Berto Acquisition Corp (TACO) 2016 Q1 法說會逐字稿

Good afternoon, and thank you for standing by. Welcome to the fiscal first-quarter 2016 conference call and webcast for Del Taco Restaurants Incorporated. I will now turn the call over to Mr. Raphael Gross to begin. Thank you sir, you may begin.

Thank you operator, and thank you all for joining us today. On the call are Paul Murphy, President, 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 will open the lines for your questions.

Before we begin, we would 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 Incorporated for a more detailed discussion of the risks that could impact for 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 America, or GAAP measure 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.

Thank you, Raphael and thank you all for joining us on the call today. We experienced a strong start to 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 our strongest quarter of 2015, resulting in an impressive 10.9% two year growth rate. Restaurant contribution margin of 18.7%, a 10 basis 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 systemwide same-store sales growth and our 15th consecutive quarter of Company operated same store sales growth.

Same-store sales at Company operated restaurants grew 2.8%, comprised a 5.4% growth in check and a 2.6% decrease in transactions. On our last call, we covered the headwinds we were facing in the first quarter, mainly the difficult traffic comparison of plus 3.9% in the first quarter of 2015, along with the heavy value promotions and deep discounting characterizing the QSR industry today. In light of these factors, we are pleased to hold the two year traffic trend positive at plus 1.3% and offset negative traffic in the first quarter this year through strong check growth driven by effective menu price increases and continued menu mix growth of over 1%.

Additionally, we were proud to have slightly expanded restaurant contribution margin this quarter, despite inflation of both the food and labor lines. Our consistent sales momentum and demonstrated ability to absorb inflationary impacts are the result of our continued focus on delivering the great value and speed that Del Taco has become known for, while layering on opportunities to broaden the locations we serve that elevate our brand promise. As we look ahead, we remain focused on the deployment on the next iteration of our combined solutions strategy.

We will be launching Fresh Combined Solutions at the end of June, which will bring a combination of improvements to market that we expect will further imbed our freshness positioning and differentiate Del Taco from the competition. Our goal is to strengthen our fresh standard value positioning without diminishing our category leading value scores or our ability to deliver speed and convenience.

As we have discussed previously, we have many exciting operations and marketing initiatives as part of this next wave. Although the market elements are planned to kick off in late June with exciting new product news and the launch of a refreshed and recharged 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 Bootcamps in franchise owner meetings across the country where we touched over 600 general managers, above-store leaders and owners. In the bootcamp training, we covered two key areas of focus to improve the guest experience. Our transaction efficiency program, designed to improve speed of service and drive through 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-wage to $15 by 2022. As we continue analyzing the potential financial impact and formulate our plans to manage it, there are several important considerations worth highlighting. First, although minimum-wage has more recently become topical at a national level, it is not new to us as we have successfully managed the California increase from $8 to $10 an hour since July 2014.

Over this time frame, we drove strong same-store sales performance on both an absolute and a 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 full $1 increase in 2019 through 2022. This, affords us time to prepare. All else being equal, we currently estimate that incremental $0.50 in 2017 and 2018 would require approximately 1% of annual incremental menu price to cover the all-in $1 impact.

Third, it is important to understand this is a level playing-field issue that will generally impact all California restaurants proportionally. Restaurant, retail and service price pressure will likely prevail across-the-board, and consumers will have to adjust to higher prices and potentially higher levels of disposable spend, which over time, 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 of pairing value and 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 barbell menu strategy across Buck & Under, mid-tier and premium tiers, provides us a broad playing field to achieve menu price in a targeted 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 systemwide 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 infill markets where we have identified over 300 trade area 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 franchisees. I'd now like to turn the call over to John Cappasola, our Chief Brand Officer.

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 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 and 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 expanded 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 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 point 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 check 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 of 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 continue 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 in 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 are able to pare it out 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 and 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 midyear.

Now I'd like to turn the call over to Steve Brake to go over our first-quarter results.

