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Edited Transcript of HABT earnings conference call or presentation 30-Oct-19 8:30pm GMT

Q3 2019 Habit Restaurants Inc Earnings Call

Irvine Nov 17, 2019 (Thomson StreetEvents) -- Edited Transcript of Habit Restaurants Inc earnings conference call or presentation Wednesday, October 30, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ira M. Fils

The Habit Restaurants, Inc. - CFO, Secretary & Director

* Iwona Alter

The Habit Restaurants, Inc. - Chief Brand Officer

* Russell W. Bendel

The Habit Restaurants, Inc. - CEO, President & Chairman

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Conference Call Participants

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* Andrew D. North

Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst

* Brian M. Vaccaro

Raymond James & Associates, Inc., Research Division - VP

* Brian P. Vieten

Cowen and Company, LLC, Research Division - Associate

* Nerses Setyan

Wedbush Securities Inc., Research Division - Senior VP of Equity Research & Senior Equity Analyst

* Nicole Miller Regan

Piper Jaffray Companies, Research Division - MD & Senior Research Analyst

* Stephen Anderson

Maxim Group LLC, Research Division - Senior VP & Senior Equity Research Analyst

* William Everett Slabaugh

Stephens Inc., Research Division - MD

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Habit Restaurants Third Quarter 2019 Earnings Conference Call. Please note that this conference is being recorded today, October 30, 2019.

On the call today we have Russ Bendel, President and Chief Executive Officer; and Ira Fils, Chief Financial Officer. Iwona Alter, Chief Brand Officer, will also be joining Russ and Ira for the Q&A portion of the call. By now, everyone should have access to the company's third quarter 2019 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 a guarantee 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 different materially from what the company expects. The company refers you to the recent SEC filings for a more detailed discussion of the risks that could impact their 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 the company's performance. The presentation of this additional information should not be considered in isolation or as substitute for the results prepared in accordance with GAAP and reconciliations to compare GAAP measures are available in the company's earnings release.

With that, I would like to turn the conference over to Russ Bendel. Please go ahead.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [2]

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Thank you. And good afternoon, everyone. As usual, I'll start the call with a brief overview of the third quarter, update you on our progress of becoming a total access brand and share some thoughts about the balance of 2019. Ira will then review our third quarter financial results in more detail as well as review our 2019 guidance before we open the call for your questions.

With that out of the way, let's dive into our third quarter results. Total revenue increased 12.1% year-over-year. And our company-operated comparable restaurant sales increased 3.1% in the third quarter, which is our sixth consecutive quarter of comp store sales growth. As a reminder, we were rolling over a 3.6% increase in last year's third quarter, our best comp quarter of 2018. Adjusted EBITDA increased 9.9% to $10.6 million. And adjusted fully distributed pro forma net income was $1.6 million or $0.06 per share compared to an adjusted fully distributed pro forma net income of $1.4 million or $0.05 last year. We continued to make progress on our mission to be a total access brand to our customers in this ever-changing consumer environment.

Our off-premise business continued to grow during the quarter, allowing our guests to enjoy Habit's great food without leaving the comfort of their home or office. As a reminder, we currently have DoorDash and Postmates as partners. We are currently in tests with Uber Eats and expect to roll them system-wide by the end of the year. We believe that adding a third partner will allow us to continue to grow our delivery business by reaching customers that are currently not being served by the other 2 providers. We are very pleased with the trajectory of the delivery channel, and it has quickly grown to be a meaningful part of our business.

In addition to delivery, our sales through our current online ordering platform and mobile channels continue to experience significant growth, with same-store sales through this channel up 25.8% during the third quarter. We executed a system-wide soft rollout of our new mobile app in mid-July, making it even easier for customers to order ahead and skip the line in-store.

With little marketing support, we have quickly seen over 100,000 guests download our app. We plan on putting marketing support behind the mobile app in Q4 of this year. Speaking of the in-store experience, we now have self-order kiosks installed in 20 of our restaurants, allowing customers a different and faster way to order in-store. On average, we're finding that over 8% of our sales are coming through the kiosks at these locations.

