Del Taco Restaurants, Inc.
Q4 2018 Earnings Call Transcript

Published: 19 Mar 2019

[Operator:]

Thank you for standing by. And welcome to the Fiscal Fourth Quarter 2018 Conference Call and Webcast for Del Taco Restaurants. 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. 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 include the reconciliations of these 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. We appreciate everyone joining us for the quarterly call. Before walking through our Q4 results and plans for 2019, I wanted to briefly highlight some key financial and strategic takeaways from 2018 as I believe they will provide great context for what we hope to accomplish this year. First, we achieve our sixth consecutive year of comparable restaurant sales growth across the Del Taco system with a 2% increase, while our company operated restaurants generated 1.5% increase. Franchise comparable restaurant sales grew at an even faster rate of 3.8%, which we view as indicative of our strengthening franchise system and Del Taco's brand portability across a diverse geographic footprint. In fact franchise AUVs increased approximately 30% in the last five years across our 13-state footprints with more than half of these restaurants located outside of California. Our franchise momentum coupled with our non-core western market refranchising strategy that will discuss shortly is expected to stimulate development interests across existing and new franchisees to help expand Del Taco's brand reach. Second, we held our restaurant contribution margins steady at 19.7%, demonstrating our effective margin management strategy despite only model same-store sales growth at company restaurants. Fiscal 2018 was our fourth consecutive year achieving a restaurant contribution margin of approximately 20%, and we only recently achieved $1.5 million AUV. Margin management has become a strong confidence at Del Taco and is critically important during this extended inflationary cycle. Third, we opened 25 restaurants across the Del Taco system in 2018, including 13 company-operated and 12 franchise restaurants. This compares to 20 openings in 2017 than only 13 in 2016. We are encouraged by the momentum we are seeing both in terms of more openings and the expanding geographic breadth of our openings as 10 states had openings in 2018 and we expect openings in 14 states during 2019. Our franchise acceleration has been particularly encouraging and has been enabled by strengthening our franchise foundation through enhancements and investments in recent years to position franchising as a pillar of our growth strategy. And fourth, we successfully rolled out elevated combined solutions, the latest iteration of our brand strategy to further our mission to be the leader in the value-oriented QSR plus segment. It included brand catalyst and operational improvements to elevate our brand positioning through a deeper focus on our fresh preparation, quality attributes and of course hospitality. We also work to further strengthen our great culture with the launch of our new advertising campaign centered on real employees, highlighting our freshly prepared ingredients in QSR plus positioning by celebrating the hardest working hand and fast foods. Regarding Q4 itself, we extended our track record at comparable restaurant sales growth to 21 consecutive quarters for the Del Taco system with a 1.9% increase, and a 26 quarters for company operated restaurants with a 1% increase. Average check growth at company operated restaurants was 4.9%, including over 1% of menu mix growth, although, transactions declined 3.9%. Franchise comparable restaurant sales grew 3.2% of the outpacing company operated restaurants. We also increased our restaurant contribution margin by 40 basis points to 20.3% and our adjusted EBITDA by $0.3 million to $23.6 million. Finally, we had 15 system-wide openings, consisting with seven company operated and eight franchise restaurants. Q4 marked a return of the fan-favorite premium limited time offer protein shredded beef, which had not been on the menu since 2012. Shredded beef included mid-tier and premium products to provide a great value and a quality food experience designed to elevate the brand. We paired that LTO with additional new product news around Epic Burritos with the launch of the new Triple Meat Epic Burrito, featuring freshly grilled steak, chicken and bacon. These promotions help drive over 1% of menu mix growth and a Q4 premium mix that exceeded 10%. Turning to our 2019 plans. We're focused on driving traffic momentum profitably through a series of strategic initiatives using a phased approach. This starts with our digital transformation through our new app and expanded third-party delivery, followed by enhancements to our core value program and delivering exciting new products designed to generate incremental occasions. Let me start with our digital transformation progress. Last November, we launched our new app as a key pillar of our CRM development strategy. Our initial focus is to provide offers to build our data base, which has now eclipsed 400,000 registered users since November. We are encouraged by the early momentum of this marketing platform and the long-term opportunity it provides us to drive guest frequency at its scales. We expanded our delivery initiative as well during the first quarter by launching Grubhub delivery in substantially all company operated Del Taco locations. We believe a multiple DSP approach will optimize driver coverage to maximize consumer demand, and we expect to launch both DoorDash and Postmates later this year. While we continue to leverage the Buck & Change feature of Buck & Under to provide pricing flexibility, we are also enhancing our value platform with the recent launch of Fresh Faves boxes. Fresh Faves addresses growing consumer demand for abundant value and better positions us to meet value-oriented guest needs. These are full meal deals with two or three entrées, French fries and a drink, designed to deliver best in class abundant value and variety that differentiates Del Taco from the competition. That differentiation really starts with our pricing approach by offering $4, $5 and $6 options, which provides the consumer great choice. The new Fresh Faves boxes will work in concert with Buck & Under and Buck & Change to offer expansive value ranging from ale cart items to bundled meal deals. Underpinning the launch of Fresh Faves boxes is our seasonal seafood promotion, featuring our popular jumbo shrimp limited time offer and two beer battered fish tacos for just $4, made with hand cut sustainable wild-caught Alaska Pollock in a crispy beer batter, sounds delicious. Finally, we plan to leverage innovation to drive incremental occasions with the launch of the Beyond Taco and Beyond Avocado Taco during the second quarter. The growing guest demand for vegan and vegetarian options created an opportunity for us to partner with Beyond Meat to be the first Mexican QSR chain to develop a proprietary blend of seasoned 100% plant-based protein that taste similar to our current ground beef. We have tested beyond meat in select restaurants in greater Latin America, our entire San Diego market and more recently, in all Oklahoma restaurants. The response on social media and results have been impressive, increasing both check in traffic as many new or lapsed users and regular Del Taco fans visit our restaurant eager to sample something innovative, which deliveries on the better for you meat steak. We believe this program will drive sales while further strengthening our QSR plus brand position. Currently, our first quarter system-wide comparable restaurant sales trends today are running slightly negative and below our prior expectations as expressed in the January. This outcome is influenced by the anticipated shift of Lent, which began three weeks later this year and adversely impacts Q1 due to our very popular seasonal seafood promotion, as well as the unanticipated extremely cold and wet weather we have experienced in California and throughout the west. Looking forward, the expected combination of normalized weather and the favorable reversal of the Lent shift in the second quarter is expected to sequentially improve same-store sales across our system, particularly as strategic initiatives kick-in and transaction compares ease. Lastly, I wanted to reiterate our portfolio optimization strategy, which is designed to help grow AUVs and stimulate new unit development. By shifting our portfolio mix to 55% franchise by summer 2020, our company operated footprint will predominantly reflect strong AUVs and restaurant margins in our core Western market plus a strategic presence in our emerging markets. We expect this to also drive a sharpened operational focus and financial benefits, including improved company AUVs and restaurant margins, reductions in recurring existing unit capital and reduced exposure to cost side inflation in California concentration. In the first quarter, we acquired three high-volume franchise restaurants and sold 13 lower volume units in the LA area to existing multiunit Del Taco franchise groups. These transactions are expected to optimize these restaurants for AUV growth. And although, we will consider buying or selling other restaurants in our core LA market, nothing further is planned at this time. We also plan to refranchise our non-core Western markets to help stimulate development, as we begin to sell for the common perspective franchisee desire to buy and build. We have no additional updates at this time other than to say that the process will proceed with a focus on transacting with the buyers who are most likely to deliver on their growth commitments. We remain confident they can all be refranchised by next summer 2020. Overtime, the net proceeds from such refranchising may help fund new company seed markets, enabling co-development or adjacent franchise growth opportunities and other efficiencies. In closing, there are a lot of exciting things happening at Del Taco. Our digital value and innovation strategies will serve as an important catalyst for sales growth. And as always, we plan to complement our top line initiatives with effective margin management. And now, Steve, will review our Q4 financials and full year guidance for 2019.

