Luby's, Inc. F4Q08 (Qtr End 8/27/08) Earning Call Transcript

| About: Luby's, Inc. (LUB)

Luby's, Inc. (NYSE:LUB)

F4Q08 Earnings Call

October 21, 2008 5:00 pm ET

Executives

Christopher Pappas – President, CEO

Scott Gray - CFO

Rick Black – Director of Investor Relations

Analysts

Will Hamilton – SMH Capital

George Green

Operator

I would like to welcome everyone to the Luby's fourth quarter fiscal year 2008 conference call. (Operator Instructions) Mr. Black, you may begin your conference.

Rick Black

Welcome everyone to Luby's fourth quarter fiscal 2008 conference call. This call is also being webcast and you can access the audio replay on our website at luby's.com. Before we continue I would like to remind you that the statements made in this discussion including statements during the Q&A session regarding Luby's financial and operating results, plans for expansion of the company's business including the expected financial performance of the company's prototype restaurant and future openings of new or replacement restaurants are forward-looking statements and involve risks and uncertainties including but not limited to, general business conditions, the impact of competition, success of operating initiatives, changes in the cost and supply of student labor, the seasonality of the company's business, taxes, inflation, governmental regulations and the availability of credit as well as other risks and uncertainties disclosed in the company's periodic reports on Form 10K and Form 10Q. I would now like to turn the call over to Luby's President and CEO, Chris Pappas.

Christopher Pappas

Welcome to our fourth quarter conference call. During my opening remarks, I'll comment on the current restaurant operating environment and discuss our perspective of how the economy is impacting our customers, sales, and expenses before I turn the call over to Scott Gray, our CFO to review our financial results in more detail.

Our current focus is to improve profitability and maintain a healthy balance sheet during these difficult times. Later, in today's call I will discuss initiatives taking place at Luby's to manage our business during this economic slowdown. I'll also provide an update on our outlook for fiscal 2009 before opening the call to your questions.

In the fourth quarter we experienced a continuation of the macro economic challenges that we've faced during the recent quarters primarily due to high consumer fuel prices and negative economic news pressuring customers and their discretionary budgets. The effect of these pressures has led to an industry wide decrease in customer frequency which negatively impacted sales during a time when many restaurant expenses continue to increase.

During the fourth quarter our costs were adversely affected primarily due to increased food commodity costs and higher utility rates. We also experienced an increase for repairs and maintenance which tends to occur when you go in an remodel units and find additional needed repairs none of all of which can be capitalized.

All of these items contributed to our loss in profitability during the quarter. However, we are focused on improving store level profits within the current economy through enhanced operational focus and our marketing efforts. We plan to launch a new branding campaign in November that highlights Luby's unique value offerings and broad based brand appeal.

Consistent with our business plan for fiscal 2008, we invested in upgrades to our existing stores, built new restaurants and grew our culinary contract service business using cash flow from operations. Expanding our brand and investing our business continues to be our long term plan for the company.

However, today we believe that in light of the current economy, it's prudent to manage capital allocations conservatively and maintain a healthy balance sheet. We've taken a conservative approach to our capital allocation in fiscal 2009 for new unit development and store up rates and now expect to significantly reduce our capital expenditures. Our current plans are to open one or two new restaurants in fiscal 2009.

We believe our operational execution has improved today through the higher standards we've committed to delivering to our customers and over the long term will enhance shareholder value. As we've discussed before, Luby's value proposition to provide quality, cooked from scratch offerings served in a convenient fast, casual environment at price below casual diner restaurants should allow us to weather macro economic storm.

Our belief is that when the economy improves, Luby's will be well positioned to outperform our peers. We have recently seen one bright spot in the economy and that has been a sharp decline in gasoline prices over the past month. While it is unclear what this might benefit and when it might benefit our customer frequency, it's certainly one step in the right direction for improving the customers' budget for discretionary spending.

I'd like to now turn the call over to our CFO, Scott Gray to review our financial results.

Scott Gray

I will not take you through our financial results for the fourth quarter followed by highlights from our fiscal year, and finally I will provide an outlook at this time for fiscal 2009.

Starting with the income statement, we had a loss from continuing operations in the fourth quarter of $3.7 million or a loss of $0.13 per diluted share compared to income of $3.2 million or $0.12 per diluted share in the same quarter last year. Included in the loss from continuing operations is an $800,000 impairment charge recorded as a result of market conditions affecting the fair value of investment and auction rate securities.

