Del Taco Restaurants, Inc. (NASDAQ:TACO)
Q3 2016 Results Earnings Conference Call
October 17, 2016 05:00 PM ET
Raphael Gross - IR
Paul Murphy - President and CEO
John Cappasola - EVP and Chief Brand Officer
Steve Brake - EVP and CFO
Jeremy Hamblin - Dougherty & Company
Peter Saleh - BTIG
Nicole Miller - Piper Jaffray
Nick Setyan - Wedbush Securities
Alex Slagle - Jefferies
Craig Bibb - CJS Securities
Good afternoon and thank you for standing by. Welcome to the Fiscal Third Quarter 2016 Conference Call and Webcast for Del Taco Restaurants Incorporated.
I would now like to turn the call over to Mr. Raphael Gross to begin.
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 the reconciliations of the non-GAAP measures to the nearest GAAP measures.
I’d now like to turn the call over to Paul Murphy, President and Chief Executive Officer.
Thank you, Raphael. We appreciate everyone being with us this afternoon and are thrilled to have delivered a terrific third quarter. I am especially proud of our team for launching and executing our Fresh Combined Solutions strategy. John will address the specifics of our brand progression momentarily but first let me review the quarterly highlights.
System-wide comparable restaurant sales growth of 6.7% which we believe will significantly outpace the QSR category. We know that we cycled over a 5.6% year ago comparison, resulting in a highest two-year growth rate so far this year of 12.3% and what we expect will certainly be one of the strongest two-year trends in the industry. Restaurant contribution margin of 20.9%, a 120 basis-point improvement over the same period last year and adjusted EBITDA of $17.0 million, up from $15.3 million in last year’s third quarter, reflecting an 11.0% growth rate.
Considering the aggressive promotional activity within QSR these days, we are especially pleased to achieve our comparable restaurant sales and transaction growth without discounting. We believe this is a testament to our philosophy that operations and marketing are on equal footing which is critical to delivering the brand promise each and every day putting the brand in a great position for enduring sales growth.
For the record, the Del Taco system and our own Company-operated restaurants have now generated 12 and 17 quarters of consecutive gains in comparable restaurant sales growth respectively. Within our Company-operated restaurants, comparable restaurant sales rose 7.1%, consisting of a 4.8% increase in check including over 1% in menu mix growth and a transaction increase of 2.3%. In understanding these metrics, please recall that during the year ago quarter, traffic grew 0.6%. So, we were gratified to have grown transactions 2.9% on a two-year stacked basis. In addition, the sequential transaction improvement from the second quarter was 410 basis points despite reported softening across the category this year.
We attribute our comparable sales, menu mix and transaction growth to three primary reasons. First, we are delivering great tasting craveable food at category-leading everyday value to our guests across all three menu tiers, Buck & Under; mid-tier and premium. Second, we are broadening our occasion set by fully leveraging our QSR-plus quality value positioning, which in turn is driving check to menu mix and elevating guest perceptions of the brand. And third, our unrelenting push to continuously improve our restaurant operations through our combined solutions approach is driving great guest experiences, which maximizes our opportunity with every transaction.
Fresh Combined Solutions, as you know, is designed to put a finer point on our brand positioning through our advertising and menu innovation including a heightened focus on fresh ingredients. We’re on a journey to define QSR-plus for Del Taco, so that’s unique and differentiated from the competition. And Fresh Combined Solutions is a key stepping stone on our brand progression.
We’re excited about the momentum that was created by the new UnFreshing Believable 2.0 campaign and the new Del Taco which John will further detail, but I wanted to touch on importance of great execution as a driver of our model.
As we’ve said in the past, our go-to-market approach always contains operations initiatives designed to complement and drive our brand initiatives in order to create a great guest experience.
In fact, the behind-the-scenes work to prepare our operations and restaurant teams was critical to the early success of Fresh Combined Solutions and the Del Taco product launch. We saw improvements on key focus areas like order accuracy, food consistency, speed with service, and execution of new product introductions due to our training and operations plan. These factors all helped fuel our performance at launch and throughout the third quarter. We couldn’t be more pleased with our execution and results but also recognize that we must continue to improve and elevate the brand.
Turning to restaurant contribution margins, we drove operating leverage on the strength of our comparable restaurant sales growth and continued food deflation, while effectively managing labor inflation from our large California footprint which continues to play out as expected. We are pleased to have again expanded restaurant contribution margin despite this headwind.
On the development front, we opened three restaurants system-wide in the third quarter, two franchised and one Company-operated location and also acquired a single franchise unit in Ontario, California. Last week, we made an opportunistic acquisition of five formally franchised restaurants in Bakersfield, California, north of Los Angeles, and are pleased to announce that plans are underway to further develop this market with additional new Company-operated restaurants.
