The Habit Restaurants' (HABT) CEO Russ Bendel on Q4 2015 Results - Earnings Call Transcript

| About: The Habit (HABT)

The Habit Restaurants (NASDAQ:HABT)

Q4 2015 Earnings Conference Call

March 2, 2016 17:00 ET

Executives

Russ Bendel - President and Chief Executive Officer

Ira Fils - Chief Financial Officer

Analysts

Will Slabaugh - Stephens

David Tarantino - Robert W. Baird

Jeff Farmer - Wells Fargo

Andrew Charles - Cowen

Joshua Long - Piper Jaffray

Paul Westra - Stifel

Matthew DiFrisco - Guggenheim Securities

Brian Vaccaro - Raymond James

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Habit Restaurants’ Fourth Quarter and Full Year 2015 Earnings Conference Call. Please note that this conference is being recorded today, March 2, 2016. On the call today, we have Russ Bendel, President and Chief Executive and Ira Fils, Chief Financial Officer.

By now, everyone should have access to the company’s fourth quarter and full year 2015 earnings release. If not, it can be found at www.habitburger.com in the Investor Relations section. Before the company begins their formal remarks, I need to remind everyone that the 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. The company refers you to their recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial conditions.

Lastly, during today’s call, the company will discuss non-GAAP measures, which they 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 now turn the call over to Russ Bendel. Please go ahead.

Russ Bendel

Thank you. Good afternoon, everyone. Welcome to our earnings conference call. I will start the call first with an overview of the quarter and our thoughts on the business for 2016. Ira will then review our fourth quarter financial results and more details around our financial guidance for the upcoming year. At a high level, we are pleased with our results for the fourth quarter.

Total revenue increased 25.4% to $60.6 million compared with the fourth quarter of 2014. Companywide comparable restaurant sales increased 3.3%. This is our 48th consecutive quarter of positive comparable restaurant sales growth. Adjusted EBITDA for the quarter increased 28.8% to $6.8 million compared with $5.3 million for the fourth quarter of 2014. We also opened 13 company-operated restaurants and 1 franchise location during the fourth quarter of 2015 and finished the year with 137 company-operated locations and 5 franchise licensed locations.

Now, for a few more details regarding our results starting with comp growth. We are particularly pleased with our comparable sales growth during the quarter, given the significant hurdles of 13.2% from the – from Q4 of 2014, resulting in a 2-year net comp sales growth of 16.5%. The components of 3.3% comp sales increase included a 3.5% increase in average transaction, of which 3.3% was price and the remainder was mix-related and a relatively flat traffic, down about 20 basis points.

In the fourth quarter, we introduced a bold and flavorful limited time menu offering, with our Tempura Jalapeno Charburger. We promoted this LTO with several digital media initiatives and targeted newspaper inserts in a select number of locations. The Jalapeno Charburger was very well received and sold at a premium price driving check average in our menu mix. Perhaps most importantly to note, The Habit delivered another positive comparable sales quarter with little or no external media in most markets.

Moving on to unit growth, during the 2015 fiscal fourth quarter, we opened 13 new company-operated Habit Burger Grills, including our first locations in Idaho and Virginia. In addition, we opened our first franchise location in Washington, Idaho. Washington and Virginia represent The Habit’s entrance into our seventh, eighth and ninth states respectively. We are very pleased with the 2015 class of openings. Our first store on the East Coast is coming into the comp base in Q1 of 2016. After moving through its honeymoon period, this location is showing consistent growth and we are very pleased with its performance. Other new store openings on the East Coast are still too early to comment on, but all-in-all, our new market expansion plan continues to be on track.

Looking forward to 2016, we continue to expect to open between 30 and 32 company-operated stores and we expect our franchisees to open between 4 and 6 locations during the year. To-date, in the first quarter of 2016, we have opened 2 new company-operated locations. As was the case in 2014 and 2015, the majority of our 2016 new locations are expected to open in the back half of the year. 6 of our new 2016 locations will be drive-throughs. Toward the end of 2015, we already have 6 drive-throughs in operation and have been pleased to-date with the favorable unit economics in those locations despite slightly higher investment costs. We will continue to utilize our drive-through design in real estate sites that will allow us to implement this design to our advantage. Overall, we believe our total restaurant potential in the United States is in excess of 2,000 locations, which includes developing both new and our existing markets.

