Del Frisco's Restaurant Group (DFRG) Mark S. Mednansky on Q1 2016 Results - Earnings Call Transcript

| About: Del Frisco's (DFRG)

Del Frisco's Restaurant Group, Inc. (NASDAQ:DFRG)

Q1 2016 Earnings Call

April 26, 2016 8:30 am ET

Executives

Thomas J. Pennison Jr. - Chief Financial Officer

Mark S. Mednansky - Chief Executive Officer

Analysts

Nicole M. Miller Regan - Piper Jaffray & Co. (Broker)

Will Slabaugh - Stephens, Inc.

Imran Ali - Wells Fargo Securities LLC

Brian M. Vaccaro - Raymond James & Associates, Inc.

Jordy Winslow - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Paul Westra - Stifel, Nicolaus & Co., Inc.

Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Del Frisco's Restaurant Group, Incorporated First Quarter 2016 Earnings Conference Call. Today's conference is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for a question.

I would now like to turn the conference over to Tom Pennison, Chief Financial Officer. Please go ahead, sir.

Thomas J. Pennison Jr. - Chief Financial Officer

Thank you, Audra, and good morning, everyone. By now, you should have access to our earnings press release for the 12-week period ended March 22, 2016. If you have not already reviewed it, it may be found at our corporate website, www.dfrg.com under the Investor Relations section. With me here today is Mark Mednansky, our Chief Executive Officer.

Before we begin, I would like to remind everyone that part of our discussion today will include forward-looking statements. These statements are not guarantees of future performance and, therefore, undue reliance should not be placed upon them. We refer you to today's earnings press release and our SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. In addition, we will also be referring to some non-GAAP financial measures this morning. We have, therefore, provided reconciliations of those measures in the earnings press release tables for the most directly comparable financial measures presented in accordance with GAAP.

And with that, I'll turn the call over to Mark.

Mark S. Mednansky - Chief Executive Officer

Thanks, Tom. Good morning, everyone. I am going to begin with a few thoughts related to the first quarter results and take it brand-by-brand and then briefly review our 2016 initiatives. Afterwards, Tom will walk through the financials with much greater detail.

Overall, I would characterize our performance as generally in line with what we had expected, which allowed us to reaffirm the annual guidance that we had previously laid out for 2016. As said, we could have done a better job controlling some of the operating costs during the quarter which will be a continued focus and with our team we will accomplish.

For Del Frisco's Double Eagle, comparable sales decreased by 0.1%, driven by a 1% decrease in average check that was offset by a 0.9% growth in entrée counts. Although we have individual restaurants that are still being affected by the downturn in the oil industry, the concept actually had a solid quarter in terms of sales growth excluding these locations.

Regarding profitability, Del Frisco's restaurant-level EBITDA fell 80 basis points to 27.9% as slight favorability on beef costs was insufficient to offset higher operating costs due to mostly the deleveraging of certain fixed costs on significantly lower sales in a few locations. We did not have any offsetting pricing during the first quarter as we took modest pricing early in the second quarter. We also expect beef cost favorability to accelerate as the year progresses.

Our promotions during the first quarter included featuring Florida's stone crab claws, a variety of other delicious fresh seafood items that included fresh Alaskan King Crab Legs. Also, we featured our Prime Pair Sundays, which is our $55 Prix-Fixe Menu at most of our Del Frisco's locations. Starting in early May, we will introduce our steak and lobster offering as well as our slow roasted prime rib for the annual Something Sweet for Mother's Day menu.

In keeping with our goals ensuring that Del Frisco's is viewed by guests as the premier destination for an incredible steakhouse experience, our culinary team will continue to evolve our craveable menu. Today's evolved guest expects quality and they want to discover new and exciting tastes. Also throughout 2016, there will be greater focus on limited-time food and beverage offers that will keep Del Frisco's brand unique among its upscale peers.

Sullivan's comparable sales fell 1.8% during the quarter, driven by a 4.5% reduction in entrée counts that was partially offset by a 2.7% increase in average check. Despite the reduction in guest counts, we are still very bold and forward-looking on this brand as sales continue to improve throughout the quarter and into Q2. We continue to experience progress rejuvenating Sullivan's brand by executing our four-point plan across leadership, menu, messaging, and remodeling. This is evidenced by higher guest satisfaction scores and more restaurants meeting their individual performance targets.

Regarding profitability, Sullivan's restaurant-level EBITDA margin decreased 80 basis points to 18.8% due to sales deleveraging as well as significant minimum wage impact with no countervailing pricing action. Similar to Del Frisco's, we did not take pricing until the beginning of the second quarter. And as I just referenced, more locations performed to their targets compared to a year-ago period resulting in higher incentive bonus pay.

Our promotions during the first quarter consisted of The Sure Thing, a $44 seasonal Prix-Fixe menu that allows our guest to mix and match starters, soups, salads, and entrées from a variety of Sullivan's favorites and we continued our Swingin' at Sully's promotion where guest can enjoy live music and great Happy Hour features every Thursday and Sunday night featuring $7 signature martinis, great selections of wine and beer and bar entrées. This summer, Sullivan's will introduce a limited-time offer of steak and crab stuffed lobster as well as begin celebrating the concept's 20th anniversary with a new marketing campaign.

Now let's turn to Del Frisco's Grille. Comparable restaurant sales decreased 2.8% with the average check declining 4.7%, primarily due to the value initiatives and focus on lunch traffic. Notably, our comparable traffic turned positive during the quarter with a 1.9% increase and has now been improving sequentially for consecutive quarters. Clearly, the initiatives we put in place to clarify the Grille's positioning are beginning to work.

