|Basis of Presentation and Summary of Significant Accounting Policies
Basis of Presentation
The Company uses a fifty-two or fifty-three week fiscal year ending on the Tuesday closest to December 31. Fiscal years 2020, 2019 and 2018 are 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. 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 2020, the Company’s financial statements reflect the fifty-two weeks ended December 29, 2020. For fiscal year 2019, the Company's financial statements reflect the fifty-two weeks ended December 31, 2019. For fiscal year 2018, the Company’s financial statements reflect the fifty-two weeks ended January 1, 2019.
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 the 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.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Variable Interest Entities
In accordance with 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.
We recognize revenue in accordance with ASC 606, Revenue from Contracts with Customers.
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 as revenue over the term of the renewal agreement. Development fees and franchise fees are 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 with the current portion included in accrued 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 lesser extent, franchise revenue also includes pass-through fees for services, such as software maintenance and technology subscriptions, since the Company is considered the principal related to the purchase and sale of the services to the franchisee and has no remaining performance obligations. The related expenses are recognized in general and administrative expenses.
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 December 29, 2020 is as follows (in thousands):
|FY 2021||$||198 |
|FY 2022||199 |
|FY 2023||191 |
|FY 2024||188 |
|FY 2025||188 |
|Total deferred franchise fees||$||3,080 |
Franchise advertising contributions consist of a percentage of a 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. Starting the last fiscal week of the first quarter of 2020, as a result of the COVID-19 pandemic, the Company
decreased franchise advertising contributions from 4.0% to 2.5% of franchise restaurant net sales for eight weeks and then adjusted the advertising contribution percentage back to 4.0% for the balance of 2020.
Franchise sublease and other income consists of rental income received from franchisees related to properties where the Company has subleased a leasehold interest to the franchisee but remain primarily liable to the landlord. The related expenses are recognized in occupancy and other - franchise subleases and other. Franchise sublease and other income also includes rental income for closed restaurant properties where the Company has subleased to a third party but remain primarily liable to the landlord. The related expenses are recognized in restaurant closure charges, net. Franchise sublease and other income also includes information technology hardware such as point of sale equipment, tablets, kitchen display systems, servers, scanners and printers that the Company occasionally purchases from third party vendors and then sells to franchisees. Since the Company is considered the principal related to the purchase and sale of the hardware to the franchisee and has 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.
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 $3.1 million as of both December 29, 2020 and December 31, 2019. The current portion of the deferred gift card income is included in other accrued liabilities on the consolidated balance sheets and totaled approximately $1.7 million and $1.6 million as of December 29, 2020 and December 31, 2019, respectively. The non-current portion of the deferred gift card income was approximately $1.5 million as of both December 29, 2020 and December 31, 2019 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 (loss) 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, delivery service providers ("DSPs") 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, receivables from DSPs are for company restaurant sales related to delivery orders fulfilled by the DSPs and the landlord receivables are for earned landlord reimbursement related to restaurants opened. The allowance for doubtful accounts is based on expected credit losses utilizing a range of information, including historical collections experience and a review on a specific identification basis of the collectability of existing receivables, and totaled approximately $0.1 million and as of both December 29, 2020 and December 31, 2019.
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 $27,000 and $0.3 million as of December 29, 2020 and December 31, 2019, 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 December 29, 2020 and December 31, 2019.
Inventories, consisting of food items, packaging and beverages, are valued at the lower of cost (first-in, first-out method) or net realizable value.
Assets Held for Sale
Assets held for sale include the net book value of property and equipment and goodwill for Company-operated restaurants that the Company plans to sell within the next year to new or existing franchisees, as well as the net book value of owned property that the Company plans to sell within the next year. Long-lived assets that meet the held for sale criteria are held for sale and reported at the lower of their carrying value or fair value, less estimated costs to sell. If the determination is made that the Company no longer expects to sell an asset within the next year, the asset is reclassified out of assets held for sale.
Property and Equipment
Property and equipment includes land, buildings, leasehold improvements, restaurant and other equipment, restaurant property leased to others and buildings under finance leases. Land, buildings, leasehold improvements, restaurant and other equipment acquired in business combinations are initially recorded at their estimated fair value. Land, buildings, leasehold improvements, restaurant and other 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 finance 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 $23.2 million for the fifty-two weeks ended December 29, 2020, $22.7 million for the fifty-two weeks ended December 31, 2019 and $23.1 million for the fifty-two weeks ended January 1, 2019. These amounts include $0.2 million for the fifty-two weeks ended December 29, 2020 and $0.5 million for the fifty-two weeks ended December 31, 2019 related to buildings under finance leases, as well as $0.9 million for the fifty-two weeks ended January 1, 2019 related to buildings under capital leases. Accumulated depreciation and amortization associated with property and equipment includes $0.3 million related to buildings under finance leases as of both December 29, 2020 and December 31, 2019.