During the fourth quarter, we anticipate opening eight restaurants system-wide, which reflects a total of 14 openings this year compared to our previous range of 15 to 18 restaurants as a few units are now slated to open in late 2017. Looking ahead, we plan to accelerate system growth to mid single digit growth in 2017 with a near-term focus that is primarily on lower risk, in-fill sites and existing markets in the western U.S., where we have identified over 300 incremental trade area opportunities.
Our pipeline also includes continued unit development in our emerging markets of Georgia and Oklahoma, as well as new Company development in the Denver, Colorado market starting in 2017. Overall, as we work to finalize specific opening targets and timelines for 2017, we are very pleased with the strength of our new unit pipeline.
Our recent momentum has clearly helped us to forge ahead with our drive to $1.5 million annual unit volumes by 2018 and also helps us attract new qualified franchise partners who we expect will help us accelerate franchise development beginning in 2018 and beyond.
I’d now like to turn the call over to John Cappasola, our Chief Brand Officer.
Thanks Paul and good afternoon everyone. I’d like to echo Paul’s sentiment on the outstanding efforts that our operations group and franchisees put into the Fresh Combined Solutions and Del Taco launch, and continue to put into our brand each and every day. They’ve risen to the challenge to continuously evolve and give our guests QSR-plus experiences.
As Paul discussed, the Fresh Combined Solutions operating plan enables great brand experiences, which we believe puts us in a position for enduring top line momentum. We couldn’t be more pleased with the early returns of the program which further builds upon the sequential improvement in each quarter this year with our focus on great, everyday value through our barbell menu strategy.
Fresh Combined Solutions also drove solid perceptual movement in the quarter on key brand attributes. Value and affordability continued to achieve category leading marks with quality and freshness perceptions further strengthening achieving our highest marks year-to-date. This combination of brand strengths is what we’re trying to sustainably achieve in order to solidify our unique QSR-plus territory.
As you know, there were several brand catalysts of Fresh Combined Solutions designed to drive demand and continue our brand progression. The new UnFreshing Believable 2.0 campaign which included a new look and feel to our menu boards, in-store marketing and merchandising enhancements, and external advertisement improvements gave our restaurants and marketing communications a fresh new look and add further dimension to our brand position. In addition, we launched the Del Taco. We’re proud to say, we now have a new signature crunchy beef Taco that is worthy of our name. The Del Taco broke the all-time sales record for new product introductions, achieving mid-teens sales mix between à la carte and combo meal sales.
The Del Taco combo meal which includes two Del Tacos and order of crinkle cut fries and a drink, became our new number one combo during the quarter at a $5.99 price point. In addition, the Del Taco was attached to 13% of all transactions in the quarter compared to the product that it replaced the $1 Classic Taco which was on 5% of transactions. The comprehensive merchandising, the sustained messaging and overall broad appeal of the product has driven solid and sustained performance.
The Del Taco was also doing its part moving key brand perceptions and improving the guest experience. Quality, value and overall satisfaction scores in our guest surveys are over-indexing on transactions that contain a Del Taco purchase. Guests love this product. So, we plan to continue to focus on in our marketing communications in either a primary or secondary position for the foreseeable future. It fits nicely as part of the mid-tier of our menu strategy, providing a great tasting product at a great value.
I’m also happy to confirm the system-wide launch of Platos later this month. We designed the Platos program as a progression of our Fresh Combined Solutions and as a complementary follow-up to the Del Taco. The Del Taco hit the bull’s eye for our core fast food occasion in an elevated yet value oriented way where Platos is an occasion expansion strategy. As I said on the last call, Platos is designed to grow our occasions of use with plated meals that can be conveniently picked up through the drive-thru at a great relative value.
The positioning around Platos will be get dinner fast, enjoy it slow. We heard from consumers that Platos are dinner worthy due to the quality of the food and the plated presentation, although we also expect to see a mix across all of our day parts including lunch in particular. In addition to providing quality and convenience, the platform will also be priced to represent a great value. One of our primary brand goals across our menu strategy is always to represent great everyday value no matter the occasion.
Platos will be priced starting at just $6.49 which will include chips and salsa, rice and beans, and an entrée. The initial entrée options will include new grilled carne asada and grilled chicken wet burritos which are topped with either green or red sauce; two of our signature beer battered fish tacos or two of our signature street tacos with either grilled chicken or carne asada. As with any of our launches, we have put a tremendous amount of rigor into commercialization and are very comfortable that Platos will be executed at a high level maintaining our speed and quality standards at the drive-thru.
Lastly, our mobile initiative is entering into the first mobile app test market in the fourth quarter after completing a successful alpha test. We expect to expand the test in the coming quarters based on our learnings across key operational, guest and financial metrics.