Throughout the first quarter, we continued to apply all of the learnings from the class of 2015 to the 2013 and 2014 classes as we reinforced the idea that our Grille is an everyday affordable upscale dining and drinking destination. That increased awareness coupled with accreted effort from our culinary team in accentuating menu items that can be prepared quickly and to our quality specifications and most importantly our value price have resulted in a stronger lunch business. As I have said in the past, our goal is to drive traffic to increase more of the everyday use component that is Del Frisco's Grille and we are doing just that.

Although our lunch day-part yields a lower check average, our goal is to utilize it as an introduction to our more accretive dinner business. We firmly believe that once guests have experienced the approachable, energetic, yet very upscale environment of the Grille, they will return for more.

Regarding profitability, the Grille's restaurant-level EBITDA margin improved by 50 basis points compared to last year's period. Similar to Sullivan's, the Grille was affected by minimum wage increases while offsetting price and was only taken at the end of the quarter. During the quarter, most of our Del Frisco's Grille locations promoted the Grab A Pair lunch where guests can try a personal size flatbread, a chicken avocado wrap or fish tacos served with their choice of the salad, Caesar Salad, or Cup of Soup for only $13.

In early May, we'll be expanding our Monday-to-Friday Daily Dish program that was started last year for the entire week. This program features outstanding upscale craveable dinner items such as slow roasted prime rib, fall-off-the-bone barbecue baby back ribs, fresh East Coast spearer mantis shrimp and chips and much more. All have a twist at a tremendous value along with speed of service that our Grille guests have come to expect.

There is no more valuable commodity than time these days and we know we must meet our guest's desire for a faster meal pace at the Grille, faster than they would expect from white tablecloth or a conventional traditional steakhouse experience. It's all about quality, pace, and value.

Lastly, the Happy Hour test we rolled out at our Cherry Creek Grille late last year as well as in a few other locations has been very well received. Every new Grille going forward will offer Happy Hour and we are rolling out this offering to the rest of the Grille restaurants throughout 2016.

In conclusion, despite near-term macro pressures, I am very encouraged by how we are faring so far this year. As we have said before, we have the right team in place and we are going to ride our ship in 2016 with initiatives that are focused on: increasing our food and beverage R&D to elevate our menu quality and showcasing our culinary teams talent; driving more enrollments to expand our reward member revenue and repeat business; learning from the success of our 2015 growth class and using that knowledge throughout the three brands; fine-tuning out Grille site selection process and leveraging our smaller more efficient prototype for greater return on investment; and lastly, increasing the effectiveness and efficiency of our media spend.

And with that, I'll turn it back over to our CFO, Tom Pennison.

Thomas J. Pennison Jr. - Chief Financial Officer

Thank you, Mark. Before we go through our financials, I wanted to share that we have slightly modified our definition of when a new location enters the comparable restaurant base.

Effective in 2016, a restaurant will become comparable on the first day of the fiscal quarter following its 18th month of operations. Previously, we considered a restaurant to be comparable in the first full fiscal period following the 18th month of operations. This change will allow for a consistent comparable base for the entire quarter being reported on as more in line with industry practices. This change had a slightly unfavorable impact on the Grille's reported comparable restaurant sales and traffic metrics for the first quarter since our Irvine, California, restaurant, which would have entered the base in our third fiscal period of the first quarter, will now enter at the beginning of Q2. This location was positive in both sales and traffic during period three and would have been accretive to the comparable restaurant sales.

Now to our results. For the 12-week period ended March 22, consolidated revenues increased 8.1% to $81.2 million from $75.1 million in the year-ago period. We benefited from a net 48 additional operating weeks across our concepts, which offset a blended 1.1% decrease in comparable restaurant sales. I would note that we essentially had no pricing in effect during the quarter. As Mark mentioned, we did take some pricing for the Grille at the very end of the first quarter, while pricing at Del Frisco's and Sullivan's took place in early second quarter. The blended price increase is approximately 1.2%.

During the quarter, blended comparable restaurants sales experienced a 150 basis point drag from three locations of the 38 in the comp base located in one of our markets most impacted by energy-related industry challenges. Although we are still expecting softness in this market throughout the rest of the year, we expect the drag to lessen as we begin to lap the softness that began in the third quarter last year.

For Del Frisco's Double Eagle, revenues increased 6.4% to $38.3 million in the first quarter from $36 million in the year-ago period. This top line improvement was due to 12 additional operating weeks related to the Orlando, Florida, opening during the third quarter of 2015. Comparable restaurant sales during the quarter decreased 0.1% and consisted of a 1% decrease in average check, partially offset by a 0.9% increase in traffic.

For Sullivan's, revenues decreased 4.7% to $18.9 million in the first quarter from $19.8 million in the year-ago period. This top line reduction was primarily attributable to the closing of the Denver location in late May 2015, resulting in 12 less operating weeks during the first quarter. Also, comparable restaurant sales decreased 1.8% and consisted of a 4.5% decrease in traffic, partially offset by a 2.7% increase in average check.

For Del Frisco's Grille, revenues increased 24.5% to $23.9 million in the first quarter from $19.2 million in a year-ago period. This top line improvement was due to a net 48 additional operating weeks related to openings in the last three quarters of 2015. Comparable restaurant sales in the first quarter decreased 2.8% driven by a 4.7% decrease in average check, partially offset by a 1.9% increase in traffic.

As Mark mentioned earlier, the initiatives we have implemented are increasing traffic, especially at lunch, which has impacted our day-part mix and our sales mix and, as a result, reduced our check average. There were 10 restaurants within the Grille comparable base in the first quarter out of a total of 20 restaurants operating for the Grille.

