Basis of Presentation and Summary of Significant Accounting Policies (Policies)

12 Months Ended

Jan. 01, 2019

The Company’s fiscal year ends on the Tuesday closest to December 31. Fiscal years 2018 and 2017 are both fifty-two week periods. 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. Fiscal year 2016 is a fifty-three week period. In a fifty-three week fiscal year, the first, second and third quarters each include twelve weeks of operations and the fourth quarter includes seventeen weeks of operations. For fiscal year 2018, the Company’s financial statements reflect the fifty-two weeks ended January 1, 2019. For fiscal year 2017, the Company's financial statements reflect the fifty-two weeks ended January 2, 2018. For fiscal year 2016, the Company’s financial statements reflect the fifty-three weeks ended January 3, 2017

Principles of Consolidation

The 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 Securities and Exchange Commission (“SEC”). The accompanying 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.

Variable Interest Entities

In accordance with Accounting Standards Codification ("ASC") 810, Consolidation, the Company applies the guidance related to variable interest entities ("VIE"), which defines the process for how an enterprise determines which party consolidates a VIE as primarily a qualitative analysis. The enterprise that consolidates the VIE (the primary beneficiary) is defined as the enterprise with (1) the power to direct activities of the VIE that most significantly affect the VIE's economic performance and (2) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE. The Company franchises its operations through franchise agreements entered into with franchisees and therefore, the Company does not possess any ownership interests in franchise entities or other affiliates. The franchise agreements are designed to provide the franchisee with key decision-making ability to enable it to oversee its operations and to have a significant impact on the success of the franchise, while the Company’s decision-making rights are related to protecting the Company’s brand. Based upon the Company’s analysis of all the relevant facts and considerations of the franchise entities, the Company has concluded that the franchise agreements are not variable interest entities.

Revenue Recognition

Company Restaurant Sales from the operation of company-operated restaurants are recognized when food and service is delivered to customers. The Company reports revenue net of promotional allowances as well as sales taxes collected from customers and remitted to governmental taxing authorities.

Franchise Revenue is comprised of (i) development fees, (ii) franchise fees, (iii) on-going royalties, (iv) renewal fees and (v) other franchise revenue. Development and franchise fees, portions of which are collected in advance and are non-refundable, received pursuant to individual development agreements, grant the right to develop franchise-operated restaurants in future periods in specific geographic areas. Both development fees and franchise fees are deferred and recognized as revenue over the term of the related franchise agreement for the respective restaurant and renewal fees are deferred and recognized over the term of the renewal agreement. Development fees and franchise fees are also generally recognized as revenue upon the termination of the development agreement with the franchisee. Deferred development fees and deferred franchise fees are included in other non-current liabilities on the consolidated balance sheets. Royalties from franchise-operated restaurants are based on a percentage of franchise restaurant sales and are recognized in the period the related franchise-operated restaurant sales occur. To a lessor extent, Franchise Revenue also includes pass-through fees for services such as software maintenance and technology subscriptions since we are considered the principal related to the purchase and sale of the services to the franchisee and have no remaining performance obligations. The related expenses are recognized in general and administrative expenses.

Franchise Sublease and Other Income is comprised of rental income associated with properties leased or subleased to franchisees and is recognized as revenue on an accrual basis. In addition, 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. The offset is recorded to Franchise Advertising Expenses. 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.

Gift Cards

The Company sells gift cards to customers in its restaurants. The gift cards sold to customers have no stated expiration dates and are subject to potential escheatment laws in the various jurisdictions in which the Company operates. Deferred gift card income totaled $2.8 million and $2.5 million as of January 1, 2019 and January 2, 2018, respectively. The current portion of the deferred gift card income is included in other accrued liabilities on the consolidated balance sheets and totaled $1.5 million and $1.3 million as of January 1, 2019 and January 2, 2018. The non-current portion of the deferred gift card income was $1.3 million and $1.2 million as January 1, 2019 and January 2, 2018, respectively, and is included in other non-current liabilities on the consolidated balance sheets. The Company recognizes revenue from gift cards: (i) when the gift card is redeemed by the customer; or (ii) under the delayed recognition method, when the likelihood of the gift card being redeemed by the customer is remote (gift card breakage) and the Company determines that there is not a legal obligation to remit the unredeemed gift cards to the relevant jurisdiction. The determination of the gift card breakage rate is based upon Company specific historical redemption patterns. Recognized gift card breakage revenue was not significant to any period presented in the consolidated statements of comprehensive income. Any future revisions to the estimated breakage rate may result in changes in the amount of breakage revenue recognized in future periods but is not expected to be significant.

