QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 26, 2019
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-36197
DEL TACO RESTAURANTS, INC.
(Exact name of registrant as specified in its charter)
Delaware
46-3340980
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
25521 Commercentre Drive
Lake Forest, California
92630
(Address of principal executive offices)
(Zip Code)
(949) 462-9300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
Accelerated filer
x
Non-accelerated filer
¨
Smaller reporting company
¨
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of May 3, 2019, there were 36,745,533 shares of the registrant’s common stock issued and outstanding.
Current portion of finance lease obligations, other debt and deemed landlord financing liabilities
481
1,033
Current portion of operating lease liabilities
20,146
—
Total current liabilities
72,542
55,695
Long-term debt, finance lease obligations, other debt and deemed landlord financing liabilities, excluding current portion, net
154,573
178,664
Operating lease liabilities, excluding current portion
217,967
—
Deferred income taxes
70,332
69,471
Other non-current liabilities
15,396
32,852
Total liabilities
530,810
336,682
Commitments and contingencies (Note 15)
Shareholders’ equity:
Preferred stock, $0.0001 par value; 1,000,000 shares authorized; no shares issued and outstanding
—
—
Common stock, $0.0001 par value; 400,000,000 shares authorized; 37,049,140 shares issued and outstanding at March 26, 2019; 37,305,342 shares issued and outstanding at January 1, 2019
4
4
Additional paid-in capital
334,144
336,941
Accumulated other comprehensive income
62
180
Retained earnings
88,486
85,149
Total shareholders’ equity
422,696
422,274
Total liabilities and shareholders’ equity
$
953,506
$
758,956
See accompanying notes to consolidated financial statements.
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
5,907
5,914
Amortization of favorable and unfavorable lease assets and liabilities, net
—
(118
)
Amortization of deferred financing costs, debt discount and interest rate cap
118
95
Amortization of operating lease assets
4,963
—
Stock-based compensation
1,577
1,274
Impairment of long-lived assets
—
—
Deferred income taxes
196
266
Loss on disposal of assets, net
290
93
Restaurant closure charges
118
33
Changes in operating assets and liabilities:
Accounts and other receivables, net
(48
)
1,017
Inventories
259
(27
)
Prepaid expenses and other current assets
2,297
3,568
Other assets
(18
)
(16
)
Accounts payable
(1,317
)
(2,609
)
Operating lease liabilities
(4,695
)
—
Other accrued liabilities
(1,051
)
(973
)
Other non-current liabilities
(118
)
654
Net cash provided by operating activities
9,903
12,400
Investing activities
Purchases of property and equipment
(7,007
)
(9,594
)
Proceeds from disposal of property and equipment, net
10,040
573
Purchases of other assets
(515
)
(474
)
Acquisition of franchisees
(3,120
)
—
Proceeds from sale of company-operated restaurants
2,090
—
Net cash used in investing activities
1,488
(9,495
)
Financing activities
Repurchase of common stock and warrants
(4,306
)
(33
)
Payment of tax withholding related to restricted stock vesting
(84
)
(79
)
Payments on finance leases, other debt and deemed landlord financing
(146
)
(362
)
Proceeds from revolving credit facility
9,000
5,000
Payments on revolving credit facility
(14,000
)
(4,000
)
Proceeds from exercise of stock options
16
48
Net cash used in financing activities
(9,520
)
574
Increase (decrease) in cash and cash equivalents
1,871
3,479
Cash and cash equivalents at beginning of period
7,153
6,559
Cash and cash equivalents at end of period
$
9,024
$
10,038
Supplemental cash flow information:
Cash paid during the period for interest
$
1,134
$
1,377
Cash paid during the period for income taxes
—
—
Supplemental schedule of non-cash activities:
Accrued property and equipment purchases
$
4,342
$
(1,492
)
Write-offs of accounts receivables
—
6
Amortization of interest rate cap into net income, net of tax
21
6
Change in other asset for fair value of interest rate cap recorded to other comprehensive (loss) income, net of tax
(139
)
174
Operating lease right-of-use assets obtained in exchange for lease obligations(1)
240,160
—
Finance lease right-of-use assets obtained in exchange for lease obligations(1)
1,185
—
Impairment on operating lease right-of-use assets related to the adoption of new accounting pronouncement
3,116
—
(1)Amounts for the twelve weeks ended March 26, 2019 include the transition adjustment for the adoption of Topic 842 discussed in Note 2 to the consolidated financial statements.
See accompanying notes to consolidated financial statements
Del Taco Restaurants, Inc. is a Delaware corporation headquartered in Lake Forest, California. The consolidated financial statements include the accounts of Del Taco Restaurants, Inc. and its wholly owned subsidiaries (collectively, the “Company” or “Del Taco”). The Company develops, franchises, owns, and operates Del Taco quick-service Mexican-American restaurants. At March 26, 2019, there were 312 company-operated and 271 franchise-operated Del Taco restaurants located in 14 states, including one franchise-operated unit in Guam. At March 27, 2018, there were 315 company-operated and 251 franchise-operated Del Taco restaurants located in 14 states, including one franchise-operated unit in Guam.
2. Basis of Presentation and Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited consolidated financial statements included herein have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) and the rules and regulations of the Securities and Exchange Commission (“SEC”). For additional information, these unaudited consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended January 1, 2019 ("2018 Form 10-K").
The Company’s fiscal year ends on the Tuesday closest to December 31. Fiscal year 2019 is a fifty-two week period ending December 31, 2019. Fiscal year 2018 is the fifty-two week period ended January 1, 2019. In a fifty-two week fiscal year, the first, second and third quarters each include twelve weeks of operations and the fourth quarter includes sixteen weeks of operations. For fiscal year 2019, the Company’s accompanying financial statements reflect the twelve weeks ended March 26, 2019. For fiscal year 2018, the Company’s accompanying financial statements reflect the twelve weeks ended March 27, 2018.
Effective January 2, 2019 (the first day of fiscal year 2019), the Company adopted the requirements of Accounting Standards Update ("ASU") No. 2016-02, Leases (Topic 842), as discussed below in Note 2, using the modified retrospective method of transition. Current year results have been prepared in accordance with the new standard.
In the opinion of management, the accompanying consolidated financial statements reflect all adjustments which are necessary for a fair presentation of the consolidated financial position, results of operations and cash flows for the periods presented. The results of operations for such interim periods are not necessarily indicative of results of operations to be expected for the full fiscal year.
Principles of Consolidation
The accompanying unaudited consolidated financial statements include the accounts of the Company and its wholly and majority owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Management believes that such estimates have been based on reasonable and supportable assumptions and the resulting estimates are reasonable for use in the preparation of the consolidated financial statements. Actual results could differ from these estimates. The Company’s significant estimates include estimates for impairment of goodwill, intangible assets and property and equipment, valuations provided in business combinations, insurance reserves, restaurant closure reserves, stock-based compensation, contingent liabilities, certain leasing activities and income tax valuation allowances.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
Recently Issued Accounting Standards
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract, which clarifies the accounting implementation costs in cloud computing arrangements. The standard is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted. The Company is currently evaluating the impact of the standard on its consolidated financial statements.