For both app and kiosk orders, we're also experiencing a higher check outreach, as both of these ordering platforms feature our menu in a way encouraging the guests to add or to upgrade their orders. Going forward, all new stores and all remodels will have self-order kiosks in the store.

And lastly, with regard to convenience, we opened 4 drive-thru locations during the quarter, bringing our overall total to 51 at the end of the third quarter, which is about 20% of our store base. Drive-thrus will continue to account for at least half of our development schedule going forward as well.

During the quarter, we continued to flex our culinary muscles by first returning with our summer favorite, Fresh Berry and Toasted Almond Salad, featuring chargrilled chicken. We followed that with our French Onion Char limited-time offer. It takes our classic flame-grilled Charburger to a new level by being topped with roasted French onion sauce and 2 golden brown onion rings.

More recently, we launched a pumpkin shake, which will be on the menu through early December; as well as our Santa Barbara Char, which is going back to our California roots and features a Double Char with cheese, fresh avocado, on our signature grilled sourdough bread.

Moving on to marketing. We beefed up our marketing team with the addition of a new vice president of digital marketing and a new partnership with the ad agency, INNOCEAN USA. During our last promotional window, we targeted selected markets with our digital first marketing campaign promoting the French Onion Char. And our next campaign will support the Santa Barbara Char promotion. We're very pleased with the results so far, especially considering the fact that we're lapping our radio campaign in the third quarter of last year.

In addition to the Santa Barbara Char campaign, as I said previously, we will promote our mobile app on a nationwide basis. In the fourth quarter, we will focus initially on customers who are familiar with The Habit and promote the app by announcing the app to our CharClub members. The promotion will also include some in-store merchandizing, including point-of-purchase materials.

Additionally, we're looking at different incentives to encourage our guests to download the app. We believe that the mobile app will be a great addition to our growing online ordering sales channel. As we said previously, we've seen a large number of app downloads and usage in the third quarter and expect even better results in Q4, when we are actually promoting this option. We are excited about the ability to communicate directly with our customers.

Finally, in the third quarter, we had our No Kid Hungry campaign and raised over $340,000 for them this year, which is expected to feed 3.4 million hungry children. We are proud to have supported this worthwhile charity for the last 5 years. And we are grateful that our guests and team members contributed to this incredible cause.

Switching now to development. During the third quarter, we opened 6 new company-operated restaurants, including 4 drive-thru locations. One of the 4 drive-thrus was our first drive-thru location in North Carolina. For the full year 2019, we expect to open approximately 21 new restaurants. Our franchisees did not open any locations in the quarter, and we now expect them to open a total of 6 restaurants in 2019.

While 2019 franchise development will end up below our initial expectations, we are setting up for a more robust franchise development for next year, with franchisees expecting to open 12 to 15 locations in 2020. Next year's franchised and licensed development, driven by international activity, will be more than double our 2019 openings. In total, we expect to open 29 to 35 locations in 2020, including 17 to 20 on the company-operated side. Again, 50% of the company-operated stores will be drive-thrus and approximately 25% to 30% on the East Coast.

With that, I'd like to turn the call over to Ira to discuss our financial results in more detail.

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [3]

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Thanks, Russ. Now turning to the results of our 13-week third quarter ended September 24, 2019. Total revenue increased 12.1% to $117.3 million for the third quarter of 2019, compared to $104.6 million in the comparable quarter last year. The 6 new company-operated restaurants opened in the quarter were open for a combined 65 sales weeks. And the 3 company-operated restaurants that we closed in the quarter were open for a combined 23 sales weeks. Our other 231 company-operated locations were open for a combined 3,003 weeks in the quarter. In total, the 237 company-operated locations opened at the end of the quarter were open 3,091 weeks in the quarter. As Russ mentioned, our sales trends during the quarter were strong as comparable company-operated restaurant sales increased 3.1%.