Excluding the after tax effect of the fair value impairment charge, a one time asset charges partially offset by a net gain on disposal of property and equipment, the loss from continuing operations in the fourth quarter fiscal 2008 was reduced by approximately $0.04 per diluted share.

During the quarter, total sales decreased $1.2 million or 1.3% in the fourth quarter of 2008 to $97.1 million compared to $98.3 million in the same quarter last year. Restaurant sales were at $94.1 million, a decrease of 2.7% compared to last year. Approximately 0.7% of the decline relates to the net effect from sales of closed stores in the prior year partially offset by new store sales in the current year.

Same store sales which included 120 units declined 2% in the fourth quarter compared to the same quarter last year which was at the lower end of the range we provided last quarter of same store sales declines in the range of 2% to 3% decline. Store level profit which we define as restaurant sales minus cost of food, payroll and related costs and other operating expenses were $8.5 million or 9% as a percentage of restaurant sales compared to $16.9 million or 17.4% last year. This decline is primarily due to significantly higher costs and a decline in customer traffic and reduced sales volume.

Food costs increased approximately $600,000 in the fourth quarter compared to the same quarter last year. Food cost as a percentage of restaurant sales increased to 28.5% in the fourth quarter from 27.1% in the fourth quarter last year. Commodity costs increased in most all categories with oils, shortenings and margarines having the greatest impact on food cost increases, followed by beef, seafood and fresh produce.

Payroll and related costs increased $800,000 in the fourth quarter compared to the same quarter last year. Payroll and related costs as a percentage of restaurant sales increased to 36.3% in the fourth quarter from 34.5T in the same quarter last year primarily due to the deleveraging of the cost of labor with the lower sales volume.

Other operating expenses primarily include restaurant related expenses for utilities, repairs and maintenance, advertising, insurance, supplies, services and occupancy costs. Other operating expenses increased to significantly by $4.3 million compared to the same quarter last year. Other operating expenses increased primarily due to; one, a $2.3 million utilities expense resulting from higher utility rates in the quarter and then two, a $2 million increase due to an increase in repairs and maintenance, marketing and some restaurant supplies expenses related to a focus on improving the appearance and functionality of the restaurants for guests and employees.

In the quarter we had opening costs of $200,000 in the fourth quarter for one new store and one new relocation store and reflects the labor, supplies, occupancy and other costs necessary to support the unit through its opening period.

Cost of culinary contract services increased by approximately $1.3 million in the fourth quarter compared to the same quarter last year. This increase was related to the food, labor and other operating expenses associated with the increase in revenue for this line of business.

Depreciation and amortization expense increased approximately $500,000 in the fourth quarter compared to the same quarter last year due to higher depreciation resulting from new restaurant openings and existing restaurant upgrades and remodels.

General administrative expenses include corporate salaries and benefits, related costs including restaurant area leaders, share based compensation, professional fees, travel and recruiting expenses and other office expenses. General administrative expenses increased by approximately $1.1 million in the fourth quarter fiscal 2008 compared to the same quarter last year. As a percentage of total sales, G&A increased to 7.8% in the fourth quarter fiscal 2008 which was within the range we provided last quarter of 7% to 8%.

During the fourth quarter fiscal 2007, G&A expenses were 6.6% of total sales. The increase was primarily due to corporate salary expense related to staffing costs to support the culinary contract service business and other departments to support the company's strategic growth plan.

Moving now to the balance sheet, at August 27, 2008, the end of our fiscal year, we had $4.6 million in cash on our balance sheet. We also had $8.5 million in long term investments comprised on auction rate municipal bond securities.

Property held for sale which are properties held for sale that are valued at the lower of net depreciable value or net realizable value at August 27, 2008, we had six owned properties and three ground leases recorded at $5.3 million on the line property held for sale which we are actively marketing these locations for sale. During the fourth quarter, we sold one owned property and for the year we have sold two properties.

During the fourth quarter capital expenditures were $14.9 million which included $4.1 million related to upgrades of our restaurant facilities including dining room upgrades and restroom remodels and new construction and land accounted for $8 million of the total.

I will now cover the highlights of the results for fiscal year 2008. Total sales decreased $2.7 million or 1% in fiscal 2008 to $317.7 million compared to $320.4 million in fiscal 2007. Restaurant sales were $309.5 million, a decrease of $2.7 million compared to last year. Approximately 0.1% of the decline relates to the net effect of sales closed from closed stores in the prior year partially offset by the new store sales in the current year.