Now, I would like to turn the call over to Steve Brake to review our third quarter financial results and updated financial guidance.
Thank you, John. Our fiscal third 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 September 6, 2016, is being compared to the two-week predecessor period ending June 13, 2015 and 10-week successor period ended September 8, 2015, which have been aggregated to reflect on a pro forma basis the combined successor and predecessor periods for the 12 weeks ended September 8, 2015 for comparison purposes.
Company restaurant sales increased 5.7% year-over-year to $100.2 million from $94.8 million in the year ago third quarter. The increase was predominantly driven by a same-store sales growth of 7.1% at company-operated restaurants, partially offset by fewer Company-operated restaurants. Third quarter company-operated same-store sales growth represents the seventeenth consecutive quarter of gains and was comprised of 4.8% in check growth, including over 1% of menu mix growth and 2.3% growth in transactions. This transaction trend also features 410 basis points of sequential improvement from our second quarter.
Franchise revenue during the third quarter increased 13.8% year-over-year to $3.7 million from $3.2 million last year. This increase was driven by a franchise same-store sales growth of 6.2% and additional franchise restaurants compared to the third quarter of the prior year as well as an increase in initial fees.
System-wide same-store sales increased 6.7% and lapped system-wide same-store sales growth of 5.6% during the third quarter of 2015, resulting in a strong two-year trend of 12.3%. Total third quarter revenue was $104.4 million, an increase of 5.9% over the $98.6 million in the year ago third quarter. During the quarter, we opened one Company-operated restaurant and acquired one franchise restaurant while franchisees two restaurants.
Moving onto expenses, food and paper costs as a percentage of Company restaurant sales improved approximately 120 basis points year-over-year to 27.5% from 28.7%. This improvement was due to the impact of the menu price increases in the mid high 3% area during the third quarter along with food deflation led by reductions in beef, cheddar cheese and eggs. We expect continued food deflation in our fourth quarter and currently anticipate full year 2016 commodity deflation of up to 2%. However, as I’ll explain shortly, we will carry less menu pricing in the fourth quarter and our food and paper cost percentage will also be influenced by our new Platos program, which is expected to drive a strong margin dollar contribution with a slightly lower than typical margin percentage similar to the new Del Taco product.
Labor and related expenses as a percentage of company restaurant sales increased approximately 90 basis points to 30.7% from 29.8%. 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 and operating leverage from our transaction gains. This outcome improved from the 110 to 120 basis points of deleverage in the first half, primarily due to the improvement in transaction trends. Overall, our experience managing higher wages remains consistent with the guidance we furnished earlier this year.
Occupancy and other operating expenses as a percentage of Company restaurant sales decreased by approximately 90 basis points year-over-year to 20.9% from 21.8% last year. The improvement was primarily driven by leverage on our comparable restaurant sales increase. Based on this performance, restaurant contribution increased 12% to $20.9 million from $18.7 million in the prior year third quarter, while restaurant contribution margin improved approximately 120 basis points year-over-year to 20.9% from 19.7%. We are proud to have continued to navigate through mandated labor inflation, while expanding four-wall margins.
General and administrative expenses were $8.6 million and as a percentage of total revenue increased by approximately 130 basis points year-over-year to 8.2%. The increase was driven by stock-based compensation from new management equity incentive plans finalized late last year, additional resources to support brand development, increased management incentive compensation and incremental public Company costs. Adjusted EBITDA in the third quarter increased 11.0% to $17.0 million versus $15.3 million earned in the third quarter of 2015. As a percentage of total revenues, adjusted EBITDA was 16.2%, up approximately 70 basis points from 15.5% in the prior year period.
Depreciation and amortization expense in the third quarter was $5.2 million, an increase of 7.2% over $4.8 million last year, but as a percentage of total revenue held steady at 4.9%. Interest expense was $1.4 million in the third quarter, down from $2.4 million in the prior year third 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 third quarter, $156 million was outstanding under this all revolver credit facility while our applicable margin for LIBOR loans remained at 1.75%. Income tax expense was $4.1 million during the third quarter for an effective tax rate of 45.2% as compared to $4.6 million income tax benefit during the same period last year. The fiscal third quarter effective tax rate was impacted by non-deductable transaction related costs incurred in connection with the offer to exchange shares with the Company’s common stock for warrants and an unfavorable permanent difference for stock-based compensation expense from restricted stock awards that vested during the fiscal third quarter. This resulted in net income for the third quarter of $4.9 million or $0.13 per diluted share compared to $2.4 million during the two weeks into June 30, 2015, the predecessor period and a net loss of $2.2 million during the 10 weeks ended September 8, 2015, the successor period, which also included $12.0 million of transaction related costs.
