Del Taco Restaurants, Inc.
Q1 2016 Earnings Call Transcript

Published: 3 May 2016

[Operator:]

Good afternoon and thank you for standing by. Welcome to Fiscal First Quarter 2016 Conference Call and webcast for Del Taco Restaurants, Inc. I would now turn the call over to Mr. Raphael Gross to begin. Thank you sir, you may begin.

[Raphael Gross:]

Thank you, operator, and thank you all for joining us today. On the call are Paul Murphy, President and Chief Executive Officer; John Cappasola, Executive Vice President and Chief Brand Officer; and Steve Brake, Executive Vice President and Chief Financial Officer. After Paul, John and Steve deliver their prepared remarks, we'll open the lines for your questions. Before we begin, we'd like to remind everyone that part of our discussion today will include some forward-looking statements. These statements are not guarantees of future performance and therefore, undue reliance should not be placed upon them. We do not undertake to update these forward-looking statements at a later date. We refer you to today's earnings press release and the SEC filings filed by Del Taco Restaurants Inc. for more detailed discussion of the risks that could impact future operating results and financial condition. Today's earnings release also includes non-Generally Accepted Accounting Principles or non-GAAP financial measures such as adjusted EBITDA and restaurant contribution. Non-GAAP financial measures should not be considered as alternatives to Generally Accepted Accounting Principles in the United States of America or GAAP measures such as net income, operating income, net cash flows provided by operating activities, or any other GAAP measure of liquidity or financial performance. We refer you to the reconciliations of the non-GAAP measures to the nearest GAAP measures included in today's press release. I would now like to turn the call over to Paul Murphy, Chief Executive Officer.

[Paul Murphy:]

Thank you, Raphael. And thank you all for joining us on the call today. We experienced a strong start to the year with first quarter results that were in line with our expectations. Highlights for the first quarter include system-wide same-store sales growth of 3.2%, even as we lapped for strongest quarter of 2015, resulting in an impressive 10.9% two year growth rate. Restaurant contribution margin of 18.7%, a 10 basis point improvement over the same period last year and adjusted EBITDA of $13.1 million, which is nearly even with the prior year. The first quarter highlighted the strength and resiliency of our brand as we leveraged our menu strategy and value perceptions to drive solid same-store sales growth in a very competitive environment. It also marked our 10th consecutive quarter of system-wide same-store sales growth and our 15th consecutive quarter of company-operated same-store sales growth. Same-store sales at continue-operated restaurants grew 2.1%, comprised to 5.4% in check and a 2.6% decrease in transactions. On our call, we covered the headwinds we were facing in the first quarter, namely the difficult comparison of plus 3.9% in the first quarter of 2015, along with a heavy value promotions and deep discounting characterizing the OSR industry today. In light of these factors we're pleased to hold the two-year traffic positive that plus 1.3% and offset negative in the first quarter this year due strong check growth driven by effective menu price increases and continued menu mixed growth of 1%. Additionally, we were proud to have slightly expanded restaurant contribution margin. This quarter despite inflation about the food and labor launch. Our consistent sales momentum and demonstrate ability to absorb inflationary impacts or the result of our continued focus on delivering the great value and speed that Del Taco has become known for while layering opportunities to broaden the occasions we serve that elevate our promise. As we look ahead we remained focused on the deployment of the next iteration of our combined solution strategy. We will be launching free combined solutions at the end of June, which will bring a combination of improvements to market that we expect will further embed our freshness positioning and differentiate Del Taco from the competition. Our goal was to strengthen our fresh paired with value positioning, without diminishing our category-leading value scores or our ability to deliver speed and convenience. As we've discussed previously, we have many exciting operations and market initiatives that's part of this next wave. Although the market elements are planned to kick-off in late June, with exciting new product news and a launch of our refresh and recharge, UnFreshing Believable 2.0 ad campaign, we have been improving our operations over the last few months with our equipment and process improvement programs and by expanding the use of our e-learning system. We internally kicked-off fresh combined solutions in March with a series of General Manager Boot Camps and franchise owner meetings across the country where we touched over 600 General Managers, a bus store leaders and owners. In the Boot Camp training, we covered two key areas of focus to improve the guest experience. We transaction efficiency program designed to improve speed or service and drive through a throughput and our e-learning system. These are foundational elements that we believe will support all of our initiatives and ensure that our team members are prepared to deliver an outstanding guest experience. Before I discuss development, I'd like to touch on recent legislation increasing the California minimum to $15 by 2022. As we continue analyzing the potential impact and poor are playing some engine, there are several important considerations where its highlight. First although minimum wage has more recently become Taco at a national is new to us as we have successfully managed the California increase from $8 to $10 an hour since July 2014. Over this timeframe, we drove strong same-stores sales performance on both an absolute and relative basis and we expanded our restaurant contribution margin. Second, the path to $15 per hour is gradual, particularly during the earlier years with 2017 and 2018 each featuring a $0.50 increase, followed by a $1 increase in 2019 through 2022. This affords us time to prepare. All else being equal, we currently estimate that the incremental $0.50 in 2017 and 2018 would require approximately 1% of annual incremental menu price to cover the all-in dollar impact. Third it is important to understand, this is a level playing issue that will generally impact all California restaurants proportionally. Restaurant, retail, and service price pressure will likely prevail a cross and consumers will have to adjust to higher prices and potentially higher levels of disposal spend which overtime may prove to serve as a tailwind for restaurants. Finally, how a particular brand is positioned and viewed by the customer will heavily influence that brand's ability to manage wage inflation. Our combined solution strategy and brand repositioning appear value convenience with fresh was designed to give us the flexibility to absorb macro events such as wage inflation. Menu price will certainly play a role. In our [Indiscernible] menu strategy across Buck & Under, mid-tier and premium tiers provides us a broad playing field to achieve menu price in a target manner without disrupting our value perceptions compared to other restaurants. In addition, our continued evolution of fresh and expansion into premium items and new occasions that typically have larger check and party sizes will help us drive favorable menu mix over time without harming our value perceptions. Overall, we believe our differentiated QSR-plus positioning and menu strategy uniquely positions us to absorb this wage pressure. Additionally, we believe that our planned unit development acceleration will provide yet another financial offset over this timeframe. Our pipeline for new development is growing stronger and we remain on track to open 15 to 18 new restaurants system-wide in 2016. This would represent a new unit growth rate of approximately 3% that we plan to accelerate to mid-single-digit growth rate during 2017. We continue to be pleased with the performance of our new openings. As we have discussed, our near-term priority for development is in-fill markets. We already have identified over 300 trader opportunities in the western third of the United States. In addition we have a significant opportunity in emerging markets and are continuing to build company restaurants in both Georgia and Oklahoma. Lastly, we expect franchise development to accelerate in 2018 and beyond as our recent growth in average unit volume and restaurant contribution margins along with our plan to further improve these metrics continues to attract interest from both new and existing franchises. I'd now like to turn the call over to John Cappasola, our Chief Brand Officer.