Cash and Cash Equivalents

The Company considers short-term, highly liquid investments with original maturities of three months or less when purchased to be cash equivalents. Amounts receivable from credit card issuers are typically converted to cash within 2 to 4 days of the original sales transaction and are considered to be cash equivalents.

Accounts and Other Receivables, Net

Accounts and other receivables, net consist primarily of receivables from franchisees, sublease tenants, a vendor and landlords. Receivables from franchisees include sublease rents, royalties, services and contractual marketing fees associated with the franchise agreements. Sublease tenant receivables relate to subleased properties where the Company is a party and obligated on the primary lease agreement. The vendor receivable is for earned reimbursements from a vendor and the landlord receivables are for earned landlord reimbursement related to restaurants opened. The allowance for doubtful accounts is based on historical experience and a review on a specific identification basis of the collectability of existing receivables and totaled $0.1 million as of both January 1, 2019 and January 2, 2018.

Vendor Allowances

The Company receives support from one of its vendors in the form of reimbursements. The reimbursements are agreed upon with the vendor, but do not represent specific, incremental, identifiable costs incurred by the Company in selling the vendor’s products. Such reimbursements are recorded as a reduction of the costs of purchasing the vendor’s products. The non-current portion of reimbursements received by the Company in advance is included in other non-current liabilities on the consolidated balance sheets and totaled $0.7 million and $1.1 million as of January 1, 2019 and January 2, 2018, respectively. The current portion of these reimbursements is included in other accrued liabilities on the consolidated balance sheets and totaled $0.4 million as of both January 1, 2019 and January 2, 2018.

Inventories

Inventories, consisting of food items, packaging and beverages, are valued at the lower of cost (first-in, first-out method) or market.

Property and Equipment

Property and equipment includes land, buildings, leasehold improvements, restaurant and other equipment, restaurant property leased to others and buildings under capital leases. Land, buildings, leasehold improvements, property and equipment acquired in business combinations are initially recorded at their estimated fair value. Land, buildings, leasehold improvements, property and equipment acquired or constructed in the normal course of business are initially recorded at cost. The Company provides for depreciation and amortization based on the estimated useful lives of assets using the straight-line method.

Estimated useful lives for property and equipment are as follows:



Buildings		20–35 years
Leasehold improvements		Shorter of useful life (typically 20 years) or lease term
Buildings under capital leases		Shorter of useful life (typically 20 years) or lease term
Restaurant and other equipment		3–15 years

The estimated useful lives for leasehold improvements are based on the shorter of the estimated useful lives of the assets or the related lease term, which generally includes reasonably assured option periods expected to be exercised by the Company when the Company would suffer an economic penalty if not exercised. Depreciation and amortization expense associated with property and equipment totaled $23.1 million for the fifty-two weeks ended January 1, 2019, $21.0 million for the fifty-two weeks ended January 2, 2018 and $20.6 million for the fifty-three weeks ended January 3, 2017. These amounts include $0.9 million for the fifty-two weeks ended January 1, 2019, $1.2 million for the fifty-three weeks ended January 2, 2018 and $1.4 million for the fifty-three weeks ended January 3, 2017 related to buildings under capital leases. Accumulated depreciation and amortization associated with property and equipment includes $2.2 million and $2.5 million related to buildings under capital leases as of January 1, 2019 and January 2, 2018, respectively.

The Company capitalizes construction costs which consist of internal payroll and payroll related costs and travel costs related to the successful acquisition, development, design and construction of the Company's new restaurants. Capitalized construction costs totaled $1.6 million for both the fifty-two weeks ended January 1, 2019 and fifty-two weeks ended January 2, 2018, and $1.3 million for the fifty-three weeks ended January 3, 2017. If the Company subsequently makes a determination that a site for which development costs have been capitalized will not be acquired or developed, any previously capitalized development costs are expensed and included in general and administrative expenses in the consolidated statements of comprehensive income. The Company capitalizes interest in connection with the construction of its restaurants. Interest capitalized totaled approximately $0.1 million for each of the fifty-two weeks ended January 1, 2019, the fifty-two weeks ended January 2, 2018, and the fifty-three weeks ended January 3, 2017.

Gains and losses on the disposal of assets are recorded as the difference between the net proceeds received, if any, and net carrying values of the assets disposed and are included in loss on disposal of assets, net in the consolidated statements of comprehensive income.