As you know, we commenced and concluded an offer to exchange 0.278 shares of our common stock for outstanding warrants exercisable for shares at an exercise price of $11.50 per share. A total of 5,516,243 warrants were tendered in the exchange offer which we accepted by issuing 1,533,542 shares in exchange. This represented approximately 4% of the shares outstanding after such issuance. We believe this exchange offer effectively helped to make the Company more attractive to holders with a long-term investment horizon by providing greater certainty around the Company’s capital structure by significantly reducing the number of shares that would become outstanding upon the exercise of warrants.
Turning to our repurchase program covering common stock and warrants which was upsized to 50 million from 25 million in August. During the fiscal third quarter, we repurchased 505,808 shares of common stock at an average price per share of $9.45 and 235,000 warrants at an average price per warrant of $1.85 for an aggregate of $5.2 million.
Since the end of the third quarter, we repurchased an additional 212,510 shares of common stock at an average price per share of $11.16 and 222,201 warrants at an average price per warrant of $3.45 for an aggregate $3.1 million. We currently have approximately $34.8 million remaining for future repurchases of common stock or warrants under our $50 million authorization.
Lastly, based on our performance to-date and expectations for the 17-week fiscal fourth quarter, we are updating our 2016 guidance. Although I will not review the entire revised outlook available in our earnings release, I will highlight a few items.
We are increasing our system-wide same store sales growth outlook to the high end of our previous range of 2.5% to 4.5%. Through the first three fiscal quarters, we are up 4.4% and expect to hold a similarly strong trend for the balance of the year. Through the first five weeks of our fiscal fourth quarter, transactions remained positive and we are tracking above this full year guidance. However, to fully understand this updated guidance, please also note the following.
After carrying about 4% menu pricing during the first half of the year and mid-high 3% menu pricing during the third quarter, we will carry menu pricing in the mid 2% area during the 17-week fourth quarter and we will end the year with approximately 2% of menu pricing from our summer and fall increases that will carry into 2017. Looking ahead, we believe this more modest menu pricing is appropriate to achieve a healthy balance across our same store sales drivers including our focus to continue driving positive transactions and menu mix. This shift is cognizant of our elevated price over the past two years, particularly in light of the widely cited inflation disparity between food away from home versus at home, the intense competitive environments and reported softening across the category this year. Ultimately, we believe a more judicious near-term approach on many placing is appropriate to help us maximize our opportunity to leverage Fresh Combined Solutions, the Del Taco and Platos to continue driving gains in transactions and menu mix.
In terms of profit, we are increasing our restaurant contribution margin outlook to a range of 20.2% to 20.3%, based on our progress to-date, expectation for same-store sales at the high-end of our original range, a more benign food cost environment and the California minimum wage impact coming in as we had forecasted at an incremental $7.2 million including preservation of appropriate wage differentials and incremental payroll taxes. We have similarly increased our range for adjusted EBITDA to between $69 million and $70 million from $67.5 million to $70.0 million previously.
We are reiterating our diluted earnings per share guidance of between $0.53 and $0.56 which reflects our full year expectations for strong same-store sales and restaurant contribution margin performance, G&A expenses towards the top-end of our original range, non-deductible transaction-related costs incurred in the warrant exchange and an aforementioned higher effective tax rate. It also takes into account an increasing diluted share count due to the warrants trending in the money and the incremental shares issued in the warrant exchange.
To conclude, the next phase of our brand progression, Fresh Combined Solutions, is being effectively executed across our organization and is enabling us to generate strong results for our shareholders while delighting our customers. We look forward to our fourth quarter providing a strong finish to the fiscal year and also setting us up for an exciting 2017.
Thank you for your interest in Del Taco and we are happy to answer any questions.
[Operator Instructions] And our first question comes from the line of Mr. Jeremy Hamblin from Dougherty & Company. Please proceed with your question, sir.
I wanted to ask first about the acquisition that was done of five locations subsequent to the end of Q3. Can you just tell us what did you pay for those on an EBITDA multiple basis or can you give us some color on that?
Hey, Jeremy; it’s Steve. We don’t want to go in any exact metrics on that. We also did pick up one unit Ontario, California during the third quarter. Overall, both of those acquisitions, we feel good about the purchase price, sets forth the foundation where we believe it will be accretive to the business certainly over time. And the one unique part of the Bakersfield that we really like a lot is that it’s a smaller market for us that definitely has a lot of room for growth. And as we noted, we definitely have plans underway to grow that market on the Company side. So, you can consider that a new small company market that definitely has a nice growth path ahead of us. So, for all those reasons, we feel really good about those moves that were made more so on an opportunistic basis.