[John Cappasola:]

Thanks Paul, and good afternoon everyone. During the first quarter we remained focused in three key areas that I'll cover in detail. First, we continue to focus on great execution at the restaurants in order to maximize our opportunity with every single transaction. This is especially important given the competitiveness of the environment in which we're operating today. We monitor our operating and guest experience metrics very closely, day in and day out in every restaurant and we achieved record high scores during the quarter in service, product, problem-free the and overall satisfaction. Continued improvement in these key metrics is a great sign that our operational initiatives are working and our restaurant teams are setting us up for success as we launch Fresh Combined Solutions. A second key area of focus during the quarter was our messaging and promotion strategy. We leveraged new product news on the Buck & Under Menu to keep value top of mind throughout the quarter while continuing to broaden our occasion base to grow check-in margins with our new premium platforms and seasonal seafood promotion. We started the year with the launch of a new Grilled Chicken Rollers platform and expand the Buck & Under Menu from 12 items to 16. Chicken rollers were very well received by our guests and quickly became the number one product launch in the Buck & Under Buck Menu. We continue to advertise Buck & Under and the new Grilled Chicken Rollers throughout the quarter, as a secondary message during our seasonal seafood promotion. We want to keep the Buck & Under Menu top of mind in 2016 by maintaining merchandising and advertising presence that feature both existing and new product news. In March, more new product news on the Buck & Under at Breakfast menu continued, with the exciting launch of a new quality protein, Chorizo. With Chorizo, we've done what only Del Taco can do well, bring in a great tasting quality protein and start it on the Buck & Under at Breakfast menu. Our entry point on Chorizo is the new Chorizo Breakfast Taco for only $1. But we also scale the protein across the menu by offering it in both Half Pound and Epic Breakfast Burrito builds. We plan to leverage Chorizo to drive value and quality perceptions in the morning to help further our momentum in the breakfast day part. The last part of our messaging and promotion strategy in the quarter, was our use of premium menu items, primarily at the part of order to entice consumers. We saw our premium menu achieve a third consecutive quarter of double-digit product mix, while driving margin dollars and incremental checks through Menu Mix. This was particularly impressive in a quarter where the messaging was primarily focused on the Buck & Under Menu and our seasonal seafood LTO. It is also further evidence that our premium platforms are resonating. We will be launching a new Epic Chicken Burrito in a couple weeks, along with highlighting our fresh sliced avocado platform, to continue to reinforce our QSR-plus positioning and drive trial of premium products at Del Taco. The third key area of focus was the development and testing of future business driving strategies and initiatives. We went into detail on the last call, but I wanted to provide a brief update on a few key parts of our upcoming Fresh Combined Solutions launch. We continued to deploy our targeted capital investments, including new bean mixers that save significant time and improve product consistency, upgraded headset systems to improve drive-thru efficiency, a dynamic new high efficiency fryer and targeted high-volume restaurants that ensures gold standard quality for all fried items and freshness coolers, which help grow quality perceptions. The Fresh Combined Solutions launch also includes a number of upcoming brand catalysts. Our UnFreshing Believable 2.0 campaign is on track to launch at the end of June, kicking off the next wave of combined solutions with our guests. The refresh will tell the story of our brand's fresh preparation and quality positioning and how we're able to pair that with category-leading value across our menu. You can expect the campaign to touch every marketing-related asset, including our restaurant merchandising, the look and feel of our point-of-purchase materials, including our menu boards and all broadcast and digital advertising. The launch will also include a new signature Crunchy Beef Taco, that we are calling the Del Taco. We dubbed this product the dream during development because it is loaded with our signature seasoned ground beef, more freshly grated cheddar cheese than any other taco on our menu, and a newly developed larger, crunchier shell to complete the experience. This taco performed very well in consumer research and test phases and we expect that it will redefine the crunchy beef taco experience at Del Taco in the category. It is expected be priced in the low to mid -$1 range at launch, with the intention of providing the best value for the money for a crunchy beef Taco in Mexican QSR. Lastly, we're excited about the testing and expansion of our plated meal program called Platos, as well as the development efforts that are occurring with our online ordering partner, OLO, on our new mobile ordering and payment platform. Platos is performing well in our original test market and we recently expanded it to more restaurants to optimize the program and prepare for a future system rollout. In regards to the mobile ordering and payment, our teams have made great progress and we will be into test locations by mid-year. Now, I'd like to turn the call over to Steve Brake to go over our first quarter results.

