El Pollo Loco Holdings Inc (LOCO) 2016 Q1 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the El Pollo Loco first quarter 2016 earnings conference call. At this time, all participants have been placed in a listen-only mode, and the lines will open for your questions following the presentation. Please note that this conference is being recorded today, May 5, 2016.

On the call today, we have Steve Sather, President and Chief Executive Officer of El Pollo Loco, and Larry Roberts, Chief Financial Officer. And now I would like to turn the conference over to Larry Roberts.

Thank you, operator, and good afternoon. By now, everyone should have access to our first quarter 2016 earnings release. If not, it can be found at www.elpolloloco.com in the Investor Relations section.

Before we begin our formal remarks, I need to remind everyone that our discussion 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. We expect to file our 10-Q for the first quarter of 2016 tomorrow and would encourage you to review that document at your earliest convenience.

During today's call, we will discuss non-GAAP 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 a reconciliation to comparable GAAP measures are available in our earnings release.

With that, I'd like to turn the call over to Steve Sather.

Thanks, Larry. Good afternoon, everyone, and thank you all for joining us on the call today. Our 2016 first quarter results included our 19th consecutive quarter of system-wide comparable store sales growth and pro forma net income of $0.17 per share. For the quarter, we saw a 0.7% increase in system-wide comparable restaurant sales growth that consisted of 1.8% growth at franchise restaurants and a 0.6% decline at Company-operated restaurants. The increase in system-wide comparable sales came on top of 5.1% growth last year, for a two-year growth rate of 5.8% and a three-year growth rate of 13%.

We continue to be pleased with our progress on the value, operational and service initiatives that we put into place throughout 2015. While we have noted that their impact on comparable sales will take time, our Company transactions, while still negative, has steadily improved since the second quarter of 2015.

In the first quarter, our consumer data and NPD research both showed continued improvement in our value and last visit excellence scores. These were further supported by the recently published Nation's Restaurant News consumer picks survey, in which our likely to recommend score increased by over 12 points in 2015 versus 2014. The improvement in these key indicators suggests that our initiatives are working, which we believe should ultimately lead to higher transactions and sales over time.

Last week, we launched a refreshed advertising campaign, which includes the introduction of the brand's new tagline Fresh From the Grill and showcases our flame grills and the more flavorful and healthier food they deliver. We have also started diversifying our media spend and engaged Harmelin Media as our new media company to help us more efficiently and effectively engage our target customers across a broader range of channels, including mobile and digital. After a transition period, Harmelin will be fully engaged by the fourth quarter.

Lastly, we continue to make progress on our mobile app, another sales-driving initiative, which will go into test this month. The new app will allow guests to order from our full menu and to pay using any credit card from their mobile devices. By the end of the year, we expect to have the app fully rolled out and fully functional, which includes the acceptance of coupons, gift cards, catering orders, as well as Apple and Android Pay. We believe that these guest experience and sales-driving initiatives will further enhance our differentiated value proposition, ultimately driving continued sales growth.

Switching to development, let me first start by welcoming John Dawson to the El Pollo Loco team as our Chief Development Officer. Given our growth strategy, we really wanted a strong, experienced leader of the development team, and John clearly fits that bill. We are very fortunate to get someone with John's development background and experience, including 17 years at McDonald's, eight years at Duncan Brands, and most recently as President and Chief Executive Officer of The Coffee Bean and Tea Leaf. John officially joined the team on Monday, and we look forward to his leadership and further developing and executive our growth strategy.

During the first quarter, we opened three new Company restaurants, including two new Company-operated restaurants in the Greater Houston area. We will continue to further expand our footprint in Texas in 2016, where, together with our franchise partners, we expect to enter the Dallas market and open approximately seven restaurants this year. Subsequent to the end of the quarter, we've opened one more Company restaurant in Nevada, our 25th location in the state.

After a thorough review of our new restaurant pipeline, we now expect to open 17 to 20 new Company-operated restaurants this year, with a more balanced opening schedule as compared to 2015.

During the first quarter, our franchisees opened one new restaurant in Brownsville, Texas, continuing our expansion in South Texas. On the franchise side, we continue to focus on accelerating development and feel good about the progress our existing franchisees are making, including those in Houston and Dallas. In addition, we are in discussion with several highly-qualified new franchise candidates looking to develop in new markets. We remain confident in our ability to deliver 10 to 15 new franchise restaurants this year.

I would like to touch briefly on the progress of our Houston development. Although we only have limited operating history, on average, our restaurant sales performance is now running modestly below our expectations. Additionally, we are currently incurring higher costs as a result of opening seven restaurants over the last five-month period.