And then, in terms of just kind of flow of the quarter on comps, obviously very impressive comps that you guys just posted. Help me think about the guidance for the fourth quarter. It seems to imply kind of roughly in the 4% to 5% range. I think on the comps, you’re lapping a little bit tougher comps by 50 basis points in the fourth quarter, so we would expect it to come down. How are you thinking about the launch of Platos in the context of your comps? Are you assuming any benefit from that or if it does become a hit, that is something that would drive potential upside; how should we think about that?
Platos, later this month, we’re definitely excited about. It’s kind of a mid-quarter introduction that we talked before that in tests we certainly see evidence of Platos providing both mix and transaction benefits. So, all that said, when you think about -- we’re 4.4% on same-store sales year-to-date, so the implied Q4 guide is high 4 area, in terms of same-store sales. So, some of the dynamics there is -- certainly as we touched on, we’re going to have less -- effective menu pricing during the fourth quarter. So, more than a full percent [ph] roll off versus Q3, I mean closer to around 1.5% has rolled off compared to the front half of the year. Certainly, we still remain in a very intense competitive environment, still marked by a lot of discounting. This is also a category that still has reported softening irrespective of the specific sector within the industry. At the same time, we mentioned the gap of food-away-from-home versus at-home. That gap continues to widen, which is one of our realities. And then lastly, the challenged consumer, what happens on November 8th, the outcome from that as well as the aftermath. So, those are some of the backdrops items I would point to. It is a long 17-week quarter for us. And although we did say, five weeks in, we’re tracking Q4 ahead of that full year guidance, right there in the mid-four area. Although we’re ahead of that obviously, it is the tough landscape and certainly we feel good about Platos as well the continued momentum that has come out of Fresh Combined Solutions and the Del Taco, but those are some of the other moving parts to think about.
And then, just one last question here. As I think about the guidance around system opening, you didn’t -- I don’t think you provided color on the split between Company openings, because I think you said eight system-wide for Q4. What’s the split we should be expecting between Company-owned versus franchise in the fourth quarter? And then just thinking about potential closures, moving forward, at least for the Company-owned side either at the end of this year or into 2017?
So, the remaining openings and also for the full year, it’ll be about half-half, maybe a slight tilt towards Company in terms of the openings. Closures to-date this year are fairly minimal. Any given year, there tends to be a very small amount of churn for various reasons. So, we expect very low closure rate continue. There are not any pockets of low performing stores or other concerns in the store portfolio that we have that would lead to any notable closures.
Now, our next question comes from the line of Mr. Peter Saleh from BTIG. Please proceed with question, sir.
I just want to ask, could you just give a sense of the level of advertisement you guys put behind the Del Taco launch and if we should expect that to be pulled back a little bit as we go into fourth quarter?
This is John. The launch contained [ph] normal rhythm, especially on a year-on-year basis for the advertising. There wasn’t investment spend involved. So, we leveraged our typical sales percent that drive the advertising dollars. And you can expect to continue to see us as we do our promotions intermittently throughout the year to continue to support those with advertising and marketing communications at the restaurants.
And then the mix for the Del Taco seems pretty significant, was that across lunch and dinner or was that contained mostly to one day part and other?
No. We saw nice success with mix across day parts. It really did well across all six, as you think about that. And as I said, that mix that was referenced on the call was a combination of the à la carte and the combo meals that we’ve instituted with the Del Taco.
So, is there any concern? I mean, you’ve got this great product out in the market, is there any concern that just launch Platos -- is it possible that one cannibalizes the other sales?
How we’re thinking about it is as I said, we think they hit really two different occasions and work really nicely and synergistically. As we think about the Del Taco really hits that core faster at occasion for us. It offers that convenient value through drive-thru experience that on-the-go kind of transaction that you’re looking for; it’s a wrapped product, a typical fast-food wrapped product. Whereas Platos is that full meal; it’s that plated option that we don’t currently offer today to not wrapped and it’s given consumers kind of a new way to use the brand and it’s elevating of course and that’s why we like it. So, we play our cards right and we execute it well, it’s potentially incremental from an occasion and a frequency standpoint.
Now, our next question comes from the line of Ms. Nicole Miller from Piper Jaffray. Please proceed with your question.
You talked a big picture about the environment, and we agree with the consumer attitude and grocery deflation as an impact. Could you talk a little bit about how you feel about supply in the limited service segment right now, unit growth?
Nicole, this is Paul. We certainly understand that in there’s been a lot kind of written lately about a bit of an oversupply. As we looked at unit growth particularly for Del Taco, our plan still is to continue to move from low single digit to mid single digit in 2017. That being said though, our approach will be one that we’re very disciplined about it with quality trumping quantity in terms of the units that we bring to market. Right now, very pleased with the pipeline and the shrink in the pipeline that we see for 2017. But, I think that you’ve seen us be very judicious as a management in terms of our growth and we will continue to be so. But we feel like -- given the wide space that’s available for our brand and frankly the results that we’re getting, certainly we think enables us to start to be able to spread our wings a bit and continue our growth, but in a disciplined fashion.