[Steve Brake:]

Thank you, John. Total fourth quarter revenue rose 7.3% to $157.3 million from $146.5 million in the year ago fourth quarter, and included $4.1 million of franchise advertising contributions and $0.2 million of other franchise revenue related to the adoption of new revenue recognition rules in 2018. Excluding these revenue recognition impacts, total revenue grew by approximately 4.4%. System wide comparable restaurant sales increased 1.9% and lapse system wide comparable restaurant sales of 2.4% during the fourth quarter of 2017, resulting in a two-year comp of 4.3%. The Del Taco system has now generated 21 consecutive quarters of positive same-store sales. Fourth quarter company restaurant sales increased 4.4% to $146.7 million from $140.6 million in the year ago period. This increase was driven by contributions from additional company operated stores as compared to the fourth quarter last year along with company operated comparable restaurant sales growth of 1%. Fourth quarter company operated comparable restaurant sales growth represents the 26th consecutive quarter of gains and was comprised of 4.9% increase in check, including over 1% in positive menu mix, partially offset by 3.9% decline in transactions. Franchise revenue increased 7.0% year-over-year to $5.3 million from $5 million last year. The increase was driven by a franchises comparable restaurant sales growth of 3.2%, other franchise revenue related to the adoption of the new revenue recognition rules and additional franchise operated stores as compared to the fourth quarter of last year. Turning to our expense items, through the paper cost as a percentage of company restaurant sales decreased approximately 40 basis points year-over-year to 27.4% from 27.8%. This was driven by menu price increases, partially offset by modest food inflation, including increased distribution costs. We also experienced slight margin pressure from our shredded beef and Epic Triple Meat promotions, which feature a slightly lower than typical margin percentage. Labor and related expenses as a percentage of company restaurant sales decreased approximate 40 basis points to 31.6% from 32%. This was driven by lower payroll taxes due to the elimination of the federal unemployment payroll tax surcharge on California wages that was retroactively eliminated in November of 2018 for the entire 2018 tax year. The favorable impacts from this payroll tax elimination was 26 basis points for fiscal 2018, which was entirely realized during the fiscal fourth quarter, we expect to retain this permanent lower rate prospectively. Occupancy and other operating expenses as a percentage of company restaurant sales increased by approximately 30 basis points to 20.6% from 20.3% last year, the 30 basis points of deleverage was due to inflationary pressure within this category that outpaced our modest same-store sales gain of 1%. Based on this performance, restaurant contribution was $29.8 million compared to $28 million in the prior year, an increase of 6.5%. Restaurant contribution margin increased approximately 40 basis points to 20.3% from 19.9%. General and administrative expenses were $13.4 million and as a percentage of total revenue, increased by approximately 100 basis points year-over-year to 8.5%. This increase was driven by increased legal and related expenses, performance-based management incentive compensation, stock-based compensation expense, incremental SOX 404(b) compliance cost and the expense side of the other franchise revenue that is now reported on a gross basis, as well as lower than expected revenues, which magnified the percentage. Adjusted EBITDA increased 1.2% to $23.6 million from $23.3 million last year. As a percentage of total revenues, adjusted EBITDA decreased 90 basis points to 15% from 15.9% last year. Depreciation and amortization expense increased 9.6% to $8.2 million compared to $7.5 million last year with the increase driven by the addition of new assets. As a percentage of total revenue depreciation and amortization rose 10 basis points to 5.2%. Interest expense was $3.1 million compared to $2.4 million last year. The increase was due to an increase of one month labor rate and a higher average outstanding revolver balance compared to the fourth quarter of 2017. As of the end of the fourth quarter, we had $159 million outstanding under our revolver and our applicable margin for LIBOR loans remained at 1.75%. Income tax expense was $2.1 million during the fourth quarter for an effective tax rate of 27.1% as compared to $24.8 million benefit during 2017, which included a one-time income tax benefit as a result of the recent tax reform. Excluding this one-time benefit, the prior year rate would have been 41.6% and the lower effective tax rate is due to the impact of the recent tax reform. Net income for the fourth quarter was $5.6 million or $0.15 per diluted share compared to $35.2 million or $0.89 per diluted share, last year. In addition, we are reporting adjusted net income, which excludes impairment of long-lived assets, restaurant closure charges and other income related to insurance proceeds. Adjusted net income in the quarter was $7 million or $0.18 