While the timing of our entry into Houston is certainly a factor, with weaker sales trends partially attributable to the well-publicized oil industry slowdown, we are proactively implementing a number of initiatives to drive higher brand awareness and comprehension. These include better communication of the brand both on the inside and outside of our restaurants, shifting resources from TV to other forms of media, including radio, increasing trial through in-store events, and focusing media on our current menu versus promoting limited-time offers. We will also look to bring elements of our new vision prototype to our restaurants in Houston later this year.

Finally, we continue to believe that the best way to build the brand's awareness is through greater penetration, and we remain committed to our Houston development strategy and are confident in its long-term success.

As we discussed last quarter, we believe it's important to update our restaurant design in order to stay relevant to our guests and ensure our restaurant reflects our elevated brand promise. We believe that our new vision design does exactly that and better reflects the quality of our food and our QSR-plus positioning.

The consumer feedback that we received on our new vision design continues to be very positive, and going forward, all new restaurants which have not already begun the permitted phase will be built utilizing this design, including our initial entry into Dallas.

With that, I'd like to turn the call over to Larry for a detailed discussion of our first quarter results and 2016 guidance. Larry?

Thanks, Steve. For the first quarter ended March 30, 2016, total revenue increased 4.3% to $94.4 million, from $90.4 million in the first quarter of 2015. The growth was largely the result of the increased Company-operated restaurant sales, which rose 4.3% in the first quarter to $88.4 million.

This increase in Company-operated restaurant sales was driven by the contribution from the 17 new restaurants opened during and subsequent to the first quarter of 2015 partially offset by a decrease in comparable restaurant sales of 0.6%. Comparable restaurant sales were comprised of 0.2% increase in average checks offset by a 0.8% decline in transactions.

Franchise revenue increased 5.1% in the quarter to $6 million, from $5.7 million in the first quarter of 2015. This increase was driven largely by the contribution of six new restaurants opened during and subsequent to the first quarter of 2015 as well as by comparable restaurant sales growth of 1.8%.

Turning to expenses, food and paper costs as a percentage of Company restaurant sales decreased by 170 basis points year over year to 30.3%. The improvement was predominantly due to lower commodity costs, particularly lower contracted chicken prices. As a reminder, for the remainder of the year, prices for all of our chicken needs are locked in, and we continue to expect commodity deflation of 3.5% to 4% for the year.

Labor and related expenses as a percentage of Company restaurant sales increased 220 basis points year over year to 27.7%. The increase in labor expenses was driven primarily by the increase in minimum wage, additional labor invested in our existing restaurants, and incremental labor required during the start-up of 11 restaurants opened in the fourth quarter of 2014 and three restaurants opened during the first quarter of 2016. These were partially offset by lower Worker's Compensation expense.

Occupancy and other operating expenses as a percentage of Company restaurant sales increased 110 basis points compared to the prior-year first quarter at 21.3%. This increase was primarily due to rent expense on new and renewed restaurant leases and the incremental costs related to opening new restaurants in the fourth quarter of 2015 and the first quarter of 2016.

General and administrative expenses increased by $1.8 million year over year in the first quarter to $9.2 million. As a percentage of total revenue, G&A expenses increased 130 basis points to 9.8%. The increase was due primarily to $1.5 million of legal costs related to the securities class-action litigation as well as the increases in restaurant pre-opening costs, travel expenses and professional fees.

Excluding costs associated with the securities litigation, G&A expenses in the first quarter of 2016 would have been approximately $7.8 million. This would have been an increase of $285,000 from the prior-year period and slightly lower year over year as a percentage of total revenue at 8.2%.

Depreciation and amortization expense increased to $3.8 million, from $3.1 million in the first quarter of last year. As a percentage of total revenue, depreciation and amortization increased 50 basis points year over year. The increase was primarily driven by our new store development as well as by our remodeling program.

Interest expense decreased by $385,000 year over year to $826,000, from $1.2 million in the first quarter of 2015. The decrease is due to the $44.5 million of prepayments on our revolver made during 2015 and the first quarter of 2016.

During the first quarter, we incurred a charge of $264,000 relating to the present value of expected payments under our income tax receivables agreement. This agreement calls for us to pay a pre-IPO shareholders 85% of the tax savings realized as a result of utilizing our pre-IPO net operating losses and other tax attributes. We recorded a provision for income taxes of $3.8 million in the first quarter of 2016, reflecting an estimated effective tax rate of 40.9%. This compares to a provision for income taxes of $4.7 million in the prior-year first quarter.

We reported GAAP net income of $5.4 million, or $0.14 per diluted share, in the first quarter, compared to a net income of $6.8 million, or $0.17 per diluted share, in the year-ago period.