Turning to our cost, total cost of sales as a percentage of revenue improved by 20 basis points to 28.6% from 28.8% in a year-ago period, primarily due to slightly lower beef cost as well as the benefit from the Grille's growing weight on the restaurant portfolio. While there wasn't significant favorability in beef cost during the quarter, we continue to expect beef cost to trend downward for the remainder of the year. By concept, Del Frisco's experienced a 10 basis point improvement in cost of sales to 29.7%, the Grille experienced a 40 basis point improvement to 26.1% and Sullivan's cost of sales remained flat year-over-year at 29.4%.

Restaurant operating expenses as a percentage of revenues increased by 110 basis points to 47.6% from 46.5% in the year-ago period. By concept, Del Frisco's operating expense as a percentage of revenue increased by 40 basis points to 40.7% as we experienced higher labor cost and a deleveraging on fixed cost in certain locations. Sullivan's operating expense rose 100 basis points to 49.9% as their brand experienced higher labor cost, primarily due in part to minimum wage increases and higher incentive bonus pay as more restaurants performed to their targets versus the prior year. Finally, the Grille experienced a 90-basis-point increase to 56.7% with higher labor cost due to minimum wage increases as well as deleveraging on fixed costs related to the decline in the average check with essentially no pricing during the quarter.

Marketing and advertising cost decreased $50,000 from a year ago, which represented a 20-basis-point decrease as a percentage of revenue. Taking all of these together, restaurant-level EBITDA increased 5.3% to $18 million in the first quarter from $17.1 million in the year-ago period, while the margin decreased to 22.2% versus 22.8% in the prior year.

By concept, Del Frisco's restaurant-level EBITDA margin decreased 80 basis points to 27.9% as lower cost of sales were offset by higher restaurant operating and marketing expenses. Sullivan's restaurant-level EBITDA margin decreased 70 basis points to 18.8% due to higher restaurant operating expenses, which were slightly offset by lower marketing and advertising costs. Del Frisco's Grille restaurant-level EBITDA margin increased 50 basis points to 15.7% as improvement in cost of sales and marketing expenses offset higher restaurant operating expenses.

Pre-opening cost for the quarter decreased $0.1 million to $1.1 million from $0.3 million last year due to the timing of new restaurant openings versus the prior year.

For general and administrative expenses, they increased to $5.8 million from $5.5 million in the prior year, but as a percentage of revenues decreased 20 basis points to 7.1% from 7.3%.

In addition to increased non-cash stock compensation, we incurred slightly higher incentive compensation during the quarter compared to a year-ago period as we're tracking toward our annual targets. Over the past year, we also added a number of positions including a General Counsel, promoted leaders for each concept, and backfilled some positions.

Depreciation and amortization expenses increased to $4.3 million from $3.6 million due to new restaurant development as well as refresh expenditures over the past year. As a percentage of revenues, depreciation and amortization increased 40 basis points to 5.2%.

Our effective income tax rate for the quarter was 31.1% versus 29.8% during the prior year. Taking these together, we generated net income for the first quarter of $5.4 million or $0.23 per diluted share and this compares to prior year net income of $5.4 million or $0.23 per diluted share.

In terms of our liquidity and balance sheet, as of March 22, we had cash and cash equivalents of approximately $2.1 million and no outstanding debt under our credit facility after paying down the $4.5 million we had outstanding at year-end. During the first quarter, we did not repurchase any shares of outstanding stock.

Finally, we are reiterating our 2016 outlook for the 52-week period ended December 27, 2016. For details on this outlook, please refer to our earnings release from this morning.

With that, I'll turn the call back to Mark.

Mark S. Mednansky - Chief Executive Officer

Thank you, Tom. Let's quickly review our development plan for the year. As we've mentioned, we are limiting our restaurant development in 2016 so we can refine and improve operation at existing restaurants and gear up for the growth of the future.

With that said, our plan to relocate our North Dallas Del Frisco's Double Eagle location to the hot Dallas Uptown district is on track and it will be completed early in our fiscal fourth quarter. In the meantime, the North Dallas location will continue to proudly serve our guests until this new outstanding restaurant is completed.

Now let's touch on our plan for Del Frisco's Grille. In mid June, we will open a Grille in Huntington, Long Island in New York that will be followed by a Grille opening in Nashville's Metropolitan area in mid September. We will have more information on a possible third Grille opening in Brentwood, Tennessee as the year progresses.

I spoke earlier about how we are making headway with regards to our Grille brand repositioning and the positive impact it is having on our traffic counts, which turned positive in the first quarter and have been improving sequentially since the third quarter of last year.

In addition to pursing initiatives to drive positive sales, we have also been assessing how we can better manage labor cost and the impact of minimum wage increases. These considerations are among the many reasons we have been working on developing a smaller, more scalable, more efficient, and more cost effective prototype. To that end, we are in the midst of putting the finishing touches on the Grille of the future, which will range between approximately 6,500 square feet and 7,400 square feet, effectively reducing our footprint by approximately 1,000 square feet from the current model. This not only increases availability of real estate options, but also results in lower occupancy cost, lower build-out cost while improving pacing in both our dining room and back of the house. Accomplishing these objectives with fewer man hours but most importantly without sacrificing the energy and the panache that create the upscale Del Frisco's real experience will only strengthen our economic model. We look forward to opening the first new Grille prototype sometime in mid 2017.

In closing, we're building a stronger foundation for these next three generation brands and we'll continue to do so throughout this year. Our exceptional highly tenured team is executing on what we intend to accomplish and we look forward to providing more updates as we forge ahead in 2016.

So, with that, operator, we'll turn the call over to you as we open the lines to take any questions from our listeners.

Question-and-Answer Session

Operator

Thank you. And we'll go first to Nicole Miller at Piper Jaffray.

Nicole M. Miller Regan - Piper Jaffray & Co. (Broker)

Thanks. Good morning. I want to ask just two quick ones. First, very curious about the marketing and advertising. Can you talk through a little bit what you're doing at each brand and specifically curious how you're kind of reaching out using technology talking to customers maybe either one-to-one, and any kind of loyalty you're doing with customers, and how the database is being created? Thanks.