We are also very pleased with our comp sales trajectory as the individual monthly comps improved sequentially as we moved through the quarter, with September benefitting from our digital marketing campaign supporting the French Onion Char.

In breaking down the comp store sales increase -- traffic decreased 2.7%, offset by a 5.8% increase in the average transaction amount. During the quarter, we were carrying cumulative pricing of approximately 5.3%, which was the price increase we took in May to combat increased wage pressure in our California markets.

Even with the recent price increase we have taken, we strongly believe that we still have pricing power. However, we do not plan to take any more price increases through the remainder of 2019.

Now turning to expenses. As a percentage of company revenue, food and paper costs were 30.1%, an increase of 30 basis points compared to last year. The increase was due to higher products cost during the quarter as well as pressure in beef. Labor-related expenses as a percentage of company revenue were 30%, a 70-basis point decrease from the third quarter 2018. The decrease was driven by lower payroll-related costs of about 50 basis points and lower direct labor costs of about 20 basis points.

For the third quarter, our average hourly rate increased approximately 5%. The increase in average wage was offset by price increases and improved labor productivity. The tight labor market, combined with government-mandated wage increases for hourly employees, continues to put upward pressure on our labor costs.

Occupancy and other related expenses as a percentage of company revenue increased approximately 130 basis points to 20%. About 70 basis points of this increase was due to higher third-party delivery costs, with another 35 basis points related to higher advertising expense. We also experienced higher rent expense of about 30 basis points resulting from the lease accounting standard ASC 842, which we adopted at the beginning of 2019.

Our general and administrative expenses increased approximately $619,000 to $10.5 million during the third quarter. As a percentage of total revenue, G&A expense decreased 50 basis points to 8.9%, as we were able to leverage our 12.1% sales increase.

Preopening costs were approximately $465,000 in the third quarter of 2019, compared to $658,000 in the prior year quarter. As Russ mentioned, we opened 6 company-operated restaurants in the third quarter of 2019 compared to 8 openings in the third quarter of 2018. We continue to expect preopening costs to range between $100,000 and $105,000 per restaurant for 2019.

Net income for the third quarter of 2019 was $1 million or $0.05 per diluted share compared to a net loss of $0.6 million or $0.03 per diluted share in the prior year. On an adjusted fully distributed pro forma basis, net income for the third quarter was $1.6 million or $0.06 per diluted fully distributed weighted average share compared to net income of $1.4 million or $0.05 per share in the third quarter of 2018.

In terms of our liquidity and balance sheet. As of September 24, 2019, we had cash and cash equivalents of approximately $37 million and no debt. We expect capital expenditures to range between $33 million and $35 million before landlord contributions for the fiscal year 2019. Based on our growth plans, we believe cash flow from operations and current cash on hand will be sufficient to fund our capital needs for the next couple years.

With regards to fiscal 2019, we are updating our full year guidance as follows. We now expect revenue to be between $463 million and $465 million. And we expect comparable restaurant growth of approximately 3% to 3.5% for the full year of 2019. We now expect our restaurant contribution margin to be between 16.5% and 16.8%, a slight increase from our prior guidance of 16.25% and 16.75%. We expect commodity inflation of approximately 3.5% for the full year. And we also continue to expect our average wage rate increase will be approximately 5% for the year.

General and administrative expenses are now expected to be between $43.5 million and $44 million, which is down from our prior guidance of $44 million to $45 million. And as Russ mentioned earlier, we remain on track to open 21 company-operated locations and 6 franchise locations for the year.

We continue to expect our depreciation and amortization expense to be approximately $28.5 million for the year. And we expect interest income to be approximately $250,000 in 2019 as opposed to $1 million in expense we saw in 2018. The difference reflects the change in lease accounting which previously resulted in $1.1 million of interest expense related to financing in 2019, which is now recorded in occupancy for 2019.

