Chuy's Holdings, Inc.
Q3 2014 Earnings Call Transcript

Published: 5 Nov 2014

[Operator:]

Good day, everyone, and welcome to the Chuy's Holdings Incorporated Third Quarter 2014 Earnings Conference Call. Today’s conference is being recorded. At this time, all participants have been placed in listen-only mode and the lines will be opened for your questions following the presentation. On today’s call, we have Steve Hislop, President and Chief Executive Officer, and Jon Howie, Vice President and Chief Financial Officer of Chuy's Holdings Incorporated. At this time, I’ll turn the conference over to Mr. Howie. Please go ahead, sir

[Jon Howie:]

Thank you, operator, and good afternoon. By now, everyone should have access to our third quarter 2014 earnings release. It can also be found at our website at www.chuys.com in the Investors section. Before we begin our review of the formal remarks, I need to remind everyone that part of our discussions today will include forward-looking statements. These forward-looking statements are not guarantees of future performance and therefore you should not put undue reliance on them. These statements are also subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial conditions. Also during today’s call, we will discuss non-GAAP financial measures which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP, and the reconciliation to comparable GAAP measures is available in our earnings release. With that out of the way, I’d like to turn the call over to Steve.

[Steve Hislop:]

Thank you, Jon, and thank you all for joining us today on the call. Our third quarter proved to a challenging one with the results coming in below our internal plan. We did see a continuation in comparable sales growth at the 3% increase during the quarter which represents our 17th consecutive quarter of positive comps. However we continue to be negatively impacted by sales in our non-comparable restaurants, particularly in our 2013 class that have settled in below our historical new unit targets as well as the corresponding labor and fixed cost inefficiencies at those restaurants. These non-comparable restaurants currently comprise approximately 33% of our total stores. In addition like many in the industry we have been played by elevated food cost pressures that in time will pass but continue to hamper four-wall profitability throughout our system. As a consequence, our restaurant level EBITDA as a percent of sales decreased by 100 basis points despite a 20% increase in revenue. As we have previously discussed we are targeting 80% of our new development through 2015 largely around backfilling existing markets which we believe will continue to enhance the awareness of Chuy’s brand and ultimately have a positive effect on the performance of our developing market. Additionally, as we continue to grow our footprint in developing markets we are recognizing that our new unit volumes are not as predictable as those in our core market. We continue to build restaurants in our developing markets that achieve results at or above our historical 4.2 million year one target, however we must acknowledge that many or some of our new units will scale and mature at lower AUVs. While sales volumes at 85% to 90% of our targets would yield solid returns of our 25% to 30% we are continuing to evaluate potential tweaks to improve returns at these sales levels. As per our existing development market restaurants, we continue to look for ways to improve their performance as well. Last quarter we noted sales enhancing initiatives focused on local store marketing and branding at our newer restaurants to highlight our strength and points of differentiation that we believe have been key drivers to success of our business for over 30 years. We are also looking at some of our mature lower volumes restaurants that have historically run mid-teen margins, but best practice is to improve our operating performance in some of our newer restaurants without disrupting the guest experience. We are confident that our developing market units can overtime reach profitability and return level that are in line with balance per unit base. We are still pleased with the early results of our 2014 openings and we believe we are seeing improving performance in certain markets. However I would caution that changes will not occur overnight. As a result, we are lowering our near-term expectations of which Jon will provide more detail in just a second. During the third quarter we opened four new restaurants. In San Antonio, Texas and Kennesaw, Georgia outside of Atlanta, Fairfax, Virginia, in the Washington, DC metropolitan area; and Sugar Land, Texas, outside of Houston. Subsequent to the end of the quarter we opened our 11th and final new restaurant of 2014 in Springfield, Virginia, also outside Washington DC. For 2015 development plan we currently are targeting 11 to 12 new restaurant openings and have signed leases or hard LOIs for all of our planned openings at this time. Again, our 2015 development will continue to include the majority of new restaurants in developing markets with existing restaurants to elevate awareness of the brand. With only 59 Chuy’s restaurants as of today we continue to have a tremendous amount white space development ahead of us. Now for our more detailed look at our third quarter results I would like to turn the call over to our CFO Jon Howie.

