Texas Roadhouse’s top-line sales and traffic remain enviable by industry standards. But there’s no question the labor war, especially at the hourly level, is taking its toll. The mounting issue showed up in force during the first quarter of fiscal 2019, announced Monday afternoon.

Texas Roadhouse’s stock dropped 8 percent in after-hours trading following the report. Fundamentally, the picture appeared rosy: Texas Roadhouse’s same-store sales jumped 5.2 percent at company-run stores, including 2.6 percent traffic growth, and 4.3 percent at franchised units (468 locations are corporate). The other 2.6 percent came from an increase in average check. Texas Roadhouse took an additional 1.5 percent, on average, in pricing at the beginning of the quarter, to build off last year’s 1.7 percent figure.

The bottom line was more troubling. Net income declined 8 percent to $50.4 million, which produced earnings of 70 cents per share—well below Wall Street’s call for 83 cents. Revenue upped 10 percent to $690.6 million.

The biggest concern, however, came from the slide in 561-unit Texas Roadhouse’s restaurant margin. Figures dropped more than a percentage point and a quarter to 17.9 percent. Operating income lowered 7 percent as a result. And the biggest worry: labor cost inflation was responsible for nearly the entire hit.

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Texas Roadhouse president Scott Colosi wanted to make one thing clear during Monday’s conference call: the chain’s managing partners are paid off the bottom line (they have stakes in each restaurant). “They have a vested interest in effectively managing their labor spending to protect sales over the long-term, even if it results in some short-term pain,” he said.

Colosi said people should bet on Texas Roadhouse’s track record.

“We feel good about weathering any storm by remaining committed to and focused on the fundamentals that have got us to where we are today,” he said.

The chain expects labor cost hikes in the 7–8 percent range for the remainder of the year.

Fight the hourly battle

Texas Roadhouse’s margin decrease of 128 basis points came from increases in cost of sales and labor. The first lifted 7 basis points compared to the prior-year period and the benefit of a higher check average was more than offset by the impact of about 1.8 percent commodity inflation and the shift to higher priced, but lower-gross margin menu items.

The labor issue was larger. Labor as a percentage of total sales hiked 118 basis points to 32.7 percent, and labor dollars per store week rose 8.2 percent compared to the prior-year period. That came from wage and inflation of about 5.2 percent and growth in hours of roughly 3.1 percent.

The growth in labor hours was greater than the growth in traffic during Q1.

Let’s zero in on the turnover issue. Colosi said Texas Roadhouse is in the “high 120s” right now. But here’s the question: Could it be worse?

Colosi said Texas Roadhouse constantly talks about culture, treating employees right, and paying market-level rates in the front and back of house. “We’re talking about hire right,” he said.

That’s a challenge, Colosi added, because of the massive volumes in Texas Roadhouse’s restaurants. Over the last decade, Texas Roadhouse has moved from about $3.6 million per restaurant to $5.2 million on average. And it’s tracking toward $6 million.

While that’s great for the balance sheet, it creates an interesting dilemma for staffing. “You throw on top of that the Amazons of the world or anybody else, offering very high hourly wage rates or high from a historical perspective,” Colosi said. “And there’s a lot of even non-restaurant competition out there just fighting for good folks.”

“So we don’t know if our turnover would’ve been 140 percent if we weren’t doing some of these things with staffing to enable us to have more scheduling flexibility,” he added. “Talking to our folks more about what they need to do a better job. All those kinds of things.”

What Colosi is saying is a realistic take from the trenches of the restaurant industry. Even a top-notch organization, one that pays attention to benefits and quality of life, is going to be saddled by triple-digit turnover rates at the hourly level. It’s an accomplishment to stay closer to 100 than 200 percent.

“We think that really bodes well for the strength of operational execution day-to-day of Texas Roadhouse because that management’s so key, and as busy as we are, you got to have a lot of managers and because you’ve got to have them in front, you’ve got to have them in the back to make everybody happy, make everybody feel good,” president Scott Colosi on manager turnover.

Texas Roadhouse has grown hours faster in the back of the house than the front. That’s where the jobs are, which makes for a whole different set of challenges. “They are hard [jobs],” Colosi said. “I mean, we’re making all that food from scratch, we still do that. And there’s a lot of it, and it’s really tough. So it’s really competitive.”

He said managing partners tell Texas Roadhouse constantly they have to pay more per hour for back-of-the-house positions than they ever thought they would. “Because the front of house is more minimum wage-based because you got tips on top of that,” Colosi said. “Back of house is probably more market-based and has more pressure.”

In the 5.2 percent wage and inflation figure, 3.5 percent comes from wage increases and 1.6 percent from other labor items, like payroll taxes and group health insurance. But of that 3.5 percent, just 1–1.5 percent is coming from front-of-house employees—tipped and non-tipped, CFO Tonya Robinson said.

Colosi added that Texas Roadhouse made strides on the management side. It was high-teens turnover a few years ago and is now in the low-teens.

“We think that really bodes well for the strength of operational execution day-to-day of Texas Roadhouse because that management’s so key, and as busy as we are, you got to have a lot of managers and because you’ve got to have them in front, you’ve got to have them in the back to make everybody happy, make everybody feel good,” he said.

Texas Roadhouse also grapples daily with a labor byproduct of its own success. Over the last three or so years, the chain witnessed an increase in labor hours around the 3 percent range. Basically, as restaurants generate higher AUVs, the average employees per restaurant also rise significantly. The result is a multiplicative impact of more employees per restaurant times a higher turnover number. “Which can lead you to more growth in hours just to rehire the people you’re losing in all the training and orientation—all that stuff that you have to do in addition to any staffing initiatives,” Colosi said.

It’s been a store-by-store issue. Some restaurants, he added, tacked on hours when they needed to—when they were understaffed. Other pushed too far.

“We talk about staffing for your next $10,00 a week in sales, but we don’t necessarily need to be staffed for our next $20,000 a week in sales,” he said. “So we just want to make sure we’ve got a good balance and we’re disciplined, and we believed in the vast majority of our restaurants that’s the case.”

It all leads to a critical point: Will Texas Roadhouse need to cost cut elsewhere, other than just raising prices, to offset the rising labor costs?

That’s something difficult to predict right now, but the price bump should guard top-line sales throughout the calendar. Texas Roadhouse opened six restaurants (four corporate) in the quarter and plans to debut 25–30 in 2019, which would push revenue up. Colosi said the labor inflation with have no impact on unit growth moving forward.

“We’re very confident we can continue to develop restaurants, no doubt,” he said. “Texas Roadhouse, in particular already being at 550. I mean, there’s only so much farther we’re going to go. Historically, we’ve said 700 to 800. Is it 700? Is it 800? Don’t know for sure, but we don’t see any reason to slow down, even with the tough labor market.”

The six company-run stores that have opened this year, Colosi said, averaged $148,000 in their first week. He said the company is “pretty jacked” about those results and it shows how strong the brand is, even in small towns, and 27 years after its founding.

On the pricing note, Colosi said, Texas Roadhouse likely won’t take another uptick until the end of year. The 1.5 percent average wasn’t uniform throughout the system, either. Some stores in higher-wage states took as much as 2.5 percent while others were less. That even changed by menu items. “Not everybody moves in sync,” Colosi said, “depending on what’s going on in the world, especially with minimum wage in different states.”