In addition to our GAAP net income, we have calculated pro forma results, adjusting for one time or unusual expenses. To arrive at pro forma net income, we have made adjustments for expenses associated with the tax receiveables agreement, losses on disposable assets, asset impairments, closed store costs and legal expense associated with the securities class action lawsuit. We have added back provision for income taxes and have applied a 40% income tax rate.

Included in our earnings release is our reconciliation of our GAAP results to our pro forma results. We believe that the pro forma results provide a useful view of our business and cost structure.

Accordingly, pro forma net income for the quarter was $6.6 million, as compared to $7.1 million in the first quarter of last year. Pro forma diluted earnings per share was $0.17 for the first quarter of 2016, compared to $0.18 in the prior-year period. Both our first quarter of 2016 GAAP and pro forma results were negatively impacted by the temporary closure of a restaurant due to fire in late 2015. While this restaurant reopened in late March, revenues and net income were negatively impacted by approximately $750,000 and $217,000, respectively.

In terms of our liquidity and balance sheet, we had $8.9 million in cash and equivalents as of March 30, 2016, and $121.1 million in debt outstanding. For the foreseeable future, we expect to finance our operations, including new restaurant development and maintenance capital, with cash from operations and borrowings under our credit facility. We expect our capital expenditures to total $34 million to $38 million for the full year.

Turning to our 2016 guide, we continue to expect pro forma diluted net income per share of $0.70 to $0.74. This compares to pro forma diluted net income per share of $0.71 in 2015. Our pro forma net income guide for 2016 is based in part on the following annual assumptions, which reflect a revised expectation for restaurants in Houston.

We expect system-wide comparable restaurant sales growth to be in the low single digits. We expect to open 17 to 20 new Company-owned restaurants and expect our franchisees to open 10 to 15 new restaurants. We expect restaurant contribution margin of between 21% and 21.4%. We expect G&A expenses of between 8.4% and 8.6% of total revenue, excluding legal expenses related to securities class action litigation. We expect adjusted EBITDA of between $68 million and $70.5 million. And we're using a pro forma income tax rate of 40%.

With that, I'll turn the call back over to Steve for some closing remarks.

Thank you, Larry. We continue to focus on delivering against our four brand pillars -- great food, excellent service, a warm and inviting atmosphere, and a good price -- while further enhancing our value proposition and customer experience. We believe this will strengthen the foundation of our business and drive results over the long term. We continue to have a long runway of growth in front of us, and we're excited about the opportunity that lies ahead.

Thank you for joining us today. We appreciate your continued interest in El Pollo Loco, and we'd be happy to answer any questions that you might have. Operator?

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Matthew DiFrisco, Guggenheim Securities.

I just had a couple of questions. I wonder if you can give us an update. Last time you spoke about the driver to the comp and trying to improve your value proposition with the combo meals and emphasizing those more. Can you talk about that or give us some sort of metrics to gauge how successful that was in the sell through?

Yes, Matt, this is Steve. We've got the -- on the Company menu, the $5 value combos are on that. We did that last -- actually, it was last summer when we put that back in, and that remains on the menu today. We've looked at a number of initiatives, as you know, to drive that value aspect. It's not just the food and value pricing. It's also the service that we're giving and the atmosphere.

But we think we've got the menu now right. We've reinstated the snack menu on the menu board. We did that also last summer. And also, a number of our LTOs -- we really looked at the pricing that we're putting on those, and we got those in the mid-$5 and maybe low $6 range, so we've made adjustments on prices on that.

And when you really look at on the value, it's really not just price. It's really the function of everything that we're doing. We're getting great ratings on our food. Now we want to bring out that service and atmosphere and provide that overall value. And I think the real measure of all this, including what you talked about, the combo meals, is the metrics that we're seeing the improvement, and they've been improving. Our transactions have been improving. All of our NPD, our market force, the recent Nation's Restaurant News all indicated that we're getting improved performance there, including that value aspect. So thanks for that question.

Okay. And then, also, I guess just can you dig into a little bit of the mix there? I think you said last call you were estimating a little less than 1% on the price, a little bit below what you have historically taken, and your mix was -- or your average check was 0.2%. So are you having now a negative mix, and I guess is that something that we should think about going forward, or is that just something that was maybe promotionally scheduled that was more seasonal?

Look, if you look at the mix and towards the balance of the year, we expect to be slightly -- well, flat to slightly negative given the calendar and our real focus on value. We expect transactions to be slightly positive. And then on pricing, we've taken -- just took actually in April a 70-point pricing increase in our Company stores, so we're currently running about 1.5% on price if you look at that as well.

We took, as you know, 0.8% last fall, in November, and we took it in a very scientific method. It was a three-tier approach, separating the restaurants into three tiers. So mix, again, would be flat to slightly negative, and transaction improvement and then the price adjustments. We'll also take a look at adjusting our prices, as we normally do, this November, but we'll see how the consumer is accepting of that at that point.