[Jon Howie:]

Thanks Steve. For our third quarter ended September 28, 2014 revenue increased 19.9% to 64.1 million from 53.5 million in last year’s third quarter. The increase was due primarily to 10.9 million in incremental revenue from an additional 140 operating weeks provided by 14 new restaurants opened during and subsequent to the third quarter 2013. The increase is partially offset by decrease in revenue related to units that are not yet in the comparable restaurant sales base and are lasting their honeymoon period. Total operating weeks for the third quarter 2014 were at 729. As mentioned earlier comparable restaurant sales increased 3% in the quarter driven by 1.7% increase in average check and a 1.3% increase in traffic. This included a price increase of approximately 1% effective implemented at the end of August which had minimal effect on our third quarter average check. There were 39 restaurants included in the comparable restaurant base during the third quarter of 2014, which included one new restaurant added, at the base, at the beginning of the quarter. We consider restaurants to be comparable in the first full quarter following 18 months of operation. As a reminder our restaurant can open at volumes greater than their eventually normalized run rate. In the case of our strongest openings this honeymoon period may last longer than the 18 months we allow before a restaurant to comparable restaurant base. Given the small number of restaurants currently in our comparable restaurant base the timing and strength of our new unit openings may create the headwind in our comparable restaurant sales percentage in some quarters in the near-term. Today, that headwind has reduced our comparable restaurant sales percentage ranging from 0.5% to 1.2% in any given quarter. Switching over to expenses, cost of sales as a percent of revenue increased 40 basis points to 28.2%, primarily due to continued commodity pressures related to beef, chicken and dairy. Current we expect pressures with regards to beef and dairy to continue through the fourth quarter and into 2015 and expect cost pressures with regard to products to affect us through the fourth quarter. We have recently seen some relief in chicken but is very early. So based on our results today and new expectations for the reminder of the year, our outlook for food inflation for the full year 2014 has increased to between 4.5% and 5%. This has put our cost of sales as a percentage of our revenue between 28.2% - 28.4% for fiscal 2014. As I mentioned previously we expect to see the commodity pressures to continue with regard to dairy, beef and to some extent chicken into 2015. Remember, we only contract approximately 25% to 30% of our commodity base and we are currently finalizing some of those contracts. So while we are not ready to release a specific projection for 2015 at this we believe our 2015 food cost inflation will increase at a lower rate than we experienced during 2014. Labor cost as a percentage of our revenue increased to 110 basis points to 33.9% primarily due to lower sales volumes of fixed labor coupled with laboring efficiencies at some of our non-comparable restaurant locations which still accounts 33% of our overall restaurant base. Labor in our comparable restaurant, as a percentage of revenue was down 50 basis points. As Steve mentioned in addition to backfilling developing markets we are focused on sales driving and operations enhancing initiatives in certain of our developing market restaurants which we believe can help return labor cost as a percentage of sales in these restaurants to a normalized level overtime. However given our current results we now expect our labor for the year to be in the range of 33.8% to 34%. Restaurant operating cost as a percentage of revenue decreased approximately 30 basis points to 14%, the improvement was largely attributable to lower liquor taxes as a result of the impact of the new liquor tax law in Texas which went into effect on January 01, 2014 and a continued increase in a number of new restaurant openings outside of Texas which generally has lower liquor taxes in Texas if any. The improvement was partially offset by high utility and insurance cost as a percentage of revenues. Occupancy cost as a percentage of revenue decreased slightly by 10 basis points to 5.9% as a result of lower property taxes which was partially offset by higher rent expense at certain new restaurants as we continue to expand and backfill into new markets. General and administrative expenses in the third quarter increased to 2.9 million from 2.4 million last year increase on a dollar basis was driven by higher stock-based compensation as a result of changes in our longer term incentive program increases in headcount since last year and higher legal and professional fees partially offset by lower performance based bonuses. As a percentage of revenue G&A expenses remain steady at 4.5%. Restaurant pre-opening cost increased 290,000 to 1.3 million in the third quarter due to the opening of four restaurants during the quarter versus two restaurants during the same quarter last year. As well as timing of the opening dates and stage of development for these restaurants are in their current pipeline. We expect our pre-opening expenses for the year to be approximately 4.4 million which included the opening of our 11th restaurant substituent to the end of the third quarter to finish our 2014 development, as well as slightly higher pre-opening cost related to obtaining possession of these properties earlier in the construction process. Depreciation and amortization increased approximately 339,000 to 2.7 million in the third quarter primarily driven by increases in equipment and leasehold improvement cost associated with our newer restaurants. Interest expense was 36,000 in the quarter and our total outstanding debt under our credit facility at the end of the third quarter was 828 million. Our effective tax rate for the third quarter of 2014 was approximately 26.3% compared to 30% during the third quarter of last year. This year’s lower effective rate was primarily attributable to a higher percentage of employment tax credit, the free tax income in 2014 versus 2013. Net income in the third quarter of 2014 was 3.1 million or $0.19 per diluted share compared to 2.8 million or $0.17 per diluted share in the third quarter of 2013. As we discuss, we continue to feel the impact of lower sales at certain of our non-comparable restaurants which houses labor and fixed cost inefficiencies as a result. Additionally we’ve also experienced higher than expected commodity cost with that in mind, we’re lowering our outlook for the balance of 2014. We now expect our fiscal 2014 diluted net income per share in the range of $0.67 to $0.69 per share. Our revised net income guidance for fiscal 2014 is based impart on the following annual assumptions. We expect comparable restaurant sales to increase between 2.7% and 2.9% for the full year. Food cost inflation for the full year is expected to increase approximately 4.5% to 5%. We expect labor cost as a percentage of revenue of approximately 33.8% to 34% and we expect our restaurant pre-opening expenses to run approximately 4.4 million for 2014. G&A expenses should run approximately 12 million for the year which includes approximately 1.4 million in projected incremental expense related to the company’s changes to its compensation in long-term incentive programs. Finally, we now expect because of our lower projected income that our effective tax rate for the full year will range between 28% and 29% and annual weighted average diluted shares outstanding up 16.7 million to 16.8 million. As Steve noted we’ve completed our 2014 development plan with the opening of our 11th restaurant in late October. Our capital expenditures net of tenant improvement allowances are still projected to be approximately 27.5 million to 30 million. And now I’ll turn the call back over to Steve to wrap up.

