Del Taco Restaurants' (TACO) CEO Paul Murphy on Q2 2016 Results - Earnings Call Transcript

| About: Del Taco (TACO)

Del Taco Restaurants, Inc. (NASDAQ:TACO)

Q2 2016 Earnings Conference Call

July 20, 2016, 05:00 PM ET


Raphael Gross - IR

Paul Murphy - President and CEO

John Cappasola - EVP and CBO

Steven Brake - EVP and CFO


Andy Barish - Jefferies

Peter Saleh - BTIG

Jeremy Hamblin - Dougherty & Company

Craig Bibb - CJS Securities

Nick Setyan - Wedbush Securities

Joshua Long - Piper Jaffray


Good afternoon and thank you for standing by. Welcome to the Fiscal Second Quarter 2016 Conference Call and webcast for Del Taco Restaurants, Inc.

I would now like to turn the call over to Mr. Raphael Gross to begin.

Raphael Gross

Thank you, operator, and thank you all for joining us today.

On the call are Paul Murphy, President and Chief Executive Officer; John Cappasola, Executive Vice President and Chief Brand Officer; and Steve Brake, Executive Vice President and Chief Financial Officer. After Paul, John and Steve deliver their prepared remarks, we'll 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 more detailed discussion of the risks that could impact future operating results and financial condition.

Today's earnings press release also includes non-GAAP financial measures such as adjusted EBITDA and restaurant contribution. Non-GAAP financial measures should not be considered as alternatives to GAAP measures such as net income, operating income, net cash flows provided by operating activities, or any other GAAP measure of liquidity or financial performance. We refer you to today’s earnings press release, which includes reconciliations of the non-GAAP measures to the nearest GAAP measures.

I would now like to turn the call over to Paul Murphy, President and Chief Executive Officer.

Paul Murphy

Thank you, Raphael and thank you all for joined us on the call this afternoon. Similar to Q1, we delivered solid results in Q2 that met our own expectations and we therefore remain well positioned to achieve our annual guidance.

Highlights for the second quarter include system-wide comparable restaurant sales growth of 3.3%, cycling over the second strongest quarter of 2015, when we achieved a 6% increase resulting in an impressive 9.3% two-year growth rate.

Restaurant contribution margin of 20.6%, an 80 basis point improvement over the same period last year and adjusted EBITDA of $16.0 million, up from $15.3 million in last year’s second quarter reflecting a 4.5% growth rate.

As you all know, the QSR industry is currently steeped in deep discounting and aggressive promotional activity, which in our view makes our very solid growth in comparable restaurant sales during Q2 all the more impressive without the need to discount.

The Del Taco System in our own company operated restaurants have now generated 11 and 16 quarters of consecutive gains and comparable restaurant sales growth respectively.

Within our company-operated restaurants, comparable restaurant sales rose 3.1%, consisting of a 4.9% increase in check, which was partially offset by 1.8% decrease in transactions.

The year-ago traffic comparison was plus 2.0%. So considering the competitive environment we were satisfied to have held our two-year traffic turn slightly positive. Moreover, our transaction trend reflected a sequential improvement of 80 basis points and similar to Q1 we experienced strong check growth as a result of effective menu price increases along with menu mix growth of nearly 1%

With respect to restaurant contribution margins, we leveraged four-wall operations despite the inflationary labor pressure as food costs were more favorable than we had anticipated and our higher sales volume drove operating leverage. I spend a fair amount of time on our last conference call discussing our approach to tackling minimum wage increases, so I’ll not repeat everything I discussed back in May.

This issue was certainly not new to us given our footprint in California and we've successfully managed it over the last few years through strong sales performance on both an absolute and relative basis while also expanding our restaurant contribution margin.

As evident within the components of our comparable restaurant sales, there are certainly an important role for menu pricing and absorbing macro events such as wage inflation, but that alone does not tell the entire story of Del Taco.

Our brand repositioning to our combined solution strategy, which bears value and convenience with fresh and our Barbell Menu strategy across Buck & Under, mid-tier and premium has enabled us to achieve effective menu price in a targeted manner without disrupting value perceptions.

In fact, this expansion of premium items designed to encourage new occasions and elevate the brand promise is helping drive favorable menu mix and aiding vale perceptions.

As we reflect on sales in the front half of 2016, we attribute our momentum to three key areas of focus that we believe will continue to support our comparable sales growth. First, we plan to continue delivering what we view as category leading everyday value to our guest across all three tiers of our menu.

This will be accomplished through new product news, designed to induce trial in marketing communications that create greater awareness, with a strong value that our sub branded menu platforms offer.

Our guests know that they can count on the consistency of our value message day in and day out. We think our consistent everyday value approach fosters greater loyalty and there is more to solidify our brand equity while delivering top and bottom line results.