As many of you who follow The Habit know, our brand is really differentiated on four pillars: quality, genuine hospitality, our environment and value. We have seen 48 consecutive quarters of same-store sales growth by focusing on these brand pillars and not discounting. We believe that our disciplined approach to telling our brand story and exceeding guest expectations is the best way to sustainably grow the company over the long-term as evidenced by our top-tier AUVs of over 1.9 million per location. While we will continue to leverage effective marketing tactics via digital media, social media, public relations and marketing in our local communities to build awareness and trial, we are not going to waver from our commitment to becoming everyone’s favorite Habit one burger at a time.

I would like to wrap up my comments by saying that I am extremely proud of the nearly 4,000 men and women in our restaurants who have helped us deliver another strong quarter and year and continue to make The Habit a very special company. I would now like to turn the call over to Ira to discuss our fourth quarter financial results as well as more details around our outlook for 2016.

Ira Fils

Thanks, Russ. Now, turning to the results of our 13-week fourth quarter ended December 29, 2015, total revenue increased 25.4% to $60.6 million in the fourth quarter of 2015 from $48.4 million in the comparable quarter last year. Company-wide comparable restaurant sales increased 3.3% in the fourth quarter, marking our 48th consecutive quarter of same-store sales growth. The increase of comparable restaurant sales was driven primarily by a 3.5% increase in average check partially offset by a 0.2% decrease in transactions. Effective pricing in the quarter was approximately 3.3%, which includes the 2.8% increase we took at the end of June 2015 and a 3.1% increase taken at the end of December of 2015.

To put that in a little more perspective, the Charburger Combo meal, which includes a burger, fries and a drink, would cost you just $7.15 in Southern California store today, up from $6.50 last time – last year at this time, a very compelling value for a complete year. The 13 new restaurants we opened during the quarter were opened for a combined 66 sales weeks during the quarter. All 137 company-operated locations were opened for a combined 1,678 sales weeks during the fourth quarter.

Turning to expenses, as a percentage of company revenue, food and paper costs were 31.5%, which was a 230 basis point decrease compared to last year. The decrease was largely driven by commodity cost declines in beef, chicken and dairy, partially offset by slightly higher produce costs. Labor and related expenses as a percentage of company revenue was 31.6%, which was 150 basis point increase versus the fourth quarter of 2014 of 30.1%. The 150 basis point increase was driven by 110 basis point increase in benefits combined with a 40 basis point increase in direct labor wages. The 110 basis point increase in benefit costs was primarily driven by costs associated with the Affordable Health Care Act and paid sick leave in California combined with higher workers’ compensation expense. A 40 basis point increase in direct labor wages was driven by the combination of inefficiencies and carrying costs related to the new restaurants, wage inflation and incremental labor costs associated with extended hours.

Occupancy and other related expenses as a percentage of company revenue increased approximately 30 basis points to 16.2% of company revenue. The increase was primarily due to higher wage and common area maintenance expense. Our general and administrative expenses increased $1 million to $6.3 million during the fourth quarter of 2015 from $5.2 million in the same quarter last year. The increase was primarily due to costs associated with supporting and increasing number of restaurants costs associated with an increasing number of administrative employees in the field and corporate supervision required to support the new restaurants along with the legal, accounting, insurance and other regulatory costs associated with being a public company. As a percentage of revenue, general and administrative expenses decreased 50 basis points to 10.4% during the fourth quarter of 2015. The company also incurs $504,000 in public stock offering related costs in the fourth quarter of 2015.

Depreciation and amortization expense increased to $3.1 million from $2.5 million last year. As a percentage of company revenue, depreciation and amortization increased slightly to 5.2% in the fourth quarter of 2015 compared to 5.1% in the fourth quarter of 2014. Pre-opening costs for the quarter increased to $954,000 compared to $754,000 in the fourth quarter of 2014. The increase is primarily due to an increase in the number of store openings to 13 openings in Q4 of 2015 compared to 11 openings in Q4 of 2014. As a percentage of company revenue, pre-opening was flat at 1.6% compared to the prior year quarter. For 2016, we expect pre-opening to be approximately 90,000 per new restaurant. Interest expense decreased approximately 28.1% to $110,000 due to the pay-down of our debt in the fourth quarter of 2014. GAAP net income for the quarter – for the fourth quarter of 2015 was $1.3 million or $0.04 per diluted share. On an adjusted fully distributed pro forma basis, net income for the fourth quarter was a pro forma $1.2 million or a pro forma $0.05 per fully distributed weighted average share compared to a pro forma of $0.6 million or a pro forma of $0.02 per fully distributed weighted average share in the fourth quarter of 2014.