Thanks, John, 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 30, 2015. Therefore, the successor trade for the 12 weeks ended March 22, 2016 is being compared to the predecessor period for the 12 weeks ended March 24, 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 represents the fifteenth consecutive quarter of gains and was comprised of 5.4% in check growth including over 1% of menu 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 lapped systemwide same-store sales growth of 7.7% during the first quarter of 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 ago first-quarter. During the quarter we opened two restaurants systemwide, 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 food 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 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 approximately 10 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 pubic 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 was primarily due to the fact that the first quarter is our lowest sales volume quarter based on seasonality. We are 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%, down 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 are 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 net income and earnings-per-share prospectively, until we lap purchase 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 30, 2015 closing of our merger and our August 4, 2015 refinance transaction. As of the end of the first quarter, $154 million was outstanding under this all-revolver credit facility, and effective March 18, 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 are happy to answer any questions.

(Operator Instructions)

Craig Bibb, CJS Securities.

Hi guys, great start to the year. Could you walk through the monthly progression of comps? You're a little bit light versus the pre-announcement, and then most importantly, how was April?

In terms of the -- there's three reporting periods. Each of the three periods net-net were very consistent. One or two above or below that 2.8 on the Company's slide, but overall pretty steady on a period-by-period basis is what we saw in the first quarter.

Craig, this is Paul, In terms of April, we are still early in Q2. From our standpoint, just a few things about Q2 I'll talk about. We haven't really seen the value environment change. It's as strong today as it was in Q1.

Some of the brands have changed their offers but others really have come into the mix. We continue to lap strong prior-year transactions in the early part of Q2, but that being said, the transaction lap piece is considerably the back half of Q2. We're really excited about the initiatives that we have going on in the marketplace.

We had [the perry and the] Buck & Under with carne asada, and that's going to be followed soon by Buck & Under alongside the launch of our new Epic Chicken Avocado Ranch burrito. And as John mentioned, as we enter into Q3 we're going to launch our Fresh Combined Solutions, which besides operational equipment initiatives, we will complement that launch with the introduction of a new product at Del Taco. We are going to use that as a consumer catalyst.

We really feel good about the initiatives we have in place to continue to strengthen the comp. We think that the resilient barbell menu strategy we have provides us a lot of levers to address either macro or competitive pressures, giving 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.

I noticed the average weekly sales growth has actually exceeded your same-store sales growth, so your non-comp units are doing well. Can you talk about the new units and newer markets?

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 infill 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 in the pipeline. We definitely remained encouraged and happy with what we're seeing on our new units.

Last question. Okay, and then last question. It sounds like you expanded the number of restaurants that are testing Platos? Have you decided to go national?

Hey Craig, its John. The decision to go national has not occurred yet but as we've talked about, we've been in a small market, 15 stores or so since last summer, and it has 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, or has been taken, in the last few weeks to a second market, which will help us to finalize the launch recommendation.

So as far as launch timing goes, like I said last call, we do see a path to getting this to market this year. It's likely Q4-ish pending the results of the second market but we feel really good about what we're seeing thus far with this program.

Great, thanks a lot.

Alex Slagle, Jefferies.

Hey, thanks. Wondering if you could provide some more commentary on what you saw competitively during the quarter at the breakfast day-part, with Taco Bell launching its dollar menu? And any comments how this has impacted your business?

Yes this is John again. Yes 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 tail end of the quarter. We launched new protein in chorizo, as I mentioned on the last call and we are really pleased with the start of that. That protein, it's already become a guest favorite in the morning. It's our new number 1 breakfast protein, even ahead of bacon right now. And that's just after one round of promotions.

When we look at that protein and the flexibility it provides us, because it starts at just one dollar on the Buck & Under at Breakfast menu. We can bring new news with breakfast through chorizo to the menu throughout the back balance of 2016, which we plan to do. As well as just 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.

Makes sense. One follow-up on the Company-owned same-store sales versus franchise. Is there a reason for the Company-owned comp to lag franchise during the quarter?

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 dynamic probably explains about half of 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 comps. We think that's a good signal of the brand and our initiatives really working as one system, one way.

Great thank you

You're welcome

Joshua Long, Piper Jaffray.

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

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. One was Transaction Efficiency 2.0, as we coined it, and that was all about preparing ourselves for the launch of Fresh Combined Solutions. So there's been a series of initiatives and focus by David Parra and his team over the past six months or so, culminating in these boot camps.

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 imbedding 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. That is more of a process and procedural change 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 what we launched last year on a system-wide basis. These are now modules that are coming into the system, so as we've paste and sequenced this in our operations, it's obviously been really important not to take on too much too quick. 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, the e-learning platform that we rolled out last year. So we just find it's helped us to be more systematic, more nimble in our training as well as being able to follow up and quantify the impact of it.