Deferred Financing Costs

Deferred financing costs represent third-party debt costs that are capitalized and amortized to interest expense over the associated term of the debt agreement using the effective interest method. Deferred financing costs, along with lender debt discount, are presented net of the related debt balances on the consolidated balance sheets.

Goodwill and Trademarks

The Company’s goodwill and trademarks are not amortized, but tested annually for impairment and tested more frequently for impairment if events and circumstances indicate that the asset might be impaired. The Company conducts annual goodwill and trademark impairment tests in the fourth quarter of each fiscal year or whenever an indicator of impairment exists.

In assessing potential goodwill impairment, the Company has the option to first assess the qualitative factors to determine whether events or circumstances indicate that it is more likely than not that the fair value of net assets, including goodwill, is less than its carrying amount. If the qualitative factors indicate that it is more likely than not that the fair value of net assets, including goodwill, is less than its carrying amount, the Company performs a two-step impairment test of goodwill. In the first step, the Company estimates the fair value of net assets, including goodwill, and compares it to the carrying value of net assets, including goodwill. If the carrying value exceeds the estimated fair value of net assets, including goodwill, the second step is performed to measure the amount of the impairment loss, if any. In the second step, the amount of the impairment loss is the excess of the carrying amount of the goodwill over its implied fair value.

The methods the Company uses to estimate fair value include discounted future cash flows analysis and market valuation based on similar companies. Key assumptions included in the cash flow model include future revenues, operating costs, working capital changes, capital expenditures and a discount rate that approximates the Company's weighted average cost of capital.

The Company performs an annual impairment test for indefinite-lived intangible assets during the fourth fiscal quarter of each year, or more frequently if impairment indicators arise.

In assessing potential impairments for the fourth quarter test for 2018, the Company performed a qualitative assessment to determine whether it is more likely than not that the fair value of goodwill or indefinite-lived trademark are less than the carrying amount. Upon completion of the fourth quarter 2018 annual impairment assessment, the Company determined that no goodwill or trademark impairment was indicated. As of January 1, 2019, the Company is not aware of any significant indicators of impairment that exist for goodwill or trademark that would require additional analysis.

Intangible Assets, Net

Intangible assets primarily include favorable lease assets and franchise rights. Favorable lease assets represent the fair values of acquired lease contracts having contractual rents that are favorable compared to fair market rents as of the Closing Date of the Business Combination, and are amortized on a straight-line basis over the remaining lease terms to expense in the consolidated statements of comprehensive income. Franchise rights, which represent the fair value of franchise agreements based on the projected royalty revenue stream as of the Closing Date of the Business Combination, are amortized on a straight-line basis to depreciation and amortization expense in the consolidated statements of comprehensive income over the remaining term of the franchise agreements.

Other Assets, Net

Other assets, net consist of security deposits and other capitalized costs. The Company capitalizes certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs include only (i) external direct costs of materials and services utilized in developing or obtaining computer software, and (ii) compensation and related benefits for employees who are directly associated with the software projects. Capitalized software costs are amortized over the estimated useful life, typically 3 years. The net carrying value of capitalized software costs for the Company totaled $2.3 million and $2.1 million as of January 1, 2019 and January 2, 2018, respectively, and is included in other assets, net in the consolidated balance sheets. Capitalized software costs totaled $1.5 million for the fifty-two weeks ended January 1, 2019, $1.0 million for the fifty-two weeks ended January 2, 2018 and $1.3 million for the fifty-three weeks ended January 3, 2017. Amortization expenses totaled $1.2 million for the fifty-two weeks ended January 1, 2019, $1.0 million for the fifty-two weeks ended January 2, 2018 and $0.9 million for the fifty-three weeks ended January 3, 2017

Long-Lived Assets

Long-lived assets, including property and equipment and definite lived intangible assets (other than goodwill and indefinite-lived intangible assets), are reviewed by the Company for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Long-lived assets are grouped and evaluated for impairment at the lowest level for which there are identifiable cash flows that are independent of the cash flows of other groups of assets. The Company evaluates such cash flows for individual restaurants and franchise agreements on an undiscounted basis. If it is determined that the carrying amounts of such long-lived assets are not recoverable, the assets are written down to their estimated fair values. The Company generally estimates fair value using either the land and building real estate value for the respective restaurant or the discounted value of the estimated cash flows associated with the respective restaurant or agreement.

