Zoe's Kitchen (ZOES) Q4 2016 Results - Earnings Call Transcript

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Zoe's Kitchen, Inc. (NYSE:ZOES) Q4 2016 Earnings Call February 23, 2017 4:30 PM ET

Executives

Sunil M. Doshi - Zoe's Kitchen, Inc.

Kevin Miles - Zoe's Kitchen, Inc.

Analysts

David E. Tarantino - Robert W. Baird & Co., Inc.

Joshua C. Long - Piper Jaffray & Co.

Jason West - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Brett Levy - Deutsche Bank Securities, Inc.

Will Slabaugh - Stephens, Inc.

Andrew Marc Barish - Jefferies LLC

Sharon Zackfia - William Blair & Co. LLC

John Zolidis - The Buckingham Research Group, Inc.

Stephen Anderson - Maxim Group LLC

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Zoe's Kitchen, Inc. Fourth Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode, and the lines will be opened for your questions following the presentation. Please note that this conference is being recorded today, February 23, 2017.

On the call today, we have Kevin Miles, President and Chief Executive Officer, and Sunil Doshi, Chief Financial Officer.

Now, I'll turn the conference over to Sunil Doshi. Please go ahead.

Sunil M. Doshi - Zoe's Kitchen, Inc.

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

I would like to remind everyone that part of our discussions today will include forward-looking statements. These forward-looking statements are not guarantees of future performance and, therefore, you should not put undue reliance on them. These statements are also subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition.

Also, during today's call, we will discuss non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP, and the reconciliation to comparable GAAP measures is available in our earnings release.

With that, I would like to turn the call over to Kevin Miles.

Kevin Miles - Zoe's Kitchen, Inc.

Thanks, Sunil. Good afternoon, everyone, and thank you for joining us on the call today.

During 2016, we made strong progress against our key strategic initiatives while delivering solid operating results, including our seventh consecutive year of double-digit sales and restaurant earnings growth. We believe that our people first culture is particularly important in the challenging restaurant environment we face today. We strive to inspire our team to do better every day, and in turn, our team inspires our guests to eat better, to feel better and to live better.

I'd first like to take a moment to thank all our team members who bring to life the spirit of hospitality and service to our guests each and every day. Our success is not possible without each of you.

Turning now to our results, key highlights for the 12-week ending December 26, 2016 include revenue growth of 17.6% and comparable restaurant sales growth of 0.7%. This is on top of a 7.7% increase in fourth quarter last year. We also opened seven new company-owned restaurants during the quarter. While the current restaurant environment remains challenging, we are reassured by the fact that we have a proven differentiated brand still in the early stages of growth. We're also confident that we have the right strategies in place to drive our business in 2017 and beyond.

As we look ahead, our mission's clear. We aim to be the dominant Mediterranean fast casual brand inspiring all guests to live Zoe's. To that end, our strategy is focused on three main objectives: providing a superior guest experience; running great restaurants; and expanding our reach.

We believe we have ample opportunity to grow the business as we stay laser-focused against these strategies. Innovation is foundational to our strategy, and we expect to showcase both menu and marketing innovation in 2017. We are working on new menu offerings inspired by the bold flavors and ingredients that span the 21 countries of the Mediterranean. We anticipate introducing these items in the back half of the year.

Additionally, over the next few months we expect to roll out a number of menu ingredient prep enhancements or simplifications, which we expect to drive back-of-the-house efficiencies, allowing for increased throughput. With a line of sight on our new menu offerings in 2017, we have our eyes set on building an even stronger pipeline of culinary innovation to fuel our future growth. We look forward to sharing more details with you on future calls.

On the marketing front, you'll see us pivot from pure brand awareness building to more sales and traffic driving tactics. In advance of building out our own CRM capabilities this year, you will see us increase our marketing activities as we engage in new partnerships, like the recent announcement relationship with Dinova, a $6 billion marketplace that better connects business clientele with dining options. In addition, we will increase spending as we develop and refine new customer acquisition strategies and reactivation strategies for lapsed customers. Over the next year, we believe our marketing will become more targeted, more measurable and more data driven.

While menu and marketing innovation will get customers into our restaurants, providing a superior guest experience and running great restaurants is what earns their loyalty and keeps them coming back for more. To that end, we have been making critical infrastructure investments in several key in-store and back office technologies in order to improve the guest experience. Planned upgrades of our network, telecommunication systems, POS systems among others, should be substantially complete by the end of our first quarter. This investment provides the necessary foundation as we shift our investment focus to customer-facing initiatives and capabilities, like catering online, improved loyalty programs and better customer relationship management to fuel digital and social marketing campaigns. We are on track with this next phase of our investment, which we believe can drive growth in the latter part of the year.

The soon-to-be-complete infrastructure enhancements will also facilitate operational upgrades as KDS in our kitchens, which we have previously discussed with you and plan to roll out this year. We expect KDS to not only improve throughput during our peak periods of the day, but also improve the customer experience by way of improved order flow and accuracy. These initiatives scratch the surface on how we'll build the next level of customer engagement.

