Berto Acquisition Corp (TACO) 2017 Q3 法說會逐字稿

Good afternoon. Thank you for standing by, and welcome to the Fiscal Third Quarter 2017 Conference Call and Webcast for Del Taco Restaurants, Inc.

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 John Cappasola, President and Chief Executive Officer; and Steve Brake, Executive Vice President and Chief Financial Officer. After John and Steve deliver their prepared remarks, we will open the lines for your questions.

Before we begin, I'd like to remind everyone that part of our discussion today will include some forward-looking statements. These statements are not guarantees of future performance, and therefore, undue reliance should not be placed upon them. We do not undertake to update these forward-looking statements at a later date and refer you to today's earnings press release and the SEC filings filed by Del Taco Restaurants, Inc. for more detailed discussion of the risks that could impact future operating results and financial conditions.

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 would now like to turn the call over to John Cappasola, Chief Executive Officer.

Thanks, Raphael. Good afternoon, everyone, and thank you for joining the call today. Let me begin by complimenting our team members and thanking our guests for enabling us to extend our track record of positive company same-store sales to 21 consecutive quarters and positive system same-store sales to 16 consecutive quarters. We believe this track record places us within very select company in the limited service restaurant segment and is directly attributable to the following factors: we've enhanced brand perceptions through dramatic improvements to the guest experience; we've made great strides establishing our unique value-oriented QSR+ position with great-tasting fresh food, combined with compelling value and speed; and lastly, we continue to innovate, launching new products and platforms that resonate with our guests. This, in turn, has enabled us to consistently grow check average beyond menu price and often with positive transactions as well. So our guest experience focus, QSR+ brand position and menu innovation provide us solid foundation for long-term success, and we'll continue to be at the forefront of our plans. We will be further fortifying our foundation through our focus on enhancing our approach to developing our people and our leadership and providing more efficient tools to maximize performance in our restaurants. We launch those efforts by providing targeted training and a new business intelligence tool to our general managers, above store leaders and franchise partners at our recent national leadership conference.

Last quarter, I talked about key leadership changes and our dynamic executive team, who is leading the charge in building our brand, both in terms of AUV and units, and also ensuring that we execute at the highest level. However, I was not able to mention Barry Westrum by name, who formally joined us as Chief Marketing Officer in August. Barry brings more than 25 years of marketing experience to Del Taco with nationally recognized brands, including Taco Bell, KFC USA, Long John Silver's, A&W Restaurants and most recently, Dairy Queen. Barry is an established brand leader who has deep experience in strengthening brands, enhancing marketing and innovation and creating strong partnerships with operators and franchisees to build sales and profits. Barry has hit the ground running, and I'm excited about the future under his brand and marketing leadership.

As you know, our mid-term goals are to reach $1.5 million AUV by next year and to achieve mid-single-digit new system restaurant growth during 2017 and 2018. These objectives are well within reach and are only the beginning of what we expect to accomplish over time. In order to truly unlock all of our potential, we will continue to evolve our strategy to achieve our next phase of AUV and system unit growth. The leadership team is actively engaged in strategic planning, and we look forward to sharing our plans to further elevate performance on future calls.

Now let's take a look at Q3 highlights. System-wide comparable restaurant sales grew 4.1%. Company operated comparable restaurant sales grew 3.7%, which included menu mix of approximately 1.5%. Note that system, company and franchise same-store sales all grew 10.8% on a 2-year stacked basis. Restaurant contribution margin of 19.2%, and by extension, adjusted EBITDA of $16.6 million were both a little short of what we had expected due to higher food costs, particularly avocados, and higher cost trends within our operating expenses. However, as you will hear, we still expect to deliver on our annual guidance across revenues, diluted earnings per share, adjusted EBITDA and new system-wide restaurant openings.

From a development standpoint, we opened a total of 4 restaurants during the quarter, 2 company and 2 franchised restaurants. So far in Q4, we have opened another 3 company restaurants and have 11 additional restaurants under construction, comprised of 2 franchise and 9 company operated locations. We expect to open 23 to 24 system units this year with up to 15 being company restaurants. This expected outcome will reach our goal of mid-single-digit new system unit growth in 2017.

Our growth model leverages both new and existing franchisees as well as strategic company development in core Western markets where our brand has strong consumer recognition and a disciplined creation of a regional hub in the Southeast. This strategy has us well positioned to drive system growth in 2018 and beyond.

Looking ahead, we see franchise growth as an important lever with high potential in the long run, from new franchisees looking to broaden their portfolios to existing franchisees eager to expand their relationship and investment in our brand. Last month, we signed a development agreement with a multiunit restaurant operator to open 5 Del Tacos in the greater Athens, Georgia area over the next 6 years, marking our fourth development agreement signed in the Southeast during 2017 as we look to build on this momentum. We will soon finalize our 2018 new restaurant opening plans and currently expect to achieve a similar outcome to 2017 in terms of growth rate and company versus franchise mix. 2018 will also have a back half of the year opening cadence and skew towards infill growth in the Western third. Ultimately, our disciplined approach aimed at quality openings to maximize returns, including our assessment of investment cost dynamics in this inflationary environment, will determine our development guidance range for 2018 when we report our fourth quarter.