Rent Expense and Deferred Rent

Rent Expense and Deferred Rent Liability

The Company has non-cancelable lease agreements for certain restaurant land and buildings under terms ranging up to 35 years, with one to four options to extend the lease generally for five to ten years per option period. At inception, each lease is evaluated to determine whether it will be classified as an operating or capital lease. Certain leases provide for contingent rentals based on percentages of net sales or have other provisions obligating the Company to pay related property taxes and certain other expenses. Contingent rentals are generally based on sales levels in excess of stipulated amounts as defined in the lease agreement, and thus are not considered minimum lease payments and are included in rent expense as incurred. Certain leases contain fixed and determinable escalation clauses for which the Company recognizes rental expense under these leases on the straight-line basis over the lease terms, which includes the period of time from when the Company takes possession of the leased space until the restaurant opening date (the rent holiday period), and the cumulative expense recognized on the straight-line basis in excess of the cumulative payments is included in other non-current liabilities. In addition, the Company subleases certain buildings to franchisees and other unrelated third parties, which are classified as operating leases.

In some cases, the land and building the Company will lease requires construction to ready the space for its intended use, and in certain cases, the Company has involvement with the construction of leased assets. The construction period begins when the Company executes the lease agreement with the landlord and continues until the space is substantially complete and ready for its intended use. In accordance with ASC 840, Leases, the Company must consider the nature and extent of its involvement during the construction period.

In accordance with ASC 840, Leases, the Company may expend cash for structural additions on leased premises that may be reimbursed in whole or in part by landlords as construction contributions pursuant to agreed-upon terms in the leases. Depending on the specifics of the leased space and the lease agreement, the amounts paid for structural components will be recorded during the construction period as construction-in-progress and the landlord construction contributions will be recorded as a deferred rent liability. Upon completion of construction for those leases that meet certain criteria, the lease may qualify for sale-leaseback treatment. For these leases, the deferred rent liability and the associated construction-in-progress will be removed and any gain on sale will be recorded as deferred income and amortized over the lease term to gain on disposal of assets and any loss on sale will be expensed immediately to loss on disposal of assets, net. If the lease does not qualify for sale-leaseback treatment, the deferred rent liability will be reclassified to a deemed landlord financing liability and will be amortized over the lease term based on the rent payments designated in the lease agreement with rent payments applied to deemed landlord financing liability and interest expense.

Unfavorable lease liabilities represent the fair values of acquired lease contracts having contractual rents that are unfavorable compared to fair market rents as of the Closing Date of the Business Combination, and are amortized on a straight-line basis over the remaining lease terms to expense in the consolidated statements of comprehensive income.

Insurance Reserves

Given the nature of the Company’s operating environment, the Company is subject to workers’ compensation and general liability claims. To mitigate a portion of these risks, the Company maintains insurance for individual claims in excess of deductibles per claim (the Company’s insurance deductibles range from $0.25 million to $0.50 million per occurrence for workers’ compensation and are $0.35 million per occurrence for general liability). The Company is not the primary obligor for its worker's compensation insurance policy. The amount of loss reserves and loss adjustment expenses is determined based on an estimation process that uses information obtained from both Company-specific and industry data, as well as general economic information. Loss reserves are based on estimates of expected losses for determining reported claims and as the basis for estimating claims incurred but not reported. The estimation process for loss exposure requires management to continuously monitor and evaluate the life cycle of claims. Management also monitors the reasonableness of the judgments made in the prior year’s estimation process (referred to as a hindsight analysis) and adjusts current year assumptions based on the hindsight analysis. The Company utilizes actuarial methods to evaluate open claims and estimate the ongoing development exposure related to workers’ compensation and general liability.

Advertising Costs

Franchisees pay a weekly fee to the Company of 4% of their restaurants’ net sales as reimbursement for advertising and promotional services that the Company provides. Fees received in advance of payment for provided services are included in other accrued liabilities and were $0.7 million and $0.3 million at January 1, 2019 and January 2, 2018, respectively. Company-operated restaurants contribute to the advertising fund on the same basis as franchise-operated restaurants. At January 1, 2019 and January 2, 2018, the Company had an additional $0.9 million and $0.4 million, respectively, accrued for this requirement.