Recently Adopted Accounting Standards
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, and issued additional clarifications and improvements during 2018. This guidance amends and simplifies existing guidance in order to allow companies to more accurately present the economic effects of risk management activities in the financial statements. The standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those years. There was no material impact on the Company's consolidated financial statements and related disclosures as a result of adopting this standard.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), along with related clarifications and improvements. This guidance results in key changes to lease accounting and aims to bring leases onto balance sheets to give investors, lenders, and other financial statement users a more comprehensive view of a company's long-term financial obligations as well as the assets it owns versus leases. The pronouncement requires lessees to recognize a liability for lease obligations, which represents the discounted obligation to make future lease payments, and a corresponding right-of-use asset on the balance sheet. The Company adopted the requirements of the new lease standard effective January 2, 2019, the first day of fiscal year 2019, electing the optional transition method to apply the standard as of the effective date and therefore will not apply the standard to the comparative periods presented in the Company's financial statements. During the process of adoption, the Company made the following elections:
•
The Company elected the package of practical expedients which allowed the Company to not reassess:
•
Whether existing or expired contracts contain leases under the new definition of a lease;
•
Lease classification for existing or expired leases; and
•
Initial direct costs for any expired or existing leases to determine if they would qualify for capitalization under ASC 842.
•
The Company did not elect the hindsight practical expedient, which permits the use of hindsight when determining lease term and impairment of operating lease assets.
•
The Company did not elect the land easement practical expedient, which permits an entity to continue applying its current policy for accounting for land easements that existed as of, or expired before, the effective date of Topic 842.
•
The Company elected to make the accounting policy election for short-term leases, permitting the Company to not apply the recognition requirements of this standard to short-term leases with terms of 12 months or less.
Upon adoption of ASU 2016-02, the Company recorded operating lease right-of-use assets and operating lease liabilities and derecognized all landlord funded assets, deemed landlord financing liabilities, deferred rent liabilities and favorable lease assets and unfavorable lease liabilities upon transition. Upon adoption, the Company recorded operating lease liabilities of approximately $230.6 million based on the present value of the remaining rental payments using discount rates as of the effective date. In addition, the Company recorded corresponding operating lease right-of-use assets of approximately $218.9 million, calculated as the initial amount of the Company's operating lease liabilities adjusted for prepaid and deferred rent, unamortized favorable lease assets and unamortized unfavorable lease liabilities, liabilities associated with lease termination costs and impairment of right-of-use assets recognized in retained earnings as of January 2, 2019. At the beginning of the period of adoption, the Company recorded the cumulative effect of adoption to retained earnings. Beginning in fiscal 2019, leases historically treated as deemed landlord financing liabilities will be treated as operating leases resulting in an increase in occupancy and other expense and a decrease to depreciation expense and interest expense.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
The impact on the consolidated balance sheet was as follows:
January 1, 2019
Effect of Adoption of Topic 842
(Leases)
January 2, 2019
Assets
(Unaudited)
Current assets:
Cash and cash equivalents
$
7,153
$
—
$
7,153
Accounts and other receivables, net
3,167
—
3,167
Inventories
2,932
—
2,932
Prepaid expenses and other current assets
4,935
(2,564
)
2,371
Assets held for sale
14,794
—
14,794
Total current assets
32,981
(2,564
)
30,417
Property and equipment, net
161,429
(13,839
)
147,590
Operating lease right-of-use assets
—
218,855
218,855
Goodwill
321,531
—
321,531
Trademarks
220,300
—
220,300
Intangible assets, net
18,507
(7,576
)
10,931
Other assets, net
4,208
—
4,208
Total assets
$
758,956
$
194,876
$
953,832
Liabilities and shareholders’ equity
Current liabilities:
Accounts payable
$
19,877
$
—
$
19,877
Other accrued liabilities
34,785
(425
)
34,360
Current portion of finance lease obligations and deemed landlord financing liabilities
1,033
(547
)
486
Current portion of operating lease liabilities
—
17,303
17,303
Total current liabilities
55,695
16,331
72,026
Long-term debt, finance lease obligations and deemed landlord financing liabilities, excluding current portion, net
178,664
(19,040
)
159,624
Operating lease liabilities
—
213,313
213,313
Deferred income taxes
69,471
708
70,179
Other non-current liabilities
32,852
(18,348
)
14,504
Total liabilities
336,682
192,964
529,646
Commitments and contingencies (Note 15)
Shareholders’ equity:
Preferred stock, $0.0001 par value; 1,000,000 shares authorized; no shares issued and outstanding
—
—
—
Common stock, $0.0001 par value; 400,000,000 shares authorized; 37,049,140 shares issued and outstanding at March 26, 2019; 37,305,342 shares issued and outstanding at January 1, 2019
Notes to Consolidated Financial Statements (continued)
(Unaudited)
Revenue Recognition
The adoption of Topic 606 in Fiscal 2018 changed the timing of the recognition of initial franchise fees, including franchise and development fees, and renewal fees, both included in franchise revenue in the consolidated statements of comprehensive income. Franchise and renewal fees are deferred and recognized over the term of the related franchise agreement for the respective restaurant. Franchise agreements typically have a term of twenty years.
During the twelve weeks ended March 26, 2019 and March 27, 2018, the Company recognized approximately $21,000 and $13,000, respectively, in franchise revenue related to the amortization of the deferred franchise fees recognized at January 1, 2019.
Deferred franchise fees are recognized straight-line over the term of the underlying agreement and the amount expected to be recognized in franchise revenue for amounts in deferred franchise fees as of March 26, 2019 is as follows (in thousands):
FY 2019
$
88
FY 2020
112
FY 2021
110
FY 2022
109
FY 2023
106
Thereafter
1,229
Total Deferred Franchise Fees
$
1,754
Summary of Significant Accounting Policies
Except for the accounting policies for leases discussed in Note 7 that were updated as a result of adopting Topic 842, there have been no changes to our significant accounting policies described in the Annual Report on Form 10-K for the year ended January 1, 2019, filed with the SEC on March 18, 2019, that have had a material impact on our consolidated financial statements and related notes.
3. Impairment of Long-Lived Assets and Restaurant Closure Charges
Impairment of Long-Lived Assets
The Company evaluates long-lived assets for indicators of impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company considers a triggering event to have occurred related to a specific restaurant if the restaurant’s cash flows are less than a minimum threshold or if consistent levels of undiscounted cash flows for the remaining lease period are less than the carrying value of the restaurant’s assets. In connection with the adoption of Topic 842, the Company evaluated the operating lease right-of-use assets for impairment indicating the carrying amount of the operating lease assets for certain restaurants may not be recoverable and recorded an impairment charge totaling $3.1 million at January 2, 2019 based on the estimates of future recoverable cash flows.
Restaurant Closure Charges, Net
At March 26, 2019 and January 1, 2019, the restaurant closure liability was $0.1 million and $2.4 million, respectively. The details of the restaurant closure activities are discussed below.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
Restaurant Closures and Lease Reserves
At January 1, 2019, the restaurant closure liability balance was $0.3 million related to restaurant closures prior to 2015. During the twelve weeks ended March 26, 2019, in connection with the adoption of Topic 842, the Company reclassified the $0.3 million restaurant closure liability to offset the respective operating lease right-of-use assets.
Restaurant Closure and Other Related Charges for 12 Underperforming Restaurants
During the fourth fiscal quarter of 2015, the Company closed 12 company-operated restaurants. During the twelve weeks ended March 26, 2019, in connection with the adoption of Topic 842, the Company reclassified approximately $1.9 million of the lease related restaurant closure liability to offset the respective operating lease right-of-use assets. A summary of the restaurant closure liability activity for these 12 closed restaurants consisted of the following (in thousands):
Total
Balance at January 1, 2019
$
2,092
Reclassified to operating lease right-of-use assets
(1,900
)
Cash payments
(192
)
Adjustments to estimates based on current activity
118
Balance at March 26, 2019
$
118
The current portion of the restaurant closure liability is $0.1 million at March 26, 2019 and $0.5 million at January 1, 2019, respectively, and is included in other accrued liabilities in the consolidated balance sheets. The non-current portion of the restaurant closure liability is zero and $1.6 million at March 26, 2019 and January 1, 2019, respectively, and is included in other non-current liabilities in the consolidated balance sheets.