On the marketing and product front, recall that we employed a threefold strategy to lap our accelerated same-store sales performance in Q3 last year as we rolled over the most successful product launch in our history, The Del Taco. This strategy was predicated on driving comprehensive improvement across the brand. First, we operated at a higher level as evidenced by year-over-year improvements in both overall guest satisfaction and speed of service. Second, we continue to embed awareness and usage of The Del Taco and Platos, which each reflect ongoing opportunities to drive check and transaction growth. Platos was a key contributor, driving our dinner daypart as the #1 same-store sales contributor in Q3. Third, we launched a very successful Carnitas LTO to start Q3. There was a lot of pent-up demand for this product, which had not been featured on our menu for 3 years and it mixed it over 5% during the promotion and peaked at over 6%. The Carnitas product lineup helped deliver strong menu mix and aided transactions, driving 2-year stack transaction growth of positive 2% for the quarter. Overall, Carnitas was a huge success that helped drive our strong third quarter same-store sales performance. And also, I wanted to provide some color on several dynamics as we enter our fourth quarter.

First, we've observed an intensified QSR focus on value, with many compelling value bundles and deeply discounted beverages in the marketplace. Second, our fourth quarter same-store sales comparisons remain very strong, including lapping 2% transaction growth last year. And lastly, we are exiting the Carnitas LTO, which drove very high demand and featured very high check averages as it skewed towards premium price points. As compared to our most recent launch of Queso, which while also driving high demand, is broadly priced across all tiers of our menu.

Against this fourth quarter backdrop, we will continue to use our Combined Solutions model to drive same-store sales and set ourselves up for 2018 and beyond, starting with innovation. Towards the end of our third quarter, we launched our newest QSR+ ingredient, Queso Blanco, which is made with real cheese, real milk, jalapenos and heavy cream and contains no artificial colors, flavors or preservatives. Queso is featured in a number of products and reflects Del Taco's continued innovation within the premium ingredients space to further and better QSR+ position. Guests' acceptance and feedback has been strong as evidenced by Queso mixing at approximately 7% in each of the first 6 weeks since its launch, compared to the approximate 2% mix from our legacy nacho cheese product. Queso has also been a win for operations, allowing us to eliminate a legacy piece of equipment, simplifying execution.

As Q4 progresses, we will leverage Queso across our barbell menu strategy, starting with new Buck & Under product innovation with our new dollar Queso Chicken Roller, which recently launched along with our annual fall price increase. Given the value environment, we will keep Buck & Under top of mind throughout the fourth quarter to manage value perceptions and drive core QSR user visits.

As we move into November, we will pair our Buck & Under news with new Epic Burritos starting at $5, designed to drive trade up and traffic opportunities. The new Epic Queso Chicken Burrito is highly craveable with a compelling $5 price point, and will launch with a new Epic Grilled Chicken and Avocado Burrito at a premium price.

Lastly, as always, our operators are highly focused on driving same-store sales through execution with an emphasis on peak periods, outlier performance management, optimal staffing and speed to maximize our throughput opportunities.

In summary, we are set up well with many levers to pull within our Combined Solutions model to continue to drive same-store sales growth. We are accelerating to an expected mid-single-digit new restaurant growth rate in 2017 and building momentum on our long-term franchise restaurant growth opportunity. Lastly, the leadership team is set and focused on evolving our plans to further elevate our performance.

With that, I'll turn the call over to Steve Brake to review our quarterly results.

Thanks, John. Third quarter company restaurant sales increased 6.1% year-over-year to $106.3 million from $100.2 million in the year-ago period. The increase was driven by company-operated comparable restaurant sales growth of 3.7%, along with contributions from additional company-operated stores as compared to the third quarter last year.

Third quarter company-operated comparable restaurant sales growth represents the 21st consecutive quarter of gains and was comprised of 4.0% in check growth, including approximately 1.5% of menu mix growth, offset by a 0.3% decline in transactions. Franchise revenue increased 7.9% year-over-year to $4.0 million from $3.7 million last year. The increase was driven by franchise comparable restaurant sales growth of 4.6%, an increase in initial fees and additional franchise restaurants operated during the quarter as compared to the third quarter of last year.

System-wide comparable restaurant sales increased 4.1% and lapped system-wide comparable restaurant sales of 6.7% during the third quarter of 2016, resulting in a strong 10.8%, 2-year trend. The Del Taco system has now generated 16 consecutive quarters of positive same-store sales.

Total third quarter revenue was $111.0 million, an increase of 6.3% over the $104.4 million in the year-ago third quarter.

Moving to expenses. Food and paper cost as a percentage of company restaurant sales, increased approximately 40 basis points year-over-year to 27.9% from 27.5%. This increase was driven by food inflation as well as impacts from our Platos and Carnitas products, which each drove a strong margin dollar contribution, but with a slightly lower than typical margin percentage, partially offset by the impact of menu price increases in the mid-2% area.