Culinary contract services revenue were up $8.2 million in fiscal year 2008, an increase of $6.1 million compared to last year. Same store sales were a decline of $2.6 million in the fiscal 2008 year compared to last year.

Total restaurant sales decline $8.9 million from fiscal 2007 to fiscal 2008. Year to date, our store level profit was $13.5 million in 2008 compared to $17.3 million in fiscal 2007. Cash flow from operations was $17.5 million in fiscal 2008 compared to $33.5 million in 2007.

I would now like to provide an update relative to the impact of hurricane Ike on our operations in the first quarter fiscal 2009. During hurricane Ike, approximately 44 Luby's locations were closed over varying lengths of time in the greater Houston area. We anticipate that restaurant sales were impacted approximately 273 days, where some of our locations were unable to open due to storm damage and/or loss of power. We estimate approximately $1.5 million in lost sales from these store closures.

The company expects to recover a portion of lost profits, property damages and some expenses incurred through insurance claims.

Now for our outlook for 2009. Our outlook for fiscal 2009 anticipates that given existing market conditions, current sales and expense trends will likely continue through fiscal 2009. Based on our outlook and the recent decline in cash flows from operations, we plan to significantly reduce capital expenditures in fiscal 2009, to the range of $12 million to $17 million.

Our outlook for sales is we currently expect same store sales to continue to trend down over fiscal 2009 due to anticipated traffic and frequency declines in the current operating environment.

In fiscal 2009 we anticipate a reduction in restaurant sales of approximately $5 million for store closures due to lease expirations and other closures offset partially by $2 million in new store sales from units that will open in fiscal 2009.

While modeling sales for our culinary contract services is difficult, we anticipate growth over last year for this business line in the range of 20% to 30% for fiscal 2009.

We expect food costs as a percentage of restaurant sales to be between 27% to 28% of restaurant sales in fiscal 2009. This assumes a leveling off of food commodity prices in the aggregate from what was experienced in the fourth quarter 2008 and increased prices.

We expect payroll and related costs as a percentage of restaurant sales to be between 35.5% and 37% in fiscal 2009. In the fourth quarter fiscal 2009, we expect a significant rise in labor costs as the first step of the minimum wage takes effect, affecting a greater portion of our employees.

We expect other operating expenses excluding opening costs to be in the range of $72 million to $74 million. We expect our R&M expense to level off from the fourth quarter levels. We continue to put hedges in place as we become comfortable locking in a portion of electricity costs in our deregulated markets. Based on current projections and taking into account our hedge positions, we still anticipate our total utility costs will be consistent with 2008.

We expect general administrative expenses to range between $25 million to $26.5 million in fiscal 2009.

As Chris mentioned the economic conditions are challenging. This type of operational environment will continue us to better manage our margins. I will now turn the call back over to Chris.

Christopher Pappas

I'd like to take a moment to comment on hurricane Ike and Luby's operational response to this storm. Our goal during these types of natural disasters is to work rapidly within the restraints of the situation to open our restaurants as quickly as possible. We believe our restaurants provide a much needed public service and we do all that we can to open stores and provide hot meals to our communities.

Hurricane Ike passed through our area on September 13, causing massive power outages and inflicting wide spread damage in south east Texas. On Monday, September 15, we were able to open 11 of 24 stores in the greater Houston area. As circumstances improved and as power was restored, we opened more stores each day until all our units were up and running by the next Saturday. The only exceptions were our Galveston store which re-opened last Wednesday and our Bedrock location where we opted not to renew our lease.

Our employees' dedication, hard work and rapid response during and after the storm were extraordinary and we applaud their efforts. I believe, and a lot of us believe that a lot of customers that had eaten with us over the years returned during this time and I believe that Houston received some marketing benefit by feeding a lot of people that had not eaten with us in a number of years in the Houston market.

Now I'd like to provide commentary on our fourth quarter results and current operations. As you all know, these are challenging times for our economy and perhaps some of the toughest times we've seen in our industry. The current conditions are especially difficult for companies that are highly leveraged.

While we are not satisfied with our recent results which were greatly impacted by the tough economy, we've managed our business through cash flow from operations. Over the past several years, we've invested our cash flow from operations back into our business through improvements to our restaurant assets.