[Steven Brake:]

Thanks, John, and good afternoon. Our fiscal first quarter 2016 results are for Del Taco Restaurants, Inc., which became a public company when it completed a business combination with Levy Acquisition Corp. on June 30th, 2015. Therefore, the successive trade for the 12 weeks ended March 22nd, 2016, is being compared to the predecessor period for the 12 weeks ended March 24th, 2015. Company restaurant sales increased 2.9% year-over-year to $93.6 million from $90.9 million in the year ago first quarter. The increase was predominantly driven by same-store sales growth of 2.8% at company-operated restaurants. First quarter company-operated same-store sales growth represented the fifteenth consecutive quarter of gains and was comprised of 5.4% in check growth including over 1% of mix growth, partially offset by a 2.6% decrease in transactions. Franchise revenue during the first quarter increased 10.9% year-over-year to $3.3 million from $3.0 million last year. This increase was driven by franchise same-store sales growth of 3.7% and additional franchise restaurants compared to the first quarter of the prior year, as well as an increase in initial fees during the first quarter of 2016. System-wide same-store sales increased 3.2% and lapsed system-wide sales growth of 7.7% during the first quarter 2015, resulting in a strong two-year trend of 10.9%. Total first quarter revenue was $97.4 million, an increase of 3.2% over the $94.4 million in the year go first quarter. During the quarter, we opened two restaurants system-wide, including one company-operated and one franchised and one company-operated and two franchise restaurants closed. Now moving on to expenses, food and paper costs, as a percentage of company restaurant sales, improved approximately 70 basis points year-over-year to 27.9% from 28.6%. This improvement was due to the impact of menu price increases of approximately 4%, carried during the first quarter, which more than offset through basket inflation of approximately 1%. Looking ahead, we continue to expect a leveling in the food basket during Q2 followed by deflation during the second half of 2016. Labor and related expenses as a percentage of company restaurant sales, increased approximately 110 basis points to 31.8% from 30.7%, primarily driven by the California minimum wage increase to $10 an hour, partially offset by the impact of menu price increases and favorable menu mix. This impact and our experience managing this increase to-date are consistent with the guidance we furnished earlier this year. Occupancy and other operating expenses as a percent of company restaurant sales, decreased by approximately 50 basis points year-over-year to 21.5% from the 22.0% last year. The improvement was primarily driven by a slight reduction in utilities, repairs and maintenance, supplies, rent, and advertising as a percent of restaurant sales. As a result of this performance, restaurant contribution increased 3.4% to $17.5 million, from $16.9 million in the prior year first quarter. Restaurant contribution margin improved approximately10 basis points year-over-year to 18.7% from 18.6%. We are particularly pleased with our restaurant contribution margin expansion during the first quarter, despite this being our only quarter expected to have both food and labor inflation. This outcome reflects favorably on future expected performance and our ability to achieve our full year guidance. General and administrative expenses as a percentage of total revenue increased by approximately 80 basis points year-over-year to 8.5%. The increase was primarily driven by additional resources to support the growth of the brand and incremental public company costs as well as increased stock-based compensation from new management equity incentive plans that were finalized during the fourth quarter of 2015. Although first quarter G&A as percentage of total revenues was slightly above our guided full year range, this is primarily due to the fact that the first quarter is our lowest sales volume quarter based on seasonality. We're maintaining our full year G&A guidance. Adjusted EBITDA in the first quarter was $13.1 million versus $13.2 million earned in the first quarter of 2015. As a percentage of total revenues, adjusted EBITDA margin was 13.5%, approximately 50 basis points from 14.0% in the prior year period. The approximately flat adjusted EBITDA is in line with our expectations and we're maintaining our full year adjusted EBITDA guidance. Depreciation and amortization in the first quarter was $5.5 million, an increase of 44.7% over $3.8 million last year and as a percentage of total revenue increased by approximately 160 basis points to 5.6%. This increase is primarily driven by purchase accounting adjustments to increase our property and equipment and intangible assets to their fair value and this incremental run rate will continue to burden that income and earnings per share prospectively, until we've lapsed purchased accounting during the third quarter of 2016. Interest expense was $1.5 million in the first quarter, down $5.3 million from $6.8 million in the prior year first quarter. The interest reduction stems from the elimination of all of our subordinated notes in March 2015, the repayment of $68.6 million in senior debt upon the June 30th, 2015 closing of our merger, and our August 4th, 2015 refinance transaction. As of the end of the first quarter, $154 million was outstanding under this all-revolver credit facility and effective March 18th, 2016; our applicable margin for LIBOR loans was reduced from 2% to 1.75%, based on our lease adjusted leverage ratio-based pricing grid. Income tax expense was $2.1 million during the first quarter for an effective tax rate of 41.2%, as compared to $0.5 million during the same period last year. This resulted in net income for the first quarter of $3.1 million or $0.08 per diluted share compared to a net loss of $4.9 million in the prior year period. Regarding our $25 million repurchase program covering common stock and warrants announced in March, during the limited trading days available during the first fiscal quarter, we used approximately$ 0.9 million to repurchase approximately 87,000 shares of common stock at an average price of $10.79 per share. During the second fiscal quarter, we remain active under the program, which highlights confidence in our strong business and ability to execute on our long-term growth strategy, as well as our commitment to enhance long-term shareholder returns. Finally, we are reiterating our 2016 guidance. For details on this outlook, please refer to our earnings release from this afternoon. As you can see, there's a lot for us to be excited about as we continue to elevate and grow our brand. Thank you for your interest in Del Taco and we're happy to answer any questions.