Production costs for radio and television advertising are expensed when the commercials are initially aired. Costs of distribution of advertising are charged to expense on the date the advertising is aired or distributed. These costs, as well as other marketing-related expenses for advertising are included in occupancy and other operating expenses in the consolidated statements of comprehensive income for Company expenses and included in franchise advertising expenses in the consolidated statements of comprehensive income for franchise expenses. Advertising expenses for the Company were $19.0 million for the fifty-two weeks ended January 1, 2019, $18.1 million for the fifty-two weeks ended January 2, 2018 and $17.2 million for the fifty-three weeks ended January 3, 2017.

Pre-opening Costs

Pre-opening costs, which include restaurant labor, supplies, cash and non-cash rent expense and occupancy and other operating costs incurred prior to the opening of a new restaurant are expensed as incurred.

Restaurant Closure Charges, Net

The Company makes decisions to close restaurants based on their cash flows, anticipated future profitability and leasing arrangements. The Company determines if discontinued operations treatment is appropriate and estimates the future obligations, if any, associated with the closure of restaurants and records the corresponding restaurant closure liability at the time the restaurant is closed. These restaurant closure obligations primarily consist of the liability for the present value of future lease obligations, net of estimated sublease income. Restaurant closure charges, net are comprised of direct costs related to the restaurant closure and initial charges associated with the recording of the liability at fair value, accretion of the restaurant closure liability during the period, any positive or negative adjustments to the restaurant closure liability in subsequent periods as more information becomes available and sublease income from leases which are treated as deemed landlord financing. Changes to the estimated liability for future lease obligations based on new facts and circumstances are considered to be a change in estimate and are recorded prospectively. Accretion expense is recorded in order to appropriately reflect the present value of the lease obligations as of the end of a reporting period. Lease payments net of sublease income received related to these obligations reduce the overall liability. To the extent that the disposal or abandonment of related property and equipment results in gains or losses, such gains or losses are included in loss on disposal of assets, net in the consolidated statements of comprehensive income.

Stock-Based Compensation Expense

The Company recognizes compensation expense for all share-based payment awards made to employees and non-employee board of directors based on their estimated grant date fair values using the Black-Scholes option pricing model for option grants and the closing price of the underlying common stock on the date of the grant for restricted stock awards. The Company recognizes these compensation costs for only those awards expected to vest, on a straight-line basis over the requisite service period of the award. The Company estimates the number of awards expected to vest based, in part, on historical forfeiture rates and also based on management's expectations of employee turnover within the specific employee groups receiving the awards. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods, if actual forfeitures differ from those estimates. Stock-based compensation expense for the Company’s stock-based compensation awards is recognized ratably over the vesting period on a straight-line basis.

Income Taxes

The Company uses the liability method of accounting for income taxes. Deferred income taxes are provided for temporary differences between financial statement and income tax reporting, using tax rates scheduled to be in effect at the time the items giving rise to the deferred taxes reverse. The Company recognizes the impact of a tax position in the financial statements if that position is more likely than not of being sustained by the taxing authority. Accordingly, the Company reports a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense.

Derivative Instruments and Hedging Activities

The Company is exposed to variability in future cash flows resulting from fluctuations in interest rates related to its variable rate debt. As part of its overall strategy to manage the level of exposure to the risk of fluctuations in interest rates, the Company has used various interest rate contracts including interest rate caps. The Company recognizes all derivative instruments as either assets or liabilities at fair value in the consolidated balance sheets. When they qualify as hedging instruments, the Company designates interest rate caps as cash flow hedges of forecasted variable rate interest payments on certain debt principal balances.

For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing hedge ineffectiveness are recognized in current earnings.

The Company enters into interest rate derivative contracts with major banks and is exposed to losses in the event of nonperformance by these banks. The Company anticipates, however, that these banks will be able to fully satisfy their obligations under the contracts. Accordingly, the Company does not obtain collateral or other security to support the contracts.

Contingencies

The Company recognizes liabilities for contingencies when an exposure that indicates it is probable that an asset has been impaired or that a liability has been incurred and the amount of impairment or loss can be reasonably estimated. The Company’s ultimate legal and financial liability with respect to such matters cannot be estimated with certainty and requires the use of estimates. When the reasonable estimate is a range, the recorded loss will be the best estimate within the range. The Company records legal settlement costs when those costs are probable and reasonably estimable.

Comprehensive Income (Loss)

Comprehensive income (loss) includes changes in equity from transactions and other events and circumstances from nonoperational sources, including, among other things, the Company’s unrealized gains and losses on effective interest rate caps which are included in other comprehensive income (loss), net of tax.

