Del Taco Restaurants Inc (TACO) Q4 2018 Earnings Conference Call Transcript

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Del Taco Restaurants Inc  (NASDAQ:TACO)Q4 2018 Earnings Conference CallMarch 18, 2019, 4:30 p.m. ET

Contents:
Prepared Remarks Questions and Answers Call Participants
Prepared Remarks:

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 — Investor Relations Contact

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 would 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 includes 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 D. Cappasola — President and Chief Executive Officer

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 achieved our sixth consecutive year of comparable restaurant sales growth across the Del Taco system, with a 2.5% increase. While our company operated restaurants generated a 1.5% increase. Franchise comparable restaurant sales grew at 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 have increased approximately 30% in the last five years, across a 13 state footprint, with more than half of these restaurants, located outside of California. Our franchise momentum coupled with our non-core western-market refranchising strategy that I will discuss shortly, is expected to stimulate development interest, across existing and new franchisees to help expand Del Taco’s brand reach.

Second, we hold our restaurant contribution margin steady at 19.7%, demonstrating our effective margin management strategy, despite only modest 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 a $1.5 million AUV. Margin management has become a strong confidency to 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 in 12 franchise restaurants. This compares to 20 openings in 2017 and 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+ segment. It included brand catalysts 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 and QSR+ positioning by Celebrating the Hardest Working Hands in Fast Food.

Regarding Q4 itself, we extended our track record of comparable restaurant sales growth to 21 consecutive quarters to the Del Taco system, with a 1.9% increase and to 26 quarters, for a company operated restaurants with a 1% increase. Average check growth in company operated restaurants was 4.9%, including over 1% of menu mix growth, although transactions declined to 3.9%. Franchised comparable restaurant sales grew 3.2%, again 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 systemwide openings, consisting of seven company operated in eight franchised restaurants. Q4, marks the return of a fan favorite Premium Limited Time Offer, protein Shredded Beef, which has 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 to 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 database, which is now eclipsed 400,000 registered users since November. We are encouraged by the early momentum of this marketing platform and a long term opportunity it provides us to drive guest frequency as it scales. We expanded our delivery initiative as well, during the first quarter by launching GrubHub delivery and substantially all company operated Del Toco 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 guests needs. These are full meal deals, with two or three entrees, French fries and a drink, designed to deliver best-in-class, abundant value and variety that differentiates Del Toco 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 Face Boxes will work in concert with Buck & Under and Buck & Change to offer expansive value, ranging from all the card 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, it 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 & Vegetarian options created an opportunity for us to partnered 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 selected restaurants in Greater LA, our entire San Diego market and more recently in all Oklahoma restaurants.

The response on social media and the results have been impressive. Increasing both check and traffic, as many new or lapsed users and regular Del Taco fans, visit our restaurants, eager to sample something innovative which delivers on the better for United States. We believe this program will drive sales, while further strengthening our QSR+ brand position.

Currently, our first quarter system wide comparable restaurant sales trends to-date, are running slightly negative and below our prior expectations, as expressed in mid-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 our 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% franchised 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 returning existing unit capital and reduced exposure to cost side inflation in California concentration.

In the first quarter, we acquired three high volume franchised restaurants and sold 13 lower volume units in the LA area to existing multi-unit Del Taco franchise groups. These transactions are expected to optimize these restaurants for AUV growth. And also 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 core — our non core Western-markets, to help stimulate development, as we begin to solve for the common prospective franchisee desire to buy, then 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.

Over time, the net proceeds from such refranchising may help fund new companies 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 important catalysts 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.

Steven L. Brake — Executive Vice President and Chief Financial Officer

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%.

Systemwide comparable restaurant sales, increased 1.9% and lapped systemwide 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 is 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 of 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 a 4.9% increase in check, including over 1% in positive menu mix, partially offset by a 3.9% decline in transactions. Franchise revenue increased 7% year-over-year to $5.3 million from $5.0 million last year. The increase was driven by a franchise, comparable restaurant sales growth of 3.2%, other franchise revenue related to the adoption of the new revenue recognition rules and additional franchise operating stores as compared to the fourth quarter of last year. Turning to our expense item’s. Food and paper costs, as a percentage of company restaurant sales have decreased approximately 40 basis points year-over-year to 27.4% from 27.8%. This was driven by many 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 is slightly lower than typical margin percentage.

Labor and related expenses as a percentage of company restaurant sales decreased approximately 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 impact 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 its performance, restaurant contribution was $29.8 million compared to $28.0 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 costs 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 increase 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 increased one month LIBOR 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%.

The income tax expense was $2.1 million during the fourth quarter, for an effective tax rate of 27.1% as compared to a $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 $7.0 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 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 a $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 have remain active when we repurchased approximately 200,000 shares in over 830,000 warrants, so far this year. One balance sheet point, is the presentation of the held for sale captioned in current assets to reflect the carrying value of property and equipment sold in connection with the 13 unit refranchised transaction during the first quarter, as well as, own property for three new restaurants open in 2018 that we expect the sale leaseback in 2019.

Two such sale leaseback transactions were finalized in the first quarter. The sale leaseback proceeds helped 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 build-to-suit leases will become operating leases and we will be recognized all the existing DoorDash assets and deemed landlord financing liabilities.

Going forward substantially all restaurants will be operating leases to be accounted for on the balance sheet. We expect to recognize operating lease liabilities of approximately $220 million to $240 million and right-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-suit leases will impact several key expense lines, primarily occupancy and other operating expenses or build-to-suit leases will now be reported.

The expenses for these leases were 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 furnishing several additional key metrics. Our top-line expectations are unchanged, including low-single digit systemwide, comparable restaurant sales growth with total revenue between $517 million and $527 million and company restaurants 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 costs and labor inflation of approximately 6% primarily driven by $1 increase in California minimum wage.

General and administrative expenses between approximately 8.7% at 9% of total revenue. This range reflects a plateau compared to 2018 in light of our first quarter refranchising activity, which created an estimated 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 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 of 70 basis points from the new lease accounting rules and we now expect between $66.5 million and $69.0 million.

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