[Steve Hislop:]

Thanks, Jon. In closing, we are working diligently to tackle what we believe are near term challenges as well as taking a thoughtful look at the evaluation of our new unit model as we grow our brand nationally. While we continue to face near term food cost inflation, we believe that our value proposition for this pricing power should elevate input pricing remains for an extended period of time. We have every reason to be excited about the long-term potential of our business including the continued growth of our restaurant base with sales volumes and returns that will exceed industry norms. In combination of freshly prepared, crave-able, Mexican inspired offerings, tremendous value and a fun energetic environment has led to industry-leading average unit volumes and a long history of consistent comparable sales growth and we believe this is an enviable base to build on. Before we go to the question-and-answer portion of our call, I’d like to take a moment to thank all of our Chuy’s employees. Our success has always been a testament to their hard work and dedication to earning the dollar of our every single day. And with that said, we thank you for your interest in our company. We’ll be happy to answer any questions you might have. Operator, please open the lines for questions.

[Operator:]

Absolutely. (Operator Instructions) We’ll go first to David Tarantino with Robert W. Baird.

[David Tarantino:]

Hi, good afternoon. Steve, I wanted to follow up on your commentary around evolving the new unit model, and I just want to first clarify, is this mostly related to what you’ve seen in the 2013 class or you’re also seeing that in 2014 class. And then I guess secondly, could you elaborate on what you mean by evolving the model?