And then my last question, with respect to development. I think you -- 17 to 20 is a little lower than the last time you talked, which was 18 to 22. Are those the stores -- I guess the one or two stores that sort of came out of your guidance range for Company openings, is that coming out of the Houston market specifically and reflective of sort of the floods and some other issues that are going on down there?

No, we took a close look at really the high end of the range, including the -- we kept the two in that rolled over from last year. We made an adjustment on two that we thought -- one was in Houston, and --

Yes, and I'll just step in here. I mean, what we did was we actually really scrubbed the development schedule, and when we looked at it, we had two restaurants that we looked at probably opening this year at that point hadn't had leases signed, and when we reviewed those leases and reviewed those sites, we just decided not to move forward on them. We didn't think they were the right sites for our concept, and so that's one of the reasons why we brought that top end of the range down.

I think, overall, we don't want to have a top end of the range that we don't think we can hit, so we dropped that, but it's really reflective of a couple of restaurants, again, that we reviewed and didn't think they were the right things to move forward on and a real scrubbing of the development schedule.

Okay. Thank you.

Andy Barish, Jefferies.

Hi. Good afternoon, guys. It's actually Reena Krishnan sitting in for Andy. Just one clarification in terms of the comps. Was there any impact that you guys possibly saw from Easter?

There was a slight impact or two, a tenth or two-tenths, but not significant impact.

Okay. And then just in terms of as you're trying to bring in more service into the equation, as we're thinking about the labor line here, you had previously said that you were expecting about a 100-basis-point impact or labor pressure. Is that still accurate, just given where minimum wage is falling and how you're trying to bring up the service level into the equation here?

I mean, what we're seeing is initially we did think the -- you look at labor is the minimum wage and then the labor investment would be about a 100-basis-point impact for the full year. What we're looking at is, quite obviously, in Q1, looking through the details, we were not where we wanted to be. We had a bit of a miss on our base business. I define base business as 2014 builds and prior, and we've since gotten that under control. If you look into the second quarter now, it's running on target in terms of labor.

And then the other additional impact we're seeing is, again, from 2015 and 2016 builds. We think -- initially, I had highlighted about a 40-basis-point impact from those restaurants, and now I think it's going to be a little more than that, and that's just reflecting the unit volumes that we've got and the fact that it really is -- I mean, we've got a new units out there. We've got a lot more being built, and we're not going to cut back on labor just to hit the margin numbers. We really think we've got to make sure in places like Houston and Dallas -- I kind of see some of this labor as an investment to make sure we're running good operations in these markets.

Okay. Thank you.

John Glass, Morgan Stanley.

I wanted to first just ask about Houston, and I apologize, because I missed some of your commentary at the beginning. You cited some weakness there, and I'm assuming it's oil and floods and stuff, but this is, I think, the first time I've heard that. So when did you -- has this been sort of creeping up and now is big enough to notice, or was it an all of a sudden kind of situation in Houston? Maybe talk about that, and within all the stores, are you worried about certain locations? A little more color around what you're seeing in Houston would be great.

Yes, John, thanks for the question. This is Steve. First of all, we think it's still very early in Houston. Seven of our 11 restaurants opened since last fall. With that being said, the unit volumes that we're now seeing are modestly below our original IPO expectations. We've looked at a lot of the internal metrics and operating from the consumer measure, et cetera. We're pleased with our primary focuses on building brand awareness and how we communicate our brand.

So we've implemented a number of changes, slight tweaks to this number of actions. We've shifted the media this year. We're going to go more on radio and digital. We're doing some local store marketing efforts, added some external signage. Our marketing calendar is going to more educate the consumer. We're implementing some materials that emphasized the brand, and also some direct-mail pieces.

We're also going to bring this fall -- we've had very good reception to our vision design that we're going to roll Dallas with, and so we'll bring some of those design elements into Houston later this year.

Finally, the best way I think to really build brand awareness is through greater restaurant penetration, and we're still very committed to Houston and its long-term success, but we opened many of these units late last year, and we just saw the volumes slightly lower and we wanted to bring that out, but we're very committed to Houston and to Dallas. In fact, in Dallas, we're looking at opening -- I believe we have probably -- probably in Dallas we have, I believe, six stores opening next year.

About that, yes.

So, very pleased there.

And I assume that there has been no impact on any of Houston's store in the comp base. Would that have had any impact on the comp or not?

John, there is I think one restaurant that now is in the comp.

Yes, I think one just (inaudible).

Yes, so that's not going to have much of an impact on comps, but to the extent it does, it's going to be negative because of the -- it's called a honeymoon period and the fallout over that time, but it's too small to make any difference in our comps.