Upon adoption of Topic 842, rent expense and non lease executory costs for these previously closed restaurants are now recorded to restaurant closure charges as incurred.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
4. Summary of Refranchising and Franchise Acquisitions
In connection with the sale of company-operated restaurants to franchisees, the Company typically enters into several agreements, in addition to an asset purchase agreement, with franchisees including franchise and lease agreements. The Company typically sells restaurants’ inventory and equipment and retains ownership of the leasehold interest to the real estate to sublease to the franchisee. The Company has determined that its restaurant dispositions usually represent multiple-element arrangements, and as a result, the cash consideration received is allocated to the separate elements based on their relative selling price. Cash consideration generally includes up-front consideration for the sale of the restaurants and franchise fees and future cash consideration for royalties and lease payments. The Company considers the future lease payments in allocating the initial cash consideration received. The Company compares the stated rent under the lease and/or sublease agreements with comparable market rents and the Company records favorable or unfavorable lease assets/liabilities with a corresponding offset to the gain or loss on the sale of the company-operated restaurants. The cash consideration per restaurant for franchise fees is consistent with the amounts stated in the related franchise agreements which are charged for separate standalone arrangements. The Company initially defers and subsequently recognizes the franchise fees over the term of the franchise agreement. Future royalty income is also recognized in revenue as earned.
The Company sold thirteen company-operated restaurants to franchisees in the first quarter of 2019. There was no refranchising activity during the twelve weeks ended March 27, 2018. The following table summarizes the related net loss recognized during the twelve weeks ended March 26, 2019 (dollars in thousands):
12 Weeks Ended
March 26, 2019
Company-operated restaurants sold to franchisees
13
Proceeds from the sale of company-operated restaurants
$
2,090
Net assets sold (primarily furniture, fixtures and equipment) (a)
(2,051
)
Goodwill related to the company-operated restaurants sold to franchisees
(83
)
Allocation to deferred franchise fees
(281
)
Favorable sublease assets, net
260
Loss on sale of company-operated restaurants (b)
$
(65
)
(a) Included in assets held for sale at January 1, 2019.
(b) Included in loss on disposal of assets, net on the consolidated statements of comprehensive income.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
The Company acquired three franchise-operated restaurants during the twelve weeks ended March 26, 2019. The Company accounts for the acquisition of franchise-operated restaurants using the acquisition method of accounting for business combinations. The purchase price allocations were based on fair value estimates determined using significant unobservable inputs (Level 3). The goodwill recorded primarily relates to the market position and future growth potential of the markets acquired and is expected to be deductible for income tax purposes. There were no franchise acquisitions during the twelve weeks ended March 27, 2018. The following table provides detail of the combined acquisitions for the twelve weeks ended March 26, 2019 (dollars in thousands):
March 26, 2019
Franchise-operated restaurants acquired from franchisees
3
Goodwill
$
2,672
Restaurant and other equipment and leasehold improvements
578
Operating lease right-of-use assets
858
Operating lease liabilities
(858
)
Unfavorable lease liabilities
(130
)
Total consideration
$
3,120
The unfavorable lease liability of $0.1 million was recorded as an adjustment to the respective operating lease right-of-use asset.
5. Goodwill and other Intangible Assets
Goodwill was $324.1 million at March 26, 2019 compared to $321.5 million at January 1, 2019. The change is due to the sale of 13 company-operated restaurants and the purchase of three franchise-operated restaurants as described in more detail in Note 4.
There have been no changes in the carrying amount of trademarks since January 1, 2019.
The Company’s other intangible assets at March 26, 2019 and January 1, 2019 consisted of the following (in thousands):
March 26, 2019
January 1, 2019
Gross
Carrying
Amount
Accumulated
Amortization
Net
Gross
Carrying
Amount
Accumulated
Amortization
Net
Favorable lease assets
$
—
$
—
$
—
$
13,118
$
(5,542
)
$
7,576
Favorable sublease assets
1,090
(22
)
1,068
—
—
—
Franchise rights
14,562
(4,609
)
9,953
15,032
(4,411
)
10,621
Reacquired franchise rights
800
(130
)
670
417
(107
)
310
Total amortized other intangible assets
$
16,452
$
(4,761
)
$
11,691
$
28,567
$
(10,060
)
$
18,507
During the twelve weeks ended March 26, 2019, the Company recorded $1.0 million of favorable sublease assets in connection with the sale of company-operated restaurants (see Note 4 for more information). Favorable sublease assets represents favorable subleases with franchisees recorded in connection with the sale of company-operated restaurants to franchisees.
In connection with the adoption of Topic 842, the Company reclassified $7.6 million of favorable lease assets, net to operating lease right-of-use assets (see Note 2 for more information) as of January 2, 2019. During the twelve weeks ended March 26, 2019, the Company reclassified $0.4 million of franchise rights as reacquired franchise rights related to the Company's acquisition of three franchise-operated restaurants and wrote off $11,000 of franchise rights associated with the closure of one franchise-operated restaurant.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
6. Debt, Obligations Under Finance Leases and Deemed Landlord Financing Liabilities
The Company’s long-term debt, finance lease obligations, other debt and deemed landlord financing liabilities at March 26, 2019 and January 1, 2019 consisted of the following (in thousands):
March 26, 2019
January 1, 2019
2015 Senior Credit Facility, net of debt discount of $393 and $459 and deferred financing costs of $132 and $155 at March 26, 2019 and January 1, 2019, respectively
$
153,475
$
158,386
Total outstanding indebtedness
153,475
158,386
Obligations under finance lease, other debt and deemed landlord financing
liabilities
1,579
21,311
Total debt
155,054
179,697
Less: amounts due within one year
481
1,033
Total amounts due after one year, net
$
154,573
$
178,664
At March 26, 2019 and January 1, 2019, the Company assessed the amounts recorded under the 2015 Senior Credit Facility and determined that such amounts approximated fair value.
2015 Revolving Credit Facility
On August 4, 2015, the Company refinanced its existing senior credit facility and entered into a new credit agreement (the “Credit Agreement”). The Credit Agreement, which matures on August 4, 2020, provides for a $250 million revolving credit facility (the “2015 Senior Credit Facility”).
The Credit Agreement contains certain financial covenants, including the maintenance of a consolidated total lease adjusted leverage ratio and a consolidated fixed charge coverage ratio. The Company was in compliance with the financial covenants as of March 26, 2019. Substantially all of the assets of the Company are pledged as collateral under the 2015 Senior Credit Facility.
At March 26, 2019, the weighted-average interest rate on the outstanding balance of the 2015 Senior Credit Facility was 4.2%. At March 26, 2019, the Company had a total of $79.7 million of availability for additional borrowings under the 2015 Senior Credit Facility as the Company had $154.0 million of outstanding borrowings and letters of credit outstanding of $16.3 million which reduce availability under the 2015 Senior Credit Facility.
7. Leases
The Company's material leases consist of restaurant locations and its executive offices with expiration dates through 2039. In general, the leases have remaining terms of 1-20 years, most of which include options to extend the leases for additional five-year periods. The lease term is generally the minimum noncancelable period of the lease. The Company does not include option periods unless the Company determines that it is reasonably certain of exercising the option at inception or when a triggering event occurs.
