John Cappasola:]

Nick, we’re certainly focused on making sure we can do anything in our – within our four walls to become more efficient. I mean, we made some strategic investment here recently that we talked about around, what we call, our FREP program, and that is the ability for our operators to use more of a food processor with the whole produce that we use like tomatoes and the £40 block of cheese, which can make that process much more efficient, potentially saving some labor. We’ve got to get our feet under us with a program like that and make sure it’s being executed well before we can start to contract. But those are the types of opportunities that we’re absolutely trying to bring into the operation to tighten up on the labor front a bit without impacting guests experience and that, I think, is really the trick. So we’ve got to be comfortable that we can do that and then we can start to become a bit more efficient. We’re also looking at things lying tightening up on the labor scheduling front and we’ve been doing a lot of work on that front this year. Quarter hours can make a difference here, over the long run making sure that we’ve got the feet on the floor that we need at the right moment to deliver on that peak. So a lot of effort going on, on that front as well. So, it’s got to be a balanced approach, as you know. I mean, this business is that of throughput and that of efficiency and you’ve got to have the ability to kind of do both if you want to be successful. But we absolutely do see, to answer your question, opportunity down the road to be able to take a little bit of labor out of the business over time.

[Nick Setyan:]

And then just final question near-term. Was the Chicken Roller, or was it just – that it was such a compelling product on its own that somebody would come in, instead of purchasing a mid-tier, or a premium product, they would actually just substitute in the $1 product instead of maybe purchasing the mid-tier and adding the $1 product. And is that really the heard of the issue?

[John Cappasola:]

Yes, it could be. I mean, I think that that is obviously – it was a highly compelling product. I mean, we talked about it breaking records relative to the number of units sold coming out of the gates and that was one of the things that obviously early on concerned us. And I think that when we do new product innovation, specifically in that mid-tier and premium area, it seems that, that product news is much more sexy. It’s much more consumers turn their heads to say, “Oh, that’s Del Taco delivering that. I’ve got to go check that out”. And I think it really excites our core, but it also excites folks that are maybe more in that medium to light user category to come in and check us out. And when we’ve been a value brand for so many years and done a lot of $1 products over the years, I’m not going to sit here today and say that, that will be part of our plan at some point in the future, because it’s a lever that we have and not a lot of brands have in our situation. But certainly, having the ability to pivot and move up the ladder a little bit puts us in a great situation and gives us a lot of levers to pull. So we don’t want to be fearful of doing that where we need to. I think, this is a great example of that, and we’ll continue to test and develop against all layers of our menu strategy to make sure that we’ve got a pipeline, so that we can be nimble in the future.

[Nick Setyan:]

Got it. Thanks very much.

[Operator:]

Our next question comes from the line of Stephen Anderson from Maxim Group. Please proceed with your question.

[Stephen Anderson:]

Yes. Good afternoon. I wanted to go a little bit deeper. I know you exposed some of the other cost lines, but wanted to talk about some of the other commodity costs where are you seeing the pressure? And I have a follow-up on the mobile launch.

[Steven Brake:]

Sure. The food pressure this year?

[Stephen Anderson:]

Yes, this year and maybe what you’re looking at as maybe you start to get a more – little more visibility into 2019?

[Steven Brake:]

Sure. This year the positive, the reduction that’s really been on the avocados, pinto beans and cheddar cheese, we had a good year on those items. The increases this year that will eventually take us through that net 1% area for the year would be soft drink syrup, French fries, chicken, steak and then some pressure from distribution renewals. So that’s the puts and takes for 2018. Looking next year, yes, the distribution renewal is the primary point of inflation at this point, I would tell you, beverage syrup customarily for us and everyone goes up every year in addition looking at some potential chicken and tortilla pressure that we’re working through. We definitely have a new French fry arrangement that’s going to be a bit of release next year. So there’s some upward and then sort of a couple of downwards as well. We think taco meat can also be a good guy next year as well beef patties. Things I didn’t note are generally the neutral zone, some small modest wins or losses and we’re still doing a lot of work against 2019, that’s why down [indiscernible] to put a tighter range on what that inflation might look like.

[Stephen Anderson:]

Okay. And the follow-up question though would be a mobile launch. I mean, what kind of SG&A or what kind of a expense you look to do with that launch? And whether directionally, you’ll see increased marking spend in Q4 versus Q3 or if that’s the only additive to what you’re doing already with the Shredded Beef launch?

[Steven Brake:]

No specific G&A pressure. And in terms of marketing spend, the 4% a year amount that we deploy as we move forward, a portion of that will begin to support delivery messaging, of course. But we don’t expect that to alter the 4% that we spent each year. It’ll just be part of the composition of how and where we spend that 4%.

[Stephen Anderson:]

Okay. Thank you.

[Steven Brake:]

Okay.

[Operator:]

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to management for closing remarks.

[John Cappasola:]

All right. Well, thank you for your interest in Del Taco. 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 at this time. Thank you for your participating.