Now, turning to our liquidity and balance sheet, as of December 29, 2015, we had cash and cash equivalents of approximately $47 million and outstanding debt of $2.4 million, which consisted solely of our deemed landlord financing. We expect our capital expenditures to be $36 million to $38 million during fiscal year 2016. Based on our growth plans, we believe our expected cash flows and current cash on hand will be sufficient to fund our capital needs for the next several years. With regards to fiscal year 2016, we are providing our guidance as follows. We expect total revenue of between $286 million to $290 million. Comparable restaurant sales are expected to increase approximately 3% for the full year. Keep in mind, we are considering the cadence of our – keep in mind when considering the cadence of our 2016 quarterly comparable sales growth that we will lap more challenging results in the first half of the year as compared to the back half.

Additionally, we have written more aggressive QSR value promotional activity early in 2016, likely driven by the significant decline of these prices. We are currently looking on additional ways to further remind our guests and our value on quality and service that have been a hallmark of The Habit brand and a driver of our long-term growth. We expect restaurant contribution margin of 20.6% to 20.1% of sales for the full year 2016. General and administrative expenses are expected to range between $28 million and $28.5 million. We expect to open 30 to 32 company-operated restaurants with two openings in the first quarter of 2016. We expect our depreciation and amortization expense to be approximately $15 million for the year. And finally, we expect a pro forma effective tax rate of approximately 43% for the year. The pro forma tax rate assumes the conversion of all our common units of The Habit Restaurants, LLC shares for shares of our Class A common stock, which would eliminate the non-controlling interests.

With that, we are happy to answer any questions you may ask.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Will Slabaugh of Stephens. Please go ahead.

Will Slabaugh

Yes. Thanks guys. I wonder if you could talk a little bit more about the competitive environment, comments that you made a minute ago, sort of what you are seeing out there now, who you see as your main competitors and what the response from Habit might look like?

Russ Bendel

Yes, that’s a good question, Will. Let me kind of start out at a higher level maybe. As you know the first quarter of 2015 we had reported comp of 12.6%, so that was quite a feet to lap over. And as Ira indicated in his guidance section, we definitely have been witnessing more aggressive QSR and casual dining value promotional activity in 2016, early 2016 here. And as he also said, probably ties into the more favorable beef prices of late. This has – most likely had a short-term impact on our sales, but we are kind of working on – currently working on ways to further remind our customers of our everyday value, quality and service that’s really have been a hallmark of The Habit brand and a driver of our long and consistent 48 quarters or 12 years of consistent quarterly comps. Again, as Ira indicated, we are expecting approximately comps of 3% for 2016 and what we experienced currently has been factored into all of those kind of forecasts.

Will Slabaugh

Understood. And one more if I could. Just following-up on the unit growth comments that you made, talking about the new space that you entered for 2015, it sounds like you are pretty pleased there, so I don’t know if you had any more commentary as far as how pleased you are with some of the newer units in brand new markets where they hadn’t heard of Habit for? And then secondarily, if you could talk about where the sites might land in 2016 in the rough standards?

Russ Bendel

Yes. It’s – as we said in our comments just earlier, our first – our original store on the East Coast in North Jersey in Fair Lawn is going to enter the comp base during this quarter of – this first quarter of 2016. And as we have always reported, we continue to be very pleased with how that store and in total how Jersey is performing. In total, we now have six stores on the East Coast, three of which are in – at the year end we had 6 stores, 3 in North Jersey, 2 in Florida and a first store in Northern Virginia. They don’t have a lot of operating history behind them, but we continue to be pleased in total with how they are performing and we continue to be aggressive and looking for additional sites in all three of those markets. On another kind of to reflect also how we feel about the East Coast, we have always communicated that we see for 2016 and beyond that, that approximately 25% of our stores will be on the East Coast. And now as we continue to get further out, that percentage will most likely increase. But for 2016, that should represent approximately 8 stores on the East Coast.