Our final strategic focus is expanding our reach. As we've expanded geographically, we have clearly established that customers love our food, and they love the experience, and we are working hard to bring Zoe's to even more customers across the country. However, it's no surprise that in today's fast-paced world convenience is becoming increasingly important to consumers, specifically the customer base that Zoe's has historically attracted. So we want to make it as easy as possible for our guests to live Zoe's.

We believe that the delivery is an exciting way to meet this increasing customer demand for convenience. For Zoe's we specifically take advantage of participating in delivery, given the proven portability of our food, our lunch and dinner relevance and our diverse menu offerings. We believe we have significant opportunity to drive growth through both catering and small order delivery for many years to come. Last year, we tested small order delivery in approximately 30 stores. After encouraging results we have been expanding our test, partnering with both national and regional players and now expect to reach approximately 100 stores or roughly 50% of our base by the end of the first quarter.

As we learn more about small order delivery, we're also focused on the execution of catering delivery to support this channel's continued growth. We're building a hybrid model where we expect to increase the use of internal labor and supplement with third party services which we believe will improve overall customer satisfaction, enable stronger demand capture. We're confident in these initiatives. Coupled with an improved app, a Web platform will drive growth.

Finally, we will continue to expand our reach through new unit development. As I mentioned earlier, we added seven new restaurants during the quarter. This brought our 2016 total to 38 new restaurants, representing 23% unit growth year-over-year. We are pleased that our new units continue to perform well. Our real estate team has done an excellent job of building strong pipelines, site selection, delivering and developing predictable year one results. So far this year we've opened three units and we expect to open a total of 38 to 40 restaurants in 2017.

In 2017, we will continue to grow our presence in our newest markets of Colorado and Kansas City. We'll continue to support these new markets with social media and local marketing campaigns aimed to build awareness and trial and accelerate our catering growth. In addition, we plan to open three to five restaurants in Colorado and one more in Kansas City in 2017. Our concept has proven to resonate with guests across the country and we're proud that our top 20 restaurants are spread across seven different states.

In summary, we're confident that we have the right strategies and initiatives in place to drive our differentiated brand forward through profitable growth. We continue to strengthen our brand positioning as the authority on Mediterranean. Our menu and marketing innovation cultivates a lasting connection with our guests. They connect to our wholesome and delicious food and they connect to the Zoe's lifestyle which inspires them to live life to the fullest.

We have made and will continue to make investments to ensure an excellent guest experience which keeps our guests coming back again and again. We have an enormous opportunity to reach more customers, both through channels such as catering and delivery, as well as the more traditional path of new unit development. Our pipeline is strong. Our new units continue to perform well, giving us the confidence in the near and long-term growth strategies. We believe that our sharp focus on these key initiatives will enable us to generate strong operating results creating a lasting value for our shareholders over the long term.

With that, I'd like to turn the call over to Sunil to take you through our financial results in more detail.

Sunil M. Doshi - Zoe's Kitchen, Inc.

Thanks, Kevin, and good afternoon, everyone. As Kevin mentioned, I'll review our 2016 financial highlights for the fourth quarter and full year, and then provide a summary of our outlook for 2017.

For the 12-week period ended December 26, 2016, total revenue increased 17.6% to $62 million. Revenue growth was driven primarily by the addition of 38 new company-owned restaurants, since the fourth quarter of last year, as well as by comparable restaurant sales growth of 0.7%. Our comparable restaurant sales growth consisted of a 3.1% increase in price and a 240 basis point decrease in transactions and mix combined. Transactions declined during the quarter with the lowest result coming in December. Catering comps continued to outpace the overall comp during the quarter.

For the fiscal year 2016, total revenue was $276 million, or 21.8% growth and comparable restaurant sales growth was 4%, beating the low end of our previously stated guidance range. We ended the year with 150 restaurants in the comp base, or 75% of our owned restaurant count. For the fiscal year, catering comps increased 14.5%, with our strongest results coming in the earlier part of the year.

Before I go through our expense line items, I would like to remind you that Q4 is seasonally our slowest quarter with historical average weekly sales running roughly 90% of full year average weekly sales.

In Q4, cost of goods sold as a percentage of restaurant sales increased approximately 30 basis points versus the prior to 30.3%. From a commodity perspective, the increase was driven predominantly by higher poultry pricing, as expected, as we continued to see more normalized levels coming off the multiyear low reached in Q4 2015. Partially offsetting this increase in poultry was lower beef pricing and leverage from our menu price increase.

Based on our current commodity outlook, we anticipate our overall commodity cost in 2017 to be roughly in line with 2016 with increases in some commodities offsetting decreases in others. Poultry costs will continue to be purchased on spot market pricing during 2017, as our current store count inhibits our ability to contract pricing for longer periods of time.