At the same time during Q2, we launched our new Chorizo lineup at breakfast as well as a new Epic Burrito for $5.49 that delivers a great value relative to the competition. These launches typified the power of our Barbell approach in everyday value positioning while enticing guest with exciting new product news.

Our second area of focus broadening our occasion set by fully leveraging our QSR-plus quality value positioning, which in turn is driving check through Menu Mix. As I said a moment ago we experienced healthy menu mix growth of nearly 1% in Q2, which was similar to Q1. The premium menu items are naturally driving this growth as guests are finding great value, and craveable products on the higher end of our menu.

In fact, Q2 marked our fourth consecutive quarter of double-digit premium mix. The strength and diversity of our menu offering provides us with the flexibility to hone our messaging through our marketing promotions based upon the business need while staying on our strategic course.

It should also help us reach the 1.5 million threshold for AUVs by 2018 that we have spoken out in the past by appealing to more consumer restaurant occasions.

And third, we're driving great guest experiences at Del Taco through our combined solution focus, which is maximizing our opportunity with every transaction. In Q2, we achieved our second highest overall guest satisfaction score as we prepared our restaurant teams with a launch of Fresh Combined Solutions through our general manager and franchise Boot Camps and the use of our enhanced training tools.

To further fuel guest experience improvement we also launched our next generation guest experience measurement program in April with our new partner InMoment. This new guest experience reporting system provides real-time scoring and analysis on the guest experience.

It also uses a proprietary algorithm to provide each location with the top two areas of opportunity that will have the greatest impact on the guest experience in their specific restaurant to further our "every guest leaves happy" objective.

As we move into Q3, we're excited about launch of Fresh Combined Solutions. The three key areas of focus that I've outlined are contributing to our top line success and are a big part of our ongoing plans, which John will touch on in a moment, but first, let me wrap up my comments with development.

Our expected range of 15 to 18 new restaurants system-wide in 2016 remains intact. This range reflects an approximate 3% system new unit growth rate, which we plan to accelerate to mid-single digit system growth rate during 2017.

We continue to focus on our internal opportunity where we've identified over 300 trade area opportunities in the western third of the United States as well as emerging market opportunities including Georgia and Oklahoma whether it’s more company activity in the pipeline.

We also continue to expect franchise development to accelerate beginning in 2018 given ongoing growth in AUVs and restaurant contribution margins along with our plan to further improve these metrics. This momentum is expected just for greater interest from new and existing franchises alike.

I'd now like to turn the call over to John Cappasola, our Chief Brand Officer.

John Cappasola

Thanks Paul and good afternoon, everyone. As Paul touched upon, our Q2 marketing program highlighted our unique barbell menu strategy and brought exciting new protein news to breakfast.

The combination of targeting occasions through our sub-branded food platforms along with our diverse day part mix give us multiple levers to pull and enabled us to continue growing comparable restaurant sales in the recent quarter.

We maintained strong Buck & Under messaging throughout Q2 to keep the platform top of mind and counteract the value and deep discounting by our competitors. Although we increased our focus on Buck & Under, we've continued to expand our margins highlighting the platform's unique ability to deliver great value and healthy margins without the need for incremental discounting.

We also devoted more merchandizing to Epic Burritos on our menu throughout Q2, including the rollout of the new Bacon Ranch Chicken Avocado Epic Burrito mid quarter. This played a role in growing Epic Burrito sales mix up from Q1 and achieving our fourth consecutive quarter of double-digit premium sales mix.

Premium platforms are in an important element of our strategy to embed our QSR-plus positioning and grow check and margin dollars through menu mix.

One last point on Q2 is that we were pleased with the performance of both our late night and breakfast day parts. We put incremental merchandizing efforts against late night and saw it lead Q2 in comparable restaurant sales.

We were also pleased with the launch of Chorizo in March, which helped us to maintain positive momentum in the breakfast day part. Day part utilization is an important part of our sales building strategy and we will continue to drive balanced messaging between late night and breakfast throughout the remainder of the year.

Turning to Fresh Combined Solutions, in week two of the third quarter, we kicked off the consumer-facing elements of our strategy. While the fundamental thinking doesn’t change from the original Combined Solutions approach, the specific initiatives for the finer point on our brand positioning to further differentiate Del Taco.

As I spoke about on the last call, Fresh Combined Solutions include several brand catalysts. Our UnFreshing Believable 2.0 advertising campaign was launched and will dramatize our unique dichotomies that only Del Taco can deliver and guests love. These include fresh preparation paired with category-leading value and Tacos and Burritos paired with crinkle cut fries.

In addition, we launched with the USB2.0 in-store marketing and merchandizing enhancements, including an elevated new look and feel to our menus. The launch was also paired with our new signature crunchy beef Taco called the Del Taco, a product we believe is worthy of the brand's name.