Mark S. Mednansky - Chief Executive Officer

Hey Nicole, good morning, it's Mark. There's a lot in there, so what I don't cover, Tom will follow-up and finish up. First and foremost, Nicole, let's start with the Grille. Before proceeding with more advertising – and traditional advertising, let's put it that away – we're really getting a handle on our guest reaction. We've been doing food evaluations with our guests. We've been getting likeability reactions from our guests and doing a lot more testing than we have in the past. So we're testing items like the Happy Hour. We'll take four units, we'll test it for a longer period of time than we've done in the past. When you start a new brand, we do tests for two months in the past and then if it was positive, we roll it. We're taking our time. We're really making sure what we have is right, that it resonates with the Grille guest that is craveable.

And then as far as technology, boy, I'd tell you, it is really moving to mobile. We see that more and more. With the guests that used the Grille brand specifically, everyone is on their mobile devices. That's where we're heading. I don't want to talk about some of our plans and how we plan to interact with the guests, but suffice it to say, we're excited about what the future will hold with advertising as far as the Grille.

Now as far as Del Frisco's and Sullivan's, we are very, very fortunate that we have some long list of very satisfied loyal guests at both of these brands. So we're reaching out to these guests through email, which as you know is very, very cost effective. You're hitting your core guest with a core message. That has been primarily the way we've gone in the first quarter. You'll see us transitioning to terrestrial radio, satellite radio here in the summer with some of these features that we'll have at both Del Frisco's and Sullivan's.

Thomas J. Pennison Jr. - Chief Financial Officer

And just to add on to that, Nicole, it was definitely seeing more digital online utilization as a medium for the Grille especially. Our Rare Rewards Program is something we've had in place for a few years, but we still continue to evolve it. And while we have some fantastic databases on both the steakhouses because they are predominantly reservation driven, so we clearly try to get those emails and other contact information for reservations, that's been a little bit more of an opportunity for the Grille where we have much greater walk-in business and is absolutely what we want. We don't want people thinking they have to have a reservation at the Grille, but that's been an initiative and focus to really enhance that database. And so from a technology usage there, we do have a lot of initiatives this year to enhance that. We're not where we would like to be. The exciting part is that it's a great opportunity for the future that is untapped, so we look forward to making some inroads better that where we're at today.

Mark S. Mednansky - Chief Executive Officer

The last thing on this, Nicole, is Rare Rewards, our loyalty program. We've had so many of our guests who want to be involved with a loyalty program and we believe that we're putting together a more exciting program that we will be able to expand to get some excitement around. You'll hear more about it throughout the year. The guests today that go to Del Frisco's Double Eagle, Sullivan's, and even the Grille, they're not looking just for financial deals. They're looking for to be part of a club that they're proud of. In upscale restaurants, they give them something that you might not get from another operator. It might be a special table, they might be invited to a special party, it might be a rollout of a brand new wine that a winery wants to introduce that are vintage, it might be a brand new scotch tasting, but you're going to see a lot more of that from us in the future as we really build that bond between the guests at all three brands with our teams.

Nicole M. Miller Regan - Piper Jaffray & Co. (Broker)

Thank you for that detail. And just the last follow-up, if I may. If I understood COGS commentary appropriately, beef was down slightly, but it would be down more through the year and I'm just curious to understand that better and then if you mean that it will go down sequentially each quarter or will it be down more in the middle of the year versus the end, as an example? Thank you.

Thomas J. Pennison Jr. - Chief Financial Officer

So, Nicole, in the Q1 of 2015 last year, we had some pretty strong favorability right at the end of the quarter. The first period of Q1 is a very strong period for the quarter and so we had great benefit last year. So this year while we were slightly below last year, it wasn't sizable, especially for some of the cuts we used for Sullivan's. What we're seeing right now is we anticipate – when you look year-over-year while we had that benefit in the first quarter of 2015, it then increased in the second quarter and was higher. So as we look to for Q2, for example, we had a higher Q2 last year while at the same time we're seeing some sequential reductions in some of the beef cuts, so the year-over-year reduction will be more favorable in Q2 than Q1, but we still have the magnitude of where we expect that reduction still later in the year to second half of the year is still what we're expecting. So to that point, it would be somewhat sequential with – we'll still have probably some of the seasonality. And when I say that, it's more year-over-year we're looking at to where we'll probably still see Q4 in absolute terms cost more than Q3 does, but relative to the prior year, we will have better savings year-over-year.

Mark S. Mednansky - Chief Executive Officer

Nicole, the futures on cattle look favorable for us. We haven't been able to say that over the last few years, as you know. But at the end of the day, it does matter what happens with retail and how much is picked up by big producers, big boxes that are now showcasing prime and high-end choice. But I will tell you, even though we expect the pricing of beef and most of our commodity basket to reduce throughout the year, we took a very modest 1.2% increase at the very end of Q1 and into Q2 and left ourselves some pricing power as we move into the fourth quarter of this year.

Thomas J. Pennison Jr. - Chief Financial Officer

And just a general note for the group on pricing, a very wide range of pricing that took place there and by concept, which ranges from a low of 0.9% up to 2% and most significant part of that depends how many locations are in areas of the county where we had minimum wage increases. For example, we have more Grilles impacted by minimum wage increases than we have Del's, so that's why the Grille has higher increases than we have at Del's, for example.

Nicole M. Miller Regan - Piper Jaffray & Co. (Broker)

Thank you.

Mark S. Mednansky - Chief Executive Officer

Thanks, Nicole.

Operator

We'll move next to Will Slabaugh at Stephens, Inc.

Will Slabaugh - Stephens, Inc.