Our focus going forward is to improve profitability and maintain a healthy balance sheet during these times. Our team has proven in the past that we can manage the business through difficult times and we are confident we will be able to do it again. When we arrived at Luby's over eight years ago, the company faced numerous challenges with poor operating results and over $120 million in debt.

We were able to right the ship since then and improved operations, paid off the debt and entered into a number of new operation elements as well as a new restaurant design and a new business line for culinary contract services.

We believe our new restaurant development and culinary business will drive growth and enhance shareholder value over the long term. In the near term we're committed to be focused on store level execution to improve our operating margins.

We have several initiatives in place to help drive sales and manage costs. We have recently implemented a new tiered pricing, marketing menu selection and pricing strategy. Our strategy is aimed at providing selected menu items and prices to best accommodate specific markets based on store volume and the geography of where the store is located.

Our menu line up of ten combination items which are Luby's classics will remain constant company wide. However, this new system will allow for flexibility to showcase specials for specific food offerings and price points. For example, restaurants in the lower Rand Valley near the Mexican border may offer enchilada platters and chicken pot pie and other favorites for that area while our high volume suburban restaurants may offer more premium products such as salmon and steaks at premium prices.

We rolled this new tier pricing strategy out last month by introducing our new menu board system in all our new units. The new menu board leverages a magnetic system which provides flexibility for regional variances and introduction of new offerings, cost effectiveness and a higher end look.

From a marketing perspective, we're excited about our new branding campaign as well that will launch later this fall. We have spent a great deal of time and effort over the past several months working with a new branding firm. We will launch this campaign through in store marketing and external bill boards and radio commercials.

During the quarter, we also continued our capital improvement projects with upgrades and remodel projects that included new tables and chairs and booth packages. We also remodeled ten new restaurants during the same quarter.

Turning to the competitive landscape, we believe our brand remains well positioned residing below casual dining and ticket price and only slightly above service prices. While we've taken price increases, we believe our competitors have also done that and we continue to be priced between the two groups I mentioned.

From a quality standpoint, we would argue that our made from scratch food and wide variety make us a much better value than our competitors.

Moving now to our culinary contract service business where we provide a food service at health care facilities, we're pleased to report continued growth in this area of our business. As we've mentioned in our press release, this piece of our business grew by $6 million year over year. We continue to gain traction in the marketplace and we're now competing for larger accounts. Our reputation and brand equity are growing in this area and we continue to view this business as a vehicle to franchise our brand with three clear advantages. The cost of capital is much lower and building a new store, the contracts tend to be multiple year commitments and there's a captive audience within the facility.

Finally, I'd like to discuss our new store development plans. Due to the current economic conditions we believe it's important to build out a cash flow from operations and not leverage our balance sheet. As we stated earlier, expanding our brand and investing in our business continues to be our long term plan.

However, in light of the current economy, we've taken a conservative approach to our capital allocation in fiscal 2009 for new unit development and store upgrades and we now expect to open one to two restaurants in fiscal 2009.

As we look at our business, it really comes down to operational excellence as the key factor to success and in spite of this tough economy we believe we're operating better today than we have in the past. While the financial results do not reflect that right now because of the pressure on restaurant sales and sharp cost increases we've experienced over the past year.

But we believe the deliberate execution with a focused plan on profitability, on reduced capital expenditures will optimize our competitive value proposition to the market and enhance shareholder value.

With that I'd like to open the call up to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first call comes from Will Hamilton – SMH Capital]

Will Hamilton – SMH Capital

I was wondering if you could elaborate a little bit more on the thinking to slow the company development. If we go back three months ago the company was certainly very optimistic about taking advantage of this current downturn to roll out this new prototype and take advantage of some of the better pricing you were seeing for real estate and leases. I understand the idea of being conservative, allocating capital but to open just one to two and not utilize the credit facility that you have available, I was wondering if you could touch on that a little bit more.

Christopher Pappas

With the current situation, we believe that and just looking at everybody else in the marketplace as well, it's been pretty much an industry wide perspective that you need to go focus a little bit more back on your existing units and work to get those back in shape, get the same store sales up and get those generating the cash flow that they were generating before.

We just felt that the additional kick that we would get from the profit side would be better suited to working on our existing units and getting those performing well. So getting our cash flow back up is what we wanted to do and not get overly leveraged.

I don't think the best real estate prospects are even out there yet either. This thing is just coming down now. I think the developers are just starting to feel the impact of it. I don't think the time has been long enough to where the really good prices on real estate have surfaced yet. I think that hasn't occurred yet.