per diluted share compared to $6.2 million or $0.16 per diluted share last year. Turning now to our repurchase program covering the common stock and warrants. During the quarter, we repurchased 765,209 shares of common stock at an average price of $11.05 per share and 20,596 warrants at an average price per warrant of $1.93 for an aggregate of $8.5 million. At fiscal year-end, approximately $29.6 million remained under the $75 million authorization. I should add that during the fiscal first quarter of 2019, we remained active as we repurchased approximately 200,000 shares in over 830,000 warrants so far this year. One of the key point is the presentation of a held for sale caption in current assets to reflect the carrying value of property and equipment sold in connection with the 13 unit refranchise transaction during the first quarter, as well as owned property for three new restaurant open in 2018 that we expect to sale leaseback in 2019. Two such sale leaseback transactions were finalized in the first quarter. The sale leaseback proceeds help to net down our capital expenditures to align with our capital guidance that is provided on a net basis, whereas our GAAP presentation uses a gross basis. Before covering our fiscal year 2019 annual guidance, I want to discuss the new lease accounting standard that is effective at the start of fiscal 2019, and how it is expected to impact our balance sheet and P&L. Upon adoption, all existing built to suite leases will become operating leases and we will be recognized all of the existing built to suit assets and being landlord financing liability. Going forward, substantially all restaurants will be operating leases to be accounted for under balance sheet. We expect to recognize operating lease liabilities of approximately $220 million to $240 million, and write of use assets of approximately $210 million to $230 million. From a P&L perspective, there is no material change to our accounting for existing operating leases. However, the accounting for our prior build to suite leases will impact several key expense lines, primarily occupancy and other operating expenses where built-to-suite leases will now be reported. The expenses for these leases are previously reported in depreciation and interest expense. This reclassification is expected to have an unfavorable impact of approximately 70 basis points on our restaurant contribution margin and adjusted EBITDA, and has been incorporated into our annual guidance. It is important to note that this change is non-cash, expected to be net income neutral and does not reflect any underlying economic changes in performance. In terms of guidance, we are reiterating what we issued in January, revised for the new lease accounting standard where appropriate and are furnishings several additional key metrics. Our top line expectations are unchanged, including low single-digit system wide comparable restaurant sales growth with total revenue between $517 million and $527 million, and company restaurant sales between $481 million and $491 million. We continue to expect menu pricing of up to 4% to help mitigate the impact of food inflation of approximately 2% to 3%, including higher distribution and transportation cost and labor inflation of approximately 6%, primarily driven by $1 increase in California minimum wage. General and administrative expenses between approximately 8.7% and 9% of total revenue, this range reflects a flat-toe compared to 2018 in-light of our first quarter refranchising activity, which created an estimate 15 basis point increase as the G&A savings from this transaction cannot be offset on a percentage basis, given the reduction in restaurant sales. With the aforementioned new lease accounting rules, we have revised our restaurant contribution margin expectations by 70 basis points to between 18.1% and 18.6%. We also revised our adjusted EBITDA estimate by the same 70 basis points from the new lease accounting rules, and we now expect between $66.5 million and $69 million. Interest expense is now expected between $7.2 million and $7.6 million, which represents the recent fourth quarter annualized run rate less approximately $2.6 million due to the new lease accounting rules, which will now be recorded in operating another expenses; effective tax rate of approximately 26.5% to 27.5%; diluted earnings per share of approximately $0.47 to $0.52; at least 25 system wide new unit openings on the gross basis, skewing towards franchise restaurants; and an estimated 1% system wide closure rate. And finally, net capital expenditures of approximately $42 million to $47 million, including approximately $18 million to $20 million for new unit construction; approximately $14 million to $15 million to maintain or enhance existing restaurants; and approximately $10 million to $12 million for discretionary investment, including a remodel program test and technology investment such as mobile order and delivery, drive-through enhancements to improve throughput and learning management and workforce management upgrades to drive operational efficiencies. With that, we thank you for your interest in Del Taco. And we are happy to answer any questions.