Yeah, thanks guys. You touched on the oil territories, I'm curious if you could give more specifics on Texas and how it performed in the quarter. I know you mentioned that was a pretty steep drop in 4Q, so I'm curious if you saw any improvement there or if you expect it to remain fairly weak until you lap that in the back half. And then on the opposite side of that, if you could speak to where the strength came from geographically to offset that and maybe some of the initiatives that may have helped that along the way.

Thomas J. Pennison Jr. - Chief Financial Officer

Sure, Will. Clearly, when it comes to Texas, there's only really one market in Texas that we're continuing to see. Well, I would say last year we were seeing some softness in a few other markets. Today, it's predominantly Houston, which is no secret out there. We have three locations in Houston and one in each concept that are in the comp base. Those three locations that I mentioned by themselves created a 150 basis points drag on the entire comp base. As we go into Q2, which we have two additional restaurants that add to the comp base in Q2, which is our DC Del's as well as our Irvine, California, Grille of the base of 40 restaurants in our period four, we still saw that drag about 130 basis points, even though in period four we were slightly positive, even with that 130 basis points drag beginning out of Q2.

But we still anticipate to have that throughout this year. It was really late in Q3, we started to see it. Really in retrospect as we look back, we saw it was a little bit more impactful than we thought it was because it definitely was more intensified in Q4, but we anticipate the drag will be less as we lap that. That said, we expect that market to be soft. Now that said, we've still seeing -- we have another restaurant that's not in the comp group that we opened up last year in The Woodlands that still continues to perform very well for us of that 2015 class despite some of the pressures in Houston in general.

Mark S. Mednansky - Chief Executive Officer

Hey, Will, as you know, one of the many, many reasons we created the Grille brand was to mitigate whether meat cost goes up, business dining goes down, or anything happens when we have the two other steakhouse brands, and we're seeing that. I really believe that we're seeing that with the Grille, even in Houston, as Tom said. The Woodlands Grille, even though it's close to the Exxon campus, really was built for the people, the affluent, and the guests that live in The Woodlands area. And even though oil and gas are taking a hit, we really are doing well in that location, and it's aspirational dining, it's their own credit cards. We do some business dining, but it's just everyone coming in for lunch and dinner throughout the week.

One other point -- you said were we doing to try to mitigate. Anchorage, Alaska, as many of you know is dominated by oil, gas, and mining, but our team up there is taking advantage of all the travel that is going through Anchorage because of the lessening of gas prices. So whether it's people going up there just to fish and hunt, if they're going up there for cruises, we've really tapped in the tourism market more than in the past. We've seen some really nice gains up there, even though other restaurants are hurting due to the downturn in the oil business.

Thomas J. Pennison Jr. - Chief Financial Officer

And, Will, in this quarter, really you talked about some of the geographics, it really was a wide range of doing – Mark alluded to that overall Del's did strongly. We were pretty nicely positive across almost all the Del's with the exception of a couple and those couple that were not strong were sizably negative. So one of the things that, when we talk about Houston, is one of those things that did create pressure in some of those fixed cost because it wasn't just a single digit, it was significant that put that drag onto it to where you have a wide range of very strong performing restaurants to pretty much Houston across pretty much all three concepts is the worst performing unit for us. And putting a sizable drag on each one of those in the comp group.

And that's why both at Del's and Sullivan's, it seems counterintuitive where we have higher incentive compensation, but there's more restaurants that delivered on their plan and you just have a few that are dragging it down significantly, so that's why that dynamic's taking place there.

Will Slabaugh - Stephens, Inc.

Got it. That's helpful. And then one follow-up, if I could. You mentioned some – a little bit of positivity there in the fourth period or in April rather. So I'm curious, given that we've heard a lot of the full-service diners speak to some softness as we worked through the first quarter and then also, I guess, as we kind of start this quarter off, I'm curious if you speak to that positivity, you mentioned earlier and then anything else about how you saw the quarter as it played out.

Thomas J. Pennison Jr. - Chief Financial Officer

Well, for us, one thing I'd note is because of our cut-off of March 22 of Q1, Easter is consistently in Q2 in both years, so we don't have any switches back and forth, which I think some people may have depending on how they're reporting, because obviously our first period of the four weeks that started March 23. There's definitely been some great pockets of strength in that and the same thing, as I mentioned, we still have some drags in the oil-related areas. We definitely saw, as Mark alluded to, some nice strength in Sullivan's coming out of the box in our period four as well as Del's was even with the strain nicely positive. We do – as you always get hit, we have certain parts of the country where there are major events that have moved the timing that are creating a few hiccups in a few restaurants are meaningful, but we'll get those back down the road, but it's really focused on the initiatives and everything that we've been focused to, go in a better direction since year-end. We're still not where we like to be, but we're going in the right direction.

Mark S. Mednansky - Chief Executive Officer

It was a good feeling to be positive as a company coming out of P4. But as you know, this very tenured group is very focused on fixing the ship this year and moving forward to profitable growth in the future, Will, so they're working very hard out there in the field right now.

Will Slabaugh - Stephens, Inc.

Okay. Thanks, guys.

Mark S. Mednansky - Chief Executive Officer

Thanks.

Thomas J. Pennison Jr. - Chief Financial Officer

Thanks, Will.

Operator

We'll go next to Imran Ali of Wells Fargo.

Imran Ali - Wells Fargo Securities LLC

Hi. Good morning. Thanks for taking my question.

Mark S. Mednansky - Chief Executive Officer

Good morning.

Imran Ali - Wells Fargo Securities LLC

I think just to clarify, I think you just said earlier that you're slightly positive so far in – or at least were positive in period four at I think both Del's and Sullivan's. Can you just talk a little bit more about that in your core state future sales and traffic trends by concept?