Segment Information

An operating segment is defined as a component of an enterprise that engages in business activities from which it may earn revenues and incur expenses, and about which separate financial information is regularly evaluated by the Company’s chief operating decision makers in deciding how to allocate resources. Similar operating segments can be aggregated into a single operating segment if the businesses are similar. Management has determined that the Company has one operating segment, and therefore one reportable segment. The Company’s chief operating decision maker (CODM) is its Chief Executive Officer; its CODM reviews financial performance and allocates resources at a consolidated level on a recurring basis.

Related Party Transactions

Of the 424,439 warrants purchased during the fifty-two weeks ended January 2, 2018, 400,000 warrants were purchased from PW Acquisitions, LP, a related party, at $3.75 per warrant, representing a 5% discount from the closing price of $3.95 per warrant on the transaction date. A member of the Company's Board of Directors is the chief executive officer and managing member of the general partner of PW Acquisitions, LP.

Fair Value of Financial Instruments

The Company measures fair value using the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of the three tiers in the fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:


•	Level 1, defined as observable inputs such as quoted prices in active markets;


•	Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and


•	Level 3, defined as unobservable inputs which reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques may include the use of third-party pricing services, option pricing models, discounted cash flow models and similar techniques.

Concentration of Risks

Financial instruments that potentially subject the Company to a concentration of credit risk are cash and cash equivalents. The Company maintains its day-to-day operating cash balances in non-interest-bearing accounts. Although the Company at times maintains balances that exceed amounts insured by the Federal Deposit Insurance Corporation, it has not experienced any losses related to these balances and management believes the credit risk to be minimal.

The Company extends credit to franchisees for franchise and advertising fees on customary credit terms, which generally do not require collateral or other security. In addition, management believes there is no concentration of risk with any single franchisee or small group of franchisees whose failure or nonperformance would materially affect the Company’s results of operations.

The Company has entered into a long-term purchase agreement with a distributor for delivery of essentially all food and paper supplies to all company-operated and franchise-operated restaurants except for one location in Guam. Disruption in shipments from this distributor could have a material adverse effect on the results of operations and financial condition of the Company. However, management of the Company believes sufficient alternative distributors exist in the marketplace although it may take some time to enter into replacement distribution arrangements and the cost of distribution may increase as a result.

As of January 1, 2019, Del Taco operated and franchised a total of 376 restaurants in California (255 company-owned and 121 franchise-operated locations). As a result, the Company is particularly susceptible to adverse trends and economic conditions in California. In addition, given this geographic concentration, negative publicity regarding any of the restaurants in California could have a material adverse effect on the Company’s business and operations, as could other regional occurrences such as local strikes, fires, earthquakes or other natural disasters.

Recently Adopted and Recently Issued Accounting Standards

Recently Adopted Accounting Standards

In March 2016, the Financial Accounting Standards Board ("FASB") issued ASU No. 2016-04, Liabilities-Extinguishment of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products, which is designed to provide guidance and eliminate diversity in the accounting for the derecognition of financial liabilities related to certain prepaid stored-value products using a revenue-like breakage model. The Company adopted the requirements of the new standard in the first quarter of 2018, utilizing the cumulative effect transition method. There was no material impact of the standard on the Company's consolidated financial statements and related disclosures as a result of adopting this standard.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which provides a comprehensive new revenue recognition model that requires a company to recognize revenue in an amount that reflects the consideration it expects to receive for the transfer of promised goods or services to its customers. The standard also requires additional disclosure regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. ASU No. 2014-09, also known as FASB ASC Topic 606 ("Topic 606") supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition ("Topic 605"). On January 3, 2018 (the first day of fiscal year 2018), the Company adopted the requirements of Topic 606, utilizing the modified retrospective method of transition. Adoption of the new standard resulted in changes to our accounting policies for revenue recognition, as detailed below. Topic 606 does not materially impact the recognition of company restaurant sales or franchise royalty income from franchisees included in franchise revenue.

Franchise Fees

The adoption of Topic 606 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. Under Topic 605, initial franchise fees were recognized when all material obligations had been performed and conditions had been satisfied, typically when operations of a new franchise restaurant had commenced, and renewal fees were recognized when a renewal agreement became effective. Topic 606 requires franchise and renewal fees to be deferred and recognized over the term of the related franchise agreement for the respective restaurant. Franchise agreements typically have a term of twenty years. The impact of the deferral of initial franchise and renewal fees received in a given year may be offset by the recognition of revenue from fees retrospectively deferred from prior years. Upon adoption, the Company recorded approximately $0.7 million as a cumulative effect adjustment to opening retained earnings comprised of $1.0 million of deferred franchise fees included in other non-current liabilities on the consolidated balance sheet as of January 3, 2018 (the first day of fiscal year 2018) related to franchise and renewal fees previously recognized since the Business Combination on June 30, 2015, partially offset by an adjustment of $0.3 million to deferred taxes related to the $1.0 million of deferred franchise fees.