And on that point, starting an accelerating development, what kind of new store rent costs do you see as being most likely and how does that impact the new store economic model and really power that forward?
Overall, as we accelerate our growth -- there has been a little bit of escalation in the average rents that we’re looking at bringing but the nice thing is we’ve also had a very meaningful growth in AUV in recent years. We’ve put a lot on the top-line. And we certainly -- we’ve talked about the 1.5 million target by 2018. We certainly kind of expect that out of our units and overall are very happy with what we’re seeing come out of the ground as we open more and more units. So, on a percentage basis overall in blend, we’re still looking at single-digit percentage rent, not double-digit. Here and there, there might be an exception that’s double-digit, but predominantly you still have that single-digit rent profile that’s an important part of the strong ROI equation is what we’ve always looked for generally achieved and see that going forward.
Great. And the last quick one if I may, with such awesome comps, what are you learning about those guests at a return guest, new guest, how are you tracking their identity?
I think couple of things, one is we’re watching our guest experience measurement at the restaurants. So, how are those experiences being played and we’re looking at it as specific as item level experiences like we did at the Del Taco. And we’re seeing some nice over-indexing in regards to satisfaction of the brand, as well as some other perceptions of the brand that are really important to us as we think about embedding the QSR-plus positioning.
The other thing that we look at obviously is our market monitor tool that we use with the NPD Group and that helps us manage perceptions of the brand really kind of how is the market relative to other QSR helping or what’s happening within the market. And clearly, we like what we’re seeing thus far. Since we launched Fresh Combined Solutions, we saw an uptick in both value and affordability marks. And we saw one of our strongest marks here to-date on quality and saw some nice momentum on the freshness perception as well.
So, we’re looking at both from what’s happening actually at the restaurant, we like what we’re seeing there and then we’re looking at a more macro view of the world when you are considering all the other players in the marketplace and we like what we’re seeing there. So I think all around, we’ve got some nice momentum relative to the brand perceptions right now.
[Operator Instructions] Our next question comes from the line of Mr. Nick Setyan from Wedbush Securities. Please proceed, sir.
My question is on the unit level margin guidance for the year, Steve. Just to reconcile, it seems like Q4, you’re implying some deleverage year-over-year. Is that correct? And maybe kind of walk through where that deleverage is coming from?
Yes. Certainly, if you look at the low end, you could derive that application. The high-end is closer to holding margins. So, things to think about, obviously we’re affirming the high-end of our revenue guidance in terms of cost. That said with a slight reduction in growth, overall revenues, a little bit of revenue pressure there perhaps. I would also point to the fourth quarter where as we said we’re going to carry pricing in the mid 2 area. That said, prior few quarters, we were in the mid-high 3s, Q3, 4% area in the front half. As you know pricing, that is the most powerful level to drive restaurant margin performance. So, I would say particularly with rolling off some price for the fourth quarter to end the year, that is an area where just mathematically it would set up a situation where what’s been a pretty healthy margin gains, that level of expansion should not be expected for the fourth quarter. So, I think I’d mainly focus on that. And as always, we’re looking to provide appropriate guidance that we certainly do feel good about and look forward to ending the year strong.
And particularly when you made the food cost commentary, just to kind of put it in perspective, we’re doing 27.5% in Q3, that was what it was in Q2, the extra cost, the lower pricing et cetera, is that kind of implying maybe closer to a 28% type of a quarter for Q4?
Yes, the moving parts of the -- as we move forward, carrying less price would suggest less year-over-year ability to reduce food percentage while deflation will remain with us through Q4, I will tell you that third quarter was the height of our year-over-year basket deflation; it won’t be quite as deflationary during the fourth quarter. So, those are a couple components to think about there as well on food in particular. And then the other comment I made is that certainly for Del Taco as well for Platos both great product introductions or about to be in an introduction for Platos that we feel good about, definitely expected to drive margin dollar contribution. That said, based on the margin on how those products mix, it’ll be slightly lower than our overall margin percentage. So that would also play into the fourth quarter food cost percentage trend.
And I understand G&A obviously this year was a year of investment and you had to comp expense, you got the transaction costs around the warrants. Is there any reason to expect another year of investment in 2017 or should we start to think about some leverage on G&A?