That's helpful, I appreciate it. 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 of it as the modules supporting what will also be some new equipment going into 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 trying to think about how the cadence of that occurs.

Yes, so some have been rolled out to this point. So as an example the new bean mixers which we've talked a little bit about have been rolled out system-wide and that's a move to improve 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 are making beans from scratch at Del Taco. 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 have 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.

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 franchisees at this point as well, which have also signed up and are rolling those out. We have other pieces of equipment on a targeted basis, 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.

Those are in process right now. Those won't be rolled out by the time we hit the street with Fresh Combined Solutions. From a consumer standpoint, at the end of June, but they're certainly going to be rolled out throughout the year. A number of initiatives both on a system basis and on a targeted basis, and we will continue to develop that as we move throughout the year.

Understood, appreciate that color. In terms of the food environment and it seems like mostly the conversations around labor inflation, as you mentioned in your prepared comments. But as 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 the spot market on them? Any sort of color you can provide in how you're thinking about managing what is expected to be a generally favorable food cost environment this year?

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 a leveling in that basket in Q2, followed by deflation, still the 50 bps of annual deflation we talked about a month or two ago, remains intact and no update to that today.

That said, certainly we are 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 that impact. We're very happy with that strategy. That said, is 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 controlled at any given point in time on a fixed price. In recent years we were well beyond that. Right now as we look at Q2, we have nearly two-thirds locked, then in the back half of the year, it diminishes somewhat. About just over 50% for the third quarter, a little more than a third for the fourth quarter.

And some of that is a purposeful dial back to enjoy some favorable spots that are out there today. Cheese would 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 balanced approach on food and are very encouraged with the balance of this year in terms of what we're seeing.

Great, that's helpful. Last one for me, in terms of the [delvelvin] 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 balance that across the year as we look forward into maybe 2017, 2018 and on.

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

Great. Thank you so much.

Thank you

Jeremy Hamblin with Dougherty & Company.

Good afternoon, congratulations on building your restaurant level margins despite a 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 seeing roughly flat costs on food next year? At what point would you have visibility on that?

Hey Jeremy, it's Steve. We are 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. As you know, we have a pretty diversified basket which is a very good thing, but it also means there's a lot more kind of double digit area percents of the basket that we need to be very cognizant and mindful of.

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 half of 2016 will typically have the dynamic of looking 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 someone to call back half of 2017, I just think is frankly probably premature for most anyone.

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

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's been no surprises, so that's sort of an all four-quarter proposition in terms of that type of 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 leverages on that line. The last two full fiscal years, for instance, we levered OpEx by 20 bps each of those last two years. 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 final piece that would help inform what the margin restaurant margin profile would 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 the cost side to help inform what menu price we think is appropriate.

So certainly we feel good about what we achieved in the first quarter, without a doubt. And we think we're well-positioned to continue to drive a nice story on the restaurant contribution, where that nets out. Certainly the food basket playing out the rest of the year as well as the menu price we elect to implement will certainly still have a bearing on that.

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?

That is correct.

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, 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 declines in 2014, is this maybe part of the cause why we're seeing some softness in traffic trends?

This is Paul. I think that what you might be seeing in the macro is just really a combination of factors. As we look at the competition out there, you have very heavy value environment. Yes you do have the election cycle this year with no one is saying anything good is 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 down five out of the last six reports. 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 consumers' behaviors right now.

Now on the flip side, we love how we're positioned to be able deal with that with our menu strategy. And we certainly believe that the value and affordability that we have in terms of our everyday value menu with the Buck & Under, it's still a full margin. We're able to work our way through those macro events as they arise or go through the year right now.

Great, thanks, appreciate you taking all my questions and best of luck.

[Great].

(Operator Instructions)

Nick Setyan of Wedbush.

Good afternoon, John, thanks for taking the question. It sounds like in Q1 we had just slightly higher than 4% menu pricing? What is the timing of when that falls off, if we don't decide to take another menu price as the year progresses?

Yes, first quarter we did carry approximately 4% in terms of what we will lap looking ahead. We principally make two 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 time frame, the other move which was much larger we will lap, so in the near term we do expect to have a menu price increase this year as we enter the summer.