The Company determines if an arrangement is a lease at inception. The right-of-use assets and lease liabilities are recognized at the lease commencement date. In determining the Company’s right-of-use assets and lease liabilities, the Company applies a discount rate to the lease payments within each lease agreement. As most of the Company’s lease agreements do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. The right-of-use asset also includes any lease payments made and is reduced by lease incentives, initial direct costs incurred and impairment of operating lease right-of-use assets and adjusted by favorable lease assets and unfavorable lease liabilities.
Some of the Company's lease agreements contain rent escalation clauses (including adjustments based on changes in indexes), rent holidays, capital improvement funding or other lease concessions. The Company recognizes rental expense on a straight-line basis based on fixed components of a lease arrangement and the Company amortizes this expense over the term of the lease
Notes to Consolidated Financial Statements (continued)
(Unaudited)
beginning with the date of initial possession. Variable lease components represent amounts that are not fixed in nature and are recognized in expense as incurred.
The Company has subleased certain properties to other third parties where the Company remains primarily liable to the landlord for the performance of all obligations in the event that the sub-lessee does not perform its obligations under the lease. As a result of the sublease arrangements, future rental commitments under operating leases will be offset by sublease amounts to be paid by the sub-lessee. In general, the terms of the sublease are similar to the terms of the master lease.
The components of lease cost were as follows (in thousands):
Twelve Weeks Ended March 26, 2019
Operating lease cost
$
8,799
Finance lease cost:
Amortization of right of use assets
133
Interest on lease liabilities
27
Short-term lease cost
101
Variable lease cost
390
Sublease income
(912
)
Total lease cost
$
8,538
Supplemental balance sheet information related to the Company's operating and finance leases (noting the financial statement caption each is included with) as of March 26, 2019 and January 1, 2019 was as follows (in thousands):
March 26, 2019
January 1, 2019
Operating lease assets:
Operating lease right-of-use assets
$
223,542
$
—
Operating lease liabilities:
Current portion of operating lease liabilities
$
20,146
$
—
Operating lease liabilities, excluding current portion
217,967
—
Total operating lease liabilities
$
238,113
$
—
Finance lease assets:
Buildings under finance leases
$
1,061
$
3,370
Accumulated depreciation
(126
)
(2,193
)
Finance lease asset, net
$
935
$
1,177
Finance lease obligations:
Current portion of finance lease obligations, other debt and deemed landlord financing liabilities
$
428
$
510
Long-term debt, finance lease obligations, other debt and deemed landlord
financing liabilities, excluding current portion, net
Notes to Consolidated Financial Statements (continued)
(Unaudited)
Weighted Average Discount Rate
March 26, 2019
Operating leases
6.97
%
Finance leases
10.48
%
Supplemental cash flow information related to leases was as follows (in thousands):
Twelve Weeks Ended March 26, 2019
Cash paid for amounts in the measurement of lease liabilities:
Operating cash flows used for operating leases
$
5,835
Operating cash flows used for finance leases
$
27
Financing cash flows used for finance leases
$
133
The estimated future lease payments as of March 26, 2019, are as follows (in thousands):
Finance Lease Liabilities
Operating Lease Liabilities
Operating Subleases
Net Lease Commitments
2019
$
422
$
27,407
$
(2,569
)
$
25,260
2020
335
34,854
(3,209
)
31,980
2021
200
33,526
(3,207
)
30,519
2022
86
34,330
(3,189
)
31,227
2023
79
29,491
(3,014
)
26,556
Thereafter
125
194,678
(23,456
)
171,347
Total lease payments
$
1,247
$
354,286
$
(38,644
)
$
316,889
Amounts representing interest
(203
)
(116,173
)
(116,376
)
Present value of lease obligations
$
1,044
$
238,113
$
200,513
Rental commitments and sublease rental receipts as of January 1, 2019, under finance and operating leases having an initial non-cancelable term of one year or more are shown in the following table (in thousands):
Finance Lease and Deemed Landlord Financing Liabilities
Notes to Consolidated Financial Statements (continued)
(Unaudited)
As of March 26, 2019, we have legally binding lease payments related to restaurant leases that have not yet commenced of $22.5 million.
During the twelve weeks ended March 26, 2019, the Company entered into two sale leaseback arrangements with third party private investors. These sale-leaseback transactions do not provide for any continuing involvement by the Company other than normal leases where the Company intends to use the property during the lease term. The leases have been accounted for as operating leases. The net proceeds from the transactions totaled approximately $10.0 million. Under one of the arrangements, the Company sold the land and building related to a restaurant constructed during 2018 and leased it back for a term of 20 years. Under the other arrangement, the Company sold the land related to a restaurant constructed during 2018 and leased it back for a term of 20 years. The sale of these properties resulted in a loss of approximately $0.1 million which is included in loss on disposal of assets, net in the consolidated statements of comprehensive income. The assets sold were included in assets held for sale as of January 1, 2019.
8. Derivative Instruments
2016 Interest Rate Cap Agreement
In June 2016, the Company entered into an interest rate cap agreement that became effective July 1, 2016, to hedge cash flows associated with interest rate fluctuations on variable rate debt, with a termination date of March 31, 2020 ("2016 Interest Rate Cap Agreement"). The 2016 Interest Rate Cap Agreement had an initial notional amount of $70.0 million of the 2015 Senior Credit Facility that effectively converted that portion of the outstanding balance of the 2015 Senior Credit Facility from variable rate debt to capped variable rate debt, resulting in a change in the applicable interest rate from an interest rate of one-month LIBOR plus the applicable margin (as provided by the 2015 Senior Credit Facility) to a capped interest rate of 2.00% plus the applicable margin. As of March 26, 2019, one-month LIBOR was 2.49%. During the twelve weeks ended March 26, 2019, the Company received payments totaling approximately $0.1 million related to the 2016 Interest Rate Cap Agreement. During the period from July 1, 2016 through March 26, 2019, the 2016 Interest Rate Cap Agreement had no hedge ineffectiveness.
To ensure the effectiveness of the 2016 Interest Rate Cap Agreement, the Company elected the one-month LIBOR rate option for its variable rate interest payments on term balances equal to or in excess of the applicable notional amount of the interest rate cap agreement as of each reset date. The reset dates and other critical terms on the term loans perfectly match with the interest rate cap reset dates and other critical terms during the twelve weeks ended March 26, 2019.
During the twelve weeks weeks ended March 26, 2019, the Company reclassified approximately $29,000 of interest expense related to the hedges of these transactions into earnings. As of March 26, 2019, the Company was hedging forecasted transactions expected to occur through March 31, 2020. Assuming interest rates at March 26, 2019 remain constant, $0.2 million of interest expense related to hedges of these transactions is expected to be reclassified into earnings over the next 12 months. The Company intends to ensure that this hedge remains effective, therefore, approximately $0.2 million is expected to be reclassified into interest expense over the next 12 months.
The effective portion of the 2016 Interest Rate Cap Agreement through March 26, 2019 was included in accumulated other comprehensive income.
9. Fair Value Measurements
The fair values of cash and cash equivalents, accounts receivable, accounts payable and other accrued liabilities approximate their carrying amounts due to their short maturities. The carrying value of the 2015 Senior Credit Facility approximated fair value. The 2016 Interest Rate Cap Agreement is recorded at fair value in the Company’s consolidated balance sheets.