Inspired by the 1964 original, the Del Taco was loaded with season beef, freshly grated cheese and includes a new larger crunchier shell. It really does have more of everything you love and at $1.39 it will be a mid tier menu catalyst for the brand.

Even though it's early, we're excited about the launch of the Del Taco and expect it to be one of the -- our most successful product rollouts. As I said before, our intent is to provide the best value for the money for a crunchy beef Taco in Mexican QSR and we believe the Del Taco will live up to that billing.

The launch also contained a number of operational enhancement initiatives to ensure we deliver quality and speed with outstanding service. As Paul reported, our efforts leading up to the launch yielded excellent results as we focused on improving our operational systems and training.

I’m also pleased to report that we continue to make solid progress on that deployment of targeted capital investments to compliment fresh combined solutions by enhancing our operational and brand capabilities.

At the time of launch, all company restaurants had installed new wireless noise cancelling drive through headset systems and upgraded to new electric beam mixtures to improve product consistency and save time. We’ve also deployed additional freshness coolers this year to drive fresh and quality perceptions, bringing our system wide total to 193 at the end of Q2.

Looking to the future, we’re excited to announce our decision to launch the Platos program in Q4 as another brand catalyst of fresh combined solutions. This is our first occasion-based expansion strategy that we have been developing for the better part of two years.

It is designed to grow our occasions of use, primarily through the dinner day part with plated meals including chips and salsa, rice and beans, and an entree that can be conveniently picked up through the drive-through at a great relative value.

We're very pleased with the consumer, financial and operational results in our testing, including incremental sales and margin dollars driven by check and transactions as well as strong brand perceptions that aligns with our QSR-plus positioning.

Finally our mobile initiative is progressing nicely as we begin testing our mobile ordering and payment platform in restaurants in Q3. Based upon our learning, we will expand the test in the coming quarters with the intention to roll it out system wide over time.

Now I would like to turn the call over to Steve Brake to go over our second quarter financial results.

Steven Brake

Thanks John. Our fiscal second quarter 2016 results are for Del Taco Restaurants Inc., which became a public company when it completed a business combination with Levy Acquisition Corp. on June 30, 2015. Therefore, the successor period for the 12 weeks ended June 14, 2016, is being compared to the predecessor period for the 12 weeks ended June 14, 2015.

Company restaurant sales increased 2.1% year-over-year to $95.9 million from $93.9 million in the year ago second quarter. The increase was predominantly driven by same-store sales growth of 3.1% at company-operated restaurants, partially offset by fewer company operated restaurants.

Second quarter company-operated same-store sales growth represents the sixteenth consecutive quarter of gains and was comprised of 4.9% in check growth, including nearly 1% of menu mix growth, partially offset by a 1.8% decrease in transactions. This transaction trend features 80 basis points of sequential improvement from our first quarter.

Franchise revenue during the second quarter increased 13.6% year-over-year to $3.6 million from $3.1 million last year. This increase was driven by a franchise same-store sales growth of 3.6% and additional franchise restaurants compared to the second quarter of the prior year as well as an increase in initial fees.

System-wide same-store sales increased 3.3% and lap system-wide same-store sales growth of 6.0% during the second quarter of 2015, resulting in a strong two-year trend of 9.3%. This was our second toughest comparison of the year in comparison to ease in the back half of 2016.

Total second quarter revenue was $100 million, an increase of 2.5% over the $97.6 million in the year ago second quarter. During the quarter, we opened one company-operated restaurant and one franchise restaurant closed.

Now moving on to expenses, food and paper cost as a percentage of company restaurant sales improved approximately 110 basis points year-over-year to 27.5% from 28.6%. This improvement was due to the impact of the menu price increases of approximately 4% carried during the second quarter along with modest deflation on our food basket.

We previously expected a leveling in the food basket during Q2; however we began to benefit from deflation earlier than expected, primarily due to favorable trends in cheddar cheese and beef. Looking ahead, we expect continued modest deflation during the second half of 2016.

Labor and related expenses as a percent of company restaurant sales, increased approximately 120 basis points to 31.5% from 30.3%. This was primarily driven by the California minimum wage increase to $10 an hour as well as increased Workers' Compensation expense, partially offset by the impact of menu price increases.

This outcome was similar to the 110 basis points of deleverage in Q1 and overall our experience managing this higher wage is consistent with the guidance we furnished earlier this year.

Occupancy and other operating expenses as a percentage of company restaurant sales decreased by approximately 80 basis points year-over-year to 20.4% from 21.2% last year. The improvement was primarily driven by leverage from our comparable restaurant sales increase.

Based on this performance, restaurant contribution increased 6.2% to $19.8 million from $18.6 million in the prior year second quarter, while restaurant contribution margin improved approximately 80 basis points year-over-year to 20.6% from 19.8%. This outcome reflects favorably on future expected performance and our ability to achieve our full year guidance.