On another note, I really think it’s important that both Ira and I and Tony, our COO, were reviewing our internal operational metrics and standards and our mystery shops for the East – all of our East Coast stores and we continue to be very encouraged and feel great about the level of execution how the brand is being operated back there. And as most of you know, we have moved two internal senior operators to the East Coast, one in Florida and one in New Jersey that have history with Habit as well as the addition of a Vice President of Operations on the East that has lots of experience and we couldn’t be happier with how we are executing on the East Coast at this point in time.

Will Slabaugh

Great. Thanks, Russ.

Operator

The next question is from David Tarantino of Robert W. Baird. Please go ahead.

David Tarantino

Hi, good afternoon. I guess I want to come back to the subject of what you are seeing recently with all the competitive discounting. And I guess first question is would you be willing to elaborate on how you think the comps will play out throughout the year? I guess, what’s the guidance assuming for the cadence of accounts for the year? And then I have a couple of follow-ups on that.

Ira Fils

Yes, I think as you mentioned, David – this is Ira. So, what we are thinking about for that 3% is it will probably be a little bit below that in the first half of the year and above that in the second half of the year is how we are kind of thinking about that 3% guidance and how it’s going to play out for the 2016. And we definitely feel that the lower beef prices have enhanced the promotional activity in the category, the segment above us and below us. And we have been doing this a long time and there are a number of factors that I spoke of earlier that we believe have driven our long-term consistent success, not only in sales, but in quality earnings and we are not going to start discounting and being promotionally oriented. We are going to continue to remind our guest of our strong attributes and we are going to manage the business for its long-term success. We are not going to change and we are not going to waver from the things that have made us successful for a very long period of time unequivocally.

David Tarantino

Got it. And then I guess the question on the discounting and sort of your conclusion there that, that might be having an impact. I guess, how did you arrive at the conclusion that, that was indeed having an influence on your business versus maybe something else either in the macro environment or operationally or internally? I guess how do you know that this was having an influence at this point, is there something in your value for us or?

Russ Bendel

Yes, that’s a great question, Dave. And I think it really – I mean, it’s you don’t know for sure, but as that promotional activities have stepped up, what we are hearing and seeing out there on both sides really not just QSR, but also in the casual dining segment, I mean, that’s when – that’s when we started to see sales we are seeing that are built into our 3% guidance for the year. So, do we know? Absolutely, unequivocally that, that’s what’s driving it? No, we are not getting negative feedback from our guests on value if that’s kind of the question, but I think it’s just that’s the one thing that’s probably changed most in the environment that we have seen. And again, we are lapping over some pretty big hurdles from 2014. And on a stack basis, we feel good about where our comps are. And as you look at our average unit volumes of over 1.9 million per location and our sales per square foot approaching $900, I think that – and just with our value pricing, the sheer amount of customers that we drive each week to the location, we feel very good about and know that with the level of execution that we provide that we feel good about the long-term strategy. There is no question about that.

David Tarantino

And then just maybe one more quick one, I guess, on the price increase, I guess you did take a second price increase in 6 months recently. Is there any way to measure whether that might be having an impact or whether you maybe step that up too much or are you getting any guest feedback on that?

Russ Bendel

We historically get very little guest feedback when we do take pricing and we haven’t gotten a whole lot of guest feedback this time as well, but we have taken more than we have historically. So, we are not hearing it from the guests. There maybe a compounding impact of that. We did take that price increase with 2 weeks less than the year and then as we kind of moved through that, that’s when we started to see some of the softness, but that’s also when this discounting and promotional activity has been increasing as well. So, that’s the other factor that’s gone on for sure. I guess from our perspective knowing how the guests have reacted to price increases historically. And when you really look at what our pricing is relative to our competitors today even after the price increase, we still think it’s a very compelling value.

David Tarantino

Great. Thank you very much.

Operator

The next question is from Jeff Farmer of Wells Fargo. Please go ahead.

Jeff Farmer

Thanks. Ira, I have a couple of questions on how productivity will theoretically impact the model. So, you gave us some color there. But for the 2016 unit openings, what average unit volume expectation is reflected in that consolidated revenue guidance that 3.86 to 2.90 number. So, if you sort of do the math there, what sales volume levels are you thinking about for that clause of 2016?