Thomas J. Pennison Jr. - Chief Financial Officer

We usually don't give that level of detail because – I mean, we're talking about four weeks of the 12-week period. Like we said, we're seeing positivity both in blended total as well as traffic right now. Like we said, as we go through the quarters, there's some things that shift for us, but we're not going to go into individual locations or areas.

Imran Ali - Wells Fargo Securities LLC

Understood. That's helpful. And just regarding your Grille development just being slow this year, can you just talk about the improvements that you've made so far to the class of 2013 and 2014 Grilles and what kind of results you're seeing so far?

Mark S. Mednansky - Chief Executive Officer

I'll take that. It's Mark. Good morning. Well, let's first talk about what we continue to do. The class of 2015 came out strong. We're still seeing some great strength not only in sales, but getting to profitability, steady state margin controls at a faster pace than we did in 2013 and 2014. We're able to serve our guests a little quicker the way we've built the kitchen with utilizing some technology to just looking at it not as a steakhouse-light, but as a Grille concept that serves the upscale guest.

So one of the learnings of 2015 had to do with technology in the back of the house. We've started now in the last few months putting some of that, new ovens, new pizza ovens, just some new ways and new recipes also in addition to technology that speeds up the process while it still gives you the same quality food. And also we tested in some of the new restaurants little things in the front of the house, the spiel that the server gives you when you sit down, shortening the spiel, putting more items on the menu than just verbalizing them. Anything we can do to speed up the process so that our guests are at their timetable, not ours, and you're going to see more of this. You'll see more technology that we haven't embraced yet that Tom and his team are working on. We hopefully will bring in some tests in some other locations by the end of this year. But more it's about the ability of our guests to come in and try something new that fits their price points. That still can be a great prime steak and a great Bordeaux. But offering them – a great example, with the new stores we opened up with our Daily Dish, which is a feature, it's the same dish every Monday night, Tuesday night, Wednesday night, and Thursday. So Tuesday night is Chicken Pot Pie at the Grille, at every Grille. So when you come in, you know you're going to get this great flaky Chicken Pot Pie that you don't make at home any more, that very few restaurants do, and it's favorable, and it's affordable, and it doesn't take forever to come out of the kitchen on a Tuesday night.

Thursday night is ribs, Friday night is fresh North Atlantic Cod, beer battered, a huge portion with chips. And then prime rib on the weekends, Saturday and Sunday night. And we got great comments from our guests. We have people coming back for the individual nights, repeating their visits more often. So we roll that out to the entirety of the Grille class, all classes, and we're starting to see some loyalty there and repeat business and that makes us pretty excited about the future.

Lastly, what we did in the first quarter, because we did slow down our growth of the individual units, we went through with a lot of time and money and this is labor cost both at the store level and G&A, pulling together all of our chefs for conferences, working on new items, perfecting the items that were on the menu in the past, that had great response about how can we make them even better, how can we be more consistent store-to-store with our offerings. So a lot of time, a lot of work, but we're very encouraged by the efforts of our team and the results that we're seeing in the field.

Imran Ali - Wells Fargo Securities LLC

Great. That's very helpful. And lastly, are you able to just give us an update on the situation with your largest shareholder and have you had any further discussions or dialogues since the last earnings call?

Mark S. Mednansky - Chief Executive Officer

No. And you're speaking of Fidelity National, all we'll say is we've had no conversations with them since the ICR Conference last year in Orlando where we had – this year at the very beginning of the year where we had a quick meeting and a quick email.

Imran Ali - Wells Fargo Securities LLC

Okay, great. Thank you.

Operator

We'll take our next question from Brian Vaccaro at Raymond James.

Brian M. Vaccaro - Raymond James & Associates, Inc.

Thanks and good morning. Just a couple of quick ones from me. First a quick clarification on the advertising question, do you expect to spend a similar amount as a percent of sales in 2016 versus 2015?

Thomas J. Pennison Jr. - Chief Financial Officer

As a percentage of sales, I would say we expect it to be consistent maybe a tad higher, but the allocation maybe from quarter-to-quarter a little bit different than what it was in the past.

Brian M. Vaccaro - Raymond James & Associates, Inc.

Okay. All right. And Mark, it sounds like the Happy Hour Program has been quite a success at the Grille. Can you give a little more color on the sales lift or sales mix you're seeing in the test units, how the guests are using it, how they're transitioning into the dining room or is it creating mostly incremental occasions? Any other color on this initiative would be helpful.

Mark S. Mednansky - Chief Executive Officer

Sure. Well, fly to Denver, spend some money at Cherry Creek and all your questions will be answered, or to one of our test stores. But if you're busy, I'll help you out here. The Happy Hour Program is 4.30 to 6.30 and what we're seeing is it is bringing in our guests, so there is a reduction in some drinks, there is a reduction in some new smaller plates that have the Grille flavors. Some of it is current menu items, but some of it is new items just at the bar. And it basically is just a taste of all of the flavors of the Grille, whether it's food or beverage, so you're getting some great cocktails and wine and beer for about $7, and some excellent small plates.

What's very, very encouraging, Brian, versus other happy hours and one of the reasons we've never done a happy hour across the three brands consistently is sometimes it brings in a crowd that really isn't your guest and they take seats from the people that expect to be able to get into your restaurant. At Del Frisco's Grille, Sullivan's and Del's, a lot of our guests love to eat dinner in the bar, so they want to be able to get in and enjoy that experience. And that's what we're really working on with this Grille Happy Hour is keeping the items upscale, not under-pricing them that will just bring people in who just want to spend a few dollars and leave.