Food inflation was primarily driven by increases in avocados, French fries and cheese. Based on continued increases in avocado prices, which only peaked last month, and additional food contracting, our annual 2017 food basket inflation is now estimated at approximately 2%, which principally arose during our second half of the year.

Labor and related expenses as a percentage of company restaurant sales increased approximately 90 basis points to 31.6% from 30.7%. This was primarily driven by the California minimum wage increase to $10.50 an hour and Los Angeles County, in Pasadena, escalations to $12 an hour on July 1, 2017, which impacted 27 company restaurants, partially offset by the impact of menu price increases.

Our experience managing higher wages remains consistent with our guidance, which included these minimum wage increases. Our Q3 result was favorable to the 100 basis points of deleverage in our first quarter when company same-store sales were 4% and our recent second quarter featured only 40 basis points of labor deleverage, due to very strong company same-store sales of 6.9%.

Occupancy and other operating expenses as a percentage of company restaurant sales increased by approximately 40 basis points year-over-year to 21.3% from 20.9% last year. This increase includes higher advertising expense as a percent of restaurant sales based on the timing of advertising as well as increased repair, maintenance, supplies, insurance and credit card fee expense as a percent of restaurant sales. Within this category, many items are fully or partially variable with sales and others with fixed attributes are subject to inflation. Over time, we expect same-store sales growth to drive leverage in this category, however, such leverage is not automatic in any given quarter or year and is ultimately dependent upon underlying expense trends across numerous categories. Based on this performance, restaurant contribution decreased 2.5% to $20.4 million from $20.9 million in the prior year.

Restaurant contribution margin decreased approximately 170 basis points year-over-year to 19.2% from 20.9%. General and administrative expenses were $8.8 million, up from $8.6 million last year. But as a percentage of total revenue, decreased by approximately 30 basis points year-over-year to 7.9%. This decrease was driven primarily by lower performance-based management incentive compensation and lower legal expenses compared to last year.

Adjusted EBITDA decreased 2.2% to $16.6 million versus $17.0 million earned last year. As a percentage of total revenues, adjusted EBITDA was 15.0%, down approximately 120 basis points from 16.2% in the prior year.

Depreciation and amortization expense in the third quarter was $5.5 million, an increase of 7.1% over $5.2 million last year. And as a percentage of total revenues, was up slightly to 5.0% from 4.9% last year.

Interest expense was $1.6 million versus $1.4 million in the prior year third quarter. The increase was due to an increase to 1-month LIBOR rate, partially offset by a lower average outstanding revolver balance compared to the third quarter of 2016. At the end of the third quarter, $148 million was outstanding under our all-revolver credit facility, while our applicable margin for LIBOR loans remained at 1.75%.

Income tax expense was $2.8 million during the third quarter for an effective tax rate of 35.5%, as compared to a $4.1 million expense during the same period last year. The fiscal third quarter effective tax rate was benefited by a favorable permanent difference for stock-based compensation expense from restricted stock awards that vested during the fiscal third quarter.

Net income was $5.1 million for the third quarter or $0.13 per diluted share compared to $4.9 million or $0.13 per diluted share during the prior year period.

Turning now to our repurchase program covering common stock and warrants. We repurchased 96,122 shares of common stock at an average price of $12.35, and 1,186 warrants at an average price of $3.97 per warrant. At the end of fiscal third quarter, approximately $24.1 million remained under our $50 million repurchase authorization.

Lastly, as John touched on, our ability to leverage our QSR+ positioning to provide everyday value and variety to our guests, coupled with ongoing innovation, has us well positioned against the recent intensified QSR focus on value, our continued challenging same-store sales comparisons and our transition off of a very high check average Carnitas LTO promotion. Through the first 5 weeks of our fourth quarter, our same-store sales are trending up in the low single-digit area or high single digits on a 2-year stacked basis. These fourth quarter dynamics, coupled with higher-than-expected food inflation and operating expense trends, have led us to revise our fiscal 2017 guidance. Please refer to today's earnings release for the details on our outlook and be mindful that fiscal 2017 contains 52 weeks and will compare to a 53-week period in fiscal 2016.

In conclusion, we are pleased to extend our long track record of positive same-store sales to 21 quarters for company-operated restaurants and 16 quarters system-wide as we very successfully lapped our strongest product launch ever in The Del Taco. As we maintain our current focus on a strong finish to 2017, we are also evaluating various strategies to accelerate restaurant contribution performance, including optimal levels of future menu price and cost-saving initiatives, both within our restaurants and across our supply chain. Thank you for your interest in Del Taco, and we are happy to answer any questions you may have.

Operator, please open the lines.

(Operator Instructions) Our first question is from Alex Slagle of Jefferies.

I want to see if you could offer a little bit more commentary on what you're seeing on a competitive environment and the top line cadence you saw through September and into October, just wondering if there's any shifts you're seeing in terms of how your customers are using the brand, possibly seeing in daypart trends or the balance between the premium and Buck & Under mix?