With regard to taxes. We expect our pro forma tax rate to be between 28.5% and 29%. And finally, I would like to remind everyone that 2019 will contain 53 weeks, with the extra week in Q4 of 2019.

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

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [4]

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Thanks, Ira. Next month, The Habit Burger Grill will be celebrating its 50th anniversary: 50 years of providing great food with great service, and now with the added bonus of convenience. We are celebrating it not only with different marketing initiatives and promotions but also by supporting our communities of guests and our employees, with $50,000 in scholarships. I'm really proud of the company we are today, and even more excited about where we're going.

With that, operator, we'd like to turn the call over for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Nicole Miller with Piper Jaffray.

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Nicole Miller Regan, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [2]

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I needed a clarification. I couldn't write as quick as I needed to, so I apologize. But what was digital as a percent of sales, and how much was it up? And then, the fundamental question behind that is how much of that could be direct on your platforms to the consumer? And how much do you think that will be out into the marketplace?

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [3]

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So we didn't give the actual digital percentage of sales as far as mix goes. The number that we did talk about was just sales through our online platform, including our new mobile app, grew year-over-year a little over 25%.

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Nicole Miller Regan, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [4]

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Is there a digital number you're ready to reference?

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [5]

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Not yet. We feel pretty good about where we're heading from a digital standpoint. It's been growing dramatically as we've kind of gone through this digital transformation. But we're just not ready to reference what that total number is.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [6]

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I mean, if we were to reference a number and the growth, Nicole, it would be pretty staggering percentages. And with all the initiatives that we've been working on for more than the last year, we're in a really good place with them and feel very confident that the growth of these channels -- whether it be third-party delivery, which we haven't disclosed what percentage of sales that is -- and with now the app and the enhancements we're making to our own online platform, along with a call center and self-order kiosk -- I mean, this is going to be a significant part of our business going forward, where the orders are going to come into the restaurant without interacting necessarily with an employee.

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Nicole Miller Regan, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [7]

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And then, just a second and final question. I want to come back and revisit unit level economics for a couple of reasons. First, if I recall, you have kind of this 3-year maturation process that gets you to a very, very healthy 40% cash and cash return. And I just want to see if you're seeing anything different structurally in today's restaurant landscape to change that. And then, if you could also dig a little deeper into the idea of -- 50% of new stores now will be drive-thru. And I imagine that just pushes those numbers higher and higher and/or faster to maturation, offset by the question mark of how is the East Coast progressing? Is that still a little bit of a drag, or maybe not, as you backfill that channel?

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [8]

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Yes. That's a great question. So just to clarify -- so our target has been 30% cash on cash returns historically, you're absolutely right. And we, a few years ago, did see that 40% number. But over the last couple years, as comps have been flat or a little lower, and we have seen cost pressures, that 30% target really is our target as we think about what we're expecting from our new restaurants.

Now in regard to your question about drive-thrus. As drive-thrus have settled in for us, they're right around the same cash on cash return as the traditional units. We do invest a little more money, we do get a little higher sales from it. But the net cash on cash returns are coming in similar to the traditional restaurants.

And just in regard to your final question, regard to the East. We are pleased about the trajectory that those restaurants are on, obviously, excluding Orlando. But the East in general is -- we're seeing same-store sales growth higher than we're seeing out in the West.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [9]

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But they don't perform at the same level the West does.

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [10]

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So that 30% number is a blended number that obviously has the West higher than that 30% and the East below that.

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Operator [11]

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The next question is from Will Slabaugh with Stephens.

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William Everett Slabaugh, Stephens Inc., Research Division - MD [12]

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I had a follow-up on the drive-thrus. Are you seeing a meaningful percentage of those customers order ahead digitally and then come through the drive-thru? Or is this a fairly standard drive-thru customer early on? And then, kind of curious on that opportunity over time, not dissimilar to what some other fast casuals have done with their drive-thrus?