In Q4, labor cost as a percentage of restaurant sales increased 100 basis points year-over-year to 31.5%. The increase was driven primarily by the impact of newer restaurant openings which typically run lower initial average weekly volumes compared to the balance of our comp restaurants and incur early labor inefficiencies for a short period of time.

During Q4, wage rates for hourly team members increased at an approximate 2.5% annualized rate, slightly above the 2.3% seen in Q3 of 2016. Partially offsetting these pressures were continued improvements in labor productivity in our comp store base and leverage from our menu price increase.

In Q4, store operating expenses as a percentage of restaurant sales increased 200 basis points year-over-year to 21.6%, driven primarily by expected increases in technology and occupancy costs. Technology cost contributed approximately 80 basis points of the increase, which we expect to continue through the first half of 2017 as part of our overall initiative to improve our technology infrastructure and build on our 2017 digital platform initiatives. Similar to previous quarters, occupancy costs from newer stores with lower average weekly sales than the balance of company contributed about 80 basis points of our overall year-over-year store operating expense rate increase.

In Q4, restaurant contribution dollars were $10.3 million, a 1.4% decrease over the same period last year. As a percentage of restaurant sales, restaurant contribution margin declined 320 basis points year-over-year to 16.6% of sales as sales growth was more than offset by the previously mentioned increases in COGS, labor and operating expenses.

For the fiscal year 2016, restaurant contribution margin rate was 20%, beating the low end of our previously shared guidance range. On a year-over-year basis restaurant contribution margin rate was lower by 110 basis points. This decrease in rate was primarily driven by newer stores, as the combined performance of restaurants through the 2014 vintage saw an improvement in restaurant contribution margin rate on a year-over-year basis. I would note that our newer stores, while they continued to perform in line with our expectations, are expected to be the primary source of pressure on our contribution margin rates in 2017. Over the next few years, we expect this type of pressure to diminish as new stores become a smaller mix of our total restaurant base.

In Q4, general and administrative costs were $7.3 million, an increase of approximately $500,000 versus the prior-year period. G&A as a percent of total revenue was 11.8% of sales, representing a 100 basis points decrease versus the prior year. This decrease was driven by operating leverage and the lapping of 2015's investments in head count, IT and professional services that were required to become SOX compliant.

For the fiscal year 2016, G&A was $30.4 million, or 11% of sales, 80 basis points better than last year. Excluding certain one-time expenses from prior year's results, which are listed in the reconciliation of GAAP results to our adjusted financial results in our press release, G&A leveraged by 40 basis points.

In Q4, adjusted EBITDA was $3 million, a 19% decrease over last year. Adjusted EBITDA margin as a percentage of total sales decreased by approximately 220 basis points year-over-year to 4.9%. For the fiscal year 2016, adjusted EBITDA was $25.1 million, or 12.5% growth versus the prior year.

Pre-opening costs in Q4 were $310,000, about $70,000 lower than the fourth quarter of 2015. Looking ahead to fiscal 2017, we expect our 2017 development plans to result in pre-opening expenses of approximately $2.7 million to $2.8 million.

Interest expense was approximately $950,000 for the fourth quarter of 2016 compared to $820,000 last year. Our interest expense primarily represents cash and noncash expenses related to leases classified as build-to-suit leases. Our Q4 tax benefit was approximately $1.7 million, a $1.7 million decrease from the benefit recorded in Q4 of 2015.

As discussed previously, our annual tax provision is derived from the book-to-tax difference created by our goodwill intangibles. This annual provision for taxes is spread quarterly based on our actual and projected pre-tax income or loss for the full year. For the fiscal year 2016, our tax expense was $861,000 compared to $839,000 in the prior year.

In Q4, net loss was approximately $500,000, or minus $0.03 per share, as compared to net income of $2.6 million in Q4 of 2015, or $0.13 per share. To account for the significant timing impact of our quarterly GAAP tax provision, we have attached a reconciliation of our GAAP results to our adjusted financial results in our press release. We believe that the adjusted results provide a useful view of our business.

Adjusted net loss for Q4 of 2016 was $1.4 million, or minus $0.07 per share, versus adjusted net loss of $500,000, or minus $0.03 per share in Q4 of 2015. For fiscal 2016, net income was approximately $1.8 million, or $0.09 per share, as compared to net income of $1.1 million for fiscal 2015, or $0.06 per share.

Weighted average diluted shares outstanding were 19.6 million in both the current and prior-year periods. Adjusted net income was $1.7 million, or $0.08 per share as compared to adjusted net income of $2 million, or $0.10 per share in the prior year. We ended Q4 of 2016 with $5.5 million of cash on hand with no borrowings against our $50 million credit facility. We do expect to utilize a portion of our existing credit facility in 2017 primarily to fund new restaurant growth.

