The second quarter was an important litmus test for restaurant operators with a footprint in California, as it marked the first reporting period following the state’s implementation of AB 1228 on April 1. The law raised the minimum wage at quick-service restaurants to $20 an hour, or by 25%.

The legislation initially raised some hell in the industry, to put things lightly. Some companies blamed the hike for layoffs, others for closures. Some operators vowed not to include California in their expansion plans. For public companies, however, the reaction has been a bit more measured. In summary, it’s full speed ahead in California, a state that is experiencing population growth for the first time in three years. But, it’s full speed ahead with significant price increases to offset the labor inflation, and those price increases have impacted traffic at many, if not most, concepts. According to Revenue Management Solutions, traffic in California has declined by 5.9% since January versus the U.S. average of negative 3.6%.

California restaurants have lost traffic since the minimum wage increase

RMS’ data finds that menu prices in California have risen over four percentage points more than the U.S. average since January, or 7.5% compared to 3.1%. Domino’s, Shake Shack, and Chipotle are three such companies that took high-single-digital pricing increases in the state following the implementation of AB 1228.

Labor optimization

In addition to taking pricing, several chains are sharpening their focus on “labor optimization” to offset wage inflation. California-based The Habit Burger Grill is one of them.

“… A comprehensive store level labor optimization effort … contributed to an impressive 520 basis point expansion of restaurant level margins from the first quarter, despite a double-digit increase in restaurant level labor rates in California stores,” David Gibbs, CEO of parent company Yum Brands, said during his company’s earnings call earlier this month.

El Pollo Loco, which has a massive footprint in California, is exploring “labor productivity initiatives,” like deployment and scheduling, in addition to increased menu prices. CFO Ira Fils said traffic in California was “a little more” down compared to other markets, but overall, “we didn’t see a whole lot of difference between the markets.”

Sweetgreen is also making improvements to its labor optimization, according to CFO Mitch Reback, while Portillo’s is testing kiosks in the California market.

QSRs hit

Of course, QSRs have beared the brunt of this inflation and executives acknowledged as much during their respective Q2 calls. McDonald’s chief financial officer Ian Borden simply called wage pressures in California “a headwind we’re working through,” adding that margins could be “down a little bit” from 2023 accordingly, but still good considering the “overall context of what we’re working through.” McDonald’s experienced its first negative same-store sales quarter since 2020.

As for Wendy’s, CEO Kirk Tanner called California “unfortunate from a wage and labor standpoint,” adding that the company is focused on “driving more productivity.”

“If you look at where consumers are, our focus is on winning and competing well in this environment. And we’re doing that with that strategy, including places like California. It goes to delivering our core, having compelling innovation and having relevant value,” Tanner said. Wendy’s sales were essentially flat in Q2.

Jack in the Box felt a swift impact, with labor costs up 200 basis points from the prior year, while franchise-level margin was $74.6 million, compared to $75.3 million a year ago. CEO Darin Harris said the chain will “regain” its margin through improved sales, and “ongoing equipment, technology, and financial fundamentals initiatives.” The chain has adopted a new oil management process, for instance, and is in the process of testing a fryer automation system, while its sister chain, Del Taco, is testing kiosks. Jack in the Box also worked with its franchisees to take a “surgical approach” to pricing. Despite the early hit on margins and sales, executives remain optimistic about California.

“California fared substantially better than we thought,” CEO Darin Harris said.

“This was the first full quarter of operating under the increased minimum wage law and we are proud of how our teams executed through this change,” CFO Brian Scott said. “[For] Jack in the Box company-owned restaurants, which are predominantly in California, same-store sales performance was better than all but one market. Del Taco had a similar result, with California being one of their top markets in the quarter.”

Full-service insulated?

Despite the law only applying to QSRs, full-service wasn’t completely insulated. Consider Kura Sushi as an example here. The company’s second quarter performance fell well short of expectations, with chief executive officer Hajime Jimmy Uba citing AB 1228 as a main culprit given that comparable same-store sales decelerated in California in April.

“What we have seen … is a general perception that restaurants as a category have become expensive, introducing industry-wide pressures regardless of a given restaurant’s relative value,” he said.

Still, many full-service concepts have experienced no change at all, or even a small tailwind from the QSR-focused legislation. For example, Texas Roadhouse’s handful of California stores are doing “fine,” according to executives.

BJ’s Restaurants, which is headquartered in Huntington Beach, Calif., also hasn’t seen changing trends from its consumers, perhaps because gas prices have come down, according to chief financial officer Tom Houdek. BJ’s executives made it a point to also note that labor levels haven’t been impacted by higher wages at QSRs and that the company is “in a better place” than in 2019 with staffing. That said, Houdek called the statewide pricing increases a “sticker shock” for consumers.

Denny’s has leaned into a silver lining from California’s wage increases, expanding its virtual Banda Burrito brand to over 300 restaurants with a priority on the state to add the revenue channel. CEO Kelli Valade said traffic outperformed QSRs during the quarter because of lower menu prices relative to QSRs, as well as the expansion of Banda Burrito. Notably, Denny’s is also targeting California as one of its growth markets for its Keke’s brand.

“We have not experienced a material increase in team wages at our 22 California company restaurants as a result of AB 1228. We believe this is in part due to our servers earning well above the AB 1228 minimum wage when factoring in tip income,” CFO Robert Verostek said, adding, “The [market share] gap we were experiencing to overall QSR, we’ve cut in half in California specifically.”

Cheesecake Factory is also seeing consistency across its geographies with no added pressure from California. CEO David Overton said the legislation mostly impacts QSRs, “which is positive for us.”

Notably, full-service brands aren’t the only ones with optimism. Wingstop had a meteoric second quarter relative to the rest of the industry, AB 1228 be damned. Wingstop did not experience transaction changes after implementing pricing increases to offset wage increases at its 400-ish California locations.

“In fact, the trends in California are following a very similar trend to what we see outside of California for our business,” CFO Alex Kaleida said.

Further, Dutch Bros experienced a 60-basis-point year-over-year increase in labor costs primarily driven by the wage increase in California, where about 20% of its system is located. The company took a 1.5% pricing increase to help offset the pressure but has otherwise been focused on business as usual.

“We had two of our top first week performers in California in the first half of this year,” CEO Christine Barone said. “We continue to be very bullish on our prospects in California and continue to look for sites and opening shops in California.”

Contact Alicia Kelso at [email protected]