Yes, Alex, it's John. More definitely, as we said, we're seeing an intensified QSR focus on value right now with particular emphasis on these compelling value bundles that are out there in the marketplace at that $5 price point as well as some of that discounted beverage activity that's going on, which in the short run, can have an impact to improve traffic on the brands that are deploying those tactics. But that pressure that is being put on us a little bit right now from a traffic perspective is just causing the trend -- the traffic trend to run below what we experienced in Q3. But we're only 5 weeks into a 16-week quarter. So it's premature to really quantify where traffic may land for the quarter. But overall, what we'd say is we expect same-store sales to continue to be positive. And we expect continue to drive strong momentum from a 2-year stacked same-store sales perspective in Q4. We're in a good position as a brand to continue to drive same-store sales in this kind of environment because of the fact that we have everyday value, and that's been our strategy for the last several years. So it's earned us category-leading value, affordability and variety marks in our core markets that in large part is due to our ultimate barbell approach that we keep top of mind. We've always said we don't want to ever be in a position to have to pivot to value. We just want to be known for it. And that's why we've taken the strategy that we have and, of course, we've led over the years with Buck & Under. So our approach in this environment is going to be to continue to highlight our great value, but also to continue our path with innovation, and that's starting right now with Buck & Under keeping that platform top of mind, to really maintain those strong value perceptions this period. We put some innovation out in the marketplace recently to just further highlight that for the consumer. And then we're pivoting into another strong value program, but more premium with the $5 Epic Burrito. We got a couple of New Epic Burritos hitting the menu here later this month that can provide us some trade-up opportunities. So again, we're leveraging innovation to drive interest visits and sales, definitely leaning into our value strengths, and we feel good about where we're positioned to continue to work through this environment with positive same-store sales trends.

That's helpful. And then with the recent hiring of Barry Westrum in the CMO role, just interested in getting any early thoughts about what you guys could do to take the brand to the next level in terms of brand awareness and perceptions. Perhaps some new ideas on building out the data insights work, or are there ways to build the brand's presence on social digital?

Yes. So I think all of the above, really, is being assessed, and I'm excited to have Barry in the business. I mentioned the type of experience that he brings to the table in my comments. And then I just can't emphasize enough how valuable it is to have a proven CMO that understands the limited service restaurant category and brand building within that category to continue our progression in that QSR+ space. And really, Barry, his work is underway, his analysis and assessment is underway. He's knee-deep in it right now. And I think that he's using that lens as being a QSR+, taking a QSR+ leadership position as a brand, which I think is a great lens to take, which is going to yield that elevation that you're talking about and that idea of taking it to the next level. So it's too early to completely talk about what is yet to come, but I will say that he's actively involved in the business, working with research and marketing and agencies right now to develop the next phase of brand development. And I do expect some exciting enhancements as we enter into 2018 and beyond.

Our next question is from Craig Bibb, CJS Securities.

Just I want to make sure I understood your response on the last question. Relative to Q3, it sounds like same-store sales are pretty much about where they were, the traffic's down and mix is up with case, how is that -- well, if you adjust...

So Craig, obviously we're only 5 weeks into a long 16-week quarter. So obviously premature to try to peg where things like traffic and mix are headed for the quarter. But thus far, 5 weeks, we have seen a sequential deceleration in both traffic and mix thus far Q4, compared to how they each performed during the third quarter.

Okay. And then -- I was looking at the 7% Queso in the mix realizing that only 5% of that is incremental. Is it replacing other things like avocados or nachos? Or...

Craig, it's mixed right now in regards to where that's coming from, but I'll say that even -- the fact is even with Queso coming into the business, we are expecting to deliver positive mix. It's just not as pronounced or robust as it was with Carnitas. And there's definitely some reasons for that when you think about Carnitas provided higher check averages compared to Queso. And really, that's due to the way that we use that protein. It was more premiumly used because our existing guests were familiar with it. And we had that pent-up demand that it carried. So we were able to really leverage that mid-tier and premium pricing. In contrast, Queso is a new ingredient. So from a consumer perspective, our goals were to and it continued to be to drive trial and crave for the ingredient, which we believe in turn will drive the long-term opportunities that we see with that more premium Queso ingredient. So we're pleased that it's been well received. It's carrying that strong and consistent 7% mix so far, and we think that trial is turning to frequency. Part of that -- part of what we've accomplished here has happened because of the way that we've positioned it to be more broadly used on the menu and accessible to guests because we wanted to drive that trial and achieve those objectives. So at the same time, there are some premium items on the Queso menu, like the Queso Loaded Nachos, and we're soon going to debut, just in the next several weeks, we're going to debut a Queso ingredient in a new Epic Burrito. And then Epic, as you might recall, are priced similarly where we price similarly to where we price Carnitas. So they're more premium. So I think we're in great shape with Queso overall. The guests love it, so that's point number one that you need to accomplish. So now we can take advantage of that, and really leverage it more broadly on our menu, depending on the needs of the business. And we've said it can be used for traffic driving reasons, it can be used for check driving reasons, and we intend to use it in both ways.