We’ll look to guide that explicitly later on as we get into next year. Certainly our main focus is do what’s right for the business from a compliant standpoint as we kind of wind down our migration as a public company and really focus on making sure SOX 404(b) that we’re prepared for, there is some incremental cost coming there. But most importantly, as far as making sure where staff does not just grow the business in terms of AUV as we’ve been doing but also as the unit growth it really begins to accelerate, there’s also some staffing that’s involved in that as well. So, we’re going to definitely focus on having the right optimal level of resource against the business. We don’t short change our opportunities, naturally pair that against what’s been a nice growing total revenue base will eventually lead us to that percentage which will bring some color on later this year.
Got it. And then just lastly, the uptick on the tax rate, that puts you one of the highest tax rates in the restaurant universe, are there some opportunities perhaps going forward, some kind of taxpaying strategy or some changes that can potentially lower that tax rate over time?
Yes. This year is a bit a typical to couple of things that arose during the quarter, one obviously the direct cost tied to the warrant exchange, very productive transaction put all those costs from non-deductible that added fresher. In addition there is some permitted unfavorable timing differences between deductibility of restricted stock that vested this summer compared to the book accounting basis. So, that’s something that is hitting is currently that will frankly depend on the differential into the future on the stock price at date of grant versus date of vesting. So that’s kind of an unknown and frankly could swing either direction into the future. Lastly we talked about in our filings, there is investment in a subsidiary that causes some additional rate pressure to-date; that dynamic should hit the point where it would not pressure the rate going forward. So, we will certainly guide on that down the road for next year, but I would definitely expect to see a much lower effective tax rate in the year ahead.
And our next question comes from the line of Mr. Alex Slagle from Jefferies. Please proceed with your question.
Just wanted to follow-up on the operational improvements you’ve seen recently and if you could talk to your confidence in your ability to rollout the new product like Platos with the same level of executional success that you’ve seen recently that with the Del Taco and Carrizo? [Ph]
This is Paul, Alex. I think as heard in the script and seen, we really have worked hard on the operational to make sure that’s on equal footing with the brand building and the marketing. And some of the things that we did in terms of the Del Taco, well even go forward to Platos, we certainly take a look at the equipment to make it easier for our teams. We did that on the Del Taco, we did some equipment upgrades that certainly helped with the speed at the drive-thru through window. But I think one thing that I would really call out is we had a very effective combination of high-tech through our e-learning, our learn program and high touch training. So, when we did the Del Taco, we had three wheels of hands on practice; we sampled over 75,000 Del Tacos but also through the e-learning we had new reporting that allowed us to ID [ph] down to the restaurant who had and who had not completed the e-training against the products. So, while we on a macro basis did a lot of good things were able to micro manage it. And we are taking a very much the same approach to Platos. And as we go forward, I think as both John and I mentioned, we see it as working in tandem between operations and the brand teams to be able to do new product execution.
Probably the last thing about the Platos are mantra internally is picture perfect on the Platos and we’re going to be doing some new things internally by bringing in a mystery shop, we’ll be taking pictures of it and every store will be audited very quickly and we’ll be able to not only say they did a great job or say they need improvement but will have a picture to prove the statement. And we think that will once again help to drive home the importance of making sure that our products are not only great and affordable and wonderful value but we’re delivering exactly what we are going to say we deliver in terms of freshness and quality.
And then on the marketing front, if you could provide some additional color on how you think you’ll highlight the Del Taco with the fourth quarter marketing plan? How that’ll fit in?
So, let me just give you a little bit of commentary on the Del Taco and Platos because I think we’re really excited about both platforms working together, as we said earlier -- they continue to generate top line momentum in 2017 and even beyond.
And with our -- with the Del Taco, we’re going to continue to brand it and market it, keep it top of mind and front and center. And we want folks to continue to purchase it. So, it won’t have a diminished merchandising real estate on our menu boards, it’ll continue to have a front and center merchandising approach. We feel like the merchandising around it, the message around it, and just like I said, the succinctness of it is really working well for the brand, so we don’t want to lose that. And we’ll continue to move that forward as we think about 2017.
Platos is one and in particular, it’s a little different because it’s an occasion expansion strategy. So, we’ll need to keep that platform top of mind as well. And as we think about building credibility and trial with it, we’ll do it through marketing in 2017, product extensions as we move through the year to keep it fresh and keep it top of mind with consumers. And obviously, we’ll just continue to work on embedding it operationally, so we can execute it really well through the drive-thru. So, I would expect to see, as we move through Q4 and into 2017, a nice balance between Platos and the Del Taco in our marketing mix. And in addition, we’ll continue to do innovation. I mean, we’ve worked really hard to develop some of the new platforms that we’ve been able to execute against that have driven the business over the last couple of three years, like Epic Burritos and Buck & Under. So, we’ve got a pipeline of products that are constantly being cultivated in the kitchen, that’ll be ready to move on and deploy to market as appropriate. So, kind of as you think about the cadence as we move into Q4 and as we move through Q4 that’s probably how you should think about it and frame it.