Ira Fils

We always believe our target is to open stores over $1.4 million and then roll that to $1.5 million right after kind of full year of operation. And early on here, a lot of those stores that we have don’t have a lot of operating history since we opened so many in the back half of the year. And so I think we are staying more towards that conservative stance early on until we see some operating history from that classic 2016 locations.

Jeff Farmer

Okay. And then one thing you know that we all look at is the spread between same-store sales growth and average weekly sales growth. And as expected, I think by everyone who has been tracking this that spread has gotten a little bit bigger here, I am just curious as we get into ‘16 if we could further expect to see average sales growth fall behind same-store sales growth?

Ira Fils

I would expect that as we talk about here, to that very fact that we opened – we are opening new stores at lower volumes and the system $1.4 millionish is rolling to the $1.5 million when our system averages $1.9 million. So, we have expected that. We are opening some new markets and that’s definitely playing into that. There is no question, but all that really still puts us right on track with our kind of our unit productivity and long-term objectives. But I would expect that number to come down a little bit as we move through the year. As you said, most people are expecting.

Jeff Farmer

Okay. And then just final one, same ballpark, again I think in terms of outlying in this model over the last 18 months, we have these discussions with the management team. But same idea, if you are thinking about a $1.4 million average unit volume number, what – theoretically, what restaurant level margin comes with that?

Ira Fils

When it start – when we open – on average, they open in the low teens. And then as they move to year three, they get up to the mid to the high-teens. I think I did misspeak when I was giving our guidance for the year. Our guidance on store level margin is 20.6 to 21.1. I think I said 20.1 when I was giving my prepared remarks. So again, just to restate, 20.6 to 21.1 is our guidance for store level margins for the year.

Jeff Farmer

Alright. Thank you, Ira.

Operator

The next question is from Andrew Charles of Cowen. Please go ahead.

Andrew Charles

Great. Thank you. The CapEx guidance are up for $32 million, $36 million in 2016 was a little higher than we are expecting, given the number of stores you are opening, is there anything we should be aware of from a technology standpoint revenue at higher?

Ira Fils

Yes. We do have some things from a technology standpoint that is driving that higher week and some drive-throughs. We have that and actually the biggest number is what Russ just talked about. We are doing six drive-throughs, six to seven drive-throughs this year. And those are quite a bit higher from the capital standpoint, so much of the increase is driven by some additional capital related to the drive-throughs. We do have some – we are always looking to improve our capital, I am our IT systems and processes. We have about $1 million of spending that we are doing there. And we are also – there is some spending related to the trucks. Currently, we had – at the end of the, year we had four trucks on the road. And by the end of – catering trucks – and by the end of 2016, we should have about nine to ten trucks on the road. So there is some incremental capital. The trucks costs about $300,000 per truck and so there is some incremental capital built-in for our – on our catering trucks.

Andrew Charles

Got it. To change the topics a little bit, I see already you talked about throughput evaluation and just kind of want to see preliminary thinking on that in terms of what you are categorizing as potential low hanging fruit to improve speed of service and what could be more of the heavy lifting part of it?

Russ Bendel

Well, I don’t know if there is a lot of low hanging fruits for the last 8 years kind of who we are and how we are wired is all about execution and improving efficiency and throughput without compromising quality. But as we spoke of even prior to ICR and then specifically at ICR, we are in probably beyond the 50-yard lines, one is comprehensive internal exercise that kind of goes by PTQ, productivity, throughput and quality, which is a comprehensive collaborative totally internal team effort in looking at The Habit of the future and what it would look like to be able to continue to push our average unit volumes above the $1.9 million mark where they are today. I will remind you that in 2008, when the company which we capitalized the company’s average unit volumes were $1.2 million. And we have got one of these projects in about 2010 – 2009. And we are doing a comprehensive one again. So I can’t tell you exactly Andrew, what result of that project will be, but we are definitely encouraged by some of the things we see in our learning and there will be a lot of things we can do in the many, many stores we are going to build in the future, but there will be some nuggets that we can take back through the system that will either improve quality, throughput or the overall productivity of pretty highly productive units to-date.

Andrew Charles

That’s helpful. Thank you.