[Operator:]

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

[Alexander Slagle:]

Just wondering if you could provide additional perspective on the plan, refranchising strategy and frame up, what the range of outcomes might look like in terms of timing and potential impact on the operating results in 2019.

[John Cappasola:]

Alex, its John, let me start with the strategy here and how we’re thinking about that. And I'll let Steve lay in a bit on the in-year impact. So, clearly, on the franchise and refranchising piece there is two components. One, which is really falling under our portfolio optimization umbrella, is what we did most recently, the deals that were completed here in Q1 of 2019 and that was the 13 units that we refranchised to three local franchisees in the LA market that we feel really good about, giving them the opportunity to turn these restaurants into a big win. And they have a proven capability of doing that in some other acquisitions that they have done within our system. So we're excited for them and excited about what they can do with these units. And obviously, we saw the opportunity to also acquire three franchise restaurants to company, because these were in territories where company operations was very strong. So as I said, we don't have any plans to do anything further in the area but we're are going to be very opportunistic in regards to portfolio optimization where it makes sense. We'll look at other opportunities as we go down the road. The other big component that we talked about, obviously, was the refranchising of non-core western markets. And little bit different part is the strategy one that as we said has not been fully activated yet. And there is no set timeline on that other than we'd like what the markets done by the summer of 2020. So we’re in process of evaluating right now and trying to make best decisions there with the ultimate focus being, let’s partner with either existing or new franchisees that can deliver on growth, and that’s really the thrust of that part of the strategy. Let me just throw it over to Steve to see he has any color on the impact of the 13 divestitures.

[Steve Brake:]

Yes, that has definitely been factored into our Q1 guidance. That is the purchase of 13 stores, sale of three stores. As we've said couple of months ago, that we will have an accretive impact to earnings, has been fully reflected in side of our guidance. However, the non-core market in the left has not yet been factored into our guidance. For now, there's no specific update on timing other than to say, there will be a process moving forward with a big focus on making sure we transact with the buyer or buyers, most likely buyers who will most likely deliver on the growth commitments that will be part and parcel with those expected transactions.

[Alexander Slagle:]

And to what extent have you identified future new market fit that you want to feed, or might hear about that…

[John Cappasola:]

Yes, we are in process. So we've been evaluating several markets and we’re not ready to announce anything just yet. But I would say that we’re getting close in realizing that what we're doing down in the South East is actually a very viable strategy to move forward within another territory, or two. So we will make that decision here in the near future and we will make sure that we update everyone as appropriate.

[Alexander Slagle:]

And just the last follow up if you had an estimate on the magnitude of the weather impact you saw in the first quarter and maybe any other views on the underlying momentum you see in the business but the recent value efforts with the mix too and recently the Fresh Faves boxes?

[Steve Brake:]

John touched on certainly adverse impact Q1 in the west, very wet, very cold. As John said, both company and system right now are slightly negative. It's not a perfect calculation. But had we experienced normalized weather, we believe we'll probably be at the slightly for company system as well. So maybe that percentage area of swing due to the weather.

[Operator:]

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

[Craig Bibb:]

It sounds like, including the impact of weather quarter-to-date, which is more likely go up in the quarter, you’re running like the 5% almost in traffic. Is that -- maybe you have 4% prior to…

[Steve Brake:]

Yes, you’re in the ballpark. The traffic for the first quarter will be sequentially lower than the 3.9 that we experienced in the fourth quarter. So in that 5% plus area is a good estimate. Although, there is nine days left to go.

[Craig Bibb:]

And you’re pushing 4% price, which is aggressive and needed, you’re confident that you’re not seeing push back there?