[Steve Hislop:]

Sure. I’d say still most of it -- To talk about ‘14 first. ‘14 is exciding our expectations as far as the model currently. We will definitely be going into our lowest index in quarter of the year is in the fourth quarter as you know. So as we look at that whole classes and we probably figure it will probably coming around $4 million number on the average. So that’s what we’re looking at there. But that most of it is definitely the ‘13 model of what we’re got. And the what we want to do is, to know the variability that we’re seeing on opening markets outside of our core base we’ve seen as I mentioned earlier it’s little harder to predict we’re not embarrass by a $3.26 million number, $3.8 million number and that’s very wrong we should be able to make a lot of money. But we’re having a hard times stick into the variability of the new markets outside of our floor.

[David Tarantino:]

And so I guess as a follow-up, what’s the game plan on how to achieve the type of returns that you seek on those may be lower volumes and developing markets, is there something you can do maybe in the near term to right size the cost structure in those units?

[Steve Hislop:]

Sure and we have like I mentioned we have a lot of stores that are in that 35 to 37 numbers and they have -- we’re going to take all of those stores as our best practices to help with our new and emerging stores at the proper time in their growth spurt to their honeymoon period. But we have plenty of examples of how to be very profitable in those areas.

[David Tarantino:]

Got it. And then I guess as it relates to the guidance, fairly big change versus what you're thinking three months ago, and I know part of that's through cost. But I guess the question on the labor side is, what specifically was the issue that caused the surprise on the labor side, that sounds like that's quite a bit higher than what you are thinking three months ago.

[Steve Hislop:]

Well for the third quarter, we definitely had it in their -- basically at the end of if the new store volumes and more specifically about the 13 stores when you look at our indexing quarter going down in the third quarter and then our worst quarter in the fourth. So, that’s what most of it was right there just basically the new store volumes that we had on those new stores.

[David Tarantino:]

And is that an issue that’s going to continue to put upward pressure on labor next year or does that normalize as you think about cycling from the issues you’re seeing this year?

[Jon Howie:]

This is Jon, David. I expected to put a little upward pressure next year as well until we can set down and kind of go through and get these best practices in and [rest] it down and get some of those best practices in those new stores.

[Steve Hislop:]

And don’t forget Jon and David also, that when we have opened our new store -- all the 2014 stores as we’ve mentioned many times before, it’s a full year ramp up on labor when we do everything from scratching at our stores and all our cross trending and so forth.

[David Tarantino:]

Got it, thank you very much.

[Operator:]

Thank you. We will take our next question from Will Slabaugh with Stephens Incorporated.

[Will Slabaugh:]

Yes, thanks guys. Want to ask about the 2014 stores. It sounds like those are still off to a pretty good start and I know in last quarter you reference those are being somewhat similar to your 2011 and 2012 kinds of the stores. So I want to kind of come back and circle around and double check out if it’s still the case and you're still pretty pleased with the trajectory of those stores and then I have a follow-up after that.

[Steve Hislop:]

Yes, David as I mentioned to you earlier right now there are -- Will, I’m sorry. As we mentioned to you before we’re pleased reading the 4.2 right now, the key to the 11 and 10, 11, 12 stores is, there was a higher percent of Texas stores in there, basically our core stores than they was in 2013 already even ’14. But again we’re pleased, but as we said we open the lot of backfill markets where we put these stores at and like I said you’re probably right around that 4 million plus member at the end of the year is what I'd say. So, a little bit less than the ’11.

[Will Slabaugh:]

And whenever you’re think your next and then the years after about building stores around these -- the newer markets that are currently opening is a little bit softer than we've seen historically. Are you planning for those to be, that they kind of open up at similar levels? How should we think about modeling that going forward in terms of -- should we think about the newer stores going forward that aren’t mark in the core market as being 3.5 to 3.7 type store?