General and administrative expenses as a percentage of total revenue increased by approximately 150 basis points year-over-year to 8.2%. This increase was primarily driven by additional resources to support brand development and incremental public company costs as well as increased stock-based compensation from new management equity incentive plans that were finalized during the fourth quarter of 2015.

Adjusted EBITDA in the second quarter increased 4.5% to $16.0 million versus $15.3 million earned in the second quarter of 2015. As a percentage of total revenues, adjusted EBITDA margin was 16.0%, up approximately 40 basis points from 15.6% in the prior year period.

Depreciation and amortization expense in the second quarter was $5.5 million, an increase of 45.7% over $3.8 million last year and as a percentage of total revenue, increased by approximately 160 basis points to 5.5%. This increase was primarily driven by purchase accounting adjustments to increase our property and equipment and intangible assets that are estimated fair value and the addition of new assets.

As a reminder, this incremental run rate will burden net income and earnings per share until we lap purchase accounting in the third quarter of 2016. Interest expense was $1.4 million in the second quarter down $2.6 million from 4.0 in this prior year second quarter. The interest reduction stems from the repayment of $68.6 million in senior debt upon the June 30, 2015 closing of our merger and our August 4, 2015 refinance transaction.

As of the end of the second quarter, $154 million was outstanding under this all revolver credit facility while our applicable margin for LIBOR loans remained at 1.75% based on our lease adjusted leverage ratio base pricing grid. Income tax expense was $3.3 million during the second quarter for an effective tax rate of 40.5% as compared to $1.7 million of expense during the same period last year.

This resulted in net income for the second quarter of $4.9 million or $0.13 per diluted share, compared to $4.6 million in the prior year period. As a reminder, we incurred $0.9 million of transaction related costs last year that consisted of direct cost incurred in connection with our two step business combination transaction.

Turning to our $25 million repurchase program covering common stock and warrants, we actively demonstrated our commitment to enhance long term shareholder returns during the second quarter.

Specifically, we repurchased 542,303 shares of common stock at an average price of $9.92 per share and also repurchased 241,806 warrants at an average price of $2.36 per warrant for an aggregate cost of approximately $6.0 million during the second quarter.

Subsequent to the second quarter, we repurchased an additional 361,573 shares of common stock at an average price per share of $8.79 and an additional 235,000 warrants at a cost of $1.85 per warrant.

In aggregate since the inception of the program in March 2016 through the current date, we have repurchased 990,555 shares of common stock at an average price per share of $9.58 as well as 476,806 warrants at an average price of $2.11 per warrant.

For an aggregate cost of $10.5 million, we currently have approximately $14.5 million remaining for future repurchases of common stock and warrants under this authorization.

In addition on July 11, we commenced an offer to exchange 0.278 shares of common stock for each outstanding company warrant exercisable for shares at an exercise price of $11.50 per share up to a maximum of $6.75 million warrants.

The offer to exchange will expire and less extended on August 5. All of our directors and executive officers who beneficially own warrants have agreed to participate in the offer and in aggregate have agreed to tender at least $1.5 million of their warrants and such details can be found in our recent SEC filings.

The purpose of the exchange offer is to reduce the number of shares that will become outstanding upon the exercise of warrants, thus providing investors and potential investors with greater certainty as of the company’s capital structure.

We believe this will make the company more attracted to holders with a long term investment horizon. If all $6.75 million warrants were tendered, the company would issue 1,876,500 shares in exchange for such tendered warrants.

As mentioned earlier, we have repurchased 990,555 shares of common stock in the open market, which is 52.8% of the potential dilution from the 1,876,500 shares.

Lastly based on our performance to date and expectations for the remainder of the year, we are pleased to again reiterate our 2016 guidance. For details on this outlook, please referred to our earnings release from this afternoon.

In summary, we are executing according to our plan and our entire organization is energized by the launch of fresh combined solutions. The next phase of our multi-year brand strategy intended to help deliver strong performance during the second half of 2016 and beyond.

Thank you for your interest in Del Taco and we’re happy to answer any questions.

Question-and-Answer Session


Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Andy Barish from Jefferies. Please go ahead.

Andy Barish

Hey guys. I was wondering if you can give us any sense with the California market continuing to be strong. Have you seen any changes in the consumer tone out here or just more competitive? And then anything on the start with Fresh Combined Solutions would be great as well.

Paul Murphy

Andy this is Paul and to kind of answer that question, I'll just speak a little bit to the cadence through Q2 and into Q3. In Q2 period for that was our slowest period, which certainly mirror the industry, yet it still is positive but in a very low single digit range.

How we’re kind of differing from reported industry trends out there both period five and period six strengthened as we move through the second quarter and what we saw was sequential transaction improvement from period four to period five and then from period five to period six.