We will keep our eyes open to that as well. What we saw in the 80's, we saw some great deals to expand on during the '80's and at those times, we're positioned well I think to go forward.

Will Hamilton – SMH Capital

What might be the timing of these one to two openings? Are those pushed out to the second half?

Christopher Pappas

They'll be in the second half.

Will Hamilton – SMH Capital

You seem to indicate you're also slowing down the remodels or maybe nearing completion of that program as well. Can you break down the CapEx budget that you have in the 12 to 17. I think $6 million to $7 million is maintenance?

Scott Gray

We'll update if there's any changes as we go through the year. The range it is now is $5 million to $6 million on a kind of recurring basis, $6 million to $6.5 million on culinary and then building and equipment for new construction and $1 million to $4 million in IT and upgrade area, IT and restaurant model upgrades.

What you have with an old fleet of restaurants is you have things happening that you weren't expecting, and we'll flip it between what recurring tends to be a little bit lower. We can use some of that budget for remodel.

Will Hamilton – SMH Capital

If you decided you wanted to ramp up the growth again how quickly could that occur? Typically the pipe line takes awhile to develop. Do you have units?

Christopher Pappas

We've got two owned properties.

Scott Gray

We have probably three to four properties that are in our pipeline.

Will Hamilton – SMH Capital

In regards to the utility expense line I think you mentioned you expected to be similar to '08. I would expect natural gas now being below $7 that if that was sustained, which some people think might occur, that you'd see some benefit across the year from that. Could you elaborate a little bit more on what's working out there?

Scott Gray

We expect improvement in the back half, the second half of the year. We have basically about 30 of our units are a natural hesitant float and then the other balance that's in regulated markets. What we try to do is, we've locked in some favorable prices in the second half and that's what we're looking to.

So the first half we have a portion of the deregulated market that's locked in. In the past when the forward curve was looking a little worse so we've locked in a small portion. We usually do 20% to 25% of the total deregulated markets at a time. We think that given where we are right now unless there's a continued further decline on the floating portion that helps pull down the other, then we see it in the second half, and then the full year being overall about the same.

Will Hamilton – SMH Capital

The labor line certainly was worse than I was anticipating for the quarter and I'm a little surprised it jumped as much as it did but sequentially year over year given that comps were down 2% and in the third quarter you were actually down 3% so the amount of loss leverage seems a bit more surprising to me. Maybe you could elaborate on what occurred there, if there's any one time thing in that, and what you're trying to do in terms of taking out people in the back of the house, on the counter to meet the demand here.

Scott Gray

What you have in the quarter is you have new stores that opened during the quarter that tend to run on the higher labor that contributed to that as well as you had a full quarter worth of hire rates this year over last year.

Christopher Pappas

We're always focusing on food and labor and this year is no different. Our guys are really working overtime on the overtime component, working on that, working on schedules, getting scheduling tools improving our scheduling tools that we have as well. So we do have initiatives going on in both those areas to address that big line item that represents labor.

Operator

Your next question comes from George Green.

George Green

A value of the company, not the buildings but just the land. Are there any studies that you're aware of and what would be the values that those studies have put on just the raw land? As you know, several of these units are 20 or 30 years old and I'm wondering if you're aware of any evaluations or studies that have been made of the land. Not the buildings, just the raw dirt and what those studies indicate those land values might be.

Scott Gray

We currently do not have any recent valuations.

George Green

Any older valuations?

Scott Gray

Probably the last time the company had done was back when we had the other banks. We have an uncollateralized revolver now. Before it was collateralized so at that time there were those values.

George Green

And what were those values that were placed on it?

Scott Gray

We don't have those in front of us. If you look in our 10K you can see the value that those have as a book value and then if you look over our history over the last few years you can see the average of what some of the properties have sold at. Other than that, we don't have a number for you?

Christopher Pappas

Thank you all for being with our fourth quarter conference call. We here at Luby's, many of us are shareholders, significant shareholders and look forward to Luby's success and growing the brand and seeing our customers come in and be excited about what they see when they come to eat at Luby's, and make Luby's a very highly successful company that it's been for the last 60 years and continue on that trend.

With that, I'll look forward to visiting with you next quarter and we hope that our economy gets into better shape that helps all our businesses and all our customers as well in the market. Thank you and I look forward to seeing you again.

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