[Steve Hislop:]

Well that’s what I think goes back to David’s question earlier about the evolution of the new store model. Again we’re learning of that single day how it’s evolving. But we probably as in the out of town markets where you don’t have core markets i.e. Texas, it would definitely be less than the 4.2 I would say.

[Will Slabaugh:]

Got it and last one for me. In terms of the guidance and trying to get there for -- forward to you to get down to the new guide. Is there any material change in core, do they trend to the top line that drove that as well or is it mainly just around the efficiencies and then cost of good sales spiking upon you little bit?

[Steve Hislop:]

With the efficiencies in the cost of good sales, exactly that.

[Operator:]

Thank you we’ll continue on to Andy Barish with Jefferies.

[Andy Barish:]

Hi guys. Is there a way to kind of I guess look at those 2 buckets that you've finished up on their Steve, the higher inflation on food costs versus the inefficiencies in terms of the impact in the 4Q, is it roughly equal or do you have enough detail on that to share with us?

[Steve Hislop:]

I think Jon --.

[Jon Howie:]

It’s roughly equal.

[Andy Barish:]

Okay, and then what -- I guess what historical data points kind of give you confidence that you add second and third stores in the market that may started out slow, let’s say at Kansas city. Is it similar to what you saw in Nashville or can you give us a little comfort on that, when you build brand awareness and you build more stores it actually raises the volume all the stores, it’s not chipping away from that original store?

[Steve Hislop:]

Yes, absolutely Andy and obviously our strategy is when we go into a market as dominator and the number of units and the volumes without cannibalization, when we add stores an example would be back in ’10 ’11, we have had Louisville, Lexington stores that started rather shy of our AUV average on a new sort of model. Those two now are one is leading the Company in same-store sales in double digits currently right now and that’s the Lexington store, and Louisville store is moving up and we have a real nice promise in both of stores, but that’s an example. And also from path, Andy you know where -- when you looked at similar type of model and growth model, I was always better of as I built out the market, and had more awareness. So that’s mostly -- but I could give other examples.

[Andy Barish:]

And then just one final thing. On the food cost basket, unless lines go crazy again, that was a big number in the first half 70 to 80 bps, what are you seeing. Currently you mentioned produce. Is it tomatoes or and then should that look better in the first half getting some of that line in --line increases back in 2015?

[Steve Hislop:]

Remember the line is kind of increased right at the end of the first quarter. So it should look a little better in 2000 in the first quarter. What we’re seeing, produce is up 5% already in the fourth quarter. So we’re seeing a pickup. And most of that -- you’re correct -- is in tomatoes and also lattice.

[Jon Howie:]

Yes, lettuce is kind all rusty and its real-real light and it’s expensive. So it’s kind of perfect hit on that type of stuff. But we continue to see cost pressures also in chicken, in beef and also daily, although chicken has come down a little bit in the last five weeks.

[Operator:]

Thank you. Our next question will come from Chris O'Cull with KeyBanc.

[Chris O'Cull:]

Thanks guys. Jon, on the last call you had seen kind of three quarters where the 2013 opening class really had really pressured labor costs, but you seem pretty confident in labor would be up only slightly in the back half of the year. So I guess I'm trying to understand what has changed or what happened or what were you expecting to happen to this 13 class in the back half here?

[Steve Hislop:]

Well a couple of things. One, I was expecting kind of our labor to ratchet down a little more. We’re expecting the sales to kind of flatten out versus go down. That's kind of normal trend with some of the sale initiatives that we’re doing in those stores, but we’re seeing kind of a normal drop off. We saw the normal drop off in school -- going back to the school as the other one. And the third thing was even though we were talking or we were looking and analyzing a price increase during our call, I factored in -- because I was looking at the cost of sales and factoring at little leverage in that price increase, which -- we got very little flow through in that price increase that we took during the third quarter.

[Jon Howie:]

And also Chris on the volumes that they were, we thought they -- it would have a little bit better back to school time and it just followed the actual history. So that’s another -- being a little too optimistic on the 13 stores.