[John Cappasola:]

So far all of our internal analysis and the work that we've done with our econometric modeling firm just continues to indicate that these pricing actions have been accretive. And that said, you can impact traffic to some degree when you take some level of pricing. But the answer right now for us is I think overall it's been accretive for us. And the focus now is let’s really execute well our transaction momentum strategy, which we believe is reassess the business coming out of elevated combined solutions. And this last year, we understood there were some -- we came to a conclusion there were some gaps that we needed to address on the digital front, as well as some enhancements we can make to our value platform and then some exciting new news we needed to bring to the table, and we have that and beyond that that will be coming soon. So, I think all-in we’re okay with our pricing strategy. We’re going to continue to watch it and watch the market very closely and see what the competition is doing and measure it. But we don't think that it's having a adverse impact, a massively adverse impact to the traffic at this point.

[Steve Brake:]

Two other things we do there, Craig. We consistently and regularly measure or monitor our value and affordability perception ratings performed by NPD group. We continue to be very strong on both of those attributes. So that’s an important part of our thought process. Then also reading the competitive landscape, it certainly levels playing field in our view when it comes to wage. And we definitely observed a lot of accelerated price happening out there in the marketplace, most of our markets certainly in California by our peers as well.

[Craig Bibb:]

And lastly, the 400,000 app downloads, sounds like a lot relative to your store base. Do you know how it compares to peers? And do you have a goal for where you want to be, and are they buying more or less than your average customers?

[John Cappasola:]

Yes, I would say our strategy going into this year was obviously use offers to build the database, so that we could pivot coming out of 2019 to either a deeper loyalty program or really start to leverage scale of this platform. So when we came into the year, our focus was really around building the database and getting registered users up, that was our number one goal. And what we have put out there internally was that we wanted to, we believe we could achieve somewhere in the six-figure range. I would love to see us achieve somewhere just right over seven figures if we can, and that’s certainly what the team is doing. Of course, we’re ramping up quickly. We're at about 700 registered users per store right now. And as you know, as you move through time, it probably will become a little bit more difficult to register folks. But I could see us in the high six-figure range maybe low seven figure range this year. And what’s important with that is, obviously, we are giving these folks reasons to come back at Del Taco on a weekly basis. We’re looking at their activity. We're sending them targeted offers. And overtime as that database becomes bigger it will be easier for us to be more certain in regard to how we can move the needle on the same store sales side of the business. So overtime, it’s a CRM platform. But right now, it's about building that database.

[Operator:]

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

[Jeremy Hamblin:]

I wanted to start by coming back to the labor comments and the payroll taxes for Q4. I think if I recall this right, 26 basis points for fiscal '18 in total. Does that imply there was roughly 100 basis points impact for Q4? What would be the impact be for Q4 on that particular item benefit?

[Steve Brake:]

The 26 basis points for the year, you could drive just over $1.2 million, which would be about 83 basis points for the fiscal fourth quarter. So looking at that line item, the leverage of 40 basis points absent that positive news from California probably would have been deleverage or 40 to 50 basis points. And the full year will de-lever probably 40 basis points rather than the 10 basis points that we reported. So a bit of a one-time good guide in some respect, but very positively it is the permanent release, if you will. That rate has currently gone away. So it is a benefit that we will carry forward into future years.

[Jeremy Hamblin:]

And as I think about your guidance for 6% wage inflation this year and how that compared to 2018. What are the factors as we think about that labor line item that’s been a hurdle for a while? How we should be thinking about that this year? Do you expect maybe slightly higher impact to that line item in total in '19?

[Steve Brake:]

We think the 6% estimate it's all, so we have a dollars of wage increase this year. Last year, there was $0.50. So last year, the original guide was 4% to 5% and we landed that inflation rate somewhere in that mid 4%. So we do feel good about the 6% this year. Every extra dollar becomes a little bit less proportionately and then fortunately things that are more fixed in nature, be it salaries, health insurance, as well as worker's compensation, have all trended in a much less inflationary manner. So it allows us to net that all down to more of that MSP type rate that right now we see at 6% for 2019.

[Jeremy Hamblin:]

And then wanted to ask a question on G&A moving forward. So after we get through the refranchising efforts and you see some normalization, you continue to see your G&A line items grow as a percent of sales over the last several years. You mentioned it flat toeing this year. How should we be thinking about that now as you go from 55% to 45% company-owned locations? As we look forward, is that something where G&A topping out and potentially could even be lower on an absolute basis with 10% fewer locations?

[John Cappasola:]

So near-term for 2019, as I mentioned, pro forma for that first quarter retrenching activity that itself causes about 15 bps of pressure. So 2018 probably would have otherwise been reported around 8.8%. So the guide for the year ahead of 8.7 to 9.0 more or less colors that outcome. So we are in essence flat toeing this year and the midpoint reflects about 5.5% dollar inflation year-on-year, which is more reflective of the very low unemployment inflationary environment that we’re in. So that’s what we’re expecting for the year ahead. As far as getting into our refranchising of the non-core markets that will happen overtime. As those happen, we will be very careful and give very good updates and guidance on what will happen at restaurant level royalties, as well as the G&A impact. So without a doubt as you refranchise larger number of restaurants, there certainly is some, I will call it, variable G&A the above store leader, the easy run eight to 12 stores is a great example. Those cuts will be made and essentially transferred to franchisees when they happened, but actually there is a large drop in restaurant sales as well as revenue. So over time as those happen, we will try to bring more color into what the percent of revenue will do, and they actually take up somewhat, but as or maybe more importantly is, what is the dollar inflation year-over-year in light of what we need to manage the business, actually we sell a lot of restaurants. A lot of those needs do go down. So we will be very focused on taking those variable G&A costs off our P&L as those restaurants refranchise transactions happen and giving good color on what that then translates to on a percent of revenue basis as we move forward.