[Operator:]

Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Craig Bibb of CJS Securities. Please go ahead.

[Craig Bibb:]

Hi, guys. Great start to the year. Could you walk through the monthly progression of comps -- little bit light versus the preannouncement and most importantly how was April?

[Steven Brake:]

In terms of the three reporting periods each of the three per is net-net we're very consistent, one or two of overblown that 2.8 of the company's slide, but overall pretty steady period-by-period basis is what is on the first quarter.

[Paul Murphy:]

Craig, this is Paul. In terms of April, we're early in Q2 and from our standpoint just a few things about Q2 I'll talk about we haven't really seen the value environment change as strong today as in Q1. Some of the passive change their offers but others really have come into the mix. We continue to lapse strong prior year transactions early part of Q2, but that being said the transaction lapse uses considerably the back half of Q2 and we're really excited about the initiatives that we have going on in the marketplace. We had a [Indiscernible] Buck & Under with Carney [Indiscernible] and that can be followed soon by Buck & Under alongside the launch of a new Epic Chicken Avocado Ranch Burrito. And as John mentioned, as we're under Q3, we're going to launch our Fresh Combined Solutions which besides operational equipment initiatives will complement that launch of introduction of a new product to Del Taco we're going to use that as a consumer catalyst. So, we really feel good about the initiatives that we have in place to continue to strengthen the comp. We think that the resilient [Indiscernible] menu strategy that we have provides us a lot of levers to address either macro or competitive pressures given us the ability to continue driving positive comps. I believe Q1 was a good example of that resiliency in the brand and as Steve mentioned, we continue to affirm our same-store sales guidance of $2.5 to $4.5 for 2016.

[Craig Bibb:]

Okay. And then I noticed that the average weekly sales growth was actually exceeded your same-store sales growth non-comp doing well, can you talk about the new units and newer markets?

[Steven Brake:]

Yeah. We mentioned we definitely continue to feel very good about all of our classes or years of performance across recent opening years and that's true both for in-fill as well as the emerging markets where we're excited to continue growing both Atlanta and Oklahoma City corporately. So far this year, two have already opened in Georgia and in both of those states; we have a lot more activity pipeline. So, we definitely remained encouraged and happy with what we're seeing on our units.

[Craig Bibb:]

Okay. And then last question, it look -- sounds like you expanded the number of restaurants that are testing platters, have you decide to go national?

[John Cappasola:]

Craig, its John. The decision to go national has not occurred yet, but as we talked about, we've been in a small market, 15 stores or so since last summer and it's really helped us to validate from a sales margin and a brand perspective that this is a great opportunity for Del Taco. We've learned a lot in regards to commercialization in that first market. So, the program is now being taken has been taken in the lastly few weeks to a second market which will help us to finalize the launch recommendation. So, as far as long time goes, like I said last call, we do see a path for getting this to market this year. It's likely Q4-ish pending the result of the second market, but we feel really good about what we're seeing thus far with this program.

[Craig Bibb:]

Great. Thanks a lot.

[Operator:]

Thank you. The next question is from Alex Slagle with Jefferies. Please go ahead.

[Alex Slagle:]

Hey thanks. Just wonder if you could provide some more commentary on what you saw competitively during the quarter at the Breakfast part with Taco Del launching its $1 menu and any comments how this has impacted your business?