[Chris O'Cull:]

And then you mentioned 33% of the stores are struggling with inefficiencies I think in the release, which would equate to 18 to 19 stores?

[Jon Howie:]

That’s not what I’ve said Chris. I'm sorry, if I misinterpreted or I said that. What I meant is that we have 33% stores that are not -- they not in our comp base. That’s what I meant by hat.

[Chris O'Cull:]

How many stores are really contributing to these inefficiencies?

[Jon Howie:]

I would say about half of them. Half of them, meaning that they're not hitting our 4.2 model.

[Chris O'Cull:]

Half of the '13 class, okay. Are there common factors that you can identify? Is it real estate? Is it?

[Steve Hislop:]

That’s great question. As you look at it Chris, obviously, it’s evolving and as I told you, the variability of our new markets, I'd be lying to you if we haven’t learned things over the years. What we learned in taxes, whenever I built the stores, you want good ingress, egress, but if it’s difficult they'd still find a way there. As we move upside of Texas, up into the southeast, it has to be perfect, it has to be perfect ingress, egress. It can be behind anything. It also has to have a full parking field. It can’t have any garage parking, which we’ve learned over the years that we’ve done. It has to be on a major road, and it's going to be an A area, but we’ve been looking at that. So we’ve learned a few things, but as far as big market, small markets we’ve done that well in the Little Rocks to Louisvilles. And we've just recently opened two stores up in our major metropolitan market up in DC, which I'm really excited about. Those were the last two that we opened this year, with the density and the urban areas up there. So we’ve definitely enhanced our real estate and development side. We've hired another gentlemen in there, now the Director of Real Estate and Development, that is continuing to evolve the science to our demographic information. His name is Don and he comes through Chuck E. Cheese' and he was there for 20 years. So we’re learning stuff every single day, but we don’t believe its site per se area issue.

[Chris O'Cull:]

So Steve, the ones that you do have a sales issue, is it possible to adjust a labor model in those restaurants to improve the margin and profitability of those stores?

[Steve Hislop:]

Yes.

[Chris O'Cull:]

Or are you going to be required to just really increase the sales to improve the margin structure of those stores.

[Steve Hislop:]

I think that it’s both, but obviously there's ways. Like I was mentioning in my scrip, I think I said that we have stores that are out there are doing 35-36, that are making that 15% restaurant number and we believe we have a lot of best practices that we can work on and we're going to continue to quickly get those in line with the expectations of the more matures stores at that time.

[Operator:]

[Operator Instructions]. We will go to Andrew Strausik with BMO Capital Markets.

[Andrew Strausik:]

So based on the new guidance for 2014, we're looking at basically flat to down a little bit earnings and some of the issues that you've had this year, it seems like in terms of whether it's labor or cost of goods inflation are going to linger into 2015. So I'm just wondering, what you can point to or what gives you the confidence that we're going to see an acceleration in terms of that earnings growth and any color around kind of the cadence to that and when you may see some of those things subside?

[Jon Howie:]

Andrew this is Jon. I would say 2015, we're seeing some of the profit sales hopefully towards the end of the year subside a little bit with -- from what we're hearing dairy and chicken. But going into -- the people remain elevated. But as work through some of these issues and get labor like Steve said, it's a yearlong proposition of training the back of the house with this made from scratch food. So a lot of these stores will add that year-end we can start doing the best practices of our store that have those high margins in those lower volume stores and we believe that will turn around and basically set this new base so where we can grow from.

[Steve Hislop:]

And also Andrew, we're going in to third quarter -- the fourth quarter which is our lowest comp base of the year, not comp base average AUVs. First quarter there was an uptick and our best quarter of the year is always the second quarter as far as our AUVs, which are significantly higher than the fourth quarter. So those are a couple of other things that go with that.

[Andrew Strausik:]

Okay. Got you. And then in terms of the G&A guidance, it's obviously only down a little bit from your earlier expectation. I just wanted to understand, are you pushing things out there or what's changed in that regard?