As of March 26, 2019 and January 1, 2019, the Company held certain assets and liabilities that are required to be measured at fair value on a recurring basis. For both periods, this included a derivative instrument related to interest rates. The Company determined the fair value of the interest rate cap contract based on counterparty quotes, with appropriate adjustments for any significant impact of nonperformance risk of the parties to the interest rate cap contract. Therefore, the Company categorized
Notes to Consolidated Financial Statements (continued)
(Unaudited)
this interest rate cap contract as Level 2 fair value measurements. The fair value of the 2016 Interest Rate Cap Agreement was $0.3 million and $0.5 million at March 26, 2019 and January 1, 2019, respectively, and is included in other assets in the consolidated balance sheets.
The Company's assets and liabilities measured at fair value on a recurring basis as of March 26, 2019 and January 1, 2019 were as follows (in thousands):
March 26, 2019 (Unaudited)
Markets for Identical Assets
(Level 1)
Observable Inputs (Level 2)
Unobservable Inputs (Level 3)
2016 Interest Rate Cap Agreement
$
308
$
—
$
308
$
—
Total assets measured at fair value
$
308
$
—
$
308
$
—
January 1, 2019
Markets for Identical Assets (Level 1)
Observable Inputs (Level 2)
Unobservable Inputs (Level 3)
2016 Interest Rate Cap Agreement
$
499
$
—
$
499
$
—
Total assets measured at fair value
$
499
$
—
$
499
$
—
10. Other Accrued Liabilities and Other Non-current Liabilities
A summary of other accrued liabilities follows (in thousands):
March 26, 2019
January 1, 2019
Employee compensation and related items
$
9,831
$
12,888
Accrued insurance
5,650
5,664
Accrued sales tax
3,733
3,952
Accrued property and equipment purchases
2,537
3,196
Accrued real property tax
2,324
1,420
Accrued advertising
2,184
1,578
Other
6,642
6,087
$
32,901
$
34,785
At January 2, 2019, the first day of Fiscal 2019, the Company reclassified $0.4 million of current restaurant closure liabilities to operating lease right-of-use assets in connection with the adoption of Topic 842 (see Note 2 for more information).
A summary of other non-current liabilities follows (in thousands):
At January 2, 2019, the first day of Fiscal 2019, the Company reclassified $12.0 million of unfavorable lease liabilities, $4.6 million of deferred rent liabilities and $1.8 million of restaurant closure liabilities to the respective operating lease right-of-use assets in connection with the adoption of Topic 842 (see Note 2 for more information).
11. Stock-Based Compensation
In connection with the approval of the Business Combination, the Del Taco Restaurants, Inc. 2015 Omnibus Incentive Plan (the “2015 Plan”) was approved by shareholders to offer eligible employees, directors and consultants cash and stock-based incentive awards. Awards under the 2015 Plan are generally not restricted to any specific form or structure and could include, without limitation, stock options, stock appreciation rights, restricted stock, restricted stock units, other stock-based awards, other cash-based compensation and performance awards. Under the plan, there were 3,300,000 shares of common stock reserved and authorized. At March 26, 2019, there were 842,054 shares of common stock available for grant under the 2015 Plan.
Stock-Based Compensation Expense
The total compensation expense related to the 2015 Plan was $1.6 million and $1.3 million for the twelve weeks ended March 26, 2019 and March 27, 2018, respectively.
Restricted Stock Awards
A summary of outstanding and unvested restricted stock activity as of March 26, 2019 and changes during the period from January 1, 2019 through March 26, 2019 are as follows:
Shares
Weighted-Average
Grant Date
Fair Value
Nonvested at January 1, 2019
1,234,531
$
12.87
Granted
62,500
10.44
Vested
(21,250
)
12.27
Nonvested at March 26, 2019
1,275,781
$
12.76
For both the twelve weeks ended March 26, 2019 and March 27, 2018, the Company made payments of $0.1 million related to tax withholding obligations for the vesting of restricted stock awards in exchange for 13,172 and 9,892 shares withheld, respectively. As of March 26, 2019, there was $9.1 million of unrecognized stock compensation expense, net of estimated forfeitures, related to restricted stock awards that is expected to be recognized over a weighted-average remaining period of 2.3 years. The fair value of these awards was determined based on the Company’s stock price on the grant date.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
Stock Options
A summary of stock option activity as of March 26, 2019 and changes during the period from January 1, 2019 through March 26, 2019 are as follows:
Options
Weighted Average Exercise Price
Weighted Average Remaining Contractual Term
Aggregate Intrinsic Value
(in years)
(in thousands)
Options outstanding at January 1, 2019
453,250
$
11.74
5.0
$
77
Granted
5,000
10.43
Exercised
(1,500
)
10.40
Forfeited/Expired
(500
)
10.40
Options outstanding at March 26, 2019
456,250
$
11.73
4.8
$
86
Options exercisable at March 26, 2019
187,746
$
10.59
4.0
$
43
Options exercisable and expected to vest at March 26, 2019
414,532
$
11.59
4.7
$
81
The aggregate intrinsic value in the table above is the amount by which the current market price of the Company's stock exceeds the exercise price on January 1, 2019 and March 26, 2019, respectively.
As of March 26, 2019, there was $0.7 million of unrecognized stock compensation expense, net of estimated forfeitures, related to stock option grants which is expected to be recognized over a weighted-average remaining period of 2.2 years.
12. Shareholders’ Equity
On February 26, 2016, the Company's Board of Directors authorized a share repurchase program covering up to $25.0 million in the aggregate of the Company's common stock and warrants which was effective immediately and expires upon completion of the repurchase program, unless terminated earlier by the Board of Directors. On August 23, 2016, the Company announced that the Board of Directors increased the repurchase program by $25.0 million, to $50.0 million. The Board of Directors authorized an additional increase for the repurchase program effective July 23, 2018 of another $25.0 million, to a total of $75.0 million. Purchases under the program may be made in open market or privately negotiated transactions. During the twelve weeks ended March 26, 2019, the Company repurchased (1) 270,874 shares of common stock for an average price per share of $10.30 for an aggregate cost of approximately $2.8 million, including incremental direct costs to acquire the shares, and (2) 840,255 warrants for an average price per warrant of $1.78 for an aggregate cost of approximately $1.5 million, including incremental direct costs to acquire the warrants. The Company expects to retire the repurchased shares and therefore has accounted for them as constructively retired as of March 26, 2019. As of March 26, 2019, there was approximately $25.4 million remaining under the share repurchase program. The Company has no obligations to repurchase shares or warrants under this authorization, and the timing and value of shares and warrants purchased will depend on the Company's stock price, warrant price, market conditions and other factors.
13. Earnings Per Share
Basic income per share is calculated by dividing net income attributable to Del Taco’s common shareholders for the period by the weighted average number of common shares outstanding for the period. In computing diluted income per share, basic income per share is adjusted for the assumed issuance of all applicable potentially dilutive share-based awards, including warrants, restricted stock, common stock options and restricted stock units.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
Below are basic and diluted net income per share for the periods indicated (amounts in thousands except share and per share data):
12 Weeks Ended
March 26, 2019
March 27, 2018
Numerator:
Net income
$
1,425
$
3,229
Denominator:
Weighted-average shares outstanding - basic
37,155,978
38,441,707
Dilutive effect of unvested restricted stock
188,934
306,583
Dilutive effect of stock options
1,407
21,454
Dilutive effect of warrants
—
454,326
Weighted-average shares outstanding - diluted
37,346,319
39,224,070
Net income per share - basic
$
0.04
$
0.08
Net income per share - diluted
$
0.04
$
0.08
Antidilutive stock options, unvested restricted stock awards and warrants excluded from the computations
6,546,264
128,048
14. Income Taxes
The effective income tax rates were 28.0% and 27.1% for the twelve weeks ended March 26, 2019 and March 27, 2018, respectively. The provision for income taxes was $0.6 million and $1.2 million for the twelve weeks ended March 26, 2019 and March 27, 2018, respectively.