That is 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 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. I think where that takes us the full-year guidance of menu price in the 3% to 3.5% area, we still feel good about achieving at least that level of price.

Got it. That is, in the near term, sounds like you could stay above 4%.

Approximately.

Got it. In terms of the labor, it's very helpful that you quantified, obviously, the impact of the minimum wage increases, but in terms of the actual deleverage we saw in Q1, with the incremental price increase here in late Q2 and maybe some learning that you probably had early on in Q1, maybe some of the initiatives. Could the magnitude of that deleverage that we've been seeing come down as the year progresses?

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 to pretty well deduce what that line will inflate by, just from minimum wage. There's of course other benefits in other areas that tend to be [lead] somewhat inflationary.

When we piece that all together in light of an approximate 4% price increase, and then obviously with transactions being 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. Naturally what we have in place to continue to drive and improve our trajectory on transactions can also have a bearing on that labor line.

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

The basic, at year end, and still as of Q1, 38.8 million common shares outstanding. Obviously with warrants all struck at $11.50, there is not currently any dilution to speak of. 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. Kind of up in that 38 million-plus area is what we have in mind in terms of our guidance there.

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

This is Paul. It certainly is competitive out there, as we're looking for the freestanding drive throughs, 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. We 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. So far we've been successful in developing the pipeline.

Thank you very much.

Peter Saleh, BTIG.

Hey, guys, congrats on the quarter. Couple questions. First seems like the discounting in the overall restaurant space has really being driven by, to a certain 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 is going away anytime soon. So do you foresee that the discounting in the overall environment, you think that's going to subside in the near future? What do you think gets us to a point of more normalized, more rational pricing?

This is Paul. You know, I don't really think that it's going to subside 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 are kind of okay with that in the sense is that we have not come off our strategy while they've been doing that. You have to remember that our Buck & Under menu is compelling everyday value. 14 to 16 items, yet it's at full margin. Having that in our business and that great barbell menu strategy has allowed us to continue to work our strategy and bring freshness to the market to embed that, to help us to continue our drive to move into $1.5 million AUVs that we talked about over and certainly the last few months.

So I don't know if it's going away anytime soon, but I think we certainly are well-positioned to be able to do battle with any competitive pressure on the discounting line. I think one thing to consider is that as everybody else is discounting, we continue to imbed our positioning in terms of freshness. I think it's going to allow us to continue to build out our mid tier and our premium tier as we move through time.

Some people might ask what is that doing to value and affordability as everybody else is discounting? Well, I can tell you we are still seeing that we have leading value and affordability scores out there in the marketplace. I think that's because of having the everyday value. People know we're not going to take that away from them some day.

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

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, then that should help spend trends in general. That said, we have been going from $8.00 to $9.00 to $10.00 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 seeing lift off of that. And then certainly, with the new path ahead, over the next six years going to $15.00 an hour, that's just a very unique and dynamic scenario that we are now facing, which, really only time will tell how that plays out. It's about consumer behavior and how that behavior will change over time. So while we agree the tailwind at some point might manifest 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.

Good and then just lastly for me, the new campaign sounds like it will launch sometime this summer? Will you be putting in a higher amount of spend behind it or how should we be thinking about your spending, your ad spending as we go into the back end of 2Q and into 3Q.

Yes. This is John. Similar level of ad spending. When you look at it on an annualized basis, it's roughly 4% of sales. We'll continue with that pace and sequence throughout the year with the campaign.

No investment spending to speak of, but certainly we are 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 through a drive thru at an believable price point and we just need to continue to demonstrate that and tell stories around the brand to further imbed it. We are excited about the campaign but no additional ad spending coming in the near future.

Great thank you very much

Thank you

Craig Bibb, CJS Securities.

Just from the small amount of buyback that you did the first quarter, from your comments about (inaudible) continuing the second quarter. The decision is made, you're going to buyback stocks not warrants, is that correct?

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

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

We're certainly very open minded on both. We believe there is 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 they're out of the money, but we certainly have interest and appetite on both sides.

Okay and then since no one else asked, did you spot Steve Ells in your units, doing research on chorizo? And does he often follow your lead?

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

Did you spot Steve Ells, Chipotle founder, in your units? (laughter)

No comment. (laughter) No, we didn't see him.

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

We want to thank everybody for participating in the call today and look forward to speaking with you on the Q2 call. Have a good day.

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.