[John Cappasola:]

Yeah, this is John. Breakfast continued to be our top-performing day part in Q1. So, we felt good about that towards the back end of the quarter, really kind of tail end of the quarter. We launched new protein in Chorizo as I mentioned on the last call and we're pleased with the start of that. That protein -- it's already become I guess-favored in the morning, it's our new number one breakfast protein even ahead of bacon right now and that's just after one round of promotions. So, when we look at that -- with that protein and the flexibility it provides us because it starts at just $1 on the Buck & Under at Breakfast menu. We can bring new news with breakfast through Chorizo to the menu throughout the balance of 2016 which we plan to do as well as just kind of continue to reinforce the variety that's expected in the morning. So far, so good with Chorizo and I think the competitive piece will continue to perpetuate itself and we feel like advertising Mexican QSR in the morning is not a bad thing for Del Taco.

[Alex Slagle:]

Thanks. And just one follow-up on the company-owned same-stores franchise, there's any reason for the company-owned comp to lag franchise during the quarter?

[Steven Brake:]

Yeah the difference was about 90 basis points this quarter. Overall anything inside a percent relatively in line that said the prior year lap was 40 bps more challenging for company compared to franchise. So that lapping the dynamic probably explains about half the difference with the balance being fairly nominal and really rounding in essence. We continue to love the fact that both company and franchise are really moving overall in lockstep in terms of comp. We think that's a good signal the brand and our initiatives really working as one system one way

[Alex Slagle:]

Great. Thank you.

[Steven Brake:]

You're welcome.

[Operator:]

Thank you. The next question is from Joshua Long of Piper Jaffray. Please go ahead.

[Joshua Long:]

Great. Thank you. In terms of the focus on transaction efficiency and e-learning during the quarter, I was curious what the balance or kind of what percentage required the rollout of new technology versus maybe a revisiting of operational procedures and at the restaurant level, you walk through a couple specific examples which was helpful but curious what that looks like overall? And then as we move into 2Q, 3Q and the back half of the year are there additional rollouts similar kind of training period needed to support the new combined solutions rollout?

[John Cappasola:]

It’s a good question Josh. The way to probably think about it is there's two parts to what we just went through with our Boot Camps and one was transaction efficiency 2.0 as we coined and that was all about preparing ourselves for the launch of Fresh Combined Solutions. So there has been a series of initiatives and focus by David Pear and his team over the past kind of six months or so, culminating in these Boot Camps. So, it really started when we launched some of our initiatives and programs at the back end of last year through our conference and we've been working through and embedding those and optimizing those and then we were ready to launch transaction efficiency 2.0 which now sets us up nicely as we move into Fresh Combined Solutions. And that is more of a process and procedural change just really optimizing how to improve throughput and still deliver the great quality that is expected as we expand our occasion base at Del Taco. The second piece is the e-learning and no new technology required. This is all -- what we launched last year on a system-wide basis. So, these are now modules that are coming into the system. So as we've kind of paced in sequence with this in our operations, obviously it's been really important to not take on too much too quick. So, the content has been developed. It's been honed, it's been tested and now new modules have been launched in conjunction with what we just did with transaction efficiency 2.0. Throughout the remainder of the year, additional modules will be rolling into the operations. So, leveraging the same existing technology, the platform -- e-learning platform that we rolled out last year. So we just find that it's helped us to be more systematic, more nimble in our training as well as being able to follow-up quantify the impact of it.

[Joshua Long:]

That's helpful. Appreciate it. And so as we think about the changes that are going to be rolling out to the restaurants over the course of the year, do we think about it as modules supporting what will also be some new equipment going to the restaurants? Or is that new equipment you mentioned in terms of headsets, the fryers, the freshness coolers, have those already been rolled out and -- so it's really just going to be focusing on the modules, just kind of think about the cadence of that occurs?

[John Cappasola:]

Yeah, so some have been rolled out to this point so as an example the new bean mixers which we talked a little bit about have been rolled out system-wide and you know that's a move to improve on the efficiency in the kitchen as well as quality of the ingredient. That's a process that we do throughout the day. As you know we're making beans from scratch at Del Taco. So, as part of that process, they have to be mixed and that mixing process by hand typically takes about 25 minutes per big batch and we've been able to take that down to inside of a minute basically across the day multiple times, so you multiply that by restaurant, it's a huge efficiency move, but it also perpetuates quality so that we can ensure consistency across the chain. So, that has happened that has rolled out. We have other programs that are in the process of rolling out, the headsets are for the most part rolled out and available to our franchises at this point as well which have also signed up and are rolling those out. We have other piece of equipment of a targeted base like a new fryer system that's going into higher volume, higher transaction restaurants and we're going to be going into about 60 restaurants with those fryers in 2016 and those are in process right now. So, those won't be rolled by the time we hit the street with Fresh Combined Solutions. From a consumer standpoint, at the end of June, but they are certainly going to be rolled out throughout the year. So, number of initiatives both on a system basis and on a targeted basis, and we'll continue to develop that as we move throughout the year.

[Joshua Long:]

Understood appreciate that color. In terms of the food environment and it seems like mostly the conversation is around labor inflation as you mentioned in your prepared comments, but we think about the food environment, is there an opportunity to lock in some of the main items of your basket, have you done that, are you looking to maybe play more of these soft market on them? Any sort of color you could provide in kind of how you're thinking about managing what is expected to generally favorable food cost environment this year?