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [13]

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Yes. We're seeing a more traditional (inaudible) about 45% of our guests, which is lower, I think, than traditional QSR. But we're seeing about 45% of our guests order through the drive-thru. And we're seeing it's about half the rate you typically see in a traditional store. You see people ordering ahead mobilely, digitally; and then going inside the restaurant to pick it up. Today we are not set up where you would order ahead and then pick up through the drive-thru. If you do order ahead, you go inside and pick it up.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [14]

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But we're looking at those opportunities as we look at this ever-changing consumer environment. But as Ira said, Will, today they are formatted in the traditional drive-thru kind of scenario.

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William Everett Slabaugh, Stephens Inc., Research Division - MD [15]

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And I did want to revisit the Orlando closures. And I guess the initial questions of why now, and then what were the bigger learnings that you can gather from what happened there? And then, I guess secondarily, do you have any other stores out there that you would say have at least some of the same worries that you had in Orlando?

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [16]

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So I think the reason why now -- as we think about the East Coast, and we talk about just in general, we slowed our growth down. Before, really last year was the first year we slowed it down. And we were slowing it this year and then a little bit next year. And with the amount of stores that we're going to open, in the markets that we have in the East, we would prefer to penetrate other markets where we're doing better. And we just weren't going to deploy with additional capital in Orlando. And at the rate that they were, and with the understanding, part of how we grow brand awareness in new markets is through building new restaurants. We were going to leave those stores kind of on an island by themselves for a little while. And based on their amount of losses, it just didn't make sense for us to keep operating them. We were better off closing those down and then really focusing our capital in other markets in the east.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [17]

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And we have stores, obviously, that perform at different levels all across the country. But we don't have a list of stores that we're planning on doing anything with at this point in time.

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [18]

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Those 3 stores in particular were significantly below the average of the rest of the system. And the rest of the East.

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Operator [19]

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The next question is from Andrew Charles with Cowen.

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Brian P. Vieten, Cowen and Company, LLC, Research Division - Associate [20]

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It's actually Brian Vieten on for Andrew. So just 2 from me. First, how are you guys thinking about plant-based proteins? I saw you guys tested them in the past. I'm just wondering what would prompt you to add them on maybe a more permanent basis.

And then, secondly, just on the franchising front, looks like you guys had a couple good deals lately. Could you guys provide some kind of split, whether it's domestic versus international, for next year or just kind of over the next couple years? Do you kind of see that being more of an international story or kind of an even split? Just a little detail around the cadence there would be great.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [21]

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Yes, I'll start out with the plant based. Yes, last year, we did a test of approximate -- it was 9 stores with the Impossible Burger. And we here feel that the Impossible Burger is the plant-based protein that most resembles the taste, texture, appearance of a beef Charburger. We were pleased with the results of that test. But when we spoke to the Impossible people, we learned it was impossible to secure supply chain for their early part, or really throughout this year, 2019.

We have a secured supply chain to again revalidate the test, since it's almost or about 1 year old now, and are going to do a test of about a half a dozen stores just to revalidate our learnings from the last time. And it is our plan. And we're trying to finalize with Impossible supply chain for a system-wide LTO for 2020. So we're encouraged by the plant-based products.

One thing that we did learn that it really didn't affect -- we have a great veggie burger we've had on the menu for a long time. And it really -- from the tests we did, it did not in any way hurt the sales of the veggie burger. So it appears to be a beef customer that's looking for an alternative product. And we think that it potentially represents incremental visits. So that's our thinking on the Impossible and plant-based products.

And franchising -- we have 2 current franchisees domestically that have been in the system pre our IPO 5 years ago. And they continue to open 2 to 3 restaurants each year. We also have currently 2 franchisees internationally -- China, which has opened 7 restaurants in less than the 2 years they've been a partner. It's hard to nail down what that split will be. But we continue to have a lot of interest internationally and are in various discussions with different groups in different countries. And based on how those discussions go, you could see that mix shift slightly to maybe more international growth, which we're pretty excited about.