[Operator:]

Your next question comes from Peter Saleh with BTIG. Please proceed with your question.

[Peter Saleh:]

I wanted to ask about the refranchising and how franchises are thinking about their capital, I guess not just this year but going forward. As the franchisees absorb some of these company units over the course of the next year, 18 months, should we think about any acceleration in new unit development as a system to get pushed out to 2021 and beyond? As the franchisees absorb some of these company units over the course of the next year, 18 months. Do we think about, you know, that any sort of acceleration in new unit development as a system to get pushed out to 2021 and beyond? You know, maybe as franchisees are absorbing some of these units, is this going to limit, the amount of capital they have to put into new unit, gross openings going forward?

[Steve Brake:]

You see Peter, I wouldn't say that would be the case. I mean, how we're thinking about this is it's a combination of new and existing franchisees is instead we're definitely looking to bring some new blood into the system that can leverage a base of company operations to get really competent on the brand very quickly and then pivot obviously into growth. And that's going to be the real catalysts of selling these markets. So whether it's a new franchisee or an existing franchisee, their ability to move and deliver on a growth agreement, that's material for us. So the idea there is to spur new unit growth, specifically franchise growth.

[Peter Saleh:]

So are all the refranchise units or all the deals together -- planning to put together over the course of the next year or so. They come with required sort of new unit build, going forward in those markets with the franchisees?

[John Cappasola:]

Yes, absolutely, growth will be a big part of the sale process and that'll be really one of the driving pieces for us, in regards to divesting these units. But it won't necessarily be just in the markets, growth in the markets that they currently reside in. There may also be adjacent growth or new territories attached to that. So again, these are folks that are likely going to be sophisticated franchisees. Some of them may have multi-state operations, some of them may not. But either way, we would expect to be able to attach some level of agreement to it that would be either within the existing market or outside of the market, TBD dependent on the groups and the attractiveness of the groups that we take a lot of look at here over the next couple of quarters.

[Peter Saleh:]

And then just my last question is, I think you guys mentioned, the addition of couple more third-party aggregators, DoorDash and Postmates later this year. Can I just talk about that decision, why you decided to move forward with more partners and what exactly is entailed to add these partners? Is it more tech investment? Are they making the tech investment? What needs to be done to further integrate these other delivery partners?

[John Cappasola:]

Yes. So, I mean, what we talked about in the past is really our strategy on delivery is, we believe a multi-year delivery service provider approach is the best way for us to kind of break through and optimize consumer demand. Once we got our heads around the economic model associated with delivery, which for us, we've talked about, the big pillars for us were check average is what we're seeing so far with our launch is nearly 2 times, so the store level checkout, there's a lot of leeway, as far as room to play with on the margin dollars side. And also, we wanted to be able to do premium pricing and we are doing now. We tested that and we found that at a reasonable level, it was, the consumer was willing to pay it because of that convenience, additional convenience suit been able to get Del Taco delivered to your doorstep. So we've activated that. So that's helped us. So the economic model we feel really good about. So now it's about let's get as much demand as we can. And what we saw on our test is that as we layered on the multi-delivery service providers, we actually saw step ups in some units in the actual delivery rate that we were, seeing at these restaurants. So we like that approach. We think every trader is a little bit different. Every market is a little bit different. And the breadth of having the three DSPs and that's GrubHub, Postmates and DoorDash activated together is important to us. The other component I would only mention is, you know, we absolutely want to have POS integration. We found through our test that, you know, the tablet approach, in having tablets laying around the restaurant wasn't very conducive to an efficient and seamless transaction for our operators, and it was actually hurting overall satisfaction from a perspective of order accuracy. So if POS integration is done for us is actually we've seen overall satisfaction scores, in some cases surpass what we see through, or drive through in dining experience. So we've removed that order accuracy issue, because you know, with the stand-alone tablet that employee is actually having the key and the order manually to the POS and we don't want that to have to happen. So POS integration is really important and we're leveraging existing technology that we have in our restaurants today, along with some new technology features that come along with platforms like we although brings to the table to make sure that we have integration.

[Operator:]

Our next question comes from the line of Joshua Long with Piper Jaffray. Please proceed with your question.

[Joshua Long:]

I wanted to circle back to some of the comments you mentioned about moving into more states year-over- year, and just curious on how you're thinking about driving brand awareness or maybe leveraging some of the new platforms and tools that you have this year versus 2018 to make sure you're really getting the most leverage out of everything, in driving awareness of the brand.