Okay. And then it looks like you continue to make progress signing franchise agreements. But at least in the near term, the actual franchise openings are lagging what the company's doing. Is there going to be a catch-up in 2018? Or maybe just more color around that.

Yes. I mean, I think the franchise piece is building momentum. And we -- that's the point we really want to make. We view that as a long-term opportunity for the brand. And we have focused and taken that very disciplined approach to start out in the Southeast with that Southeastern hub that we've talked about. And so we're excited that we've got 4 deals signed down in the Southeast with 4 highly qualified quality franchisees that we think can help to build the brand. Overall, as we said, we think 2018 is going to feature a growth rate that's similar to 2017 in that mid-single digit area, which will reflect that continued acceleration that we achieved in 2017 over 2016. Remember that we approximately doubled this year what we open in each of the previous 3 years prior to 2017. So that acceleration has occurred, and we hope to maintain that acceleration as we think about 2018 and beyond. We feel -- we certainly feel good about our future pipeline right now and how that's building. But as we stated, as we think about 2018, we've got to consider the construction costs, and we have observed recent inflationary pressure across labor and materials this year, which is impacted by that tight labor market that's out there and that lower unemployment and rising wages environment. So the extent of the inflation we know varies across market. So it's not going to have a demonstrable impact on our growth rate, but we are going to take the appropriate responsible approach to reassess the pipeline and make sure that we proceed with projects that are still expected to drive strong returns. So some portion of our pipeline is going to be fluid as deals come in and out, and that's a normal activity to happen as you evaluate these deals. But the good news is that we believe that we can still continue that acceleration in mid-single-digit territory. We'll get some of these guys down in the Southeast to start opening restaurants. And I think we'll see some of that in 2018, and we hope that, that accelerates beyond that with them and others that we plan to bring into the fray in 2018.

And Craig, as far as the mix itself, I think what we've said before, definitely remains true, this year and next year, it will tilt towards more company openings versus franchise. It's really -- beginning in '19, we see a good chance of that beginning to even out longer term beyond '19. We absolutely believe there's a long-term potential for the franchise growth to really accelerate beyond company openings. We'll still go corporately. We're motivated. We like the returns. But longer term, we do see that inflection playing out in '19 or beyond.

Our next question is from Peter Saleh of BTIG.

I wanted to ask about the labor line. I know you've been seeing pretty meaningful inflation on the labor side. Are there -- aside from taking price, is there anything else you guys are doing within the 4 walls of the restaurants to reduce the overall labor hours or the pressure on labor line? And how should we be thinking about that for next year, given the continued inflation in wages?

Peter, it's Steve. A good question. Certainly, labor, it's going to be a holistic approach. It's not a silver bullet. As you mentioned, menu price certainly has and will continue to play a role. In addition, traffic and mix, we're now -- the last 4 years, positive traffic, this year through 36 week, traffic's up 50 bps, we're now 3.5 years, 14 quarters consecutively into having meaningful menu mix. It's actually averaged 1.3% in the last 14 quarters. So all those levers are really driving that ongoing AUV story. That in itself is our highest priority to help overcome costs, where it's generally labor being a big one of them. At the same time, we're very open-minded and in various levels of testing or even deployment, a lot of solutions that well over time help with the labor hour side of the equation. We call it targeted discretionary investment on capital. There's a lot of various equipment ideas, some have been rolled like that bean mixer we may have talked about in the past. Others are in test or about to roll. So whether it's food processors, other things we're doing in the back of the house in terms of equipment as well as some of our older kitchens doing some retrofits that enhance productivity. So those are things we're absolutely trying to put what I call smart capital forward to improve our plate in terms of managing hours. And then technology as well, we're being very open-minded there. As you know, we're in test and learn in terms of technology initiatives. Can some of these be a mobile device or kiosk or other ways for consumers to order, over time gaining traction and take labor hour pressure off the front counter. We think that's very possible, and we're in a good position to further understand that, then all of the above will be deployed when and if we see a nice accretive path. So it's a good question, and it's definitely something we have been and will remain focused on indefinitely.

Got it. And then just any updates on your mobile order and pay strategy and the test you've been doing there?

Yes. Our online ordering and mobile app pilot, it's available in more than 50 restaurants now. We like what we're seeing from an ops execution and average check standpoint. But we're still working to perfect the model for usage and what's already a very fast and convenient dining experience environment. So there are marketing opportunities, including the things like push notifications and loyalty-like type programming that we want to better understand that the team is looking at right now. But the push lately for us just evolving from that has been the launch into a couple of delivery tests that we've got out in market now to really help us understand the demand around delivery in our space and what that could look like in the future. I think we've talked about using all those dispatched platform in our mobile app test, and we've been able to add delivery to that as an option to the Del app. And online ordering for the assessed stores is coming together with that delivery piece. And then we've also partnered with Grubhub recently, and that is actually active and out in test environment right now, so -- that we can try to operationalize that program and really understand what that third-party delivery option looks like. And we're also looking at another 1 or 2 partners to bring into -- get some additional learnings. So I think we're making good progress, just to continue to try to figure out what the right model looks like for quick service restaurants with a drive-through. I think we are in a good position to be able to use some deployment on a wider scale as we think about 2018 and beyond, as long as we continue to make good momentum and progress on some of the consumer demand dynamics.