[Steven Brake:]

Sure, we're definitely encouraged by the food landscape that we see ahead of us. As we said Q1 was inflationary we now expect that to change. We've indicated definitely leveling in that basket in Q2 followed by deflation. Still the 50 bps of the annual deflation we talked about a month or two ago remains intact and no update to that today. That said, certainly we're encouraged by the environment and we definitely use forward contracting techniques from time-to-time. Certainly in those multiple years of inflation, we were very aggressive and got pretty far out to mitigate a lot of impact. We were happy with that strategy. That said now the pendulum begins to swing the other way. We've dialed that back somewhat. We still like to have 60% plus of our basket control at any given point in time on a fixed price. In recent years, we are well beyond that. Right now as we look at Q2, we have nearly two-thirds locked the back half of the year. It diminishes somewhat more about just over 50% for the third quarter, a little more than a third for the fourth quarter. Maybe -- and some of that is a purposeful dial back to enjoy some favorable spots that are out there today. Cheese will be a good example of that. That said we also try to balance that with appropriate coverage. We're not a brand that tries to chase bottom, it's like trying to catch a falling knife. We stay away from that. So, we have a nice balance approach on food and are very encouraged with the balance of this year in terms of what we're seeing.

[Joshua Long:]

That's helpful. And then last one for me in terms of the [Indiscernible] element guidance that you provide, how would you think about that from a cadence perspective? I believe last time we talked maybe that being a little bit more backend loaded. And then secondarily over time, is there an opportunity to maybe balance that across the year as we look forward into maybe 2017, 2018 and on?

[Paul Murphy:]

This is Paul. Certainly for 2016, it is frankly more back half loaded. It's fairly our goal to get that more balanced, but be transparent about it, I think 2017 will continue to be a little more back half loaded and I think our first real opportunity of having more balance is in 2018.

[Joshua Long:]

Great. Thank you so much.

[Paul Murphy:]

Thank you.

[Operator:]

Thank you. The next question is from Jeremy Hamblin of Dougherty & Company.

[Jeremy Hamblin:]

Good afternoon. Congratulations on building your Leo restaurant-level margins, despite a pretty impressive or -- pretty big headwind, very impressive. I wanted to just ask a follow-up question on the food cost as we think about 2017 -- and I think you said you don't want to get too far ahead of yourself on contracts, but would you be thinking at this point that you'd be seen roughly flat cost on food next year? At what point would you have visibility on that?

[Steven Brake:]

Hey Jeremy, it's Steve. We're now just hitting the point where we are beginning work against 2017 on a very limited number of SKUs, primarily the early aspects or early portions of the year. So, it really is premature to have any broad-based comment about what the 2017 food basket might do. I mean as you know we had a pretty diversified basket which is a very good thing, but it also means there's a lot more kind of double-digit area of percent to the basket that we need to be very cognizant and mindful of. So, a bit early to put any commentary out on 2017 other than there's definitely a nice trend in 2016. Obviously things that emerge back at 2016 will typically have the dynamic to look in the same on front half of 2017. So, you could sort of read the tea leaves that front half of 2017 is probably going to be a fairly good year for the industry as a whole in terms of food. For some to call back half of 2017, I just think is probably premature for most anyone.

[Jeremy Hamblin:]

Okay. Let me just follow-up on a point you made. Q1 was going to be the only quarter that you saw inflation on both food cost as well as labor. You're able to still generate a positive gain in your restaurant-level margin. Should we be thinking then for the remaining three quarters that you'd able to -- or you're expecting assuming that you hit your same-store sales target that you could generate positive margin in each of the next three quarters this year?

[Steven Brake:]

The way I would think about the line items is certainly a labor we framed up good guidance around what that line will do. As I said there has been no surprises so that's sort of all four quarter proposition in terms of that type pressure that we'll see. As you know, OpEx, a lot of that's fixed -- it does leverage, but a lot of its variable or semi-variable. So, when we comp nicely, we typically can see some annual leverage on that line. The last two full fiscal years, for instance, we levered OpEx by 25 bps each of those last years. And then in terms of food, certainly leveling in Q2 followed by deflation sets forth a nice opportunity to have further improvements in food on a percentage basis. The following -- the final piece that would help kind of inform what the margin -- restaurant margin profile will look like would be the level of price increase that we continue to carry throughout the rest of the year. As we said earlier in our annual guidance, we expected to have menu price in the low to mid 3% area. We continue to believe that we'll be priced at least at that level, but we have a lot more calendar left on the year and we certainly are very careful with any and all pricing decisions, constantly reading the consumer, the macro, as well as cost side to help inform what menu price we think is appropriate. So, certainly we feel good about the achieved in the first quarter without a doubt and we think we're well-positioned to continue to drive a nice story on restaurant contribution where that's out, certainly the food basket point out the rest of the year as well as the menu price we elect to implement that will certainly still have a bearing on that.

[Jeremy Hamblin:]

Fair enough. I want to make sure I heard this right. In terms of the $0.50 increase in minimum wage for next year, you would expect with a 1% increase in menu price that you'd be able to cover that cost? Did I hear that correctly?

[Steven Brake:]

That is correct.