Operator

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

Joshua Long

Great. Thanks for taking the question. Given the current environment and then also given some of the pressures that you are facing on particularly the labor line, we had – I want to revisit the conversation we had previously about the opportunity to take an additional price in the year, it seems like where that might have been on the table before preps has pushed towards later in the year, so if you could – can you remind us you are thinking about managing that price value equation, given the updated environment and kind of balancing those costs that are going to continue flowing through?

Russ Bendel

Yes. I will start with that and then maybe Ira could add more color on that, good question Josh. As we have talked about, we have taken more price than we have historically have, and it was the right thing to do. We have always been hesitant to take price prior to this year, only four price increases in over 6 years. And most of those have been the reason is associated with pretty strong headwinds that are all around the labor line, either direct labor or associated labor costs. But we don’t feel at this point – we don’t have an additional price increase scheduled for the near-term or the mid-term, but we always will evaluate price, but there is nothing anticipated in the near-term future at all.

Joshua Long

Okay, great. Thank you for that. And then Ira, as we think about the CapEx guidance to the earlier question, can you remind us what’s kind of the difference and build-out is for a drive-through store versus the non-drive-through store. And then may be Russ as we are thinking about the longer term pipeline, did we pull some of this forward or are we just finding a better opportunity to build the stores that’s drive-through just trying to pick up the opportunity for those to become an increasing part of the development pipeline going forward?

Ira Fils

Yes, that’s a great question. So it’s actually a multi-answer because depending on how we get the site from a drive-through standpoint, it can have some very different cost. There is one project that we are actually building from the ground up, first time. So for the first time, we are doing a ground lease where it’s a complete build. And so that store we are looking closer to $1 million – or about $2 million, $1.8 million that’s a net FTI, but about $2 million in CapEx costs. So, quite a bit more growth CapEx and the number I quote is all growth CapEx, it’s not net FTI. So just remember that as well, when I talk 36 to 38, that’s the growth CapEx. The TI number is not reflected in that. But this will be the first drive-through we have ever done where we have done a ground lease and basically done all the site work and build a building etcetera, etcetera. Today, the six we have, four have been failed traditional QSR locations and two are NCAP drive-throughs, that’s the last two that we opened in the fourth quarter of 2015. So we, at this point with six, feel confident and comfortable that they generate while they require more capital, they generate higher sales and their returns are in line or better than our historical returns. So as we have talked about before, not only at ICR, but individually with many of you, is that it will continue to be more of a focus for us. We don’t see it as being half or anywhere near half of our development pipeline, but we are encouraged and we are making a conscious effort to do more drive-throughs and seek out those opportunities as we see them.

Russ Bendel

And so to finish on that, so ground up is one kind of tier of cost and you have got a conversion where we might spend $1.5 million, $1.3 million to $1.5 million when we are doing a conversion. And then the third tier, which we are probably just as excited about, they might not do as much in sales, but the NCAP drive-through is only looking at maybe a couple of hundred thousand incremental costs as opposed to the standalone. So depending upon the mix of how those fall, we could see some different capital costs for those stores. But at every kind of tier, we will have – we believe will have returns at or above what we have seen historically.

Joshua Long

Great. Thank you, that’s helpful. And then one last one on the CapEx what are you expecting core TI if that 36 to 38 was a gross number what should we be thinking about for kind of the net number?

Russ Bendel

No. We get – typically, we get anywhere from $80,000 to $100,000 per site by the 30 to 32 locations that we would pull down.

Joshua Long

Okay, great. Thank you.

Operator

The next question is from Paul Westra of Stifel. Please go ahead.

Paul Westra

Great, thank you. I have a follow-up on sort of the comp guidance and maybe it was higher in the second half than first half. Can you maybe discuss a little bit about your lapse in your opinion get a little easier in the second half on a 2-year basis since you obviously won the Best Burger award in ‘14. On a clear stack lap comparison, it’s about the same. It’s not arguably a little bit harder in the second half. So, question is why do you think it’s easier and how will comps accelerate with pricing falling off in the second half of ‘16 given right now you don’t have additional pricing assuming your guidance?

Russ Bendel

Your question was hard to understand, Paul, some of it.

Ira Fils

We couldn’t quite hear. Maybe if you could recap it a little bit.