Our next question comes from the line of Mr. Craig Bibb from CJS Securities. Please proceed with your question.
Just so I understand, the Del Taco, is it more being sold as the combo box or more of an add-on?
It’s a combination for sure. But I’d probably say that the à la carte and the combo sales that we’re getting out of the Del Taco are about a 50-50 mix, somewhere in that area. So, folks are definitely liking our new number one combo, which is as I mentioned the two Del Tacos crinkle cut fries and a drink and we’re seeing really nice mid-single digit mix on that. And then when you think about the Del Taco and how it’s behaving right now, we’re pretty excited about it. Because we want it to see it used by consumers much like the Buck & Under item would be used, adding onto a transaction or bundling in multiples, due to that great price point at a $1.39 compared to the typical Buck & Under transaction around $1. And it’s nice to see that kind of mix and it’s nice to see that kind of purchase behavior happening. It’s really telling us that that’s kind of a great product at a relatively great price point, a fair value, a little bit higher than Buck & Under. It’s a strong potential model for us as we think to the future. It’s definitely something that we’re looking at and thinking about and how we can apply that to other products down the road. But certainly, Craig, it’s nice to see it on so many transactions as I said. And certainly at that price point, it’s accretive.
And then on the attachments, did that stay kind of the same percentage through the quarter or was there a honeymoon early in the quarter and taper [ph] off?
I’d say 13%, it was a couple of point in time measurements that we did on that and it was right in that ballpark. So, I don’t have the cadence in front of me by period or by week or anything like that, but I’d say that’s around the ballpark that we’re in even today. So, that’s strong performance relative to that kind of product.
And then you’ve got two markets where you have both Platos and the Del Taco?
And is there any observations from those two markets in terms of what we should expect?
As I said on the last call, the results that we’ve been able to deliver throughout the development process, both in research and then in these test markets you referenced are really exciting. So, from a consumer perspective in test, Platos products delivered a great food experience. And we were able to kind of quantify that with consumers; they considered it high quality item; they got the fresh ingredient piece and they really did align it with the dinner occasion which we liked. Additionally, on the top line of the sales front, we saw transaction check-ins in market -- in both of these markets. And as you would expect, the higher price points in the larger party size associated with the occasion, Platos should continue to drive menu mix -- it should be part of our menu mix story as we move forward. But we need to execute it, it’s a new occasion, it’s one that we’re going to have to build our credibility in. And I think we’re set up to do it. As Paul said with the picture perfect Platos program, we put a lot of efforts into that over the previous months in our test markets. And I think we’re well-positioned to build our credibility and really do well with this platform.
And I think one thing I would add is I think people got to know it’s we’re disciplined, we’re data driven and we test things. And as John said, we liked it certainly on the consumer front and on the financial front. As we looked at it, all systems were green and we made a decision to launch it. And to previous question, I think it’s actually complementary to the Del Taco, it is a new occasion for the brand. And I think at that point, there is a level of incrementality that we think definitely could be there. Obviously that to be well executed and we think that we’re set up to do that, and we proved that with our ability to execute the Del Taco and Fresh Combined Solutions.
And it sounded like in your efforts on making sure you executed the roll out of the Del Taco, you had extra [training] cost and other operational costs associated with that. Can you kind of ballpark that and will it be at the same level for Platos?
I’d say most fiscal quarters we have some levels of -- call it above and beyond focus on a particular promo window or product. So, the trending Q3 compared to what’s lying ahead of us, I don’t think there is a dramatic call up there on the labor at all. We’re always getting our aces in their places and doing the right thing to train and execute.
So, nothing bumps because of Platos on the cost side?
Fresh coolers, the percentage of units of fresh coolers by yearend should be?
Yes, I think we said we’ll be right in that mid-200 store range by the end of the year, we continue to do our rollout and we’re continuing to make progress kind of month-to-month, quarter-to-quarter. So, we’ll be right in that range that we had talked about at the beginning of the year.
Okay. And then price rolled off on October 1st, the 1% plus?
Recently, we did lap a meaningful increase a year ago. There will be another minor increase we lapse in a couple of few weeks. So, the net of it is, we’ll carry in the mid-twos this quarter, which is lower than we’ve been carrying in recent quarters.
There are no further questions at this time. I will turn the call back over to management for any closing remarks.
A - Paul Murphy
Thanks everybody, really a great quarter; team did a great job of executing the Fresh Combined Solutions and I think the results certainly are bearing that out. And we look forward to finishing the year strong in fourth quarter. Thank you for your time today.
Ladies and gentlemen, this does conclude our teleconference for today. We thank you for your time and participation. You may disconnect your lines at this time and have a wonderful rest of the day.
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