The income tax expense for the twelve weeks ended March 26, 2019 is driven by the estimated effective income tax rate of 28.0% which primarily consists of statutory federal and state tax rates based on apportioned income and the impact of non-tax deductible compensation to executives, partially offset by federal targeted job credits. The income tax expense for the twelve weeks ended March 27, 2018 is driven by the estimated effective income tax rate of 27.1% which primarily consists of statutory federal and state tax rates based on apportioned income and the impact of non-tax deductible compensation to executives, partially offset by federal targeted job credits.
Management believes it is more likely than not that all deferred tax assets will be realized and therefore no valuation allowance as of March 26, 2019 and January 1, 2019 is required.
15. Commitments and Contingencies
The primary claims in the Company’s business are workers’ compensation and general liabilities. These insurance programs are self-insured or high deductible programs with excess coverage that management believes is sufficient to adequately protect the Company. In the opinion of management, adequate provision has been made for all incurred claims up to the self-insured or high deductible limits, including provision for estimated claims incurred but not reported. Because of the uncertainty of the ultimate resolution of outstanding claims, as well as the uncertainty regarding claims incurred but not reported, it is possible that management’s provision for these losses could change materially. However, no estimate can currently be made of the range of additional losses.
Notes to Consolidated Financial Statements (continued)
(Unaudited)
Purchasing Commitments
The Company enters into various purchase obligations in the ordinary course of business, generally of short term nature. Those that are binding primarily relate to commitments for food purchases and supplies, amounts owed under contractor and subcontractor agreements, orders submitted for equipment for restaurants under construction, information technology service agreements and marketing initiatives, some of which are related to both company-operated and franchise-operated locations. The Company also has a long-term beverage supply agreement with a major beverage vendor whereby marketing rebates are provided to the Company and its franchisees based upon the volumes of purchases for system-wide restaurants which vary according to demand for beverage syrup. This contract has terms extending into 2021. The Company’s future estimated cash payments under existing contractual purchase obligations for goods and services as of March 26, 2019, are approximately $55.1 million. The Company has excluded agreements that are cancelable without penalty.
Litigation
In March 2014, a former Del Taco employee filed a purported class action complaint alleging that Del Taco has not appropriately provided meal breaks and failed to pay wages to its California hourly employees. Discovery is in process and Del Taco intends to assert all of its defenses to this threatened class action and the individual claims. Del Taco has several defenses to the action that it believes could prevent the certification of the class, as well as the potential assessment of any damages on a class basis. Legal proceedings are inherently unpredictable, and the Company is not able to predict the ultimate outcome or cost of the unresolved matter. However, based on management’s current understanding of the relevant facts and circumstances, the Company does not believe that these proceedings give rise to a probable or estimable loss and should not have a material adverse effect on the Company’s financial position, operations or cash flows. Therefore, Del Taco has not recorded any amount for the claim as of March 26, 2019.
In September 2018, the Equal Employment Opportunity Commission (“EEOC”) filed a complaint on behalf of an individual complainant and an additional class of individuals alleging that Del Taco engaged in unlawful employment practices on the basis of sex and retaliation in violation of Title VII and are seeking an unspecified amount of damages. Del Taco has several defenses to the action that it believes could prevent a finding of liability in the case. Legal proceedings are inherently unpredictable, and Del Taco is not able to predict the ultimate outcome or cost of the unresolved matter. However, based on management’s current understanding of the relevant facts and circumstances, Del Taco does not believe that these proceedings give rise to a probable or estimable loss and should not have a material adverse effect on Del Taco’s financial position, operations or cash flows. Therefore, Del Taco has not recorded any amount for the claim as of March 26, 2019.
The Company and its subsidiaries are parties to other legal proceedings incidental to their businesses, including claims alleging the Company’s restaurants do not comply with the Americans with Disabilities Act of 1990. In the opinion of management, based upon information currently available, the ultimate liability with respect to those other actions will not have a material effect on the operating results, cash flows or the financial position of the Company. However, due to the risks and uncertainties inherent in legal proceedings and litigation, actual results could differ from expectations.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Company's audited consolidated financial statements for the fiscal year ended January 1, 2019, and related notes thereto, along with the related Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 18, 2019.
In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks and uncertainties such as the number of restaurants we intend to open and estimates of our effective tax rates. We use words such as “estimates,” “projected,” “expects,” “anticipates,” “forecasts,” “plans,” “intends,” “believes,” “seeks,” “may,” “will,” “should,” “future,” “propose,” “preliminary,” “guidance” and variations of these words or similar expressions (or the negative versions of such words or expressions) to identify forward-looking statements. These statements are based on assumptions and information available to us as of the date any such statements are made and are subject to risks and uncertainties. These risks and uncertainties include, without limitation, consumer demand, our inability to successfully open company-operated or franchise-operated restaurants or establish new markets, competition in our markets, our inability to grow and manage growth profitably, adverse changes in food and supply costs, our inability to access additional capital, changes in applicable laws or regulations, food safety and foodborne illness concerns, our inability to manage existing and to obtain additional franchisees, our inability to attract and retain qualified personnel, our inability to profitably expand into new markets, and the possibility that we may be adversely affected by other economic, business, and/or competitive factors. Our actual results may differ materially from those anticipated in these forward-looking statements due to these risks and uncertainties, as well as others, including, without limitation, those discussed in Item 1A. Risk Factors in our Annual Report on Form 10-K for our fiscal year ended January 1, 2019. We assume no obligation to update or revise these forward-looking statements as a result of new information, future events or any other reason.
Fiscal Year
We operate on a 52- or 53-week fiscal year ending on the Tuesday closest to December 31 for financial reporting purposes. Fiscal year 2018 is the 52-week period ended January 1, 2019 ("Fiscal 2018"). Fiscal year 2019 will be a 52-week period ended December 31, 2019 ("Fiscal 2019").
Overview
We are a nationwide operator and franchisor of restaurants featuring fresh and fast cuisine, including both Mexican inspired and American classic dishes. As of March 26, 2019, we have 583 Del Taco restaurants, a majority of these in the Pacific Southwest. In each of our restaurants, our food is made to order in working kitchens. We serve our customers fresh and high-quality food typical of fast casual restaurants but with the speed, convenience and value associated with traditional quick service restaurants (“QSRs”). With attributes of both a fast casual restaurant and a QSR — a combination we call QSR+ — we occupy a place in the restaurant market distinct from our competitors. With a menu designed to appeal to a wide variety of budgets and tastes and recently updated interior and exterior designs across most of our entire system, we believe that we are poised for growth, operating within the fastest growing segment of the restaurant industry, the limited service restaurant (“LSR”) segment. With an average system check of $7.72 during Fiscal 2018, we offer a compelling value proposition relative to both QSR and fast casual peers.
Our first quarter 2019 results and highlights include the following:
•
Total revenues increased 1.5% for the twelve weeks ended March 26, 2019 to $114.2 million compared to $112.6 million for the twelve weeks ended March 27, 2018 primarily due to growth in franchise-operated same store sales and additional company-operated and franchise-operated restaurants open during 2019 compared to 2018, partially offset by slightly negative company-operated same store sales.
•
During the twelve weeks ended March 26, 2019, we opened four new franchise-operated restaurants, purchased three franchise-operated restaurants, sold 13 company-operated restaurants to franchisees and closed one franchise-operated restaurant. During the twelve weeks ended March 27, 2018, we opened three new company-operated restaurants and closed one franchised-operated restaurant.