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Operator [22]

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The next question is from Nick Setyan with Wedbush Securities.

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Nerses Setyan, Wedbush Securities Inc., Research Division - Senior VP of Equity Research & Senior Equity Analyst [23]

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Congrats on another very, very solid quarter. Just on the marketing -- I know this year, we saw a little bit of an uptick in terms of percentage of sales. Obviously, it seems to have had a pretty good result. How are we thinking about marketing going into 2020, whether we'll see another uptick or not?

And also, just kind of bigger picture, what are some learnings from the marketing evolution this year? What is that spend going to go towards in 2020? Maybe talk about the differences between existing markets versus -- or core market versus some of the newer markets? What are some brand attributes you guys are highlighting (inaudible) the quality? Any and all of that would be helpful.

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Iwona Alter, The Habit Restaurants, Inc. - Chief Brand Officer [24]

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So as Russ talked about, we did support our French Onion Char with digital marketing. It was very much mobile focused. So we did look at partners that feature the product as our guests are out and about. What we also infused in terms of the creative angles was not only to represent the product but also start conveying what the brand stands for as far as the quality [cues] and so on.

And what we have seen, first of all, a very positive response as far as a brand awareness direction. So as we looked at our metrics -- and this was in several markets, everywhere we did move the needle in terms of introducing the brand and explaining the brand. And as far as the response that we had seen in terms of the sales component and the popularity of the product, again positive. And I would say that our newer markets did react even more positively to the product news.

So all around, we do feel that the mobile and digital first direction is what worked. Right now, you probably are seeing some similar communication for the Santa Barbara Char. And we will continue refining it with INNOCEAN in terms of what that spend optimally is and which partners work best as far as driving the traffic into the restaurants.

One of the things that we do love about having the digitally forward marketing is that we can actually measure that traffic coming into our stores. So next year, you will see potentially more of the brand story being conveyed through that media and incremental changes to product promotion.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [25]

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Nick, that's a great question. And you know historically, our spend in the marketing area has been pretty low. We've made a commitment, when we brought Iwona onboard, to continue to invest in some very talented resources on the inside here and add to our infrastructure. We brought on INNOCEAN as a digital agency that we were very pleased with early on. And we're committed to incrementally spend a little more. And we'll be able to measure its effectiveness pretty quickly. We certainly believe that telling our story, especially in newer markets, really is a big opportunity for us and are very pleased with the early-stage results.

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Nerses Setyan, Wedbush Securities Inc., Research Division - Senior VP of Equity Research & Senior Equity Analyst [26]

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Have you guys seen the mix of burgers versus salads start to trend in the newer markets more in line with some of your core markets? Or is it still very heavily burger-centric?

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [27]

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New markets, as we've said before, really don't behave that much radically different than new stores in many places. Our new market -- a new store in a new market, when it opens, will typically sell -- 80% to 90% of the menu mix entrees will be burgers. In our more mature markets, the West primarily, that menu mix is about 60% burgers. And we see the same trends in the East, more in North Jersey and in South Florida, where we have a couple of years of operating history, where they've certainly come into that overall menu mix.

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Nerses Setyan, Wedbush Securities Inc., Research Division - Senior VP of Equity Research & Senior Equity Analyst [28]

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We've seen across the industry restaurants going back and renegotiating their third-party delivery fees to make them more favorable. Is there an opportunity for you guys to maybe approach some of your existing partners to see what the opportunities are?

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [29]

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Yes, I think there is an opportunity there.

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Nerses Setyan, Wedbush Securities Inc., Research Division - Senior VP of Equity Research & Senior Equity Analyst [30]

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And is there like a time frame or anything like that you can communicate?

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [31]

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No. It's not for us to talk on this call about the timing of that. But we like your thinking.

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [32]

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We think there's an opportunity. Because you are seeing that across the industry for sure. So yes, there's an opportunity.

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Nerses Setyan, Wedbush Securities Inc., Research Division - Senior VP of Equity Research & Senior Equity Analyst [33]

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And then, just last question. CapEx next year, is it going to be similar to this year? Or could it be down a little bit?

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [34]

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It'll be down a little bit. Because we'll probably end up a restaurant or 2 below this year. So we'll probably see it similar to down a nick.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [35]

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Down a tick, Nick.

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Operator [36]

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The next question is from Drew North with Baird.

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Andrew D. North, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [37]

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I just wanted to ask one on the labor line. You commented on benefits from labor productivity in Q3. Can you just provide some additional context on what you're doing specifically to drive those productivity gains, and how we should think about the sustainability of these productivity gains in Q4 and maybe even into 2020?

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [38]

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Yes. I think it's a little bit of what Russ talked about. We're getting a lot of sales digitally. And so when you're starting to bring in -- more of the revenue is being keyed in by not our cashiers but by the guests themselves, makes the labor a little more efficient. And hey, I think our ops team just does a great job using the tools that they have in the restaurant to manage labor efficiently.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [39]

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Our technology team internal has done an incredible job on a number of initiatives, whether they be consumer-facing or older tools that are really geared towards the management teams inside the restaurants. And we have great tools on how to deploy labor that are really very proprietary to each store, each market, based on the configuration, on how large the restaurant is, whether it has a drive-thru; with a lot of individual characteristics that give the men and women in the restaurants great tools to forecast their business and really deploy labor. And they're all geared around maximizing sales at the key times and focused on throughput, and then minimizing labor costs in those downtimes or slower times, and especially when there are no customers in the restaurant.

So big kudos to the technology team. And as Ira said, the men and women in the field have really embraced them over the years. And while labor is very challenging, especially in the West, we have a lot of confidence in our operators in doing smart things around scheduling labor.

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Operator [40]

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(Operator Instructions) The next question is from Stephen Anderson with Maxim Group.

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Stephen Anderson, Maxim Group LLC, Research Division - Senior VP & Senior Equity Research Analyst [41]

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I wanted to go onto the food cost line. Seems a little bit of deleverage on that line. Wanted to get a little deeper into the reasons why we (inaudible). I saw a little bit of an uptick in ground beef, and certainly avocadoes were in the mix. I just wanted to see if there's anything else we should add and anything that we should look out for going into Q4.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [42]

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Yes. As we called out in the call, there's certainly a little bit of pressure on beef. The avocado market has been very challenging, especially with the Mexico crop and what's gone on there. But earlier in the year, we had a lot of extreme heat in the West. And that put a lot of pressure on greens, lettuce, leafy products. And while those spikes are more short term, we certainly felt the pressure of that.

And a little more recently right now, there's a little bit of upward pressure on dairy. Again, not gigantic, but probably a little more pressure on food costs than we thought earlier in the year when we were doing our forecasts.

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Stephen Anderson, Maxim Group LLC, Research Division - Senior VP & Senior Equity Research Analyst [43]

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Any thought at all to what you would expect for '20 at this point?

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [44]

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It's still early. We haven't really given any guidance on that right now. You can expect to hear more from us on our next call around what our thinking is on supply chain, market basket, et cetera, et cetera. But nothing's jumping out at us right now that we're overly concerned about.

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Operator [45]

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The next question is from Brian Vaccaro with Raymond James.

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Brian M. Vaccaro, Raymond James & Associates, Inc., Research Division - VP [46]

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Just following up on that COGS question. Ira, the updated guidance -- so 4Q, we should be thinking about somewhere 2%, 2.5% on the basket year-on-year? Is that right?

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [47]

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No. I think you're going to be more in the 3%-plus range, 3% to 4%-ish range.

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Brian M. Vaccaro, Raymond James & Associates, Inc., Research Division - VP [48]

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And back to the drive-thrus, one question I want to ask. Can you remind us how the store margins of a drive-thru compare to a traditional unit? And is part of some of the labor favorability you're seeing related to the rising mix of drive-thrus?

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [49]

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No, it's not that.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [50]

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No, it's not that.

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [51]

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Actually, it takes a little more labor to operate a drive-thru of the same volume compared to a traditional restaurant.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [52]

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But we have expectations they do higher sales.

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [53]

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Correct. So typically, they will do higher sales to get enough margin to get the proper return.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [54]

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Yes.

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Brian M. Vaccaro, Raymond James & Associates, Inc., Research Division - VP [55]

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So that's what I would've thought. The sales are a lot higher, or they're higher in a drive-thru, but it's not enough to offset, from a margin perspective, on the labor side?

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [56]

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Yes, that's exactly right. But we've learned a lot. We opened our first drive-thru in 2011 and the next 3 years only opened one each year. It's really only been a 2.5-year, really, where we've penetrated with a lot of drive-thrus. And our development team has learned a lot, along with the operators, on how to make the drive-thru more efficient in a Habit kitchen. And we've taken some space out of it and engineered the layout to be much more efficient, not only through better technology, different equipment in some fashion; and then, especially more labor efficient.

So a drive-thru that we build today is much different in regards to the labor profile than a drive-thru we may've built in 2016. So we feel much better about the capital, the labor, et cetera, et cetera.

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Brian M. Vaccaro, Raymond James & Associates, Inc., Research Division - VP [57]

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And one other one on the drive-thrus that comes to mind. When thinking about efficiencies in throughput, how does the sort of optimized drive-thru of today compare from an average time through the drive-thru, compared to where we were? Are you seeing improvements in drive-thru speed, for instance?

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [58]

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Only as the kitchen gets slightly more efficient. Hey, we still -- we don't make anything till you order it. So our cook times are approximately 6 minutes. So really, the drive-thru experience is more about us having the appropriate queue of 5 to 6 cars. And if we're not able to have that queue, or the line is longer, which is a good problem, we will have Habit teammates take the order on digital pads. And we can start the cooking process, jumpstart that a little earlier, while you're in the queue line. But we still cook everything to order, and our customers appreciate that.

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Brian M. Vaccaro, Raymond James & Associates, Inc., Research Division - VP [59]

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Wanted to ask a quick follow-up on the delivery side. I know you don't typically share sales mix. But can you share what you saw in terms of year-on-year growth in that channel, and maybe how that compared to Q2?

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Ira M. Fils, The Habit Restaurants, Inc. - CFO, Secretary & Director [60]

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It was over 100%. So pretty significant growth in that channel. And that was similar to Q2. Yes.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [61]

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And that's why our marketing team, operating team and technology folks are currently implementing Uber with a direct technology connection to our KDS systems.

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Brian M. Vaccaro, Raymond James & Associates, Inc., Research Division - VP [62]

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And then, on capital allocation, with slowing growth, looks like you'll start generating $10 million, if not $15 million, of free cash flow. Curious how you're thinking about capital allocation, kind of balancing perhaps a need to build up some cash to reaccelerate company unit growth at some point down the road? Or perhaps thinking about [share repo] or some other use?

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [63]

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Yes. I mean, there are obviously board discussions that take place in those sessions. But they are all options that will be under consideration or have been under consideration for a while.

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Operator [64]

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This concludes the question-and-answer session. I'd now like to turn the conference back to Mr. Russ Bendel for any closing remarks.

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Russell W. Bendel, The Habit Restaurants, Inc. - CEO, President & Chairman [65]

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Hey, as always, I want to thank you for your time and your interest in The Habit. And we feel good about where we've been. And the initiatives and the focus that we've had over the last year on becoming much more convenient are certainly starting to pay results.

So thank you again for your time.

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Operator [66]

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This concludes today's conference call. You may now disconnect your lines. Thank you for participating.