[John Cappasola:]

Our playbook that we've developed over the last several years, which has really helped us to perform across our diverse geographic footprint within our franchise base, certainly it is a very local market driven approach to trying to own the four walls in that trade area. So we call it being best on block. And it starts with combined solutions obviously, that's our overarching strategy that is to make sure that we are absolutely focused on guest metrics, operating metrics and people metrics, at the restaurant level to drive our performance. So when the marketing comes in, we're going to able to deliver on that promise. So having really solid operations underneath us, being best on block is an absolute driver of our performance. The other piece is obviously getting ourselves into good real estate. So, you know, we want to make sure, especially as we getting into a market that may be considered more an emerging market or a state where we don't quite have the level of brand awareness, picking the right sites and getting into the right straight areas, are critical. And, you know, that kind of two things working together, we've talked about this over time. We really see success like what we've seen over the years in a market like Michigan and what we're starting to see down in the southeast is pick-the-right real estate, with the right operating model and mindset and you can win. And then obviously, we do a lot on the local marketing side. We don't have national advertising to fall back on. So typical to kind of who we are as a brand, we're very scrappy and as the combined solutions is all about. So we do a lot of local marketing, digital advertising. We try to get involved in the trade area and the communities around the trade area. And we want franchisees that, have that belief and willingness to do that as well. So, that's been some of the key things that we've seen, that we set ourselves up for that have helped the brand in some of these newer markets over the last few years.

[Joshua Long:]

Very helpful color, I appreciate that. When thinking about some of your commentary about how trends improved sequentially. You mentioned the comparison and obviously we can see that as well. Just curious of that was more of a back half of your comment, knowing that comparisons do materially ease the 3Q, 4Q period. If you felt confident enough in the initiatives and some of the new-mini platforms you have for them to start being more of a contributor here into 2Q in the first half the year as well?

[John Cappasola:]

Yes, I mean I think the way to think about it is as these big transitory headwinds start to subside, weather and lent offset, which we've been very transparent about and talked about on this call today. I think we're poised for same-store sales improvements in Q2 and I think, you should expect some further acceleration as the year goes on and we implement both the transaction momentum strategy, but also this compare start to ease, specifically in Q3 and Q4. So I think, when you look at the transaction momentum strategy, we've gotten the second phase out the door now in the last couple of weeks with Fresh Faves Boxes, Beyond Meat is about to come toward the back-end of the April so right within Q2. And we feel really good about those platforms being on transaction momentum drivers for the brand.

[Joshua Long:]

Okay, that's exactly what I was looking for, I appreciate that context. And then last one for me, in terms of some of the discretionary spending you highlighted in the CapEx bucket. Curious if there's anything you could talk about in terms of the remodel test that you outlined or maybe some of the other upgrades around operations and operational efficiency. I'm sure it's still early and you're testing a lot of things that -- try to really be getting the specific details. But just curious, can you give us a sense of where some of those dollars or what some of the projects you're thinking about could be down the road?

[John Cappasola:]

Sure. Good question Josh. So certainly, we did touch on our plans to have a remodeled test program during 2019 -- we always looking to make sure we understand what the right design and look & feel of that next generation remodel looks like during this year, go there being to optimize that program, look at the return profile, and then beyond 2019, we'll be in a position to talk about more of the likely acceleration of that on a longer term basis. Other exciting things kind of discretionary uses of capital, certainly technology investments ranging from you know, investment to further operationalize and roll-out things like mobile ordering as well as expanding delivery, some drive through technology enhancements to help improve throughput at the drive through and other investments in both learning management and workforce management systems that help drive operational efficiencies long-term. So a number of items going on there that we're pretty optimistic about.

[Steve Brake:]

One other thing I wanted to just add, because I think it's a good point and color and context in regards to, you know, setting ourselves up for success within the four walls with combined solutions is. We've got nearly 450 restaurants today that have rolled out the new two-tier warning devices, which we're excited about. Some of you guys may have seen those in our restaurants we've talked about them a bit so that innovation is going to provide a real quality and consistency within our operations. We have 250 million products sold annually in the two-tire Del Taco. And we want them to be hot. So this device really improves throughput for us because it's been a bottleneck for us in the past, while also improving quality for our guests. So that's another piece that we're excited about and our operators and franchisees are really getting on board with an excited about as well.

[Operator:]

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

[Nick Setyan:]

My question is on the third party delivery, I mean, so far, have you guys been happy, relatively through your expectations around the economics. Are you seeing that attach rates, turn into the higher margin items like sodas, kind of in-line with your original expectations? You know, aside from obviously the top-line impact, you know what -- the margin impact. Any -- just kind of any color around the early learnings would be helpful. Is there any kind of way to think about, you know to what extent it's benefiting makes, but it's impacting transactions as a shifting individual people into maybe bigger groups.