Got it. And then just lastly, on your menu pricing going forward. Maybe it's 2018, how are you thinking about that given the overall inflationary environment, plus coupled with what we're continuing to hear more on the value side, more value promotions. So is your pricing going to be different than what we saw this year? Higher or lower? How should we be thinking about that?

We'll guide that explicitly down the road. But as I touched on in my prepared remarks, we are currently evaluating strategies to improve restaurant contribution performance. Really on 2 fronts: first, potential cost savings opportunities across our supply chain and at the restaurant level; and then second, we are working to optimize our menu pricing as we move forward. In terms of that future menu price, we definitely believe we're very well positioned to successfully flow through our future menu price increases in an accretive manner that has limited impacts on traffic and/or menu mix performance. So the magnitude, it's something we'll discuss down the road. And in any event, as we get into the next year, it's all about working that barbell. We will always have that compelling low end. Today, obviously, it's Buck & Under, which is a compelling value and variety play within our category. And then a lot of optionality in the mid-tier and premium areas over the last year. You saw a huge mid-tier win with The Del Taco. And we've had a lot of long-term success at the premium areas. So truly, that balanced menu strategy, we can be nimble. And when there is an intensely competitive environment like we have today, much like the early half of '16, we can lead into Buck & Under that much more and do very well. In other environments, we can lean in on premium or mid tiers. So we love the strategy. It's very versatile, coupled with the right amount of menu price, innovation, all the things you're used to seeing from us, it's going to set us up for another good year ahead.

Our next question is from Jeremy Hamblin of Dougherty & Company.

I wanted to come back to margins and food costs for a second. And just see if we could get a little bit more color. You mentioned that Platos and Carnitas they were a negative for margins, although they were positive overall contribution to margin dollars. Can you give me a little color on Queso as it relates to margins? Is that a margin-accretive product in general? Or is it more similar to Platos and Carnitas where it is margin negative?

Today, how we've used it on the menu, it's just very slightly margin negative. As John touched on, we love the versatility of Queso, the ability to use it from really the top to bottom of our menu. As you use it in different builds or products, that margin profile can vary. So to-date, there's a very small minimal margin drag. As we move forward, that could probably neutralize or maybe even tilt the other way. But not as noticeable as what we've talked about in the past with like a Del Taco or Platos or Carnitas. Those were more of a gap from our normalized margin.

Okay. And then following up, you mentioned that avocado cost probably were the biggest surprise in the quarter. And can you call out the basis point drag that, that caused in Q3, and kind of what you're expecting in Q4 from the higher-than-expected avocado cost?

The avocados, they only peak -- the good news, they have peaked and began to ease their way down, yet still elevated. They peaked kind of the latter half of last month, which was already squarely in our fiscal fourth quarter. As far as the impact on Q3 itself, a couple of tenths in terms of year-over-year pressure. It's a little bit of that, I think, was anticipated in our early plans, but certainly, it did remain elevated. And still is elevated in the fourth quarter. While we have seen some relief, the extent of that relief and duration of that relief is still a bit hard to call. So avocado, it's a 1.5% of our food basket item. It doesn't sound big, but when it's priced essentially right about double, that moment in time from a normalized historical price, it certainly can end up having a significant dollar impact on the year at hand.

So you're thinking as of now about another 20 basis points for Q4 impact?

On a year-over-year basis, I would not expect it to be worse than that to what extent it can improve. Meaningfully, inside that, time will tell, we're still early days in this long fourth quarter.

Okay. And then on the marketing cost, it sounds like -- I think maybe the biggest surprise that we saw was your occupancy in other operating expenses deleveraging by 40 basis points. You guys really haven't seen something like that in quite a few years. Can you just give us a sense for was that kind of planned marketing cost growth? What was the change year-over-year on either advertising spend or marketing spend in total that caused that 40 basis points of deleverage or seemed to be the primary cause?