[Jeremy Hamblin:]

Okay. And then just one other question on -- we've been hearing generally speaking some softer trends in the industry. I think including QSR which really had been an outperformer, is it possible -- I mean in terms of gas prices, they have crept up in the last six or seven weeks, and I think that just like it had an immediate benefit, when you started to see those does clients in 2014, is this may be part of the cause why we're seeing some softness in traffic trends?

[Paul Murphy:]

This is Paul. I think that what you might be seen kind of in the macro is just really a combination of factors. As we look at kind of competition out there, you have very heavy value environment. Yes, you do have, I think, the election cycle this year with -- and kind of no one saying anything good as having some impact on the marketplace. I'm not really so sure about the gas prices, but I think it's something that could be having a short-term effect and I think that if you look at the consumer confidence data, it's been kind of down five out of the last six reports and I think internally for us, to me that kind of summarizes what's going on out there. I think there's just a lot of uncertainty that is impacting the consumer's behavior is right now. Now, on the flipside, we love how we're positioned to be able to deal with that with our menu strategy and as we certainly believe that the value and affordability that we have in terms of our everyday value menu with the Buck & Under yet still full margin we're able to work our way through those macro events as they arise or go through the right now.

[Jeremy Hamblin:]

Great. Thanks. Appreciate you taking all my questions and best of luck.

[Paul Murphy:]

Great.

[Operator:]

[Operator Instructions] And then next question is from Nick Setyan of Wedbush. Please go ahead.

[Nick Setyan:]

Good afternoon gentlemen. Thanks for taking the question. It sounds like in Q1 we had slightly higher than 4% menu pricing and so I guess what's the timing of when that balls off if we don't decide to take another menu price as the year progresses?

[Steven Brake:]

Yeah, first quarter we did carry approximately 4% in terms of what will lap looking ahead. We principally made price moves each year. So, we will first lap late second quarter, just over 1% of menu price that we took last year and then in the fall timeframe, the other move which was much larger we'll lap. So, in the near-term, we do expect to have a menu price increase this year as we enter the summer. That's similar slightly less than the over 1% we took a year ago and the timing will be very similar. So, that is the near-term dynamic. And then as far as fall, we certainly have a lot more time to kind of read, as I said, the consumer, the macro, as well as, our cost environment to help decide what type of menu pricing would be appropriate later this year. So, I think where that takes us the full year guidance of menu price in the 3% to 2.5% area, we still feel good about achieving at least that level of price.

[Nick Setyan:]

Got it. That is to the near-term its sounds like Q2 should stay above 4%.

[Steven Brake:]

Approximately.

[Nick Setyan:]

Got it. In terms of the labor it's very helpful that you guys quantify obviously the impact of the minimum wage increase, but in terms of the actual deleveraged we saw in Q1, what incremental price increase I guess here in late Q2? And maybe some learning that you probably had early on a Q1, maybe some of the initiative, I mean could that -- I guess could the magnitude of that deleverage that we've been seeing come down as a year progresses?

[Steven Brake:]

Certainly, the amount of price we end up carrying will have a large bearing on what that labor percentage look like. The data we did furnish does enable folks pretty well to do. So what that line will inflate by just the minimum wage, there's, of course, benefits in other areas that tend to be somewhat inflationary. So, when we piece that altogether in light of approximately 4% price increase and then obviously with transactions being he negative, there's a bit of a mild loss of leverage there as well. I think the outcome we posted should have been in the ballpark of what folks could reasonably anticipate. So, as we move forward, certainly that menu price level will play a role in our labor percentage and naturally what we have in place to continue to drive and improve provide our trajectory on transactions can also have a bearing on the labor line.

[Nick Setyan:]

Makes sense, makes sense. Your EPS guidance, what kind of a share count does that imply?

[Steven Brake:]

The basic year-end in still as of Q1 38.8 million common shares outstanding. Obviously with warrants all struck at 11.50, there is not currently in a dilution to speak out. So, in general, the guidance is intended to capture what we think will reasonably be where we land for the year. As you know there's also share repurchase that's ongoing and out there which kind of goes the other way as compared to warrant dilution that could be driven by stock price gains. So, kind of up in that 38 million plus area is what we have in mind in terms of our guidance there.

[Nick Setyan:]

Got it. And I guess lastly just in terms of -- as you build a pipeline for your unit growth acceleration here over the next couple of years, what are you guys seeing out there. Is there a lot more competition for similar spaces than you guys maybe anticipate going into it. I guess what is -- maybe just you tell us what the color is? Has it been pretty easy-going, are there some challenges et cetera?

[Paul Murphy:]

This is Paul. I mean it certainly is competitive out there as we're looking for the freestanding, at drive -thrus. But our focus is on quality of the site. Quantity certainly is important, but we want to make sure that we're getting the right site, for the right reason to present the brand and drive the brand forward. So, we're -- so far have been able to find sites where we're looking and does it take a little bit more work, the answer is yes. But so far we've been successful in developing the pipeline.

[Nick Setyan:]

Thank you very much.

[Operator:]

Thank you. The next question is from Peter Saleh of BTIG. Please go ahead.