Now turning to guidance, based on our year-to-date performance and our current forecasts, we are offering the following guidance for 2017: we expect total revenue between $325 million and $327 million; we expect to open between 38 and 40 new restaurants this year. From a timing perspective, our current calendar anticipates that our openings will be slightly more back weighted this year versus last year. We expect full year comparable restaurant sales to increase between 1% and 2%.

In terms of cadence, we expect our quarterly comps to sequentially improve throughout the year for two reasons. First, as we move throughout the year, our comparisons become more favorable. As a reminder, 2016 comps started off at 8.1% in Q1 of 2016 and sequentially declined throughout the year to 0.7% in Q4 of 2016.

Second, many of our revenue growth drivers that Kevin described, including new menu offerings, web and mobile app initiatives, new online catering capabilities, and expansion of our delivery initiatives are more likely to impact the second half of the year. With this context and based on our year-to-date trends, our annual guidance range of 1% to 2% anticipates that our first quarter 2017 comps will be in the negative low-single-digit range.

We expect our 2017 annual restaurant contribution margin rate to range from 19.0% to 19.3% of restaurant sales. G&A expenses are expected to leverage again in 2017. We expect the G&A expense rate of approximately 10.7% to 10.8% of sales. Our full-year G&A guidance is inclusive of $3.1 million in non-cash equity-based compensation expense. Capital expenditures net of tenant allowances is expected to be between $38 million to $40 million.

With that, I'd like to turn the call back over to Kevin.

Kevin Miles - Zoe's Kitchen, Inc.

Thanks, Sunil. That concludes our prepared remarks, and we're happy now to answer any questions that you may have. Operator, open the line, please.

Question-and-Answer Session

Operator

Certainly. Our first question today is coming from David Tarantino from Robert W. Baird. Please proceed with your question.

David E. Tarantino - Robert W. Baird & Co., Inc.

Hi. Good afternoon. A couple of questions. First, on the outlook for the first quarter, Sunil, I think you said down low-single digits on comps. Can you maybe talk about what you're seeing, what you're experiencing so far and why you think the trends have slowed from the fourth quarter into the first quarter?

Sunil M. Doshi - Zoe's Kitchen, Inc.

Sure. Yeah, thanks, David. There are couple of things: one, as we've mentioned in the prepared remarks, in the fourth quarter we did see December present a little more of a traffic challenge than we had seen in the earlier part of the quarter. Through the first part here of the year, we've continued to see a little bit of choppiness in the traffic trends. In trying to dissect through the true underlying drivers of that, we probably need a little more time to get a sense of kind of the steady go-forward trend, if you will. But January had a little bit of weather. We do have about 10 stores to 12 stores in our comp base that are in the DC-ish area, and we saw a little bit of noise around the inauguration. And February has been a little bit choppy. We've had some positives and then kind of offset a little bit as well.

So from a trend perspective, that's a little bit of what we've been seeing in our business. And then really beyond that, our thinking is shaped by the fact that we are, at least from what we're lapping and kind of what we're up against last year, our strongest comp from last year was, as we'd mentioned, in the first quarter and then it got sequentially easier. It will get sequentially easier as we go through the year in terms of comparisons. So we know that we're up against our toughest compares right now as we finish out the first quarter.

And then also, as we mentioned, just from a revenue growth perspective, the drivers that we are working on, really excited about the impact of the initiatives that we have. But those are more back-end weighted than they are front-end weighted.

David E. Tarantino - Robert W. Baird & Co., Inc.

Got it. And then just a clarification on that. Are you seeing or did you see trends fall off in February? I guess we've heard a lot of talk about that from others. And do you think one of the reasons people are talking about are tax refund delays? Do you think that would affect your consumer? Any comments related to that?

Sunil M. Doshi - Zoe's Kitchen, Inc.

Sure. With respect to February, no, we didn't see any deterioration in February. Actually, February was a little bit better than January from a traffic perspective, but there was still some choppiness as we went through the month. And I probably couldn't pinpoint how to think if the tax refund-type thing would be driving any of that.

David E. Tarantino - Robert W. Baird & Co., Inc.

Got it. And then one more, if I can. On the margin outlook, the restaurant margin outlook, it assumes a little less compression in 2017 relative to 2016 than what you saw in 2016 versus 2015, even though the comps are going to be quite a bit lower. So can you talk about why you think you'll see less compression at the restaurant level this year?

Sunil M. Doshi - Zoe's Kitchen, Inc.

Yeah. One of the drivers that's been compressing, at least in the last couple of quarters, has been our increased spending in technology and those operating costs. Those costs will continue to cause some pressure in the first two quarters as well kind of our revenue outlook in the first, but we'll begin to lap that as we go into the third quarter. We're also working hard on identifying opportunities as we get a little bit bigger in scale to drive some improvements kind of in the middle of the P&L, if you will, again, taking advantage of our scale and seeing where we can make some improvements in the restaurant-level margins.

David E. Tarantino - Robert W. Baird & Co., Inc.

Got it. Thank you very much.

Operator

Thank you. Our next question today is coming from Joshua Long from Piper Jaffray. Please proceed with your question.

Joshua C. Long - Piper Jaffray & Co.

Great. Thank you. In the development pipeline, we talked about adding some new units in those Colorado, KC markets. Wanted to see if you might be able to talk about how you're coming together on site selection for those? And maybe when you start looking at adding a new market beyond KC and Colorado? Maybe that's late 2017 or maybe early 2018?

Kevin Miles - Zoe's Kitchen, Inc.

Yes. Sure, Josh. This is Kevin. Absolutely, Colorado is coming together well. As we mentioned, three to five, I believe. Well, we have the leases signed. We've got some new development that's happening, so that could kind of bounce around a little bit. So it looks like Denver is going to have – or Colorado is going to have three. We do have one in Kansas, kind of outside of Kansas City a little bit that we'll open up. So those are all pretty, call it, four – three in Colorado, one for sure in Kansas – that should definitely happen. And then we'll continue to build that pipeline for 2018 as well in those markets. Colorado is very early stages. We believe that market is well north of 20-plus locations in the state for sure.

As far as new market entry, you won't see us enter a new market. We will still penetrate Kansas City and Denver – or Colorado in 2017. 2018 could be a possibility. We have narrowed that down to a couple of markets at this point in time. We'll be discussing that internally here in the next few weeks during one of our board meetings coming up as well to kind of nail that down, and we'll give more insight into that. But we have done the work on that and we do have those kind of narrowed down to kind of two specific markets that we'll share at a later date.

Joshua C. Long - Piper Jaffray & Co.

Great. Thank you. And then as we think about the menu and prep simplifications that will roll in over the course of the year, I was hoping you might be able to flesh those out a little bit in terms of how to think about those. Is that optimized labor in the back of the house? Maybe bringing in some things already prepped outside. Just how do you balance that with your current culinary profile and what that might look like as we start thinking about the model in the back half of the year?

Kevin Miles - Zoe's Kitchen, Inc.

Yes, sure. With Antonio on board now a little over a year, he's really been working on this now for a good part of the year that he's been here as well as developing new items. So as we've discovered in especially our busier locations, we've talked about equipment, we've talked about KDS, we've gone through that, and we've really been looking at can we pre-cut lettuce, as an example, versus cutting lettuce? That's an opportunity for us that we've looked at. We've also looked at better ways to skewer our kabobs, cut our proteins, and give the team some other advantages.

So, yes, some labor, potentially. Not necessarily labor savings, but more deployment of labor and better opportunities, which will allow us to add some additional items without having to add more labor to the system. So simplifying the prep and we'll give more detail as we officially roll all that out and give you some more background on it. But it's both prep as well as just deployment of that labor is what we're seeing and the ability to add new items without adding labor.

Joshua C. Long - Piper Jaffray & Co.

Got it. Okay. And then last one for me. In terms of the interest expense line in 2017, how should we be thinking about that? It's stepped up over time as you've continued to grow your pipeline in some of those stores end up flowing through that interest expense line, but it also sounds like you might tap into that line of credit you have. So I mean, is 3.8% (30:13) that you did for the year a nice starting point, and then any sort of direction in terms of how much that increases with the unit pipeline that you have now?

Sunil M. Doshi - Zoe's Kitchen, Inc.

Yes, terms of the interest expense that's associated with our credit facility are disclosed in the 10-K, so you can probably take that information, and we could start borrowing against that line to support growth at some point late in the first quarter, potentially into the second as well.

Joshua C. Long - Piper Jaffray & Co.

Got it. Thank you.

Operator

Thank you. Our next question today is coming from Jason West from Credit Suisse. Please proceed with your question.

Jason West - Credit Suisse Securities (USA) LLC (Broker)

Yeah. Thanks. I guess just a quick one there, just following up. Can you remind us the size of that line of credit? How big does that go?

Sunil M. Doshi - Zoe's Kitchen, Inc.

Sure. $50 million.

Jason West - Credit Suisse Securities (USA) LLC (Broker)

Okay. What's drawn on that today?

Sunil M. Doshi - Zoe's Kitchen, Inc.

Zero.

Jason West - Credit Suisse Securities (USA) LLC (Broker)

Zero. Okay. And then as you're thinking about the comp outlook, I know you guys took some pricing in 1Q of last year I believe. Can you remind us the timing on that and what you're planning to do as you come up to lap them?

Sunil M. Doshi - Zoe's Kitchen, Inc.

Yes. The price increase that we took last year was in the first quarter. And this year, as we approach it, as we've said before on previous calls, we didn't think the price increase at that time when we had talked about it would be as significant as we did in 2016. And that's generally how we're still thinking about it. We are evaluating price increase, and we'll share more details on that as we determine our plan on that. We won't exactly lap it at the same time in the first quarter, but we are looking at price increases during the year, just probably to a more modest level than we did last year.

Jason West - Credit Suisse Securities (USA) LLC (Broker)

Okay. Got it. And then just one more on the margin side. You guys finished the year sub-17% margin and guiding to quite a bit better than that for the full year 2017. I guess, how much visibility do you guys have on some of the costs that are more discretionary and can be managed versus just seeing kind of deleverage? It sounds like a lot of this has kind of come from new stores. I guess another way to ask this is: did 4Q margins kind of surprise you guys in any way, other than maybe the sales deleverage? Are some of these cost things that you could maybe flex back if it looks like you're not getting to your margin targets?

Sunil M. Doshi - Zoe's Kitchen, Inc.

Good question. No. The fourth quarter didn't surprise us. We ended the year at 20%, which is consistent with the range that we had provided at the end of the third quarter call. So our results in the fourth quarter were very much in line with how we had set up the updated guidance for the year there. And a reminder: the fourth quarter, as we said in our prepared remarks, is a seasonally slower period for us. And so the average weekly volumes are around 90% of just kind of the full year average weekly volumes, which does just create a general kind of lower level on the restaurant contribution margin rate for us in the fourth quarter. So our guidance takes all of that into account, but again, just a clarification that the fourth quarter is a seasonally slower period.

Jason West - Credit Suisse Securities (USA) LLC (Broker)

Thank you.

Operator

Thank you. Our next question today is coming from Brett Levy from Deutsche Bank. Please proceed with your question.

Brett Levy - Deutsche Bank Securities, Inc.

Sure. Good afternoon. First, just one clarification: did you mention how much you would borrow on the credit facility?

Sunil M. Doshi - Zoe's Kitchen, Inc.

No, we didn't throw out a number there for (34:06) the year. No.

Brett Levy - Deutsche Bank Securities, Inc.

Okay. Second, on unit expansion, given that you've seen some incremental hit on your margins and your cash balance has continued to come down and now you're talking about borrowing, is there any thought of slowing down your expansion a little bit? Or is there any possibility of having some of the second half roll into 2018 without seeing (34:32) any hit to your P&L? Or are you already too far along on those? And then how do you feel about your current liquidity scenario? Thank you.

Kevin Miles - Zoe's Kitchen, Inc.

Yes. Sure, Brett. We'll break this down. This is Kevin. As far as our development plans, as we mentioned, leases are signed and we're in process of designing and developing. That said, could some flop into next year. As always, some could move in there, some could move out, some could move up. So, we're not seeing anything in our openings that tell us that we shouldn't open or we should slow that down. The macro environment is such that everyone on the call knows, but we still believe in what we're opening and how we're opening our restaurants. So at this point in time, nothing's giving us pause to slow that growth down. As far as liquidity, I'll turn that back to Sunil and let him kind of touch on the liquidity side for you.

Sunil M. Doshi - Zoe's Kitchen, Inc.

Yeah. I mean, with the terms of our revolver, again, this is disclosed in the K; we feel pretty good from a liquidity standpoint. What I will probably offer up, just in addition to what Kevin shared from a development perspective: we don't anticipate any changes in our strategy and our approach. We've kind of deployed this hub-and-spoke strategy as we've grown the business from 100 units to 200 units, applying a lot of diligence in how we go about site selection. The real estate team has continued to build a very strong pipeline so that we're not chasing deals. And Kevin's been very adamant kind of with that philosophy: build a strong pipeline so that we have options as opposed to running after things. And so I think the combination of that hub-and-spoke strategy about how we think about real estate and the diligence that we have around site selection, building a strong pipeline, is something that's very core to us. And that's the discipline that we'll continue with as we think about our expansion and our overall balance sheet.

Kevin Miles - Zoe's Kitchen, Inc.

Brett, to just to chime in, I think I'd want to be a little bullish on just kind of talking about the brand as well. As we grew the brand in 2009, in the peak of the worst economic crisis we were having, and at the time they are – now going on my ninth year of growing and seeing how our restaurants are performing, we're still performing well, so there's nothing that's given us that pause. I feel that we're seeing our restaurants open up well. We're seeing it resonate with the consumer. So to Sunil's point, the strategy is intact, the initiatives are intact and our pipeline is strong, so we feel very confident as we move forward.

Brett Levy - Deutsche Bank Securities, Inc.

Can you share a little bit more detail on the class of 2015 and 2016 stores? Growth in AUVs? Profitability? What kind of progress you're seeing versus some of the older, more mature successful stores? Thank you.

Sunil M. Doshi - Zoe's Kitchen, Inc.

Yeah. So those two classes, if you will, are performing consistent with our model expectations that we've shared in the past. So kind of in the existing market arena, we're opening right around that $1.3 million, and that's been pretty consistent for us. The newer stores are off of a lower base, comping higher than the older stores. But in this overall environment, our overall comps, as you know, aren't as high as we would like them to be. So from that standpoint they are outpacing the balance of chain, but everything is just at a little bit of a lower level.

Operator

Thank you. Our next question is coming from Will Slabaugh from Stephens. Please proceed with your question.

Will Slabaugh - Stephens, Inc.

Yeah. Thank you. Regarding the comps (38:31) you mentioned earlier, is there anything geographically that's worth calling out? Or anything with regard to newer or older stores in the comp base that may help us understand that a little bit better?

Kevin Miles - Zoe's Kitchen, Inc.

Yeah. Hey, Will. It's Kevin. I think what we've seen, exclusive of weather in parts of the country and election that Sunil alluded to earlier, we've definitely in some of our Texas stores seen a little bit more pressure. I think that's two-fold there: a little bit of competitive pressure as well as our own kind of pressure. We've built Dallas now to 24 locations, purposely built, as we talk about convenience and continuing to penetrate the market. We've added revenue to the market overall, but we've definitely seen a little bit more probably in Dallas as we've grown versus San Antonio, Austin or Houston. But kind of that Texas market is pricing a little bit more of that than other parts of the country, exclusive of any of those weather-related type things.

Will Slabaugh - Stephens, Inc.

Got it. And then just a quick housekeeping, if I could, on new units for 2017. Can you remind us what percentage of those new units are opening up this year in new versus existing markets? And then what that looked like last year? I'm just kind of curious what that means for average weekly sales as we model that out for 2017?

Kevin Miles - Zoe's Kitchen, Inc.

Yes. So last year, we were right around 21% of our new store count was in what we would call new markets. This year, in 2017, that'll be somewhere between 10% and 15%.

Will Slabaugh - Stephens, Inc.

Great. Thank you.

Operator

Thank you. Our next question today is coming from Andy Barish from Jefferies. Please proceed with your question.

Andrew Marc Barish - Jefferies LLC

Hey, guys. Just, again, sorry to beat a dead horse; following up on the comp normalization, I mean, is part of the Texas challenges just the volumes you run in that market? Or have you seen incremental competition in Mediterranean? Or is it just the broader growth we've all kind of watched in fast casual, you think?

Kevin Miles - Zoe's Kitchen, Inc.

I think it's probably a little of all, but primarily, the volume. And we had some pretty big openings in Dallas, specifically in 2015 and 2016. So those stores opened well above the model, and continued – those comps are much challenging comp at that higher volume. I wouldn't say we've seen more Mediterranean competition. There's definitely more fast casual competition in Dallas, and even casual dining competition in Dallas than we've seen. Dallas is still growing very rapidly from a population standpoint as well as restaurant, new restaurant openings. So I think a bigger portion of it's our volume than anything else.

Andrew Marc Barish - Jefferies LLC

Thank you.

Operator

Thank you. Our next question today is coming from Sharon Zackfia from William Blair. Please proceed with your question.

Sharon Zackfia - William Blair & Co. LLC

Hi. Good afternoon.

Kevin Miles - Zoe's Kitchen, Inc.

Hi.

Sharon Zackfia - William Blair & Co. LLC

Just a quick question, Sunil, on the cadence of the restaurant level margin; I'm assuming that since the first quarter is expected to have the weakest comp that you'll see the most pressure on that year-over-year in the first quarter? And then it will kind of get better, year-over-year, as the year goes on. Is that kind of what you're thinking there?

Sunil M. Doshi - Zoe's Kitchen, Inc.

Yeah, definitely. When we look at – kind of three things, one, you have the normal kind of pressure that comes from occupancy costs as it pertains to new stores. I alluded earlier to technology costs as we've increased that level of spending starting in Q3 of last year. That will continue as we go through Q1 and Q2 of this year. And then the last point, with what we think is our lowest comp plan of the year, or lowest comp period of the year being the first quarter, that will add some pressure on the restaurant level margins, and then sequentially gets better, we think, over the course of the year.

Sharon Zackfia - William Blair & Co. LLC

Okay. And then with the small order delivery rolling out to half of the base this quarter, are there any incremental startup costs associated with that? Or, and in tests, did you believe that was incremental to the sales you're seeing already? Or can you give us some perspective on that?

Sunil M. Doshi - Zoe's Kitchen, Inc.

Yeah. First, from the test standpoint, the 30 stores, I think we felt strong enough in the results that they were positive and that there was incrementality there to expand from 30 and really work to where we could identify a larger set of stores. So that, we've been hard at work there, working on that. That's for the most part working with third parties as opposed to initiating our own catering, or I'm sorry, our own delivery with our own folks. That'll take a little bit more time for us to work through and to work through that model.

With respect to using our own folks, we are going to expand our usage, kind of the hybrid model that we talked about before with respect to catering where the dollar volume that we're doing from a catering perspective is more conducive to exploring increasing the amount of internal labor that we're using there. But no, no significant capital outlay or cost outlay on expanding from the 30 stores to the 100 stores.

Sharon Zackfia - William Blair & Co. LLC

And just to be clear, in your comp outlook, are you assuming any kind of benefit from small order delivery in that?