Same Store Sales
Same store sales growth reflects the change in year-over-year sales for the same store base. We include a restaurant in the same store base in the accounting period following its 18th full month of operations and exclude restaurant closures. The following table shows the same store sales growth for the twelve weeks ended March 26, 2019 and March 27, 2018:
12 Weeks Ended
March 26, 2019
March 27, 2018
Company-operated same store sales
(0.6
)%
2.6
%
Franchise-operated same store sales
0.4
%
5.2
%
System-wide same store sales
(0.1
)%
3.7
%
The decrease in company-operated same store sales in the twelve weeks ended March 26, 2019 was comprised of an increase in average check size of 4.9% offset by a decrease in traffic of 5.5% compared to the twelve weeks ended March 27, 2018. The increase in company-operated same store sales in the twelve weeks ended March 27, 2018 was driven by an increase in average check size of 2.6% compared to the twelve weeks ended March 28, 2017.
Del Taco restaurant counts at the end of the twelve weeks ended March 26, 2019 and March 27, 2018, are as follows:
12 Weeks Ended
March 26, 2019
March 27, 2018
Company-operated restaurant activity:
Beginning of period
322
312
Openings
—
3
Closures
—
—
Purchased from franchisees
3
—
Sold to franchisees
(13
)
—
Restaurants at end of period
312
315
Franchise-operated restaurant activity:
Beginning of period
258
252
Openings
4
—
Closures
(1
)
(1
)
Purchased from Company
13
—
Sold to Company
(3
)
—
Restaurants at end of period
271
251
Total restaurant activity:
Beginning of period
580
564
Openings
4
3
Closures
(1
)
(1
)
Restaurants at end of period
583
566
Since 2012, we have focused on repositioning our brand, increasing brand awareness, re-imaging our restaurants, strengthening operational capabilities and refinancing indebtedness to build a foundation for future organic and new unit growth. New restaurant development is expected to contribute to our growth strategy. We currently plan to open at least 25 system-wide restaurants in Fiscal 2019. From time to time, we and our franchisees may close restaurants.
Key Performance Indicators
In assessing the performance of our business, management utilizes a variety of financial and performance measures.
These key measures include company restaurant sales, same store sales, company-operated average unit volumes, restaurant contribution and restaurant contribution margin, number of new restaurant openings, EBITDA and Adjusted EBITDA.
Company Restaurant Sales
Company restaurant sales consists of sales of food and beverages in company-operated restaurants net of promotional allowances, employee meals and other discounts. Company restaurant sales in any period is directly influenced by the number of operating weeks in such period, the number of open restaurants, same store sales and per restaurant sales.
Seasonal factors and the timing of holidays cause revenue to fluctuate from quarter to quarter. Revenue per restaurant is typically lower in the first quarter due to reduced January traffic. As a result of seasonality, quarterly and annual results of operations and key performance indicators such as company restaurant sales and same store sales may fluctuate.
We regularly monitor company, franchise and total system same store sales. Same store sales growth reflects the change in year-over-year sales for the comparable company, franchise and total system restaurant base. We include a restaurant in the same store base in the accounting period following its 18th full month of operations and exclude restaurant closures. As of March 26, 2019 and March 27, 2018, there were 285 and 292 restaurants, respectively, in the comparable company-operated restaurant base. As of March 26, 2019 and March 27, 2018, there were 254 and 241 restaurants, respectively in the comparable franchise-operated restaurant base. This measure highlights the performance of existing restaurants as the impact of new restaurant openings is excluded. Same store sales growth can be generated by an increase in the number of transactions and/or by increases in the average check resulting from a shift in menu mix and/or higher prices resulting from new products, promotions or price increases.
Company-Operated Average Unit Volumes
We measure company-operated average unit volumes (AUVs) on both a weekly and an annual basis. Weekly AUVs are calculated by dividing the sales from comparable company-operated restaurants over a seven day period from Wednesday to Tuesday by the number of comparable restaurants. Annual AUVs are calculated by dividing sales for the trailing 52-week period for all company-operated restaurants that are in the comparable base by the total number of restaurants in the comparable base for such period. This measurement allows management to assess changes in consumer traffic and spending patterns at our company-operated restaurants and the overall performance of the restaurant base.
Restaurant Contribution and Restaurant Contribution Margin
Restaurant contribution and restaurant contribution margin are neither required by, nor presented in accordance with U.S. GAAP. Restaurant contribution is defined as company restaurant sales less restaurant operating expenses, which are food and paper costs, labor and related expenses and occupancy and other operating expenses. Restaurant contribution margin is defined as restaurant contribution as a percentage of company restaurant sales. Restaurant contribution and restaurant contribution margin are supplemental measures of operating performance of restaurants and the calculations thereof may not be comparable to those reported by other companies. Restaurant contribution and restaurant contribution margin have limitations as analytical tools, and you should not consider them in isolation or as substitutes for analysis of results as reported under U.S. GAAP. Management believes that restaurant contribution and restaurant contribution margin are important tools for investors because they are widely-used metrics within the restaurant industry to evaluate restaurant-level productivity, efficiency and performance. Management uses restaurant contribution and restaurant contribution margin as key performance indicators to evaluate the profitability of incremental sales at Del Taco restaurants, to evaluate restaurant performance across periods and to evaluate restaurant financial performance compared with competitors. See the heading entitled "Management's Use of Non-GAAP Financial Measures" for the reconciliation of restaurant contribution to company restaurant sales.
Number of New Restaurant Openings
The number of restaurant openings reflects the number of new restaurants opened by us and our franchisees during a particular reporting period. Before a new restaurant opens, we and our franchisees incur pre-opening costs, as described below. Some new restaurants open with an initial start-up period of higher than normal sales volumes, which subsequently decrease to stabilized levels. Typically new restaurants experience normal inefficiencies in the form of higher food and paper, labor and other direct operating expenses and, as a result, restaurant contribution margins are generally lower during the start-up period of operation. Typically, the average start-up period after which new company restaurant sales and restaurant operating expenses normalize is approximately 26 to 52 weeks. In new markets, the length of time before average company restaurant sales and restaurant operating expenses for new restaurants stabilize is less predictable and can be longer as a result of limited knowledge of these markets and consumers’ limited awareness of our brand. When we enter new markets, we may be exposed to start-up times that are longer and restaurant contribution margins that are lower than typical historical experience, and these new restaurants may not be profitable and their sales performance may not follow historical patterns.
EBITDA and Adjusted EBITDA
EBITDA represents net income before interest expense, provision for income taxes, depreciation and amortization. Adjusted EBITDA represents net income before interest expense, provision for income taxes, depreciation, amortization and items that we do not consider representative of ongoing operating performance, as identified in the reconciliation table under the heading entitled "Management's Use of Non-GAAP Financial Measures."
EBITDA and Adjusted EBITDA as presented in this quarterly report are supplemental measures of performance that are neither required by, nor presented in accordance with U.S. GAAP. EBITDA and Adjusted EBITDA are not measurements of financial performance under U.S. GAAP and should not be considered as alternatives to net income (loss), income from operations or any other performance measures derived in accordance with U.S. GAAP or as alternatives to cash flow from operating activities as a measure of liquidity. In addition, in evaluating EBITDA and Adjusted EBITDA, you should be aware that in the future we may incur expenses or charges such as those added back to calculate EBITDA and Adjusted EBITDA. Our presentation of EBITDA and Adjusted EBITDA should not be construed as an inference that future results will be unaffected by unusual or nonrecurring items.