Okay. And just, lastly, just when you think about development in 2017 and you've got a new development person onboard, but you also talked about how you scrubbed your development for 2016 and a couple units fell out. Why did those fall out? I mean, were you finding that you weren't -- you were changing your criteria, or did you find your criteria wasn't being adhered to? I guess why did that happen, and as you think about 2017, how do you think about initial thoughts or high-level thoughts on how many stores you think you should or could open in 2017?

I mean, John, one of them fell out because as we look -- the real details are it was really part of a two-restaurant deal with the landlord, and we really only wanted one of them, but initially we thought we were going to have to take both in order to get the one that we really wanted, and our development team did a great job negotiating so they could break it apart. And so with that, then we did not go forward with the other unit, and it was mainly because it was going to have a negative impact on two other restaurants of ours, and while we thought maybe the penetration would work, we just said it looks a little too risky, and now that we don't have to do it, we're not going to do it.

And then the other one was just when it came in initially, we thought we could get the rent down, but the rent came in at a level that was just too high for us to swallow, so we just said let's pass on that one.

Gotcha. Okay, and thoughts on 2017?

John, I just wanted to add those were two that we didn't have leases actually signed. The balance now of our pipeline is basically almost everything has signed leases. I think only one restaurant doesn't have a signed lease, but everything else is signed and moving forward.

And just on 2017, is there any way to put a framework around that?

Yes, just roughly half are going to be in new markets, so that would be in Houston and Dallas areas, and the remainder in our existing markets -- California, Arizona and Las Vegas.

Thank you.

And also we expect a better balance across the quarters, not back-end loaded like we had last year, so it'll be a little back-ended, a little heavier weight on the second and third, but not like we did last year.

(Inaudible) coming together. We've got a number of signed leases, and we feel confident about the development schedule.

And John, as we mentioned on the call, we're very pleased to have John Dawson onboard. Although he just started Monday, we think he's a great addition to our development team.

Yes. You bet. Okay, thank you.

Sharon Zackfia, William Blair.

Hi, this is Matt Curtis on for Sharon. I just have another question on Houston. Are you actually going to be spending more on marketing in Houston during the second quarter or pulling dollars forward from the rest of the year, or are you just changing what you're allocating those dollars to?

It's really more of just an allocation. We charge our restaurants 5% sales. That's what we spend. We might put a little incremental in, but it won't be that significant, so it's really just a shift in where we're spending that money.

Okay. And then on comps through the quarter, how did comps trend through the quarter? I mean, was February the strongest month or not? And then if you'd be willing to share what trends were like in April, that would be helpful.

Matthew, give me a second here. The one thing -- let me start with April. I mean, we normally don't give guidance on the quarters, but what we'll say about April is that we talk about how our transactions have steadily improves since Q2 last year, although they've still been negative, and right now that improvement continues, and actually Q2, to date, we're running positive and we expect to see positive transactions through the quarter.

Okay. Great.

In terms of -- yes, just in terms of how comps were during the quarter, I mean, some of it is driven by what you're lacking in things, and so each of the periods, we at the Company level ran negative and were a little more negative in period three than the other two periods from a company basis, but, again, Q2 we feel good about where the transactions are to date. We expect them to be positive for the quarter.

Okay, thanks for that. And then I guess, finally, on your mobile app, I know you haven't gotten into testing yet and you'll know more after that, obviously, but do you view the app as more of a check builder or something that could be a potential transaction driver?

Yes, I see it near term I think as a check builder. I think longer term, it's a transaction driver, especially as we start layering in things like loyalty programs and, obviously, reaching people through digital ads and those types of things. But, yes, I think like most other companies out there with any of them, it's going to be probably a check builder early on and, long term, a transaction driver.

Okay, I appreciate it. Thanks very much.

Jake Bartlett, SunTrust.

My question is about your labor exposure to minimum wage. There was some detail in the K that kind of showed how much revenue you get from Los Angeles County. Maybe if you could just clarify how many of your Company-owned stores are impacted or are within Los Angeles County itself given that they're having a higher minimum wage increase.

Sure. Yes, so, Jake, initially I think I had previously communicated that LA County -- we thought somewhere around 55 restaurants, Company restaurants, would be impacted. We've since gone through and scrubbed -- really looked through legislation and scrubbed to see how many restaurants would be impacted, and the number I believe is 22, so 22, 23 restaurants will be impacted.

So it's probably about half the original impact we thought it would be, and so where previously I think we had built in probably $500,000 for the LA minimum wage impact, we're still working through how we manage the compression, wage compression, but I expect that to be somewhere around half of what we originally anticipated for LA.

Okay. And just to clarify, in the K it said it -- I think it was 42 or somewhere around there of your revenue was generated in Los Angeles County you said. Was I misinterpreting that?