Paul Westra

Sorry about that. So, your 2-year comparisons are about the same each quarter and you commented that second half comparison might be easier in FDA, a source of comps accelerating the second half, but my question was on a 2-year basis, given you won the Best Burger in America award in the mid-2014. On a 2-year stack basis, you lapsed anything harder in the second half. So, I was just asking why you think lapse do get easier in the second half? And then also you have pricing falling off in the second half of the year assuming you are not planning to take any additional pricing at this point?

Russ Bendel

Yes. I mean, that’s a great question. I think we believe the business still has some good momentum in it and I also believe that while there is a lot of discounting going on kind of both above and below us, I would think at some point in time that’s going to mitigate and I think that will help us recapture maybe some of how that might be impacting us. And again, it’s not just on the QSR side it’s a little bit above us as well.

Ira Fils

And you are right, on a 2-year stack, you are absolutely correct, but as you look at on a 1-year basis, just looking at 2015, this quarter, we are going up against a Q1 is up 12, 12.6 and then the 1-year comparisons fall off slightly from there.

Paul Westra

Okay. And then maybe on your margin guidance, can you give us a little bit more direction on line basis maybe some rough deflationary expectations on the cost of goods sold basket for ‘16 and maybe compare that through your projected wage labor lines inflation rate and maybe discuss a little bit about the wage impact, specifically in California and how much of that boosting up the rest of the scales in the different quarters?

Russ Bendel

Yes. We are expecting actually some continued deflation in the first quarter of the year from a food cost standpoint, 1% to 2% kind of range. And then as we move throughout the balance of the year, in the middle of the year, we will be flattish and then slightly up as we get towards kind of the back end of the year in regards to food cost inflation. So, all-in-all, about pretty moderate. Really, where we are seeing the pressure is on the labor side as I think we have talked about before. From a wage standpoint, we are expecting a little over 7% wage push, which is quite a bit obviously driven dramatically by the dollar increase that we took in California minimum wage regulatory the first part of the year. So, that’s what’s really pushing up the wage. Then on top of wage rate of 7%, then we are also seeing some benefit pressure as I kind of talked about we saw it in Q4, we are going to see that as we move on into the second half of the year. We are going to see about 90 basis points of impact during the year related to benefits. When I say benefits, I mean, we have – and given these are annual numbers, but we have the annualization of Affordable Healthcare and paid sick leave in California. The combination of that is 40 to 50 basis points. And then we have got about 45 basis points in workers’ comp rates. We have seen our workers’ comp rates grow up fairly dramatically and that’s the expense that we are seeing kind of in the fourth quarter and as we move on into 2016 as well. So, we are really seeing it on the both sides. We are seeing benefit cost go up and we are also seeing some wage pressure as well.

Paul Westra

Great. In those commentaries is before you taking price, those were the impacts?

Russ Bendel

Yes, yes.

Paul Westra

Okay, okay. Great. That’s all I had. Thank you.

Russ Bendel

Thanks, Paul.

Operator

The next question is from Matthew DiFrisco of Guggenheim Securities. Please go ahead.

Matthew DiFrisco

Thank you. I just had a couple of quick follow-up questions with respect to – there was a comment made though also about sort of how you are going to address this discounting going forward. I know your menu hasn’t changed that much over the years. It’s been one of the secrets of the model also is that you haven’t had a lot of complexity, you haven’t done a lot of LTOs or anything like that. What would you do or what have you done historically to sort of battle back both the guys above you and the guys below you as far as when they get into value mode?

Russ Bendel

That’s a great question. So, we are going to use – we are not going to go out and pound the airwaves or newspaper print that’s not really what we do. What we are going to do is kind of use social media in promoting our everyday value that the fact that you can get a complete meal for $7.15. We are going to do it through social media and we are going to do it through our e-mail club. We have an e-mail club, where we send messages about every 3 weeks to folks that have obviously wanted to sign up for that and wanted to receive messages from us. So, those are two examples of ways that we are going to just kind of remind our guests, hey, we are a great value.

Matthew DiFrisco

And then I guess also could you sort of give the context of both the low end and the upper end, I know some brands especially in the casual dining space in California haven’t even taken the price increases yet, have you been – is there any – could we read into this maybe that you guys were earlier and more aggressive with taking the price you expect competitors or are competitors running that similar sort of plus 5% year-over-year price increase in your opinion of what you view as your competitors or could it be also that maybe they will be coming on later with price increases and before us too?