EBITDA and Adjusted EBITDA have limitations as analytical tools, and you should not consider them in isolation, or as substitutes for analysis of results as reported under U.S. GAAP. Some of these limitations include but are not limited to:
(i)
they do not reflect cash expenditures, or future requirements for capital expenditures or contractual commitments;
(ii)
they do not reflect changes in, or cash requirements for, working capital needs;
(iii)
they do not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on debt;
(iv)
although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements;
(v)
they do not adjust for all non-cash income or expense items that are reflected in the statements of cash flows;
(vi)
they do not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of ongoing operations; and
(vii)
other companies in the industry may calculate these measures differently than we do, limiting their usefulness as comparative measures.
We compensate for these limitations by providing specific information regarding the U.S. GAAP amounts excluded from such non-GAAP financial measures. We further compensate for the limitations in the use of non-GAAP financial measures by presenting comparable U.S. GAAP measures more prominently.
We believe EBITDA and Adjusted EBITDA facilitate operating performance comparisons from period to period by isolating the effects of some items that vary from period to period without any correlation to core operating performance or that vary widely among similar companies. These potential differences may be caused by variations in capital structures (affecting interest expense), tax positions (such as the impact on periods or changes in effective tax rates or net operating losses) and the age and book depreciation of facilities and equipment (affecting relative depreciation expense). We also present EBITDA and Adjusted EBITDA because (i) we believe these measures are frequently used by securities analysts, investors and other interested parties to evaluate companies in their industry, (ii) we believe investors will find these measures useful in assessing our ability to service or incur indebtedness, and (iii) we use EBITDA and Adjusted EBITDA internally as benchmarks to compare performance to that of competitors. See the heading entitled "Management's Use of Non-GAAP Financial Measures" for the reconciliation of EBITDA and Adjusted EBITDA to net income.
Key Financial Definitions
Company Restaurant Sales
Company restaurant sales represents sale of food and beverages in company-operated restaurants, net of promotional allowances, employee meals and other discounts. Company restaurant sales in any period is directly influenced by the number of operating weeks in such period, the number of open restaurants, same store sales performance and per restaurant sales.
Franchise Revenue
Franchise revenue consists of franchise royalty income from the franchisee and, to a lesser extent, renewal fees and franchise fees from franchise owners for new franchise restaurant openings, as well as other franchise fees. Franchise fees are collected upon signing a franchise agreement and deferred and recognized as revenue over the term of the franchise agreement and renewal fees are deferred and recognized over the term of the renewal agreement.
Franchise advertising contributions consist of a percentage of franchise restaurant's net sales, typically 4%, paid to the Company for advertising and promotional services that the Company provides.
Franchise Sublease and Other Income
Franchise sublease and other income consists of rental income received from franchisees or other third parties in the case of previously closed restaurants, in both cases related to properties where we have subleased a leasehold interest to the franchisee or third party but remain primarily liable to the landlord, as well as other franchise income related to information technology hardware such as point of sale equipment, tablets, kitchen display systems, servers, scanners and printers that we occasionally purchase from third party vendors and then sell to franchisees. Since we are considered the principal related to the purchase and sale of the hardware to the franchisee and have no remaining performance obligations, the franchisee reimbursement is recognized as Franchise Sublease and Other Income upon transfer of the hardware. The related expenses are recognized in Occupancy and Other - Franchise Subleases and Other.
Food and Paper Costs
Food and paper costs include the direct costs associated with food, beverage and packaging of menu items. The components of food and paper costs are variable in nature, change with sales volume and are impacted by menu mix and are subject to increases or decreases based on fluctuations in commodity costs. Other important factors causing fluctuations in food and paper costs include seasonality, promotional activity and restaurant level management of food and paper waste. Food and paper are a significant expense and can be expected to grow proportionally as company restaurant sales grow.
Labor and Related Expenses
Labor and related expenses include all restaurant-level management and hourly labor costs, including wages, benefits, bonuses, workers’ compensation expense, group health insurance, paid leave and payroll taxes. Like other expense items, we expect labor and related expenses to grow proportionately as company restaurant sales grows. Factors that influence fluctuations in labor and related expenses include minimum wage, paid sick leave and payroll tax legislation, health care and workers compensation costs and the performance of Del Taco restaurants.
Occupancy and Other Operating Expenses
Occupancy and other operating expenses include all other restaurant-level operating expenses, such as rent, utilities, restaurant supplies, repairs and maintenance, credit and debit card processing fees, advertising, insurance, common area maintenance, real estate taxes and other restaurant operating costs.
General and Administrative Expenses
General and administrative expenses are comprised of expenses associated with corporate and regional supervision functions that support the operations of existing restaurants and development of new restaurants, including compensation and benefits, travel expenses, stock-based compensation expenses, legal and professional fees, information systems, corporate office occupancy costs and other related corporate costs. Also included are expenses above the restaurant level, including salaries for field management, such as area and regional managers, and franchise operational support.
Franchise Advertising Expenses
Franchise advertising expenses consist of the franchise portion of advertising expense.
Depreciation and Amortization
Depreciation and amortization expenses are periodic non-cash charges that consist of depreciation of fixed assets, including leasehold improvements and equipment, and amortization of various intangible assets primarily including franchise rights.
Occupancy and Other – Franchise Subleases and Other
Occupancy and other – franchise subleases and other includes rent, property taxes and common area maintenance paid on properties subleased to franchisees where we remain primarily liable to the landlord, as well as other franchise expenses related to information technology hardware that we occasionally purchase from third party vendors and then sell to franchisees and recognize in Franchise Sublease and Other Income.
Pre-opening costs are incurred in connection with opening of new restaurants and incurred prior to opening, including restaurant labor related to the hiring and training of restaurant employees, as well as supplies, occupancy and other operating expenses associated with the opening of new restaurants. Pre-opening costs are expensed as incurred.
Restaurant Closure Charges, Net
During 2018, restaurant closure charges, net, consists primarily of (1) future obligations associated with the closure or net sublease shortfall of a restaurant, including the present value of future non-lease obligations net of estimated sublease income, if any; (2) accretion of the liability during the reporting period; (3) any positive or negative adjustments to the liability as more information becomes available; and (4) direct costs related to restaurant closures including lease termination costs. During 2019, restaurant closure charges, net, consist primarily of (1) rent expense related to previously closed restaurants; (2) non-lease executory costs for closed restaurants, including any positive or negative adjustments to these amounts as more information becomes available; and (3) direct costs related to restaurant closures.
Loss on Disposal of Assets, Net
Loss on disposal of assets, net includes the loss on disposal of assets related to sales, retirements and replacement or write-off of leasehold improvements, furniture, fixtures or equipment in the ordinary course of business, net of amortization of deferred gains on asset sales associated with sale-leaseback transactions and gains or losses recorded associated with the sale of company-operated restaurants to franchisees.
Interest Expense
Interest expense consists primarily of interest expense on outstanding debt including finance lease obligations, other debt, capital lease obligations and deemed landlord financing liabilities. Deferred financing costs and debt discount are amortized at cost over the life of the related debt.
Other Income
Other income consists of a gain related to insurance proceeds related to a fire at one company-operated restaurant.
Provision for Income Taxes
Provision for income taxes consists of federal and state current and deferred income tax expense.
Comparison of Results of Operations for the Twelve Weeks Ended March 26, 2019 and Twelve Weeks Ended March 27, 2018
The following table presents operating results for the twelve weeks ended March 26, 2019 and twelve weeks ended March 27, 2018, in absolute terms and expressed as a percentage of total revenue (or company restaurant sales), as compared below: