The Habit Restaurants' (HABT) CEO Russ Bendel on Q2 2016 Results - Earnings Call Transcript

| About: The Habit (HABT)
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The Habit Restaurants (NASDAQ:HABT) Q2 2016 Earnings Conference Call August 3, 2016 5:00 PM ET

Executives

Russ Bendel - President and Chief Executive Officer

Ira Fils - Chief Financial Officer

Analysts

Joshua Long - Piper Jaffray

Andrew Charles - Cowen & Co.

David Tarantino - Baird

Will Slabaugh - Stephens Inc.

Matthew DiFrisco - Guggenheim Securities

Paul Westra - Stifel

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Habit Restaurants’ Second Quarter 2016 Earnings Conference Call. Please note that this conference is being recorded today, August 3, 2016. On the call today, we have Russ Bendel, President and Chief Executive Officer and Ira Fils, Chief Financial Officer.

By now, everyone should have access to the company’s second quarter 2016 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 will now turn the call over to Russ Bendel. Please go ahead.

Russ Bendel

Thank you and good afternoon everyone. Welcome to our earnings conference call. I will start the call with an overview of the quarter and our thoughts for the remainder of the year. Ira will then review our second quarter financial results before we open up the call for your questions.

At a high level, we are pleased with our results for the second quarter. Total revenue increased 25.4% to $71.1 million compared to the second quarter of 2015. Company operated comparable restaurant sales increased 4%, our 50th consecutive quarter of positive comparable restaurant sales. Adjusted EBITDA for the quarter increased 15% to $8.7 million compared to $7.6 million for the second quarter of 2015.

Throughout the quarter, we remained focused on our strategy of delivering everyday value, quality and genuine hospitality that has been a hallmark of the Habit brand and a driver of our 50 quarters or 12 plus years of consistent quarterly same-store sales growth. The components of the 4% comparable store sales increase included a 4.3% increase in average transaction amount partially offset by a 0.3% decrease in transactions.

While we look to grow transactions year over year we are nonetheless pleased to have experienced significant sequential improvement in our transactions from Q1. The improvement was driven primarily by the use of high quality LTOs, targeted digital strategies and innovative media partnerships while staying true to our differentiated brand positioning and continuing to focus on operational execution.

I think it is important to mention that we only spent around 60 basis points towards marketing. And that the real story with The Habit is about our focus on quality and our everyday value, and how these help us drive customer loyalty and repeat business.

As we mentioned back in May, we introduced a new limited time offering: our Super Food Salad during the first half of the second quarter. As a reminder, the salad featured hand-fillet, marinated char-grilled chicken breast, served over tender baby kale, with tri-colored quinoa, sliced tomatoes, cucumbers, carrots, feta, Craisins and slivered almonds tossed in a zesty house-made kale pesto dressing. It was the most popular salad we have ever featured at The Habit and was fully priced at $7.95. The salad was on trend and appealed to a broad audience reinforcing that one of The Habit’s strengths is our ability to successfully execute a broader menu built on quality.

Our menu variety allows us to have a balanced gender mix, a balanced day part mix and ultimately some of the highest AUVs in the better burger segment. The success of the Super Food Salad also underscores our ability to focus on quality to drive traffic and not take part in the intense discount wars going on in the QSR category or discounting that we have seen increasing in casual dining over the last few weeks.

We used our expanded social media channels, our newly expanded CharClub email database and targeted digital engagement campaigns to tell the quality story with our featured LTO. And it really resonated with our guests in the quarter. We also continue to use these channels to reinforce our positioning of having the best tasting burger in America at a remarkable value available only at The Habit.

Another unique way we drove traffic and sales during the quarter was with an innovative and creative partnership with local radio stations in the Los Angeles DMA. While traditional radio and television buys can be cost prohibitive to a company of our size, we were able to partner with two radio stations by using our fleet of Habit catering trucks to raise money for the local charities selected by the on-air personalities. The series of events to large crowds by offering our char burger with cheese combo for $5 and 100% of those funds were donated to the charities. The event exposed the brand to thousands of guests who attended while at the same time providing The Habit with on-air exposure to millions of listeners in the greater Los Angeles and Orange County area where we have over 55 stores in the comp store base.

As we move into Q3, we are continuing to build on our strategy of high quality, relevant premium priced LTOs. We began the third quarter featuring our Strawberry Balsamic Chicken Salad, a perfectly seasoned chargrilled chicken breast atop a bed of hand-cut garden greens and fresh strawberries, dried blueberries and feta cheese crumbles, tossed in a house-made strawberry balsamic vinaigrette. In the latter part of the quarter we will feature the Hatch Chile festival promotion, including full southwest flavor of our charburger or chargrilled chicken sandwich with grilled Hatch green chiles, melted cheese, fire roasted pole [ph] sauce of tomatoes, lettuce and mayo.

We will also feature our Hatch Chile chicken salad with wine marinated chargrilled chicken breast on top of hand-cut greens, cheddar cheese, sliced tomatoes, carrots, black beans, chargrilled Hatch Chiles and fresh Alonso tossed in a house made [indiscernible] honey lime ranch dressing. By featuring seasonal ingredients like fresh strawberries and New Mexico Hatch Chiles, we are able to leverage our culinary creativity and keep The Habit contemporary, relevant with quality menu offerings, not temporary bundles or discounting.

So in summary, by using high quality LTOs, targeted digital strategies and innovative media partnerships, we were able to amplify The Habit’s brand strategy of delivering everyday value, premium quality and genuine hospitality. Together with great operational execution we were able to deliver our 50th consecutive quarter of positive quarterly comp store sales increases.

More importantly, we believe that The Habit is well positioned to continue to build on our 50 consecutive quarters of same store sales increases in the current challenging consumer environment.

Moving on to unit growth. During the second quarter we opened 6 new company operated Habit Burger grills, including 2 drive-throughs. In addition, we opened one franchise location in the residential area of Blue Diamond, Las Vegas. This is the second franchise location in Vegas and is also a drive-thru location.

We finished the quarter with 146 company operated locations and six franchised licensed locations. During the quarter we opened 2 new locations on the East Coast, one in Parsippany, New Jersey and the other in Rockville Maryland. We now have a total of 9 stores on the East Coast, including 4 which are in New Jersey, 3 in Florida and 2 in the greater Washington D.C. area. Looking forward we still expect to open the same number of restaurants in 2016 as we have previously communicated, although the composition will shift slightly.

On the company operated side, we have experienced developer delays which has resulted in a number of locations now expected to open later in the year than originally projected. In addition, we also expect to open a couple of units originally scheduled for late 2016 that will now likely open in early 2017. In total we now expect to open between 29 and 31 company operated locations in 2016 compared to our previous expectation of between 30 to 32 company operated locations.

Alternatively our franchisee development schedule has accelerated slightly. We now expect them to open between 5 and 7 franchise locations compared to our previous expectation of between 4 and 6 locations. We feel very confident in our pipeline for 2017 and 2018 and look forward to sharing with you our unit growth guidance for 2017 on our Q3 call.

I would now like to turn the call over to Ira to discuss our results in more detail.

Ira Fils

Thanks Russ. Now turning to the results for our 13-week second quarter ended June 28, 2016. Total revenue increased 25.4% to $71.1 million in the second quarter of 2016 from $56.7 million in the comparable quarter last year. As Russ mentioned, company operated comparable restaurant sales increased 4% in the second quarter. The six new restaurants we opened during the quarter were open for a combined 34 sales weeks. The 146 company operated locations were open for a combined 1854 sales weeks in the second quarter.

Turning to expenses. As a percentage of company revenue, food and paper costs were 29.8%, which was a 220 basis point decrease compared to last year. The decrease was largely driven by leverage gained from our recent price increases combined with decreases in commodity costs, specifically beef.

Labor and related expenses as a percentage of company revenue were 32.3%, which was a 240 basis point increase versus the second quarter of 2015 of 29.9%. Of the 240 basis point increase, 130 basis points was due to an increase in direct wages and a 110 basis point increase was due to an increase in the labor related expenses. The increase in direct labor was largely due to the wage rate increases for hourly employees combined with labor inefficiencies associated with new restaurant openings. The increase of labor related expenses was primarily due to higher costs associated with workers’ compensation expense, health insurance and mandatory California sick pay.

Occupancy and other related expenses as a percentage of company revenue increased approximately 80 basis points to 16% of company revenue. The increase was primarily due to higher rent and CAM costs primarily associated with new unit development. In addition, we experienced higher repair and maintenance costs combined with slightly higher marketing expense.

Our general and administrative expenses increased 31.6% to $7.5 million joining the second quarter of 2016 from $5.7 million in the same quarter last year. As a percentage of revenue, general and administrative expenses increased 50 basis points to 10.6%. The increase was primarily due to costs associated with supporting an increasing number of restaurants in a larger geographic area, including an increasing number of administrative employees and field and corporate supervision. In addition, increased management turnover has put pressure on our new manager training and recruiting expenses which are carried in G&A.

Depreciation and amortization expense increased $3.6 million from $2.7 million last year. As a percentage of total revenue, depreciation and amortization increased slightly to 5% in the second quarter of 2016 compared to 4.7% in the second quarter of 2015.

Pre-opening costs were $0.5 million for the second quarter of 2016 compared to $0.4 million in the prior year quarter. As a percentage of total revenue, pre-opening increased slightly to 0.8% of sales from 0.7% of sales in the prior year quarter. For 2016 we expect pre-opening expenses between $85,000 and $90,000 per new restaurant.

GAAP net income for the second quarter of 2016 was $1.2 million or $0.07 per diluted share compared to $678,000 or $0.05 per diluted share. On an adjusted fully distributed pro forma basis, net income for the second quarter was $2.3 million or $0.09 per fully distributed weighted average share compared to $2.3 million or $0.09 per fully distributed weighted average share in the second quarter of 2015.

In terms of our liquidity and balance sheet, as of June 28, 2016 we had cash and cash equivalents of approximately $49.8 million and outstanding debt of $4.7 million which consists solely of our deemed landlord financing. We expect capital expenditures to be between $36 million and $38 million for the fiscal year 2016. Based on our growth plans, we believe 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 updating guidance as follows. We now expect the total revenue will be between $284 million and $286 million compared to our previous guidance of between $286 million to $290 million, an increase in comparable restaurant sales between 2% to 2.5% for the full year adjusted slightly from our prior guidance of approximately 2%. We expect our restaurant contribution margin of 20.6% to 21.1% which is unchanged from our prior guidance.

General and administrative expenses are now expected to be between $28.6 million and $29.1 million compared to our previous guidance of between $28 million and $28.5 million. And as Russ said earlier, we now expect to open between 29 and 31 company operated locations compared to our prior guidance of 30 to 32 company operated locations.

We also expect our franchisees to open between 5 and 7 locations this year, a slight increase from our prior guidance of between 4 to 6 franchise locations. In total, this brings system-wide new store openings to between 34 and 38 combined company operated and franchise locations. We expect to open 8 to 9 company operated locations and 2 franchise locations in the third quarter.

We continue to expect depreciation and amortization expense of approximately $15 million for the full year and finally we expect an effective tax rate of approximately 42%.

With that, I'd like to turn the call back over to Russ for final remarks. Russ?

Russ Bendel

Thank you, Ira. 50 consecutive quarters of positive same store sales. What an accomplishment! We believe this is due to what we call The Habit difference, which has always been part of our DNA. This includes focus on food quality, making sure the environment of our stores is warm and inviting, exceeding our customers’ expectations for service at every visit, and also delivering them exceptional value.

As usual and always I'd like to wrap up my comments by saying that I am extremely proud of the over 4000 men and women in our restaurants who have helped us to deliver a very strong quarter and continue to make The Habit a very special company. Their work every day, taking great care of our guests is The Habit difference and allows us to produce 50 consecutive quarters of comparable same store sales growth.

With that operator, I’d like to turn it over to the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Joshua Long, Piper Jaffray.

Joshua Long

I was curious if we might be able to get your latest thoughts on the industry, the competitive backdrop, now you provided some of those comments in your opening remarks. But I was curious just what you saw geographically or maybe progressively through the quarter and then also as we think about your updated guidance for the year, what is changing there? It seems like the top line expectation has dropped down a little bit but you’re still able to maintain your restaurant level margins. So I was curious if it's as simple as cost of goods sold and favorable cost environments offsetting that or a few cents and some new workarounds to help you maintain the strong margins.

Russ Bendel

Thanks Josh. I'll take the first part of the call in regards to the environment and I will let Ira comments on the guidance portion. It's not the first time we've heard the question of what we felt the environment is like. Without question it seems to us that we are in a time of unprecedented discounting, not only below us in the QSR category which seems to -- in our opinion have seemed to accelerate discounting again as we finished Q2. But now also a tremendous amount of discounting in casual dining sector which has been challenged in this environment as well. And we feel that the strategy that we've stuck to without getting into discounting and really staying focused on our every day value positioning and upping the communication of that through the different channels that are available to us, along with promoting some of these more premium higher quality fully priced limited time offers that our customers have confidence enough to delivering to them has been successful. And that's the path we're going to continue to stay on. We're going to avoid getting into discounting That's not who we are. We’re going to stay the course and we believe that over the medium and long period of time this allows us to continue to maintain the position we have and be able to deliver consistent comparable sales results and earnings growth over a longer period of time.

Ira Fils

And I'll take the second part of that question. So we -- just I think like many others in the industry we saw the deceleration really happen in June. As we talked on our last call we felt pretty good how we started the second quarter in April, and we started it fairly strong and carried that into May and really saw a deceleration into June and that's quite frankly carried for on as it has for most people into the second -- and I'm sorry – into the third quarter. And so we adjusted our guidance down to reflect that. And obviously we're up 3% year to date for the first six months and 2% to 2.5% for the balance of the year implies a 1% to 2% guidance for the back half of the year and I would think given our two year stack we're probably going to be on the lower end of that in the third quarter and the higher end of that on the fourth quarter as we think about what our comparables are.

And in response to your margin question, we're able to hold margins more I think for the fact that commodities continues to get better and maybe come in a little better than our expectations, not a lot but enough to help us be able to maintain our margins, because as you saw we're not – we’re obviously not seeing it on the labor side, it's really as is not most people in the history, it's mostly on the cost of sales side where we’re able to get a little bit of that back.

Russ Bendel

And Josh, I remind you as I'm sure you're aware, if you look at our two year stacked comp numbers and the kind of the hurdles we're jumping over, we're awfully proud of the way the operators and the companies performing to deliver our 50th consecutive quarter.

Joshua Long

Understood, appreciate the color on both of those items. And similarly on the adjusted new development outlook but to maintain CapEx, understand the opportunity to – remember the opportunity but some of the delays that are coming on the developer side in those units shifting into next year. I was curious if you're able to divert some of those dollars and for CapEx that you're thinking of into other projects or despite them shifting into the early part of next year you're still spending those dollars upfront so that's why we don't see much of a change on the expected CapEx dollars?

Russ Bendel

Yes, good question. First of all there aren't any other projects, we have plenty of projects that we've carefully outlined earlier in the year that are on track and basically on budget. With the improvement of the commercial real estate situation over the last number of years, as we've talked about previously, the majority of our new store development are in new shopping centers which are always nice to be a part of, but it's less in our control and less predictable on when those centers will be completed or turned over to us for RPI improvements. And many of those have shifted and we're getting them later in the year and we've lost some sales week in regards to that. But we're still spending the money as they are either under construction or will be under construction before the year ends. So that really won't affect in any significant way the amount of capital that's deployed.

Joshua Long

Within a specific year?

Russ Bendel

Within this year.

Operator

The next question comes from Andrew Charles from Cowen & Company.

Andrew Charles

Great thanks. Russ, I know last call you talked about the increased CharClub base of members and the opportunity to tap into that to spread news and drive offers. I realize you don't want to exhaust this labor but how do you evaluate when and how frequently you decide to tap into the database to issue deals like the free Charburger you did last quarter?

Russ Bendel

We know free works. It drives traffic and we want to be cautious on how often we use that but in the last quarter as you're probably aware, our database had about 60,000 people in the CharClub. And we were communicating with them once or twice a month with updates on limited time offers, and the types of ingredients we used, more lifestyle type of messaging. And then we had the push to increase the sign-ups. And we grew that base to well over 200,000 and we're still communicating to them a couple of times a month. Our most recent communications have been more round the introduction of the Strawberry Balsamic Chicken Salad which I don't think I did -- I know I didn't say which is also selling at similar levels that the Super Food Salad did in Q2. And again this is a fully priced entree salad that we feel differentiates ourselves from some of our direct and indirect competitors and is selling at levels that we're very happy with. So we'll continue to use it for those type of things and we're always going to be cautious on how often we do something free. But we're not afraid to do free and we would much rather do something as a gift to our most loyal customers as opposed to doing broad based discounting.

Andrew Charles

Okay, that's helpful. And then Ira, when we do the math, it looks like AV growth during the quarter was up about 1.4% and same store sales growth for the first time since you guys went public. So I'm just curious what drove that.

Ira Fils

That's quite frankly what we've been saying for quite a while, as you know our new unit stores we’re projecting to open at volumes below our system average. We're adding a few more new markets as well and it's really just a function of adding new stores at lower volumes than the system average.

Russ Bendel

This is nothing different than we've communicated for the eight quarters since we've been public.

Operator

The next question comes from David Tarantino from Baird.

David Tarantino

Hi good afternoon. A couple of questions related to the comp trends. First, Ira, can you give us a breakdown of what pricing and mix were during the quarter because I think you had more pricing than the check growth which would imply negative mix but is that correct?

Ira Fils

The net pricing was 5.4% which obviously we talked about the three-tenths decline in traffic, so the check itself was down 1.1% which was driven in large part by the similar items that we've had in prior quarters, which we're seeing our drink incidents declined. And we saw a little bit of decline in side incidents as well during the quarter.

David Tarantino

And I guess the follow up to that is, how does that carry forward into Q3? I know you're rolling down pricing unless you took some recently, I don’t think you did – I think pricing is going to be closer to 3% in the second half, is mix also expected to be negative? I'm just trying to get a feel for what your implied expectation is on the traffic side of the transaction?

Russ Bendel

Yes, I think mix will continue to be negative but it won't be negative as it was in the second quarter.

David Tarantino

So if I'm hearing your correctly, the transaction pace that you're expecting in the second half is only modestly below what you saw in the second quarter or –

Russ Bendel

Yes, that's exactly.

David Tarantino

And is that -- if you're willing to talk about quarter to date trends, is that what you're seeing quarter to date so far, because I think the recent months is perhaps maybe one of your most difficult comparison for the year given –

Russ Bendel

You know, we try not to get into specifics. We obviously decelerated and we’re towards the low end of our guidance quarter to date. So we're comparing against some pretty big number last year and quite honestly what's changed. more recently as I spoke of was the amount of deep discounting the kind of in the bar grill category of casual dining.

David Tarantino

And so I guess on the outlook -- a couple more questions. First is how much did the shift in new openings hurt the revenue outlook? Was that a material change related to the revenue?

Ira Fils

It was a material change. Without getting into specifically quantifying it, it was a material change.

Russ Bendel

Yes, while we still feel we will open 29 to 31 restaurants it is extremely backend loaded.

David Tarantino

And then does that -- I guess the last question I guess back to one that I think was just asked by Andrew. On the new unit productivity side, are those tracking in line with your expectations or I guess theoretically that could be a little better than your expectations of the timing of the opening affecting the revenue side?

Russ Bendel

Is it – are they tracking – they’re tracking maybe slightly better than our 1.4% kind of stated average that we talked about. But that's still going to be below our 1.9 average which is going to -- by math going to drive down our AUVs a little bit.

Ira Fils

Yeah but we're slightly ahead of those numbers and the shift in sales weeks is a significant contributor to the revenue shortfall. But those stores that we don't get open at the end of this year will be under construction and open early in 2017. It's not like we lost the deals or anything like that.

David Tarantino

That's helpful and then last one. Could you give us an update on how the 9 locations in the East Coast are doing and if you can talk any specifics –

Russ Bendel

Again one of the most asked questions are -- and we continue to be pleased with how we're doing on the East Coast. We're operating at levels that we feel incredibly happy and proud of. We have one store -- with a total of 9 now we have one store that is in the comp base for second full quarter or the second quarter, and that store continues to outperform the comp performance of the company. And our second location there while not yet in the comp base is open more than one year and it is performing similar to the store in the comp base. So we're pleased, we're happy with how we're executing. We continue to be aggressive and looking for high quality sites in the East. We plan on opening a few more before this year ends back east. And you'll probably see next year the pace of development on the East Coast in the areas that we've talked about probably increase slightly.

Operator

The next question comes from Will Slabaugh with Stephens Inc.

Will Slabaugh

Want to ask about store level margins and mainly over time to think about labor pressure that you saw. So I'm curious if you think that we're now in a position to more or less just expect margins to sort of decline over the next three to five years, as that is layered on from a minimum wage standpoint or are there things we can do in terms of being more aggressive with pricing? I realize that you guys didn't take any more in the middle part of this year, wondering what that might look like going forward and then other offsets that could potentially sort of keep us in a particular range of the restaurant level, and if you had a range in mind over time.

Russ Bendel

I'll take the first part of the question, Will and then let fill in some more of the financial specifics. But again it is over an extended period of time. We have a long history of building comp store sales, historically and we've always said going forward it will be a combination of approximately half price and half traffic. We still believe that. We know we have one incredible value proposition to the consumer and if you look at our prices compared to our direct competitors we continue to believe we have pricing power. We have used a little more of that recently, don't plan on price increases for the remainder of this year. But price will play a factor in how we protect the margins going forward.

We also have a number of initiatives on how to best deal with increased labor costs not only in California but in many other places we do business and more coming in the future. And one thing we talk about internally the best way to deal with labor increases is to build comp store sales, that has always been our focus as an organization, that's how we reward people, incentivize them with their incentive compensation and in our DNA is an expectation that we build sales steadily in every restaurant all the time. Having said that we are looking at a number of initiatives that allow us to be more productive with -- productive meaning if we can do more throughput, as an example we have KDS systems in all of our restaurants. We're testing in a couple of restaurants now an expanded version of that, that is a little more robust and potentially could allow us to improve throughput especially in our peak time periods. We're looking at more the ability to do more mobile ordering that not only helps throughput but it also addresses the needs of today's consumer, specifically millennials. So this will be a multicast approach to win over a longer period of time. What we're not going to do is to change the experience level that our customers come to expect at The Habit.

Ira Fils

And just to add to that a little bit, you talked about other places, we're growing at 20 plus percent revenue annually. So there's ways that we can continue to leverage our increased purchasing power so we might not get things back all in labor as well. We need to continue to manage the other lines of the P&L as well to continue to help offset some of that labor increases, as well as Russ talked about a lot of the technology initiatives we're going to do and it's not going to be easy. But I think at the end of the day if we can keep driving sales and keeping the guests coming through we'll continue -- we'll be able to help -- it will be to help manage and navigate through this challenging labor environment as well.

Russ Bendel

As you look at these headwinds with labor and they're not going away and they're not just in California and New York and other places they're coming -- they're coming everywhere. I think you're going to see restaurant P&Ls look a little different in the future than they've looked in the past. So I think we all have to be sensitive to that and like Ira said it may not all come out of one line of the P&L but we will look to be productive in a lot of ways.

Will Slabaugh

If I can follow up on the labor line from this quarter. You mentioned higher health care and workers’ comp. Specifically on the higher health care, I know it’s difficult to forecast for workers’ comp. But would you expect any more abnormalities like that or would you consider that an abnormality as you look into the back half of the year?

Russ Bendel

Which line again were you talking about –

Will Slabaugh

I think you mentioned health care and workers' comp hurt labor a little bit this quarter.

Russ Bendel

Yes, we're going to continue to see the pressure on workers' comp through the back half of the year and we will still see some healthcare pressure as well and it might mitigate a little bit from where it's at, because we're going to roll over our initial compliance with mandatory provided health care in August. So we'll get a little bit of relief but we're also enrolling more folks as well that's going to offset that a little bit. But we should see – it should ease a little bit in the back half of the year.

Operator

The next question comes from Matthew DiFrisco with Guggenheim Securities.

Matthew DiFrisco

Hi, I just had a couple questions on the same store sales and then on the development side. Are there 109 stores in your comp base now?

Russ Bendel

Yes, I think as of the end of the quarter there was 109. We will get you a number here in a second or two. But you're not far off.

Matthew DiFrisco

And then are you guys experiencing cannibalization at this time particularly –

Russ Bendel

We expected 107 at the end of the quarter, we have been into 109 into July but it was 107 at the end of Q2.

Operator

Please go ahead Matthew.

Matthew DiFrisco

So are you experiencing any cannibalization in California? You said six company stores this quarter, two on the East Coast. So where were the other four coming from?

Russ Bendel

Well, any time we build a store in most locations in the West, we have great pretty strong brand awareness etc etc and there is cannibalization but we've been dealing with cannibalization long before we were public over the last eight years as we've accelerated growth. Since we've been a public company we're trying to be a little more sensitive to it and thoughtful on where we put locations and at what time they go in. But even with a little cannibalization these are just -- we feel these are good business decisions that are worthy of investing our capital and generate industry top tier returns. So yes there is cannibalization in our numbers, we're trying to be thoughtful about it. It's more heavily penetrated markets we’re in throughout California than anywhere else, with nine restaurants along the East Coast, it's not as much of an issue.

Matthew DiFrisco

And then as far as the June-July weakness you mentioned, would you attribute that to California or even just a change in advertising or any marketing?

Russ Bendel

No, I don’t think we’re really changing the marketing. I mean the best marketing we do is provide a great guest experience to our customers. That's what this business has been built on for over 48 years. We are getting better smarter at how we can use some new channels to stimulate awareness, because our issue is more about awareness. If we can drive awareness and drive people to the restaurants, we're very confident that the customer experience will create a desire for them to return. We feel the biggest headwind we have with sales right now is a little bit of the state of the consumer, I am not an economist, so I am not going to get into that. But without question the amount of discounting and aggressive promotional offers both below us and above us is it even feels like it’s heavier than it was in 2008 and 2009.

One other thing we are doing to drive sales increase AUVs, is in our development pipeline, as we’ve communicated before to up the amount of drive-throughs we did. In the quarter I think we opened two company drive-throughs and one -- the first drive-through outside of the state of California, our franchise partners in Vegas opened that in Q2 and we continue to feel very bullish on the drive-throughs. We have developed a kitchen and operating platform that allows us to be committed to cook to order off of our full menu and have it available in a more convenient channel for our guests because we know convenience is incredibly important to them. And we believe as we can slowly increase the amount of drive-throughs through our development pipeline, is a good thing to drive sales, deploy a little more capital and generate returns that are in line with our historic north of 40% cash on cash returns.

Matthew DiFrisco

Are those drive-throughs still providing around a 15% sales --?

Russ Bendel

I don't know, we’ve never really disclosed. But that's -- you can probably back into a number something like that.

Matthew DiFrisco

And just my last question, you increased the number of franchisee openings. But does that also include maybe a new franchise partner or is that within the number of franchisees?

Russ Bendel

We have the same franchise partners that we've had since prior to going public but both are our group in Las Vegas. And our group in Seattle are now starting to hit their stride in regards to their own development schedule, and we're seeing the benefit of that. Quite honestly, they were probably last year a little behind and this year they have caught up and there are two great groups, we couldn't be happier with the two groups we have, and they're doing good work.

Operator

The next question is from Paul Westra with Stifel.

Paul Westra

A couple of quick ones here, hi everyone. Ira, on the G&A line, it seems like this quarter was the majority of your increase for the year and maybe even by quarter, the third and fourth quarter G&A may be lower than the second which is somewhat abnormal. Just any more color on the upfront expense, it seems like you took here in 2Q in the G&A line.

Ira Fils

It really was -- had a lot to do -- driven a lot by our increased management turnover which drove -- a lot of that -- it drove the higher MIT expense and recruiting expenses as well. Our turnover – our management turnover has gone from 25% in last year to 33% this year. So we're definitely seeing some incremental costs there associated with that. And then we've had -- I mean quite frankly we've made some other investments as we've continued to grow a little more geographically diverse – we put some more operational infrastructure in place and we have another -- we have added another district operator. So in that supervisors, district managers, director of operations up in northern California, and we've added a little more horsepower behind our [DJM] program to get to ensure we have great coverage and making the stores are hitting all the quality standards as well. We spent a little bit more money in marketing as well. So there's -- it wasn't all just related to our MIT expense but we had a few things that we're investing in this quarter that drove a little bit of that -- the drove that kind of higher expense in G&A this quarter.

Paul Westra

And then if any of these are ongoing and higher, you had some offset, so the second half G&A doesn’t look as high --

Ira Fils

Yes, a little bit, a little bit.

Paul Westra

That makes sense and then I guess a little more on the pricing outlook. I know you don’t want to be wildly specific here. But in a 2017 environment that your traffic start to come by and obviously you have some labor pressures offset hopefully by continued benign commodities, kind of a third quarter run rate continues here. Just philosophically on pricing for 2017, would you think about holding margins the same or maybe prone to give some up in the environment or just how should we think about 2017?

Russ Bendel

So long as we're generating returns north of 20%, 20.5% we've always been cautious to raise price because over a longer period of time we always believe the longer we're going to hold off on taking price because history has shown our competitors will be more aggressive than we are, we feel we're able to grab more share. So we would -- we have not decided what we're doing. But we always are on taking less price and holding off than taking more and going early. That's how we're wired.

Paul Westra

And then lastly on the environment, I mean you mentioned a lot of the promotion. Is it getting even more choppier or the din of discounting so much is just constant, are you seeing –

Russ Bendel

It’s bumpy out there. I don't think that comes as any surprise to anybody in the restaurant sector, that it is choppy. And there's always a silver lining in everything. We feel by staying true to who we are, trying to be somewhat creative on some of the unique marketing initiatives that Matt and his team are coming up with are helping us navigate the tough competitive environment. We feel when we come out of it we're going to come out of it as strong as we did at the end of 2009 and 2010, they were tough years. We stayed positive then. We feel at least the consumer environment feels pretty similar to what it was then and then you'll probably see less new seats coming into the restaurant space maybe in the next year or so. So there's always something favorable that comes out of challenging times.

Paul Westra

Well, good luck on number 51. Talk to you later.

Operator

This concludes the question and answer session. I would like to turn the conference back over to Russ Bendel for any closing remarks. Please go ahead.

Russ Bendel

As always we appreciate all of your ongoing support. Ira and I always try to be available for any additional calls or information you may need and as always thanks for your support.

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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