Russ Bendel

Yes, that’s a good comment, Matt. We don’t know exactly what our competitors are going to do going forward, but we probably were more aggressive earlier than some of them were. So, I think with the advantage of beef prices, some of them have held off. But again, in my opinion only, I don’t know how they can sustain some of these peak value discounts both above us and below us and have the level of profitability and the returns to justify some of the things they are doing. Again, that’s just me commenting on them and we are not going to get into that game. We have built this for over a long period of time and are looking to the long road ahead of us and we know that if we execute at the level that we do with the value proposition that we have, it works over a very long period of time. And there is going to be some highs and lows and maybe we are hitting a few potholes right now. But let me tell you, this team and this organization continues to be on the path that it’s been on for a very long period of time and we are not wavering.

Matthew DiFrisco

Okay. And then I guess my last question you only have 40 stores or so, less than 40, I think, now outside of California, but how have – I know like one of your peers below you, Jack in the Box seems to be one that is ceding share to McDonald’s recovery a little bit here and sort of mirrored somewhat of a slowdown in their same-store sales as well with this value positioning. I am curious have your California – have the 40 stores outside of California perform better? Is there anything that you see different from those stores? I am just curious about that. And then if that also – if there is anything to read into what gives you confidence that there isn’t cannibalization issues here, where obviously you look through the last – 2015, you opened a lot of stores in the Inland Empire maybe about another 8 or 9 and you already had a lot of stores in there. Is there any concern that there is some pockets of cannibalization or saturation levels in California?

Russ Bendel

Yes. Without question, it’s hard for us to quantify all of that, but for example, in the Bay Area, we have doubled our footprint, the number of restaurants we have in Northern California in both 2014 and 2015 and there is a level of cannibalization that we have inflicted upon ourselves. While that has occurred, we think these are great locations that have very strong volumes and are generating very good returns, but we are probably our biggest competitor and the same thing has happened in Utah. We have doubled. We continue to be bullish on Utah as well. So, we have doubled our footprint in Utah in both the last 2 years. And over a long period of time, we believe and we continue to believe that, that helps us with brand awareness and giving us lift in the market over a longer period of time. But what the exact effect of Jack in the Box and McDonald’s, I don’t think we can sit here and tell you exactly what that is.

Matthew DiFrisco

I appreciate that. Thank you very much. That’s very helpful.

Operator

The next question is from Brian Vaccaro of Raymond James. Please go ahead.

Brian Vaccaro

Good evening and thanks for taking my questions. Just a couple of quick clarifications if I could. I wanted to circle back on your comments on the more intense competitive backdrop and the recent sales deceleration. Can you comment on what you are seeing at lunch versus dinner? Has there been a greater deceleration in either day-part that’s worth calling out?

Russ Bendel

No, I think not really…

Ira Fils

Across both parts.

Russ Bendel

Yes.

Brian Vaccaro

Okay. So, clearly….

Russ Bendel

Historically, dinner has been – on a multi-year trend, dinner has been stronger for us…

Ira Fils

Growing at a higher rate.

Russ Bendel

It’s obviously been growing – dinner has been growing at a higher rate than lunch and we are still seeing that relative gap between the two, the same for the most part.

Brian Vaccaro

Okay. And one clarification if I could on the food cost outlook, Ira you said down in Q1, deflation in Q1 flat middle part and then up in the fourth quarter. Can you walk through the components of that outlook and maybe what you are expecting in terms of the biggest cost items, including ground beef, produce chicken, any other puts and takes that we should be aware of?

Russ Bendel

Yes, I think that’s a great question. I think beef will be down considerably in that first quarter of the year, a little bit in the second quarter and then pretty much flat now kind of in that back half of the year. The other line, while we are getting a little pressure maybe the other way has really been produce, produce has been a little more volatile than we have kind of seen historically. I mean, there has been some weather that especially in Northern California that impacts us there. Those are the two that are really kind of moving around the most. Everything else is pretty fairly tamed right now.

Brian Vaccaro

Okay, that’s helpful. Thank you.

Operator

This concludes the time allocated for questions. I would like to turn the conference back over to Mr. Bendel for closing remarks.

Russ Bendel

Thank you all as always for your continued interest and support and we are continuing down the path. That’s what we are doing.

Operator

This concludes today’s conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.

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