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 $0.8 million for the fifty-two weeks ended December 29, 2020, $1.8 million for the fifty-two weeks ended December 31, 2019 and $1.6 million for the fifty-two weeks ended January 1, 2019. 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 (loss) income. The Company capitalizes interest in connection with the construction of its restaurants. Interest capitalized totaled approximately $34,000 for the fifty-two weeks ended December 29, 2020 and $0.1 million for both the fifty-two weeks ended December 31, 2019 and the fifty-two weeks ended January 1, 2019.
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 and adjustments to assets held for sale, net in the consolidated statements of comprehensive (loss) 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 the carrying amount, the Company performs a quantitative impairment test. 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. As the Company adopted ASU 2017-04, Simplifying the Test for Goodwill Impairment, in 2019, the Company recognizes goodwill impairment for the carrying amount in excess of fair value. The Company also 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.
During the fifty-two weeks ended December 29, 2020, in the first quarter, the Company identified indicators of impairment and performed quantitative impairment assessments, which resulted in a non-cash impairment of goodwill of $87.3 million and a non-cash impairment of trademarks of $11.9 million. See Note 6, Goodwill and Other Intangible Assets, for further discussion.
During the fourth quarter of 2020, the Company performed its annual impairment test using a qualitative assessment to determine whether it is more likely than not that the fair value of goodwill or indefinite-lived trademarks is less than the carrying value. Based on the qualitative assessment, the Company determined that no additional goodwill or trademark impairment was needed.
Intangible Assets, Net
Intangible assets primarily include franchise rights, reacquired franchise rights and sublease assets. 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 (loss) income over the remaining term of the franchise agreements. Reacquired franchise rights, which represent the fair value of reacquired rights that were previously granted to franchisees to use Del Taco's trade name under a franchise agreement, are amortized on a straight-line basis to depreciation and amortization in the consolidated statements of comprehensive (loss) income over the term of the former franchise agreement. Sublease assets, which represent subleases with stated rent above comparable market rents, are amortized to sublease income over the term of the related sublease.
Other Assets, Net
Other assets, net consist of security deposits, straight-line rental income related to subleases 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 three to five years. The net carrying value of capitalized software costs for the Company totaled $2.5 million and $2.9 million as of December 29, 2020 and December 31, 2019, respectively, and is included in other assets, net in the consolidated balance sheets. Capitalized software costs totaled $1.6 million for the fifty-two weeks ended December 29, 2020, $2.0 million for the fifty-two weeks ended December 31, 2019 and $1.5 million for the fifty-two weeks ended January 1, 2019. Amortization expenses totaled $1.9 million for the fifty-two weeks ended December 29, 2020, $1.4 million for the fifty-two weeks ended December 31, 2019 and $1.2 million for the fifty-two weeks ended January 1, 2019.
Long-lived assets, including property and equipment and definite-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 the discounted value of the estimated cash flows associated with the respective restaurant or agreement. During the fifty-two weeks ended December 29, 2020, the Company evaluated certain restaurants having indicators of impairment based on operating performance and recorded an impairment charge totaling $8.3 million related to eight restaurants. During the fifty-two weeks ended December 31, 2019, the Company recorded an impairment charge totaling $7.2 million related to seven restaurants. During the fifty-two weeks ended January 1, 2019, the Company recorded an impairment charge totaling $3.9 million related to five restaurants.
The Company has non-cancelable lease agreements for certain restaurant land and buildings under terms ranging up to 50 years, with one to four options to extend the lease generally for to years per option period. At inception, each lease is evaluated to determine whether it will be classified as an operating or finance lease. Certain leases provide for contingent rentals based on percentages of net restaurant sales or have other provisions obligating the Company to pay related property taxes and certain other expenses. Contingent rentals are generally based on restaurant 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). In addition, the Company subleases certain buildings to franchisees and other unrelated third parties, which are classified as operating leases.
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. Beginning in 2020, one workers compensation claim per policy year has a deductible of $0.75 million in California only. 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 used 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 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. The Company is not the primary obligor for its workers' compensation insurance policy, so therefore, the Company records a liability up to its deductible exposure.
Insurance Recovery Assets
In the normal course of its business, the Company incurs losses, such as those resulting from property damage and legal actions, that are covered by the Company's insurance policies. The Company records insurance recovery assets for losses it is entitled to recover under its insurance policies and when such recovery is probable. In determining whether a recovery is probable, the Company considers whether the Company has exceeded its deductible, the limits of its insurance policies and subsequent payment of claims.