No. I mean, those facts are true. In fact, I went back and reviewed that knowing that you were interested in this question, and part of it was kind of forward-looking to think, okay, where else might adopt the LA minimum wage rules, and we kind of -- I think we put that language in there. But, again, when we actually went through the details of the legislation -- and I think we're probably -- we're conservative in our 10-K, but when we actually went back and did the detail analysis and dug into it, we determined that 22 companies and I think about -- I'm trying to remember off the top of my head -- it was less than 22 on the franchise side would be impacted.

Got it. Okay, we can maybe go over it offline, but it says in the K that on September 29, 2016, the Board of Supervisors in LA County adopted the ordinance within the city of Los Angeles, but we can talk about it later.

Yes. Yes.

But maybe just overall, in terms of the minimum wage increase that California looks to be passing through, I mean, you're going to have multi-years of wage pressure from that. How do you plan on dealing with that longer term? I mean, do you think you can get efficiencies or maybe raise pricing enough to get labor leveraged or to hold labor as a percentage to sales going forward, or what's your approach to deal with that kind of pressure going forward?

Matt, let me just give you just a quick overview. We're obviously looking at a number of ways to manage that impact. First of all, we did see this year some commodity deflation. We're looking at scrubbing every line of the P&L for cost savings. Obviously, technology -- we think that's a big aspect. We're looking at kiosks in the stores so we can possibly offset some of the labor there, cashier labor, and then pricing ultimately on the end of that, but we want to make sure that we don't do anything to upset the value equation we have.

And of course, all the other competitors will be facing the same thing, and I think, Larry, if you have other detail beyond that -- those are the areas we're looking at.

Yes. No, those were the main points I was going to hit. I think the -- yes, quite honestly, the big thing we've set up (inaudible) or about to set up the California minimum wage task force to go after all the things we go after to mitigate the impact, certainly looking for other cost savings, and then probably a big one would be looking at what technologies are out there that we can use to get more efficient and help manage it that way rather than just take price.

Great. And then another question on your -- the traffic looks to be recovering, and that's encouraging. Are you seeing -- who are you getting back? It seems like a tough environment still to gain back that value consumer given what they're hearing from some of the QSR competitors, but are you seeing maybe your higher-end consumer growing faster or are you getting back both your kind of value consumer (inaudible) losing a few quarters ago, or how is that working out?

The initial indications are that the heavy user, the heavy consumer that loves our brand, is really coming and coming more frequently.

Yes, and I'll just add -- I think Steve is absolutely right on that, and I'll just add that we want -- we don't want to get too positive, but the fact that the burger guys are out there heavily discounting and yet we're seeing improvement in our transaction trends is still encouraging.

Yes, the steps that we took with our pricing has been spot on and really brought the -- we're focused on the transaction increase, and given the heavy competitive -- from the burger guys and all the QSRs, I think we're holding our strategy very well, and we think that strategy is the right one, because I think if you get into that discounting end, it's going to hurt the brand long term.

Great. And the last question, on your tiered pricing place, could you maybe explain how that's being implemented? Is it a matter of increasing in some markets and holding other markets like Houston flat, or are you actually decreasing in some markets? Maybe if you can give us an idea of maybe how much you're increasing in kind of tier one or tier three, tier two, just give us a sense of how that's all working.

Really, we separated it out into -- now, it really was five tiers if you added in Houston, which we haven't taken any pricing increases there, as we're just launching the brand, so that could be really the fourth. We also treat our Sacramento market like that. The others were in the three tiers, and how we take pricing is as we see the ability through working with Czar Metrics to move from one tier into the next, which raises the prices, we shift that store into that, and those are in our -- the balance of our markets are LA, Las Vegas and Phoenix.

And Jake, that's really almost a restaurant-by-restaurant type of analysis. It's not like certain sections of LA or Orange County. It's restaurant by restaurant.

Got it. Thank you very much.

Uh-huh.

Thank you.

Sam Beres, Robert W. Baird.

Steve, I know you've talked in the past about some operational enhancements, whether it's the pagers in the Company locations and moving in the franchise as well the new center line kind of crepe layouts, so I'm maybe wondering if you could talk about where you're seeing speed of service trend in the most recent quarter and how you think that's impacting potentially the improving trend on traffic.

Well, thank you for that question, because we're very -- as you know, last year we implemented a number of initiatives, and most of them were the third -- well, the majority in the fourth quarter being our line improvements, our POS simplification, pagers on the inside for inside speed of service. We also increased our labor on the inside -- or labor in the store to improve that as well.

What we're seeing on speed of service is we're -- we've always been very strong on the drive-thru. We've always measured that. That's running just about four minutes for both Company and franchise, and we monitor that. We monitor it daily, both Company and franchise. I've always focused on that. We've seen real improvement on the inside, because we really -- since we've put the pagers in, that's a way of measuring the inside speed of service.