[Steve Hislop:]

Basically what has changed is we're pulling down quite a bit of the performance based bonus. So that’s the biggest thing that's changed in that.

[Operator:]

Thank you. We will now hear from Nick Setyan with Wedbush Securities.

[Colin Radke:]

Hi guys, this is Colin Radke on for Nick. My question is just on pricing. You guys mentioned having pricing power. Should input prices remain elevated? So could you work to take more than your sort of traditional 1% to 2% kind of range next year, given what you're seeing with commodities?

[Steve Hislop:]

This is Steve. Good question Nick. One thing I did mention in our script is obviously over the last seven years we've taking about 1.5% in price to 2%, and that’s because we've been in a really good commodity price for the last seven years until this year. So that’s what really afforded me to be able to do that and while I was doing that, people might have been taking a little bit more. So I think my value equation over the seven years has even grown. It’s gotten bigger and bigger. So we definitely have the pricing power to look at it. Usually I do my price increase will be February 2015. Right now between now and then, I'm studying what’s happening with the rest of the year and commodities, how it rolls into next year. Looking at my competitive base and I'll take an appropriate one based on the commodities in my competitive set but we have the opportunity to be higher than 1.5 to 2 and it will be based on commodities to my competitive set.

[Colin Radke:]

Okay thank you. And then I guess my other question. Your comps continue to be pretty impressive. Is there a certain level you think you need to reach in this kind of inflationary environment to kind of hold your margins?

[Steve Hislop:]

Well we have done pretty well with the 1.5 to 2 but obviously in this inflationary environment, yes, we would need to probably be in that 2 to 3 or little higher than that to maintain those margins in this environment. But like I say, we're hopeful that that will subside a little bit next year and we will get back into more reasonable inflationary period.

[Jon Howie:]

And then going back to your first question, the same compliance.

[Operator:]

Thank you. Our next question comes from Paul Westra with Stifel.

[Paul Westra:]

I just want to follow-up on some of the questions already asked. With respect to the second half, still of a margin outlook, it sounds like you essentially reduced it by close to 200 basis points from your prior guide at the store level, and deducing that your comp base obviously had very good comps and good margin increase. So just want to make sure I'm getting it right that that the vast majority of that guide down is just coming from the class of 13 stores and maybe just a half or so, that's not below 4.2%. And if so it's looking at -- those stores seem to be maybe even negative cash flow margins or am I missing something on trying to delineate down where the trouble is coming from?

[Steve Hislop:]

No, at the current point in time, you’re absolutely right. There are few that are pulling it down in our negative cash flow currently.

[Paul Westra:]

Okay. And then when you talk about the evolution of the model, now you’ve seen some of these stores I guess pull down and I guess in hindsight, would you have -- if you had -- tacking me this evolution of the model commentary, just is it, just because you maybe to be more aggressive on the labor side to prepare for it? I'm just trying -- in fact to get out -- your efforts to make those stores, I guess more profitable lower volumes when they're in this nascent stage of development.

[Steve Hislop:]

Well, the big thing is time and we're our best practices of the stores that are already there that are little bit more mature to give them a better stair step on how to get very, very profitable and we expect to make good money at those numbers. So this is just basically on where they're in their life. As I mentioned to you earlier, it takes a whole year in our stores to bring our labor down to where it's efficient for a mature store and a lot of those are in the middle of that stuff.

[Paul Westra:]

Okay and then follow-up question on the same-store sales guide or the implied one for the fourth quarter, just trying back into what that guidance is for the fourth quarter. It looks like the guide is somewhere around 1.5% or 2% which would be sequentially down from the fourth quarter. We’ve seen elsewhere, the overall trends pick up. I just want to make sure also getting that number correct. And if so is there a function of some new stores coming to the base that are adding a little more headwind and what happened in the third quarter.

[Steve Hislop:]

Actually the implied is I believe if you do that calculation, the implied is somewhere between 1.8, 2.7, I believe.

[Paul Westra:]

Okay.

[Steve Hislop:]

So that’s the implied rate there.