And as kind of so far through the first five weeks of the third quarter, transactions are positive with the transaction momentum much more pronounced in the most recent three weeks following the launch of the Fresh Combined Solutions and the Del Taco and I think this speaks mostly to our strategy and the execution of that strategy but also says that I think what we’re doing is really resonating with the consumer out there, not only in California, but in all the marketplaces where we’re doing business.

Andy Barish

Thanks. That’s great to hear and then just…

Paul Murphy

I could add John to give a little bit more color in terms of the Del Taco, which is the product catalyst with Fresh Combined Solutions.

John Cappasola

Yes, obviously the new ad campaign in the Del Taco, we’re real pleased with the early results. As Paul said, it is early on the Del Taco, but we’re very happy with the launch. I would say, I characterize it as it’s living up to our goal of leveraging the product as a brand catalyst of Fresh Combined Solutions and as I said, we really do expect it to be one of the most successful product rollouts to date.

So based on our testing and early results, we believe the product, the Del Taco has potential to drive both mix and transactions and in fact we think the product has played a role in the positive traffic that we -- that Paul just referenced in Q3 and we also like it because of the $1.39 price point and we think that’s going to be helpful for us in sustaining a favorable menu mix trend.

So we’re focused now with the restaurant teams is on execution as you can imagine. We know the demand and repurchase intent is there and we should need to execute it well and continue to embed that muscle memory among our restaurant teams and so we built in a detailed and redundant checks and balances system from internal restaurant audits to guest experience and perception ratings after purchasing the Del Taco and we’re doing a great job thus far and just need to keep that up.

So we’re very pleased thus far. It’s only been three weeks since the launch of Fresh Combined Solutions, but certainly like the momentum we’re seeing and we’re certainly liking the performance of the Del Taco today.

Andy Barish

That’s great to hear. And then just one quick one again, Steven, were there any -- I’m sure it’s in your plan, but any noticeable cost just on getting the teams ready in such in 2Q for Fresh Combined Solutions?

Steven Brake

No, really nothing that’s worth calling out. There is obviously a lot of training focus within the Four Walls. That said, most quarters especially last few years, we’ve been very busy in the Four Walls bringing a lot of great stuff to market. So nothing worth calling out in that regard.

Andy Barish

Thanks guys.


Our next question comes from Peter Saleh from BTIG. Please go ahead.

Peter Saleh

Great, thanks and appreciate the color on the traffic and the same-store sales trends throughout the quarter. Can you just remind us if you -- if you don’t take any more price going forward, how much price will you have in your comp for the balance of this year?

Paul Murphy

Sure. So in terms of pricing, as you know we've now carried about 4% each of the last two quarters of menu price. That said, late in the second quarter we lapped a little over 1% of price a year ago. We did replace that with similar timing with a little less than 1% price this year.

So as you think about Q3, kind of more in that mid-to-high 3% area is the menu price that we’ll be carrying, then the final primary moveable lap is this fall kind of middle part of -- early to mid part of Q4, we will be lapping a more substantial price increase from a year ago that was more of that mid 2% area.

The work has begun against what we might do this year. It’s still very early to call the exact timing or magnitude of the price increase that we'll take this year. All that said, our prices refer you back to our annual guidance low to mid 3% menu pricing for the full year, that’s still very much intact and we expect the full year to kind of land in that area.

Peter Saleh

Great. And then I think I heard you correct, you guys I think you said late night was the strongest, if that’s correct, was breakfast the second strongest and how did the rest of the day parts hold up throughout the quarter?

Paul Murphy

Yes, graveyard had number one same-store sales ranking this quarter and breakfast was right there in the middle of pack. We again had a lot of balance across our six day part with all driving same-store sales in that 2% plus area.

So I think relative to breakfast we continue to be well positioned to drive value and variety at breakfast with that Chorizo launch that we talked about on the last call. It will be a big part of how we leverage breakfast through remainder of the year through our marketing efforts.

It’s proven to be relevant and the Chorizo is selling four times more than the previous sausage protein that we had in the business and it’s represent in a meaningful portion of our breakfast sales mix launch to date. So we'll continue to toggle between breakfast and late night in 2016 to bring the life and achieve our day part utilization strategy.

Peter Saleh

Got it. And then on the Platos, how many products or how many different items will you guys be launching and what is the anticipated price point that you guys will have when you launch this nationally?

Paul Murphy

Yeah, so the plated meals will be right around, we’ll probably launch with three plated meals and that will -- the Wet Burrito that we've been testing for some time as well as a couple of core products that are already on the menu that will not be new to operations and those are a couple of street taco versions that we have on the menu both fish and we’ve got chicken and Carne Asada.

So we'll be plating these things together with our already grate slow-cooked beans as well as our rice that we have on the menu today and chips and salsa. So most of what we've been executing over the last when you think about the last kind of year or so on the premium front, we've been a progression to really prepare ourselves to execute Platos well and that progression has put Carne Asada in the business.