We did take it prior to that from mystery shops, but that was more of a range. It would be under four minutes, four to six minutes, so now we're getting -- what we saw when we first initiated the inside speed of service with the pager was that we might be over five minutes initially, so as we've added those in, we're now close to that four-minute mark in all the Company restaurants, and franchise about, I would say, 80 or 90 have put the pagers because they see that improvement.

So we think those enhancements that we made in the fourth quarter and the back half of last year are really part of improving our operations this year, and it's really reflective in every metric that we look at. If you look at the NPD metrics, we just got our first quarter in, and we improved there on all the service metrics. If you look at our market force metrics, they're the highest that last visit excellence has been.

You look at all of the -- you look at the Nation's Restaurant News, the one that just came out, and we went from, I think, seventh down to fourth and improved in the majority of categories, especially on service speed. So we're very happy that we took the time and did that right last year on all of that, and we think we're going to reap the benefits and improving it more this year, especially as franchisees add those pagers into their stores.

That's helpful. Thanks. And maybe one follow up. The Company has been leading the franchise system in terms of the ramp up in unit development, so any perspective on the comps you have and accelerating the pace of franchising growth in 2017 and beyond? Are you seeing the pipeline build to where you're confident you can deliver a high rate of franchise growth next year?

Yes, we're seeing some nice improvement. We didn't increase our forecast on the franchise side yet, but they've had a nice improvement. We said 10 to 15, and we feel very comfortable that we'll hit that or higher. We're also looking at, as we mentioned in the call, a number of highly-qualified franchisees, especially like if you look at the Henry Group that joined us in Dallas, that's going to co-develop Dallas with us.

They're going to open up almost simultaneously with us, so they're going to have two or three stores open this year as well, and we're looking at groups for other smaller markets in our existing markets. Plus we've got franchise -- existing franchisees in Utah, and two of our existing groups are developing the Utah market, so we're seeing good interest there and good actual action on that.

Yes, and just to add to that, I think Steve hit the nail on the head. I'd just add that really the key to getting our franchise acceleration is -- like he said, we have existing franchisees who are looking to develop, but the thing we're working hardest on is getting new franchisees into the system. And certainly in terms of long-term growth, 2017 and beyond, it's critical that we continue adding new franchisees, like the ones we have in Texas and the one we have in Houston. If we get them onboard, then we'll feel good about being able to ramp up franchise development in later years.

Great. Thank you.

Paul Westros, Stifel.

I was wondering if you could just kind of officially give us an update on your view of the competitive environment that's coming out there? I know you alluded to it in one answer, but maybe how it started off and then if you feel the same, if it's gotten better or worse now in April versus maybe at the beginning of the first quarter.

Well, I think -- first of all, I think we're seeing the -- in LA, I think the economy is reasonably strong. The competitive environment is what you see, especially in the burger brands. It's what you see in all of the markets. There's a lot of discounting going on, the burger war, so to speak. As we said, we're not getting into that, but that certainly is going on here, and we're very pleased with our transaction growth that we've maintained and improved in light of that competitive environment. So we think that's strong performance there, but it certainly is there and we're aware of it.

And can you tell whether it's gotten any better or worse as you've moved that throughout the year?

I would say it's hard for us to put an actual dollar number on it. We see it as we go around and see all the promotions, but it's hit us a little bit, but --

Well, I was just going to -- I think what you see is it started in the last year. It hit hard in January, and I don't think really I have seen much change. I think it's as strong today, from what we can see in the marketplace, as it was, say, in January.

Paul, we really think -- as I mentioned, it would be a mistake for us to try and kind of join those burger wars or join that really heavy discounting. Those battles haven't worked for long term, and it's really going to, we think, denigrate the brands, and that's not -- we think we're clearly differentiated with our food and our taste, and we're offering that at rate value, and that's where our positioning with the QSR-plus we think is the right one, and we're going to stay with that.

Great. Thanks. And then moving over to thinking about the store-level margin number, I guess is seasonally in question. Your full-year margin guidance points to the number of like 50 basis points stronger for the year than what you saw in the first quarter. At least the last couple of years, it was reversed. The first quarter margins were a bit higher. I know you hinted to some of that regarding the inefficiencies in labor and some of the new store startups, but any way to quantify that impact and just sort of why this year we'll see stronger margins in the final three quarters?

Yes, well, like I said, when we look at the first quarter in terms of margins, I think the ones -- we always anticipated the first quarter would be a little lower this year given the number of new restaurants we had coming onboard late last year. We knew that was going to have an impact on the first quarter, so we anticipated our first quarter margins to be lower than in past years.