Sunil M. Doshi - Zoe's Kitchen, Inc.

No. We're trying to do our best right now just looking at the trend of where we're at in terms of providing some of the specifics around the first quarter. And then as we move through the year, we do have, through kind of the combination of lapping over easier comparisons as well as holistically the revenue growth drivers that we're looking at from online, catering to delivery, to new menu items, all of those things, collectively, as being growth drivers for the comp as we move throughout the year.

Sharon Zackfia - William Blair & Co. LLC

Okay. Thank you.

Operator

Thank you. Our next question today is coming from John Zolidis from Buckingham Research. Please proceed with your question.

John Zolidis - The Buckingham Research Group, Inc.

Hi. Good afternoon.

Kevin Miles - Zoe's Kitchen, Inc.

Hi, John.

John Zolidis - The Buckingham Research Group, Inc.

I want to think back to a year ago when comps were close to 8% and margins were expanding, do you think the company has done anything differently between that performance and what we're experiencing right now?

Kevin Miles - Zoe's Kitchen, Inc.

I think we've grown, continue to grow. No. I mean, from an operational standpoint, John, no, we did roll a little bit of food in price a year ago. So that was in there. We haven't done that yet. We will – again, back to innovation, we will continue that development. But not really. I mean, online was back then. I mean, if anything, we'll have more robust online. We'll have online catering. So our work that has been done in the last year is really this deep infrastructure work in order to launch us into the back half of the year. So nothing from an operational standpoint and kind of, if that's what you're referencing. We haven't changed our model or how we operate or any of our food specs or quality. We're still getting great feedback from our consumers from that standpoint. I guess, the one key initiative is no new food in February really this year and no price in February of this year.

Sunil M. Doshi - Zoe's Kitchen, Inc.

And then on the margins, John, maybe just to add in, as we look back, there was significant cost of goods favorability on a year-on-year basis. So if you look at any of the quarters from 2015 compared to 2014, some significant tailwinds there from a cost of goods standpoint that was helping to expand the margins.

John Zolidis - The Buckingham Research Group, Inc.

Just continuing on that theme, when you look at the customer feedback around the restaurant experience, the food, anything that you can point to that would explain the sequential deceleration in the trend over the course of the year that might be something that is fixable or that you can pivot around?

Kevin Miles - Zoe's Kitchen, Inc.

Yeah, nothing, John, that is pointing to directly into Zoe's, per se. I think we're not seeing any consumer demand or lack of demand because we've done something different or there's like an easy fix, anything like that. I think, it's more of a macro. I think back to the convenience side, we absolutely believe that the consumer is seeking convenience. And in some cases, that convenience is outweighing quality, potentially, meaning you might be willing to take a lesser quality product that's conveniently delivered to your home or to your office that today we're not playing in that arena. And that's again back to our infrastructure work. We know we need to be there. That demand has rapidly increased as everyone knows, and it's something that we know are highly focused on and will continue to focus on. That would probably be the one thing that we hear quite a bit. I wish you could deliver it to my office, or I wish you could deliver it to my home, and back half of the year, we'll be able to do that.

John Zolidis - The Buckingham Research Group, Inc.

Great. That sounds like a great initiative. Thanks a lot.

Kevin Miles - Zoe's Kitchen, Inc.

Thanks.

Operator

Thank you. Our next question today is coming from Steve Anderson from Maxim Group. Please proceed with your question.

Stephen Anderson - Maxim Group LLC

Yes. Thank you. Talking about on margin once again, I know in past calls you've talked about some of the initiatives in back of the house. You've done KDS and you've been, actually, talking about batch cooking, can you inform us about some progress on that initiative?

Kevin Miles - Zoe's Kitchen, Inc.

Yeah. So KDS, as we mentioned in the prepared remarks, will start to roll now that our infrastructure work is done. That will be the initiative that will get us kind of – hopefully, by the end of the year we'll have all our locations rolled out with that. That will be there. We have looked at batch cooking in the prep enhancements, and one of the things that we've found with Antonio's work is the prep enhancements and the batch cooking with our ovens is working well and allowing us to expand and produce larger catering orders, multiple catering orders, which we're prepared for with our online catering going live kind of in the summer here as well. So all that's working.

We are being selective of how we roll those ovens out and how we go back in, so those ovens have gone into many of the higher volume locations and in many of our new locations, we're opening with those ovens at this point in time. But the prep enhancements will also be a big part of that initiative that's going in. So all that should be live in most of our locations throughout this year.

Stephen Anderson - Maxim Group LLC

Okay. Great. Thank you.

Operator

Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

Kevin Miles - Zoe's Kitchen, Inc.

Thank you, operator. Again, I'd like to thank everyone for joining the call and your continued interest in Zoe's Kitchen. We welcome you to join us at one of our restaurants soon to understand the benefits of Mediterranean lifestyle and living Zoe's. Thanks, everyone.

Operator

Thank you. That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.

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