So operation is used to that and our progression is put on the street tacos in the business. So really what we’re bringing to the table is a way to kind of plate that and combine that in a new and interesting way for consumers to drive kind of that incremental behavior that we're looking for.

On the price point front, we're going to be in that $6 to $8 range on each of the plated meals, which relative to the competitive set I think we're going to be -- it's going to be value oriented and we’ll be in a good position. Again our strategy across all tiers of our menu is always to have a great everyday value position. We don’t want that to be any different with the Platos program.

Peter Saleh

Great. Thank you very much.


Our next question comes from Jeremy Hamblin from Dougherty & Company. Please go ahead.

Jeremy Hamblin

Hey guys. Congratulations on a really strong environment -- results in a tough environment. I wanted to just follow-up a little bit on Platos and just get a sense for the markets where you have that in terms of the comp trends that you're seeing presumably you're getting a little bit better results in those markets than you are in the rest of your chain?

John Cappasola

Yeah, as I said in my comments, we really liked what we saw and actually continue to see in the test markets regarding all three of the commercialization territories. So you think about consumer, financial and operations.

The second test certainly helped us to round out our thinking and really validate the results we saw in the first test market and both tests achieved the incremental sales and margin dollars driven by both check and transactions that I referenced in my comments.

So just as a reminder though, we don’t view Platos as a promotional play. It’s our first occasion-based expansion strategy and we view it as a long-term driver for us that really can provide the business, the brand, a step-up potential in both sales as well as our evolving positioning QSR-plus in the marketplace.

So we'll need to execute it well. We're set up to do that and we'll build our credibility as we launch it with guest and over time and this is something that should lead to solid results for us in short term, but also provide an opportunity for future and more elevated occasions that we're interested in exploring as sales builders over time.

So first thing first and let’s get Platos to market and progress them from there based on the performance and the learning, but we're excited to get it to market. Obviously we've been talking to all of you about it for some time now. So it will be a good move for the brand in Q4.

Jeremy Hamblin

Understood. Also I wanted to ask about your unit growth and just thinking ahead at this point you probably have a fair bit of your location for next year signed and hopefully in the pipeline, are we going to see a bunch of new geographies? I know what you had said historically is that the unit growth is probably going to be mostly backfill in existing markets, but any kind of hints what we should be looking at for 2017?

Paul Murphy

This is Paul. For 2017 it will still be more kind of backfill infill and then certainly build out of Atlanta, Oklahoma City and us entering into the Denver market. As we look at new geographies that’s really a year or two out after that because we certainly have a lot of wide space kind of close into us, but also just -- they are just getting that pipeline filled.

The one thing that is important to us as we look at both '17 and '18 is start to get more of the cadence of the stores being built throughout the year. It’s no secret both certainly last year and this year we're little bit heavy on the back half. And so a lot of strategically what we're trying to do is to get that -- the flow with the openings. So more across the full year and then as we get that in the pipeline in place we'll talk about new geographies.

Jeremy Hamblin

Okay, great. And one last question just on the warrant and thinking about potential next steps with that I think the tender closes on August 5. Is there potentially a second step along the same lines, what kind of inspired doing it this way?

Was it to get a quicker resolution on this potential overhang I think it’s probably had on the stock. Can you just give us a little more insight into the thinking going forward on the remaining warrants?

Paul Murphy

Jeremy, at this point I'll just have to say, it’s absolutely premature to make any comment around what if anything will transpire after this current process is completed.

Jeremy Hamblin

Okay, fair enough. Congrats on the great results and best of luck in Q3 and beyond.

Paul Murphy

Okay. Thank you.


Our next question comes from Craig Bibb from CJS Securities. Please go ahead.

Craig Bibb

I would like to extend my congratulations on positive traffic that is a fantastic news.

Paul Murphy


Craig Bibb

And to that point, so what the Del Taco, is the Del Taco the key driver to the product and in your comparison to the return to positive comps actually to improve your stock traffic or be up to?

John Cappasola

Yeah, I just point to the fresh combined solution launched three weeks ago. So and to Paul’s comment where we started to really see some of that strengthening during that period of time, the energizing of the field and our franchises as we really prepared for the launch.

We got the restaurants ready and the teams ready to really accelerate and then obviously the catalyst that has been the new campaign, the new spin from a dichotomy point of view on the brand that we're bringing to life and then of course the Del Taco, which has done well as we stated.

So I think it’s a good testament to the overall strategy of Fresh Combined Solution. We're seeing some of the good things from our operating metrics and its all working together nicely to drive the business right now.

Craig Bibb

Okay, and so the Del Taco, are people using that as an add-on or the ordering multiples of them or how is it putting in?