I think the thing that surprised a little bit and that took it even a little bit lower, like I highlighted, was the labor inefficiencies, which in Q2, we've eliminated that issue on our base business, and still in some of our 2015 builds, we built in inefficiencies, but we've seen that we need to keep some labor in these restaurants to make sure we maintain our service levels.

So certainly in terms of the base inefficiencies, that should go away as we move through the year, and even some of the 2015 rollover impact, that also should become better as these restaurants come onboard and we -- normally when we open these restaurants, we put a lot of extra labor in them for the first eight weeks or so. They'll work through that, and so I would expect to see the margins improve the balance of the year.

The one thing I'll highlight, because when I look at the business, I always break this down between -- I look at it in terms of 2015 builds, 2016 builds and then my base business, and then you've got some other items going on, and even in the first quarter, even with that labor inefficiency, the base business was basically ran flat margins year on year, and so that to me is good performance certainly the full year, and we're still looking for that base business. Again, those are 2014 builds and prior to run flat, if not slightly improved, margins through the year.

And again, it's just the amount of building we're doing of new units and 2015 rollover units, which we want to maintain our labor in or maintain service levels. That's where we're seeing a little bit more margin impact, and that's why I dropped the margin guidance.

That's very helpful. Thank you. And then maybe, lastly, maybe a peek at what your current marketing for the calendar schedule looks like here in 2Q and as far out as you're willing to go, maybe what's on the -- coming down the pipeline for the summer.

Yes, sure, we're -- if you look at -- hold on, let me grab our calendar here. We're currently on our double chicken salads, which is our limited-time offer. Again, we always run our family meals as well here. We don't want to get too much into giving you our marketing calendar publicly here for the balance of the year, but we've got some great things lined up for the balance of the year. We're doing nine modules this year, and we're very pleased with what Heather and the R&D group has for us.

But generally the entrees will be priced comparable on a year-over-year basis?

Well, we've actually lowered the -- we lowered the range, as I said in one of the comments before. We're trying to keep them in the mid to low -- if we go over $6, then the low $6 range. We're very conscious on that value aspect, and we think we've really done a lot over the last year, really, if you look from Q2 last year to address those issues, and we think we've got the right products and the right pricing, so we don't want to get too high into that $6 -- the high end of the $6 with these. But the great -- the most important thing is the products taste great, which they do.

Great. Okay, thank you. I look forward to those Dallas stores.

Uh-huh.

Matthew DiFrisco, Guggenheim.

Just one of the questions I asked earlier about the quarter-to-date trends, you were I think also referring to annual guidance. I just want to make sure I heard that clearly. You were saying you anticipate positive comps and positive traffic in 2Q? Was that correct?

No, what I said, Matt, was Q2 to date, we are positive transactions, and we expect to be positive transactions for the quarter. We're not giving -- we've given a full-year low single digit comp growth. That's still our guidance for the full year. But like I said, we've seen a positive trend in transactions since Q2 last year. That's continuing. And again, we'll be -- we're positive to date and expect to be positive transactions for the quarter.

Positive transactions. Okay. I guess you were not positive transactions in 1Q. That's why I was a little confused when you said continuing positive transactions.

Well, I meant the continuing from the positive trend in transactions. Although we're negative in Q1, they were still call it less negative than -- each quarter since Q2 last year, we've still gotten better, although still negative, and now we've seen in Q2 that we're running positive and expect to be positive for the quarter.

Okay, that's very clear. Thank you. And then the last question, I guess, just looking at -- you referred to 17 guidance of sort of half of your openings for the Company coming outside of California. Is there any risk that the underperformance in the Houston stores would cause you to further scrub or look at those potentially, I guess, if it's half of the 17, 18 that you're opening -- or 17 to 20 you're opening this year, so call it eight to ten stores that might open in Texas or other markets outside California. When you consider it, is there a risk of those maybe being deferred for longer-term growth later?

Well, let me clarify. First of all, on the 17, I was referring to 2016 growth, the 17 to 20, half in new markets, half in the existing markets, and we haven't really given a mix of 2017. It's really too early to call that. But we're still very -- first of all, we're very optimistic on --obviously, if you look at the commitment to Dallas, we feel very good on that, and we feel good on Houston as well.

But it's too early for us to really see what the mix will be for 2017, because we're bringing -- we've got -- if you look at the areas where we're underpenetrated -- Northern California, Sacramento, a lot of opportunity there. I know John Dawson is just new onboard, only been here four days now, but he sees a lot of opportunity in our existing markets as well, and so, again, early for us to make a call on the mix in 2017.

Okay. Thank you.

Thank you. I would like to turn the floor back over to Steve for closing comments.

All right. Thank you very much, operator, and thank you, everyone, for your joining us today and your interest, and we look forward to the next call. Have a good evening.

This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.