Franchisees pay a weekly fee to the Company of 4.0% of their restaurants’ net sales as reimbursement for advertising and promotional services that the Company provides. As a result of the COVID-19 pandemic, starting the last fiscal week of the first quarter of 2020, the Company decreased franchise advertising contributions from 4.0% to 2.5% of franchise restaurant net sales for eight weeks and then adjusted the advertising contribution percentage back to 4.0% for the balance of 2020.
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 (loss) income for company expenses and included in franchise advertising expenses in the consolidated statements of comprehensive (loss) income for franchise expenses. Advertising expenses for the Company were $16.4 million for the fifty-two weeks ended December 29, 2020, $18.8 million for the fifty-two weeks ended December 31, 2019 and $19.0 million for the fifty-two weeks ended January 1, 2019.
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. Pre-opening costs were $0.5 million for the fifty-two weeks ended December 29, 2020, $1.7 million for the fifty-two weeks ended December 31, 2019, and $1.6 million for the fifty-two weeks ended January 1, 2019.
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. Prior to the adoption of Topic 842, 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 were 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. After the adoption of Topic 842, these restaurant closure obligations primarily consist of rent, property tax and common area maintenance on closed restaurant properties and the present value of non-lease executory costs for closed restaurant properties, net of non-lease executory costs to be recovered from sublessees. Changes to the estimated liability for future non-lease executory costs based on new facts and circumstances are considered to be a change in estimate and are recorded prospectively. The change resulting from the adoption of Topic 842 led to an increase in restaurant closure charges for the fifty-two weeks ended December 29, 2020 and the fifty-two weeks ended December 31, 2019 as compared to the fifty-two weeks ended January 1, 2019.
Stock-Based Compensation Expense
The Company recognizes compensation expense for all share-based payment awards made to employees and non-employee 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.
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 recognized all derivative instruments as either assets or liabilities at fair value in the consolidated balance sheets. When they qualified as hedging instruments, the Company designated interest rate caps as cash flow hedges of forecasted variable rate interest payments on certain debt principal balances.
For derivative instruments that were designated and qualified as cash flow hedges, the effective portion of the gain or loss on the derivative was reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affected earnings. Gains and losses on the derivative representing hedge ineffectiveness were recognized in current earnings.
The Company entered into interest rate derivative contracts with major banks and was exposed to losses in the event of nonperformance by these banks. However, these banks were able to fully satisfy their obligations under the contracts. Accordingly, the Company did not obtain collateral or other security to support the contracts. The Company's interest rate cap agreement, as discussed in Note 8, expired on March 31, 2020.
The Company recognizes liabilities for contingencies when an exposure 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 (Loss) Income
Comprehensive (loss) income 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 (loss) income, net of tax.
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
There were no related party transactions in the fifty-two weeks ended December 29, 2020, the fifty-two weeks ended December 31, 2019 or the fifty-two weeks ended January 1, 2019.
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 restaurant 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 December 29, 2020, Del Taco operated and franchised a total of 370 restaurants in California (232 company-operated and 138 franchise-operated restaurants). 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, other natural disasters or regional restrictions and regulations including those related to the COVID-19 pandemic.
Recently Adopted Accounting Standards
In June 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-13, Financial Statements - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires companies to measure credit losses utilizing a methodology that reflects expected credit losses and requires a consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The standard is effective for fiscal years beginning after December 15, 2019. The Company adopted the requirements of this new standard in the first quarter of 2020, utilizing the modified retrospective approach. There was no material impact on the Company's consolidated financial statements and related disclosures as a result of adopting this standard.
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. The Company adopted the requirements of this new standard in the first quarter of 2020, utilizing the prospective approach. There was no material impact on the Company's consolidated financial statements and related disclosures as a result of adopting this standard.
Recently Issued Accounting Standards
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which simplifies the accounting for income taxes by removing the following exceptions: (1) exception to the incremental approach for intraperiod tax allocation when there is a loss from continuing operations and income or gain from other items; (2) exception to the requirement to recognize a deferred tax liability for equity method investments when a subsidiary becomes an equity method investment; and (3) exception to the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. Furthermore, ASU 2019-12 simplifies the accounting for income taxes by doing the following: (1) requiring that an entity recognize a franchise tax (or similar tax) that is partially based on income as an income-based tax and account for any incremental amount incurred as a non-income-based tax; (2) requiring that an entity evaluate when a step up in the tax basis of goodwill should be considered part of the business combination in which the book goodwill was originally recognized and when it should be considered a separate transaction; (3) specifying that an entity is not required to allocate the consolidated amount of current and deferred tax expense to a legal entity that is not subject to tax in its separate financial statements; and (4) requiring that an entity reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020. Early adoption is permitted. The Company is currently evaluating the impact of the standard on its consolidated financial statements.