If you went into the Grille, you'll see our guests, you'll see them staying past 6.30. There has always been this misperception in the restaurant industry and again, it's four years of managing in the industry, with a lot of happy hours under my belt. People always say, well, happy hour leads to dinner. That rarely happens. What we're encouraged is that we're stopping happy hours 6.30 and the guests are having such a good time with socializing that they're staying till 7.00, 7.30. So by the time the next shift of bar guest come in, they're coming into a vibrant bar and the sociability index continues at a very high pace and it creates a fun, energetic upscale atmosphere. And that's what we were hoping for and so far that's what we're achieving. And again, we've positioned it so these items don't – they don't hurt us as far as our bar cost, they don't hurt us as far as our food cost. They are accretive. Sometimes we'll bring out items, we'll just make some brunch items and bring them out. And today's guests, as I was talking about, the upscale guest today is really evolved. They really want different tastes. They want value as everyone does, but they want to experiment, they want to have fun, they want to be proud of where they go. So we think Happy Hour specifically at the Grille allows our chefs and our very experienced bartenders to experiment a little more, create a fun atmosphere, taste, exciting new taste that will only create even more loyal guests.

And lastly, part of the rewards program that our chief marketing team and operations are working on together is creating a rewards program that does more than just give you points and dollars. It gets you into special happy hours where you can taste new items and taste new drinks before any of our other guests, and that's what we're creating this year being able to roll by the end of the year.

Brian M. Vaccaro - Raymond James & Associates, Inc.

Okay, great. That's helpful. One other quick one, if I could. On the store margin guidance, I know it was unchanged, but any update or change in the underlying components there on the food cost side or on the labor wage inflation side? Are those basically (47:55) where I think you were at 0 to down 2% on COGS deflation for the year and your wage outlook I think was 3% to 4% if my notes are right. Any change to those, Tom?

Thomas J. Pennison Jr. - Chief Financial Officer

No change at this time. The only thing I would add to it and we definitely feel very positive especially as we look at some of the pricing as far as our cost of sales, there is still some components of potential labor pressures that aren't even settled yet that government would put in place this year. I don't think there is any changes at this point. Well, that's something as we look to this year, we're definitely encouraged by Q1, which was definitely slightly in some ways better than what we expect; in another ways, not everywhere we want it to be. But as we look to the tail end of this year and some still things that are being worked on in different parts of the country wage wise, we're kind of holding back to see swhat plays out with that before we would update anything. But right now, we still continue to feel very strongly about this year.

Mark S. Mednansky - Chief Executive Officer

And Brian, I want to reiterate that we took very, very modest pricing here at the beginning of Q2. And our plans are to have pricing in place by the beginning of Q4 not really to handle any commodity increases. We're pretty confident where that's going to be. It will be more for wage pressures, so we don't have any dilution going into that very important fourth quarter.

Brian M. Vaccaro - Raymond James & Associates, Inc.

All right. Excellent. Thank you.

Mark S. Mednansky - Chief Executive Officer

Thank you.

Operator

We'll move next to Jordy Winslow of Credit Suisse.

Jordy Winslow - Credit Suisse Securities (USA) LLC (Broker)

Hi. Good morning. Thanks for taking the question. It's Jordy on for Jason. Just want to go back to the marketing and advertising. Did your advertising split between lunch and dinner, did that change at all from 4Q? Are you still focused on driving traffic at lunch with advertising spend?

Thomas J. Pennison Jr. - Chief Financial Officer

We had a stronger advertising spend in Q4 for the Grille on that. Q1, especially year-over-year, will see our advertising spend is lower for the Grille. We still had some online items and some of the lunch promotions, but we're starting to evolve that a little bit more into the dinner promotions but while still maintaining the lunch components.

Mark S. Mednansky - Chief Executive Officer

Yeah, Q1 was all lunch at the Grille. Now you'll see since we – I mentioned it already -- you'll see us now transitioning to really building loyalty with our Daily Dish feature, which our entrée is offered at dinner, craveable, something you can't get everywhere, really comfort food, Grille food with a twist. It gives you the ability to come in and get something that you can't get somewhere else. I can get it. My wife can come with me. She can get a big New York steak. I can eat my Chicken Pot Pie and be very, very happy. And you will see us moving to more dinner this year.

And then by the end of the year in all three brands, you'll see us into check building. That's where we'll go with advertising, more into check building. As we believe the economy still continues to move forward, I know there's some choppiness out there, but our guest right now except in the oil problems in Houston primarily, our guests out there I think are getting more comfortable with the environment, the financial environment, and we're seeing a little more stabilization across the board.

Jordy Winslow - Credit Suisse Securities (USA) LLC (Broker)

Okay. And just on the traffic versus check then, so you said your strategy is more to a shift to driving check throughout the year. Is that more a back half initiative? Are you still going to be more focused on driving traffic with (51:53) the LTOs and other things in the second quarter?

Mark S. Mednansky - Chief Executive Officer

Yeah. Well, this summer, Del Frisco's and Sullivan's have some great features that are not just value based as we have in the past. We'll still have a great prime Sundays. You can come in and get a three course dinner for $55 at Del Frisco's. We'll always have our Sure Thing menu at Sullivan's. We can come in and get a great three course dinner for $44 at Sullivan's. But you will see us doing advertising and marketing and in-store promotions with some great lobster, fresh crab legs, stuffed lobster, head-on shrimp, different exciting cuts of prime meat, some cool seafood items that can help drive the check of the guests that want to ride all the rides. We'll have that available and that we'll continue that and accelerate that into the fourth quarter of this year.

Thomas J. Pennison Jr. - Chief Financial Officer

I would add, our focus to driving traffic will continue to be primary. It's going to be both as we go through because the – depending on the concept, building the traffic is very important at the Grille for us.

Mark S. Mednansky - Chief Executive Officer

But we think we have room now for check enhancement, especially at Sullivan's and Del Frisco's.