[Jon Howie:]

And it was a good question and also it is important to note that, we had about 0.9% headwind of the stores that entered in the second and third quarters. So it’s actually little bit better than that.

[Paul Westra:]

Okay. And I think there [indiscernible] when could you revisit additional pricing opportunities?

[Jon Howie:]

In February; beginning of the second period of 2015.

[Operator:]

Thank you. Our next question comes from Bryan Elliott with Raymond James.

[Bryan Elliott:]

I just would like to clarify a couple of things that I’m not sure about. So we’re focusing in on about half of the class of ‘13 as being a real headwind. I don’t think I’ve heard much if any details on the class of ‘14. Are they materially better on an AWS standpoint now? It is too early to tell because of the timing and the honeymoon curves and all of that or could you give us some feel for what your thoughts are on this year’s class?

[Steve Hislop:]

Yes, at the end of the day it’s a little too early to tell because we’re just -- ‘14 is going, but as I said to you right now, they’re moving ahead. They’re beating our expectations of the 4.2 model as a group. As I mentioned to you, we’re going into the fourth quarter, which is our lowest indexing quarter for AUVs. So we’re expecting them to go down a little bit from where they’re at and we probably expect them settle at year end about -- around that $4 million number which is slightly below our 4.2 million model.

[Bryan Elliott:]

Would that be a run rate for the fourth quarter or do you expect them to be down on a full year rate of 4.0 versus 4.2 annualized rate for that. I don’t want to understand quite the big difference.

[Jon Howie:]

That maybe settling at its normalized rate of 4 million.

[Bryan Elliott:]

Even though they’re running at 4.2 now. So that’s --

[Jon Howie:]

No, they're running in excess of that Bryan --

[Bryan Elliott:]

I’m sorry, go ahead.

[Jon Howie:]

So they’re running in excess of the 4.2 right now. So they’re running in excess of that and so we expect them when they settle down into the normalized level after the honeymoon to be somewhere in that 4 range or a little under.

[Bryan Elliott:]

Right. And that’s I guess a function of fourth quarter index seasonality. I guess the drop-off is pretty substantial. It's 10% or more sequentially, looking at history isn’t it?

[Jon Howie:]

Yes, it is. But we've opened up some strong stores here in the later part of the third quarter and then here in the fourth quarter. We’ve been very pleased those openings.

[Bryan Elliott:]

Right, outside of Texas, Atlanta and now two stores in Northern Virginia, DC market are kind of your big urban -- dense urban markets and a lot of class of ‘13 if I recall correctly, would kind of been in smaller markets. So maybe could you speak to what you’re seeing a very early in DC and continued penetration into Atlanta to get a sense of how it works in sort of prosperous growing metropolitan areas?

[Steve Hislop:]

Sure Bryan. Atlanta is a tough market and it’s been tough one for us just to get in and penetrate. We’ve been there for a few years and finally got our second store Kennesaw, a just a couple of quarters or a quarter ago. And now on, it’s little bit different and those ones are not as high as what believe the ones in DC are. DC is really too really to talk about but we are extremely excited about both our units that we've already opened there. One was in Fairfax where we actually remodeled the smaller building actually. It’s only a 6,500 square foot building and we’re really, really pleased with that store and its volumes and how efficient that little building is, something that we’ll look at moving forward on that little building moving forward in other markets. And then we also opened one just a week ago in Springfield right outside of DC and we’re really excited about our first week there. But it was a very, very strong opening. The acceptance levels, the sophistication of the market, all the demographics that it leaves us much stronger then the Atlanta market and it's definitely shown, even on the initial volumes.

[Operator:]

Thank you. And with no additional questions in the queue I’d like to turn things back over to management for any additionally closing remarks.

[Steve Hislop:]

Okay thank you again for joining us this afternoon, and we look forward to speaking with you in the future. Thanks again.

[Operator:]

Thank you. And again ladies and gentlemen that does conclude today’s conference. Thank you all, again for your participation. You may know disconnect.