During the fifty-two weeks ended January 1, 2019, the Company recognized approximately $0.1 million in franchise revenue related to the amortization of the deferred franchise fees recognized at January 3, 2018 as a result of the adoption of Topic 606, and recognized approximately $0.1 million in franchise revenue as a result of the termination of one development agreement.

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 January 1, 2019 is as follows (in thousands):



FY 2019	$	87
FY 2020	83
FY 2021	81
FY 2022	80
FY 2023	77
Thereafter	962
Total Deferred Franchise Fees	$	1,370

Advertising

The adoption of the new guidance changed the reporting of advertising contributions from franchisees and the related advertising expenses, which were not previously included in the consolidated statements of comprehensive income. Topic 606 requires these franchise advertising contributions and expenses to be reported on a gross basis in the consolidated statements of comprehensive income, which impacted our total revenues and expenses. However, the franchise advertising contributions and expenses are expected to be largely offsetting and therefore does not have a significant impact on reported net income. The current year impact to revenue for franchise advertising contributions and to expenses for franchise advertising expenses for the fifty-two weeks ended January 1, 2019 was an increase of $13.3 million for both revenue and expense as a result of applying Topic 606.

Other Revenue Transactions

The Company, previously under Topic 605, recorded certain other franchise expenses net of the related fees received from franchisees. Under Topic 606, the Company is now including these revenues and expenditures on a gross basis within the consolidated statements of comprehensive income. While this change materially impacted the gross amount of reported franchise related revenue and related expenses on the consolidated statements of comprehensive income, the impact is an offsetting increase to both revenue and expense such that there is not a significant, if any, impact on operating income and net income. The current year impact to revenues for the fifty-two weeks ended January 1, 2019 was an increase of approximately $0.7 million as a result of applying Topic 606, with an offsetting increase in expenses.

Comparison to Amounts if Previous Standards Had Been in Effect

The following tables reflect the impact of the adoption of Topic 606 on the Company's consolidated balance sheet as of January 1, 2019 and on the Company's consolidated statements of comprehensive income and cash flows from operating activities for the fifty-two weeks ended January 1, 2019 and the amounts as if Topic 605 was in effect ("Amounts Under Previous Standards") (in thousands):



	January 1, 2019
	As Reported		Adjustments for Prior Revenue Recognition Standards			Amounts Under Previous Standards
Liabilities and shareholders’ equity
Current liabilities:
Accounts payable	$	19,877	$	—		$	19,877
Other accrued liabilities	34,785		—			34,785
Current portion of capital lease obligations and deemed landlord financing liabilities	1,033		—			1,033
Total current liabilities	55,695		—			55,695
Long-term debt, capital lease obligations and deemed landlord financing liabilities, excluding current portion, net	178,664		—			178,664
Deferred income taxes	69,471		370			69,841
Other non-current liabilities	32,852		(1,369		)	31,483
Total liabilities	336,682		(999		)	335,683
Shareholders’ equity:
Preferred stock	—		—			—
Common stock	4		—			4
Additional paid-in capital	336,941		—			336,941
Accumulated other comprehensive income	180		—			180
Retained earnings	85,149		999			86,148
Total shareholders’ equity	422,274		999			423,273
Total liabilities and shareholders’ equity	$	758,956	$	—		$	758,956