Jordy Winslow - Credit Suisse Securities (USA) LLC (Broker)

Got it. Thanks. I just had one quick one on Irvine coming into the Grille comp base. I thought you said that it was a negative impact coming in, but (53:24)

Mark S. Mednansky - Chief Executive Officer

No.

Jordy Winslow - Credit Suisse Securities (USA) LLC (Broker)

Positive. Did I mishear that?

Mark S. Mednansky - Chief Executive Officer

Basically, that restaurant is performing nicely positively. Where the negative impact was in Q1 by excluding it out of Q1's comp base, it was unfavorable impact to Q1 because Q1 would have shown a little bit stronger for the Grille if we wouldn't have excluded it. Because it was positive in both traffic and sales and would have been accretive to the comp base in Q1, but that's going in – it did start in Q2.

Jordy Winslow - Credit Suisse Securities (USA) LLC (Broker)

Okay. Are there any others coming into the comp base throughout the year that you would expect to have a meaningful impact or change the trend at all?

Mark S. Mednansky - Chief Executive Officer

Not specifically at this time. I mean, we have restaurants coming throughout the year. As I mentioned, in Q2, we do have both our Washington DC Del Frisco's coming into the comp base as well as the Irvine that we just spoke to came in the comp base in Q2.

Jordy Winslow - Credit Suisse Securities (USA) LLC (Broker)

Okay. Thank you.

Operator

We will go next to Paul Westra at Stifel.

Paul Westra - Stifel, Nicolaus & Co., Inc.

Great. Thanks. Good morning. Most of my questions have been answered, but maybe just a follow-up on pricing specifically, maybe some clarity. You mentioned 1.2% is taking now a range of 0.9% to 2.0%, which sounds like the Grille. Just clarify that. And also within each of the brands you mentioned a little bit, you're taking more pricing of course in higher minimum wage states. Can you give us a range of what the pricing is by restaurant within each of the brands?

Thomas J. Pennison Jr. - Chief Financial Officer

Within each of the brands, our Del's is the one that has had the least exposure so far to some of the minimum wage increases. So that's where we have the lowest component of the pricing where I mentioned the 0.9% to that point, it's definitely where we have, there's definitely more pricing power at Del's as we go forward.

As we look to our Sullivan's, we have Sullivan's in areas like Palm Desert, California, and Anchorage and in Seattle where we're definitely seeing some prices. And the Sullivan's concept is within tiers, so the tiers for Sullivan's range from a low of a 1.7% to a high of a 2.3%. Once again, you would expect the higher. We're going to be looking at places like Seattle where they're pushing the limits every chance they can as well as California with other interesting items. Within the Del's, I mean, it's – once again, you have a pretty wide range in the Del's I would say as low as a 0.5 point up to a little bit under 2%. Once again, all depends on what's happening with the minimum wage and then for the Grille, there is also a pretty good range from call it a 1% almost up to almost a 3%.

Paul Westra - Stifel, Nicolaus & Co., Inc.

Great. And then maybe just following up on the line item outlook. You're maintained your zero to 2%. Is that outlook – is that for beef or is that for your whole cost of goods sold basket?

Thomas J. Pennison Jr. - Chief Financial Officer

That's predominantly for beef. Our other areas are relatively flat. I mean, beef is a big driver there. It still makes up a little bit over a third of our cost of sales. We do have a lot of beverage components we're doing that there are some opportunities that we may be able to improve that, especially with some of the liquor features we're working with right now. And that's one of the things for the Grille that assisted in some of the favorability you see there is we've e actually seen stronger increase in our liquor mix, a little bit at the expense of wine, which the wine cost is actually higher than our food cost. So slightly lower wine played in some of that reduction of cost of sales also.

Mark S. Mednansky - Chief Executive Officer

Yeah, Paul, I want to remind everyone that at the end of last year, we engaged a third-party company to really help us. We've always prided ourselves. Paul, you know this from being a longtime follower of the brands. We've always prided ourselves in being at the forefront with beverage sales and trying to be creative and embracing it. But like anything else, we need to evolve, we need to continue to improve. We engaged a third-party company late Q4 of 2015. We're in the process of evaluating all their studies. We've been testing some of their suggestions and so far we're very pleased on the progress we've made and we think there is still a lot of low-hanging fruit for us in the future with profitable beverage sales not just at the Grille, but throughout the three brands.

Paul Westra - Stifel, Nicolaus & Co., Inc.

Great. And then lastly on the operating expense line. I think you mentioned in your prepared comments, 1Q you felt like you made some missteps there. Was that just short-term nature or just couple of locations, maybe a little more clarity on there?

Mark S. Mednansky - Chief Executive Officer

Yeah. A little of everything. A couple of the stores that were really hit in the Houston area, we did a poor job reacting quickly and consolidating cost and putting the right reductions. But I'd also tell you that in Q1 because we've had our training teams all available without opening any units, we spent time and money in Q1 and beginning of Q2 really looking at the three brands, especially the Grille, getting our culinary teams together, our chefs together, our trainers together, and really building a solid foundation to close out this year, moving to 2017 with expanded growth. And we think the money we spent will be well served. But as always, this company has always been a culture of controlling cost and we're never pleased when we leave any money on the table.

Paul Westra - Stifel, Nicolaus & Co., Inc.

Okay. Thank you.

Mark S. Mednansky - Chief Executive Officer

Thank you.

Operator

And that does conclude our question-and-answer session. At this time I'll turn the conference back over to management for any closing remarks.

Mark S. Mednansky - Chief Executive Officer

Once again, I would like to thank everyone for their time this morning and we appreciate your continued support for Del Frisco's Restaurant Group and we hope to see you in our restaurants here soon. Lunch today would be perfect. Have a great day.

Operator

And that does conclude today's conference. Again, thank you for your participation.

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