So advertising for every given fiscal year will run 4.0%. During the third quarter, it ran 1/10 higher than last year. Year-to-date now through 36 weeks, it's 2/10 higher than last year. Because this year will run the same 4.0% that we ran a year ago. That means fourth quarter, it'll finally reverse and turn. So fourth quarter ad expense will be probably about 30 bps higher year-over-year for Q4. So when you segregate the 1/10 high run rate in the third quarter on advertising, it left you with 30 bps of what I would call real year-over-year OpEx pressure. So OpEx, it's a variety of things. As I touched on OpEx, every single thing in there is subject to inflationary pressure. Some things like property tax and rent feel fixed than they are, but rents have CPI bumps every 5 years and every now and then they renew, for instance. Other areas are purely variable like your credit card fees and by the way, usage on credit fees continues to grow at a high rate year-over-year. And then a lot of things were semi-variable. So utilities is a good example. When throughput and consumption's up, utilities are up. So in general, items and OpEx do have year-over-year dollar inflationary pressure even with a unit base that hasn't grown much yet. At the same time, the couple areas that did run higher than expected, occurred within supplies, services, repairs, maintenance, those broad categories. You're going to have good quarters and good years and this has been a tougher year. We've had some things unexpectedly inflate on us across those categories. So when you put it all together, some things that feel fixed still grow over time on dollars. There are a couple of lines within that we're getting real small amounts of leverage on. But others have had inflation this year that outpaced the overall revenue growth. So the net of it, as you saw in Q3, is that 30 bps of real pressure year-over-year. The other maybe data point, I would take you back to 2014 and 2015. Both those years, we comped 5% and 6%, respectively. Both those years' OpEx, we had a modest 20 bps of leverage. 2016, we had 80 bps. That was a better year. That was a year where things went our way, probably 2014, 2015. A bit more normalized. We think, long term, we should and expect to have leverage with good comps on that line item. But it will generally look more modest than robust because a lot what's in there is partly or fully variable.

Our next question is from Nick Setyan, Wedbush Securities.

As this year's gone on, obviously, we've seen the food cost inflation expectation go up. As we kind of looking at early 2018, and I'm sure you're already contracting, et cetera, what are you seeing out there? What's your early expectation for what food cost inflation could be for 2018 or at least for the first half of 2018?

Yes, we're certainly beginning to work on calendar 2018 or intra-2018 buys, but really at this juncture in mid-October, it's a bit too early to provide any real guidance or clarity on what we think the 2018 food basket will do, whether it's front half or the full year. So it's a big focus as well as I touched on, also looking at areas across the supply chain, adding restaurants where we can try to have cost-savings initiatives play out here in the near term without it all impacting guest experience or operational effectiveness. So we're trying to attack it from a contracting front, certainly like we always do and also just trying to be creative on making sure we can kind of optimize our cost structure both in supply and within the restaurants.

And then just kind of revisiting that price increase question from earlier, like, for example, Q4 '15, first half of '16, we saw 3.5%, 4% type of price increases. Is that off the table into that kind of magnitude of price increases, given environment?

I would not say that's off the table. Next year, we have a continued path of wage inflation with the heavy California footprint. Next year is another $0.50 that several years after that or a dollar each year. So certainly, the extent of cost headwinds be them labor or food or a combination thereof tends to have some impact on the price set that we look to seek. As you recall, it was about a year ago, we made the very conscious decision to step away from that 3-plus percent pricing that we did carry in each of fiscal '15 and fiscal '16 for those full years. It was Q4 of '16 that we consciously brought it down to 2.5%. That's what we'll continue to carry this year through the fourth quarter. And that was really based on what's been a very tough, challenging environment for restaurants, highly competitive, marked with a lot of aggressive discounting by many of our peers as well as that CPI gap of food away from home versus at home, that widened considerably. So all of that definitely informed our view to have a more modest, for us, 2.5%. This year over the last, say, 5 quarters, as we move forward as I mentioned, we're absolutely looking to optimize that. Our goal is to make sure that traffic and mix disruption, if any, is limited. And there's definitely a balance. Taking too much price, there is elasticity at the consumer level that could cause more long-term damage to a brand. So while we take actions quarter-to-quarter, year-to-year, it's really that long-term vision that we have in mind, making sure that we're appropriately driving check through, hopefully a healthy balance of price and mix like we've done for 3.5 years now. And also doing what's right to preserve and hopefully drive at least on a relative basis that traffic base into the future. So it's a balancing act, so we're absolutely challenging ourselves to optimize that for the year ahead. I would say there is no number off the table. That said, I would probably think and practice that the amount we carry this year is probably a floor to think about. Maybe not every quarter in the future, but at least for the near term knowing that we have a lot of wage to overcome. The food basket, as we touched on, it's hard to call year-to-year. That can swing either way quickly. We've seen it be a bit volatile just in the last 24 months going from deflationary to inflationary. So the nice thing about price is we can be nimble. Whatever you're carrying right now, within 3, 6 or 9 months, you can bring it up or bring it down based on what's warranted. So we're just trying to be thoughtful, disciplined and eventually drive accretion.

Yes. Nick, it's John. I mean we've set ourselves up here with being able to watch the competitors and watch the environment and the consumer very closely. As we think about it, we know that in a wage inflationary environment, it really is going to be a level playing field for restaurants and retail. And that's what we're going to be dealing with in California for the next several years. But the key pieces for us are to continue to maintain that value advantage. The good news is we've got a significant value advantage against the limited service restaurants. So others are going to be taking price and, as Steve said, price will be part of our path as well as other things that we'll be doing, and we've got a great econometric model in turn that we're using as well as a consumer research team that's in-house. So I think we've got the right insights coming through to help us to make those decisions, as Steve said very nimbly.