Steve Brake

Yeah, Greg this is Steve, its little early to get a full read that we can share on the exact usage of it. We’re certainly seeing nice early traction across day parts. It is part of a numbered combo meal, which certainly has great traction, but we also see a large amount of all the card.

So, really just three weeks in change into it. It's going to take a bit more time to see to enjoy watching it reach its full potential and when it gets there we'll be happy to report next quarter about the ins and outs of what it’s doing for the business.

Craig Bibb

Okay. In that two Platos markets -- Platos is available lunch and dinner? Is that correct?

John Cappasola

Yes, yeah it’s not just dinner platform, it’s obviously akin to dinner the way that it’s been positioned with the plated meal, but it is being purchased across day parts. So, we're seeing activity at lunch as well as dinner and other day parts.

So, it’s something that gets you in the mindset of dinner of course and it's something that is going to be well positioned for dinner, but the good news is its being used for the drive through, it's being used in the dining room and it's being used across day parts, which we feel really good about.

Craig Bibb

Is it having a space impact on dinner?

John Cappasola

Space impact or…

Paul Murphy


Craig Bibb

Biggest tropical mix.

John Cappasola

It's skewing -- it's skewing dinner a bit right now, but we're seeing some nice movement during the other key day parts as well lunch especially. So, it's not exclusively dinner.

Craig Bibb

And are you seeing people coming and ordering family style or it's one-offs?

John Cappasola

Yeah we can give a bit more color on it on the next call as we can finalize our test results and really get the timing of the launch for Q4 ready to go. What we can dive into some of those types of metrics, but as you can imagine it is a higher check average that we're seeing.

It's definitely positioned for larger party size because it is more of a dinner skewing platform. So, we’re seeing some nice things on the check-in on margin side of that platform.

Craig Bibb

It's launching right at the beginning of Q4 or…

John Cappasola

We’re finalizing the details right now it will not be any later than mid Q4 at this point.

Craig Bibb

Okay. All right. Well, thanks a lot guys.

Steve Brake

You bet.


[Operator Instructions] And our next question comes from Nick Setyan from Wedbush Securities. Please go ahead.

Nick Setyan

Thank you and congrats on a great quarter guys. Just a quick one in terms of the EPS guidance, does that take into account the potential dilution in the second half of the shares.

Steve Brake

I’m sorry, can you repeat that question. You are kind of breaking out a little.

Nick Setyan

In terms of the guidance on that EPS the reiterated EPS guidance, does that take into account, the dilution from warrants?

Steve Brake

Well, as you know the guidance was done much earlier this year. Since then obviously we've been very productive in the market buying back essentially around a million shares.

That said it fully subscribed, I think we would deploy nearly 1.9 million shares, so kind of little more than half of that dilution so to speak is already been acquired in the open market. The guidance range of $0.53 to $0.56 has not changed.

I think anyone with a pocket of warrants out there calling the dilutive share base is always a bit of a challenge. So, I would just tell you at this point we still feel very good about that diluted EPS guidance that we're affirming today.

Nick Setyan

Got it. Got it. And then just in terms of the comparative environment, obviously we're seeing the cadence ease a little bit from a dollar price point, so it seems like it wants to gravitate towards that both side of the oil price point.

And longer to your bigger kind of regional competitors obviously was offset for four -- about four weeks or five weeks ago and maybe that also helped will accelerating transaction trends. I guess what are your thoughts around the competitive environment today and then going forward, do you think there is a chance that we get back to the tone and that type of an aggressive stance again going out of this year and into 2017?

Paul Murphy

Into 2017, okay Nick this is Paul, from my standpoint, it’s a little hard to tell. I think it’s really two issues, it's going to be how are these other brands performing. We like the course that we're on. We like the strategy that we have and certainly the results that we’re seeing in our business with our strategy vis-à-vis what's going on the macro, couple of things to always consider is that in early '17 some of these other brands that are having had more of a heavier discount have to lapse what they did in 2016.

So note that point now internally from them it comes down till they have some real decision making. We know do they toggle back more towards check than trying to drive transactions and also if some of them were a little bit more heavier franchise presence, it’s also for the franchise communities going to be excited to keep on discounting or they're going to feel like that they’re leaving money on the table.

And if the commodity environment starts to be little bit less deflationary it makes it tougher for some of these brands to do what they're doing, If you know about our strategy with Buck & Under its full margins. So it's not discounting.

So our view is we’re going to always monitor them look what's going on the macro, but as we've said a few times this year, we’re sticking with our strategy. We like the results that it's doing with the launch of the Fresh Combined Solutions and the everyday value that we're able to present, we think is going to enable us move through this in a very strong fashion and come out the other end as one of the top brands.

Nick Setyan

Thank you. That is very helpful. And just final question, Steve the incremental food deflation, you commented on, is that relative to Q2, so is that a sequential deflation again or are we just talking about it on an annual year-over-year basis?

Steven Brake

Yeah, it was on a year-over-year basis. So previously we did expect a leveling in that food basket year-over-year. We did achieve a modest deflationary outcome year-over-year with the basket deflating primarily due to very favorable cheese pricing that prevailed through the spring as well as some wins out of the beef category.

Nick Setyan

Got it. Thank you.


Our next question comes from Joshua Long from Piper Jaffray. Please go ahead.

Joshua Long

Great, thank you for taking my question. Wanted to see if we might be able to go back to 3Q of '15 and remind us what the cadence was through that quarter? If I remember correctly you were promoting salads and maybe avocadoes at that time or avocado add on.

So just curious on what the cadence look like through 3Q of '15 obviously understanding that generally the trends get easier as we go through the course of this year, but just wanted to balance those two if we could?

Steven Brake

Sure. This is Steve. So Q3 a year ago the fresh sliced avocado originally debuted very early June, which was back part of Q2. So avocado was still in play during Q3, still relatively new. I believe we were sustaining a new Epic Burrito that had featured that fresh sliced avocado and then right as we went into Q3, we had just launched the new Enchilada platform.

So that definitely played a pretty key role at the end of Q3. So I guess really the front half would be characterized by the fresh avocado launch in that new Epic that featured the fresh avocado and in the back half very tail end of Q3 had the launch of Enchilada.

Paul Murphy

Yes the salads were really September for the most part. So would have been more Q4 impact.

Steven Brake

And then August I believe had a bit of Buck & Under focus.

Paul Murphy

That’s right.

Steven Brake

So it was a good quarter. As you know a year ago, good mix of some premium re-hitting Buck & Under as we opt to do and certainly this year we're being nimble and weaning in on Buck & Under a bit more and then it did close out that quarter with the exciting launch of Enchilada. Is that helpful?

Joshua Long

Yes that is. Thank you. I appreciate that color. And then as we shift over to the food cost environment with the deflation coming in a little bit earlier than you expected and being some of those key items being favorable overall, does that change how you think about contracting some of those items?

I think as of the last quarter you were about 50% to -- 30% to 50% contracted for each of the following quarters. Just curious where you're contracting it now and if you're philosophy for the remainder of the year has changed?

Steven Brake

Yes, we feel pretty good about where we are. As we look ahead, the back half, we’re still expecting continued modest deflation across the food basket on a year-over-year basis.

Right now we have about three fourth of our basket contracted for the back half, third quarter a bit higher than that, fourth quarter a bit lower than that. So we have pretty good coverage across the basket. So we feel pretty good.

That said the one area of main focus right now is block cheddar cheese. We do have partial coverage the balance of this year, but that has been fairly volatile. It was very, very favorable through the spring. It went as low as high $1.20, really held in the $1.30 for May. That said, the last two days it’s now at $1.68.

So cheese often is very volatile, that’s how it's behaving currently. The heat of summer is driving some of that. So we're certainly doing the work trying to cite the right balance of coverage and/or floating to make sure that round is out appropriately for us as we wrap up the year.

So that and a few other renewals in areas that we'll take down some coverage are in process. So I’d say by next quarter we’ll have a very, very good read on how the year will wrap up, but right now we're focused and overall pleased.

Joshua Long

That’s helpful. Thank you. And two questions on the unit development. One, wanted to just confirm the gross openings and net closings for company and franchise in the quarter.

And then a longer term question as you start thinking about both your growing, are you growing into larger percentage development over time and then also franchises growing out into 2018 as you mentioned on the call? Any investment that need to be made there or have those already been made and truly just kind of growing into the scale that you already have as an organization?

Paul Murphy

Yes, this is Paul. In terms of the investment, the major investment was bringing on Jeff Little as a Senior VP of Development and he certainly has made a couple of changes in his department, but we feel like we are set up.

We have the organization set to deliver '17 and '18. So I don’t see that we're going to need much more investment certainly on the personnel and to make that happen in terms of the guidance that we've given for the balance of '16 and we’ve reiterated that we feel good about the number and our focus right now is really more on '17 and '18.

And as I mentioned earlier, trying to get to more of the cadence across all four quarters instead of being backend loaded, which is just tougher to execute that. So we know that to get into the higher percentage of growth, you need to have growth in all four quarters.

John Cappasola

As far as there was growth, there was one opening company one closing franchise for the quarter.

Joshua Long

Got it. Great. Thank you so much.

Paul Murphy



Thank you. I’d now like to turn the floor back over to management for any closing remarks.

Paul Murphy

Well, I just want to thank everybody for your time today. Certainly second quarter met our expectations and love the start that we're off on to the third quarter and just look forward to speaking again at the end of the third quarter. Thank you for your time.


Thank you. This concludes today’s teleconference. You may disconnect your lines. Have a nice evening.

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