	52 Weeks Ended January 1, 2019
	As Reported			Adjustments for Prior Revenue Recognition Standards			Amounts Under Previous Standards
Revenue:
Company restaurant sales	$	471,193		$	—		$	471,193
Franchise revenue	17,569			(370		)	17,199
Franchise advertising contributions	13,300			(13,300		)	—
Franchise sublease and other income	3,428			(312		)	3,116
Total revenue	505,490			(13,982		)	491,508
Operating expenses:
Restaurant operating expenses:
Food and paper costs	128,873			—			128,873
Labor and related expenses	151,954			—			151,954
Occupancy and other operating expenses	97,745			—			97,745
General and administrative	43,773			(770		)	43,003
Franchise advertising expenses	13,300			(13,300		)	—
Depreciation and amortization	25,794			—			25,794
Occupancy and other - franchise subleases and other	3,167			(312		)	2,855
Pre-opening costs	1,584			—			1,584
Impairment of long-lived assets	3,861			—			3,861
Restaurant closure charges, net	394			—			394
Loss on disposal of assets, net	1,012			—			1,012
Total operating expenses	471,457			(14,382		)	457,075
Income from operations	34,033			400			34,433
Other expense, net
Interest expense	9,075			—			9,075
Other income	(660		)	—			(660		)
Total other expense, net	8,415			—			8,415
Income from operations before provision for income taxes	25,618			400			26,018
Provision for income taxes	6,659			108			6,767
Net income	18,959			292			19,251
Other comprehensive income:
Change in fair value of interest rate cap, net of tax	122			—			122
Reclassification of interest rate cap amortization included in net income	44			—			44
Total other comprehensive income	166			—			166
Comprehensive income	$	19,125		$	292		$	19,417
Earnings per share:
Basic	$	0.50		$	0.01		$	0.51
Diluted	$	0.49		$	0.01		$	0.50



	52 Weeks Ended January 1, 2019
	As Reported			Adjustments for Prior Revenue Recognition Standards			Amounts Under Previous Standards
Operating activities
Net income	$	18,959		$	292		$	19,251
Adjustments to reconcile net income to net cash provided by operating activities:
Allowance for doubtful accounts	45			—			45
Depreciation and amortization	25,794			—			25,794
Amortization of favorable and unfavorable lease assets and liabilities, net	(767		)	—			(767		)
Amortization of deferred financing costs and debt discount	445			—			445
Stock-based compensation	6,079			—			6,079
Impairment of long-lived assets	3,861			—			3,861
Deferred income taxes	1,097			108			1,205
Loss on disposal of assets, net	1,012			—			1,012
Restaurant closure charges	449			—			449
Other income	(523		)	—			(523		)
Changes in operating assets and liabilities:
Accounts and other receivables, net	616			—			616
Inventories	(220		)	—			(220		)
Prepaid expenses and other current assets	1,949			—			1,949
Other assets	(125		)	—			(125		)
Accounts payable	2			—			2
Other accrued liabilities	(488		)	—			(488		)
Other non-current liabilities	3,647			(400		)	3,247
Net cash provided by operating activities	$	61,832		$	—		$	61,832

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.

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. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company's consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), and issued additional clarifications and improvements throughout 2018. This guidance will result in key changes to lease accounting and will aim 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 minimum lease payments, and a corresponding right-of-use asset on the balance sheet. The new leasing standard will be effective for fiscal years beginning after December 15, 2018, and for interim periods within those fiscal years. The new guidance requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with certain practical expedients available. The Company will adopt the requirements of the new lease standard effective January 2, 2019, the first day of fiscal year 2019, and will apply a modified retrospective adoption method using 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. The Company has elected the package of practical expedients which allows an entity to not reassess whether any existing or expired contracts contain leases, nor reassess lease classifications for existing or expired leases, and an entity does not need to reassess initial direct costs for any existing leases. The Company will not elect the hindsight practical expedient, which permits the use of hindsight when determining lease term and impairment of right-of-use assets. Further, the Company will elect a short-term lease exception policy, permitting the Company to not apply the recognition requirements of this standard to short-term leases with terms of 12 months or less. The Company is finalizing the impact of the standard to its accounting policies, processes, disclosures, and internal control over financial reporting and has implemented necessary upgrades to its existing lease system.

The adoption of ASU 2016-02 will have a significant impact on our consolidated balance sheet as the Company will record material right-of-use assets and operating lease liabilities upon adoption and will derecognize all landlord funded assets, deemed landlord financing liabilities and deferred rent liabilities upon transition. The Company expects to record operating lease liabilities of approximately $220 million to $240 million based on the present value of the remaining minimum rental payments using discount rates as of the effective date. In addition, the Company expects to record corresponding right-of-use assets of approximately $210 million to $230 million, based upon the operating lease liabilities adjusted for prepaid and deferred rent, unamortized favorable and unfavorable lease balances, 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 will record the cumulative effect of adoption to retained earnings. Following adoption 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. The Company anticipates substantial new disclosure requirements under Topic 842. The Company is continuing its evaluation, which may identify additional impacts this standard will have on its consolidated financial statements and related disclosures.