That's very helpful. And just the last question, I know in the past we've talked about the new units as you kind of accelerate the new unit growth. Because they're mainly in mature markets, you expect them to kind of have, off the bat, system type of volumes and margins. Is that kind of what you're seeing in practice as you open up sort of 9, potentially 9 units here? How should we think about the near-term impact at least in terms of unit inefficiencies, et cetera, on the unit-level margins?

Yes. Mature markets tend to have a relatively normal volume. Occasionally in the emerging markets, we'll have what we call a honeymoon, just an elevated sales volume. Given you're the new game in town, there's a lot of excitement. Over time, that will temper down to something more realistic. As far as on the margin side, new units in mature markets, it's certainly not out of the gate, but definitely within that first year, the teams quickly worked their way towards a normalized margin environment. Lots of team members are often barred from other stores, things like that. So we get efficient quickly. It's new markets where our past decks have talked about it. It really being a 3-year target. It takes a few years to get to that area of having efficient margins and flow-throughs in emerging. We want to keep enough feet on the floor. Really do what's right to make sure those units are set up for long-term success. So those are the couple of distinctions, I think, you were asking about.

Our next question is from Stephen Anderson, Maxim Group.

You answered most of my questions, but I do have a follow-up question regarding the delivery test as well as the mobile payment. And also I wanted to ask if you were prepared to announce any additional markets for testing? I know you had said previously looking at Denver for delivery, also the arrangement with Grubhub in San Diego, I believe it was Detroit as well.

Stephen, what we've said is that we're testing in our mobile app environment right now through the Olo platform. And that's in Las Vegas. And we're also now testing in Southern California in select stores at this point with Grubhub. So we haven't expanded that beyond those geographies just yet, but more to come on future calls.

Our next question is from Joshua Long, Piper Jaffray.

Wanted to circle back to the improved satisfaction scores. Curious what the guests were calling out specifically that you might be able to share with us? And then also as we think about this improvement, is there a bit of a lag? You've been continually improving and putting in new procedures and products. And so is the idea that this is more or less real-time? Or are we -- should we expect this to continue to drift higher as guests get a little bit more time and frequency with some of the new products and operational procedures that you have there at the store level?

Yes. Josh, just to clarify, are you talking about overall guest satisfaction? Is that what you're referencing, our GEM scores?

Yes, that's what I'm talking about in terms of just really that being a nice tailwind driver to a lot of the work you're doing. Just curious how real-time you see those satisfaction scores move around, whether it's new products or if this has really been a slow build from just the longer-term Combined Fresh Solutions (sic) [Fresh Combined Solutions] and just continued execution at the store level?

Yes. I mean, I think it's really the latter there. We have seen a nice steady improvement through our Combined Solutions efforts over the last several years. We typically have seen, as we move forward, 400 to 500 basis point improvements year-to-year on top box overall guest satisfaction. A lot of that is due to the products that we're bringing in that are creating better experiences for the guests. But it's also because of our operation's focus and the big part of our Combined Solutions model is, obviously, complementing those brand promises with real, material improvements at the restaurant that come to life in regards to how they think about our service and how they rate us on service, how they think about our product execution and how they rate us on product as well as speed. And we've made nice improvements across the set, which is really driven the overall satisfaction improvements. So our goal would be to continue that improvement year in, year out and it might not be to the tune of 400 or 500 basis points every single year. But I think at the level that we're at now, nice steady improvements are meaningful to the guests. And as we look at pieces of equipment, that can simplify operations or improve guest experience through quality or as we look at some of the employee and leadership training that we're doing at the restaurant level, all of these things should add up to better guest experience. And we need to be measuring that. And that's what we intend to do. So more to come on that. But I would expect a continued tailwind from our improvements in operations.

Great. And then in terms of just thinking about the current pipeline and then you mentioned some increased costs just in terms of inflation in the general construction process, but was curious on how you feel about the real estate pipeline in general, what sites are available. And kind of how that should turn into near-term new units over the next year or two in terms of just quality and availability and pricing on real estate for your portfolio?

We feel good about the pipeline as we move into 2018 and beyond. And so it's just a matter of really watching the environment very closely, understanding it by geography and making sure that we make good decisions in the short run for lasting investments, right? So these sites we'd signed for 20 years or a franchisee signed for 20 years, it's really important that we set the unit economics up in a way that can continue to yield some nice profits and some nice returns for us over time. And we certainly don't want to get ourselves into deals that are highly inflationary in the short run when there's other deals to be had out there in the market that are more reasonable. So it's just a matter of finding them. So again, we feel good about moving into 2018 in mid-single-digit range, and we'll continue to kind of firm that up over the next couple of months and give you guys some more color on it as we move into '18.

Our next question is from Craig Bibb, CJS Securities.

I will defer till next quarter.

Okay. You got it. Thanks, Craig.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to management for closing remarks.

Well, thank you all for your interest in Del Taco. We couldn't be more excited about the continued opportunities that lie ahead of us. And we wish you all a wonderful day.

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