[John Cappasola:]

Nick, these are all great questions. I can answer every single one of them right now. Sitting here today as we're in the middle and we just kind of finished up our full roll-out here with GrubHub and we're learning each and every day. So far what I'd say about the volume is, you know, as we kind of expected was on an overall average, it's relatively low right now. But you know, we are seeing some locations that are significantly outperforming and we think that as we move forward, we believe the performance is going to continue to get better and there is going to be further demand driven. You know, a couple of things are gonna help out. One is really just this quarter we just started the marketing around it and each promotion you're going to see more marketing related to GrubHub delivery in the markets that we are offering in. And as DoorDash and Postmates come on, you'll see marketing around that's, so driving brand awareness is going to be a key piece for us, as we move forward. And then obviously the other piece that's going to help, create some more demand on the delivery front is going to be adding the additional few providers. So right now it is a single provider that we're using really with GrubHub, outside there are some tests that we're doing with DoorDash and once DoorDash comes on and Postmates come on, on full system. Now you've got the full suite, if you will, really helping us to drive demand and we would expect performance to improve. So I would say, as we move forward on the transactional front or the demand front, that should get better and get stronger as we move through times -- as we move through time for the reasons that we outlined and just in regard to the overall mix, check. Listen, you know, the check average, like I said, is about to 2X right now. That what we're experiencing in our restaurants compared to what we're seeing on the delivery front. We kind of anticipated that would happen. So it's nice to see that what we saw on test markets, is fairly similar. And we feel good about that and we feel good that we're not getting a lot of pushback on the incremental pricing that we've put out thus far like I said, the overall satisfaction associated with delivery transactions actually rivals to that of our drive through and our dining room right now. So, Steve, any color you want to add on, on the margin front?

[Steve Brake:]

Yes. The 2X check, helps create some margin efficiencies, if you will, things like the credit card fee, wipes are on the DSP, not us. And, the premium pricing, that's not the whole commission, but you know, a very good chunk of it. Those all can go a long way to neutralize any potential adverse margin percentage impact. So we feel good about that. So at this point about scaling the first two and three in the later this year, we'll have a better -- for overall velocity and what -- how it kind of ramps up as it becomes more material as the year progresses.

[Nick Setyan:]

And a similar question on the app, we've gotten a lot of reports from others that maybe it's not necessary driving, our transactions and it is putting pressure on mix. What's been the early experience so far with the app?

[John Cappasola:]

Yes, I mean, like I said, we're at 400,000 registered users and almost 700 registered users per restaurant. The way you think about probably margin management on this, Nick, is, in the long term as CRM kicks in, we believe this can become very creative, obviously, in the long term. You're thinking about, you can start to target to an individual user to spur behavior that you wouldn't have otherwise received. Right. So it becomes incremental on transactions that you're driving, right now we're in build the database load and let's do that through offers, so that we can get to the point that we can use CRM. So in the short-term, as we think about 2019, well, what we're really doing is we're managing the discount rate across the business, right. So we have other discounts that are happening in our business, whether it be email marketing or print marketing that we do out and some of our markets for coupons are offered, local store marketing efforts that field marketing uses. So whether we've asked marketing to do is really rationalize some of that existing discount that is in our margin line already or baked in to pivot that over to or transition that over to the mobile app. As we know that we're going to have to invest a bit, to get this thing up and running right. So what you saw in our guidance that Steve provided was that we modeled that fully out within our guidance range. And that kind of horse-trading that's occurring between, the different marketing avenues right now. And obviously we played our cards right. We're able to manage the margin in the short-run while we build the database, which provides a bigger opportunity down the road.

[Operator:]

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

[Steven Anderson:]

So just want to ask about some of the menu news you have forthcoming, I know you've addressed value most recently, mostly in the middle of the menu barbell. Late last year, you did the lower end of that barbell. But I just want to see if you have any news coming toward the higher end? Now you have the plateaus come out, coming up against the two and three year anniversary of that and just want to see if you have any news forthcoming on that later this year.

[John Cappasola:]

So I said beyond meat is definitely in what we're thinking about beyond taco, that's definitely more in that mid tier premium range of our menu strategy. Steven so, we feel really excited about what the opportunity is with beyond. And, you know, obviously one of the things we wanted to do here was tap into that better for unique state to really help to further differentiate Del Taco as a QSR plus brand. But we also believe it's going to drive incremental sales by attracting a user that maybe a new user or a lapsed user. And we've seen through our tests, that it's also applicable to existing users. So the consumer opportunity is immense and it's exciting and we think that activating that platform more in that mid-tier and premium range is absolutely appropriate. It will literally be, when you think about the accessibility to a product like this that Del Taco is going to create, there is no one else doing it in our category at the price point that we're about to offer. So, our ability to do that and create accessibility at a lower price points than what you're seeing from others in Mexican QSR, particularly but across the category is we're pretty excited about.

[Steven Anderson:]

That's what you reiterated, in face that you've have seen for Beyond Meat, you're seeing increased traffic as well as ticket…

[John Cappasola:]

Traffic and check growth, yes.

[Operator:]

We have reached all the time we have for questions, and I would like to turn the call back to John Cappasola for closing remarks.

[John Cappasola:]

All right, everyone. Well, thank you for joining us today and spending time with us on the brand. We appreciate your interest in Del Taco. And we look forward to sharing our progress on future calls. Have a great, rest of your week.

[Operator:]

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.