[Peter Saleh:]

Hey guys, congrats on the quarter. Couple questions. First seems like the discounting in the overall restraint space is really been driven by -- to some extent some of the deflation that we're seeing on commodities and it doesn't sound like from your comments or other operators that the deflation has gone away anytime soon. So, do you guys foresee that the discounting in the overall environment, you think that's going to subside in the near future or what do you think gets us to a point of more normalized, more rationalize pricing?

[Paul Murphy:]

This is Paul. I don't really think that it's going to subside just right around the corner. I think you are correct in your hypothesis that the deflationary environment probably emboldened some brands to be able to hold their discounts longer. Frankly, from our standpoint, we're kind of okay with that in a sense that we have not come off our strategy while they have been doing that. You have to remember that our Buck & Under Menu is compelling everyday value 14 to 16 items, yet is at full margin and so having that in our business and that great kind of Barbell Menu strategy has allowed us to continue to work our strategy and bring freshness to the market to embed that to help us continue our drive to move into our $1.5 million AUVs that we've talked about over -- in certainly the last few months. So, I don't know if it's going away anytime soon, but I think that we certainly are well-positioned to be able to do battle with any competitive pressure on the discounting line. I think one thing that to consider is that as everybody else is discounting we're continuing to embed our positioning in terms of freshness. I think it's going to allow us to continue to build our mid-tier and premium tier as we move through time. Some people might ask what's that doing to value and affordability as everybody else is discounting, well, I can tell you we're still seeing that we have leading value and affordability scores out there in the marketplace. And I think that's because of having the everyday value. People know we're not going to take that away from them some day.

[Peter Saleh:]

Great. And then just a question big picture, have you guy ever seen any evidence that when wages rise, is there any sort of lag or any sort of correlation with the minimum wage is going up and your sales increasing as well?

[Steven Brake:]

Yeah. We don't have any direct, internal, or third-party data handy that would directly corroborate that. We certainly would acknowledge and agree with the tailwind hypothesis that as more spend goes in back pockets, potentially net of some job losses assuming that nets out in the positive and that should help spend trends in general. That said, we have been going from eight to nine to 10 over the last nearly two years now in California. It's very hard to carve out or measure to what extent if at all we're lift off of and then certainly with a new path ahead, over the next six years going to $15 an hour, that's just a very unique and dynamic scenario that we're now facing which really -- I think time will tell how that plays out. Certainly those consumers -- it's about consumer behavior and now that behavior will change over time. So while we agree the tailwind, at some point, might manifests itself in our favor, it's really premature for us to point to or call that out. And I haven't seen really any good third-party research yet that's validated it one way or the other.

[Peter Saleh:]

Got it. And then just lastly for me, the new campaign sounds like launch sometime this summer, were you guys be putting a higher amount of spend behind it or how should we be thinking about your spending -- your ad spending as we going to the back end of 2Q and into 3Q?

[John Cappasola:]

Yeah, this is John. Similar level of ad spending when s you look at it on an annualized basis, it's roughly 4% of sales and will continue with that pace and sequence throughout the year with the campaign. So, no investment spending to speak of, but certainly we're excited as we narrow the focus on the campaign to drive further differentiation and really take the UnFreshing Believable message to another level of communication with consumers to keep trying to reinforce the idea that we can offer a great fresh prepared product to a drive-thru at an unbelievable price point and we just need to continue to demonstrate that intel stories around the brand to further embed it. So, we're excited about the campaign, but no additional ad spending coming in the near future.

[Peter Saleh:]

Great. Thank you very much.

[Paul Murphy:]

Thank you.

[Operator:]

Thank you. The next question is from Craig Bibb of CJS Securities. Please go ahead.

[Craig Bibb:]

Hi. Just from -- just follow about a buyback you did in the first quarter and from your comments about that it's continuing in the second quarter. The decision is made, you guys are going to buybacks stock, not warrants, if that's correct?

[Steven Brake:]

What we've communicated was that the program of 25 million covers both common and warrant. So, we certainly have the approval to do one or the other or both.

[Craig Bibb:]

Is there -- like is there something that might change that would cause you to lean toward the warrants?

[Steven Brake:]

We're certainly very open-minded on both. We believe there's long-term benefits and accretion absolutely on both. Mathematically, buying common does provide an accretive immediate EPS benefit. On the warrants, that situation is not present because there's a money, but we currently have interest and appetite on both sides.

[Craig Bibb:]

Okay. And then someone else asked did you guys spot Steve [Indiscernible] in your units doing research on Chorizo and to be often [Indiscernible]?

[Steven Brake:]

I'm sorry; can you repeat the first part of that question?

[Craig Bibb:]

Did you guys spot Steve [Indiscernible], chipotle founder in your units?

[Steven Brake:]

No comment.

[Paul Murphy:]

No we didn’t see him.

[Operator:]

Thank you. At this time, we have no further questions. I would like to turn the conference back over to Mr. Murphy for any closing remarks.

[Paul Murphy:]

Okay. Well, we want to thank everybody for participating the call today and look forward to speaking with you on the Q2 call. Have a good day.

[Operator:]

Thank you. Ladies and gentlemen this does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.