Kona's CEO Discusses Q4 2012 Results - Earnings Call Transcript

Feb.19.13 | About: Kona Grill, (KONA)

Kona Grill Inc. (NASDAQ:KONA)

Q4 2012 Results Earnings Call

February 19, 2013 5:00 PM ET

Executives

Berke Bakay - President and CEO

Christi Hing - Chief Financial Officer

Analysts

Ross Licero - Craig-Hallum Group

Mark Smith - Feltl & Company

Operator

Good afternoon. And thank you for joining us today to discuss Kona Grill’s Results for the Fourth Quarter and Full Year Ended December 31, 2012. Joining us today are Berke Bakay, Kona Grill’s President and Chief Executive Officer; and Christi Hing, the company’s Chief Financial Officer. Following their remarks we’ll open up the call for questions. (Operator Instructions)

Before I begin, I would like to remind everyone that the financial guidance the company provides for its first quarter 2013 results, statements regarding the company’s future growth, sales, profits and expectations regarding same-store sales are forward-looking.

All forward-looking statements made during this call are based on information available to the company as of today and the company assumes no obligation to update these statements to reflect events or circumstances after the date of this call.

These statements are subject to risks and uncertainties that could cause actual results to differ materially from those described in the statements. Investors are referred to the discussion of risk and uncertainties contained in the company’s filings with the Securities and Exchange Commission.

I would now like to turn the call over to Kona Grill’s President and CEO, Mr. Berke Bakay. Sir, please go ahead.

Berke Bakay

Thanks, Lorenzo. Good afternoon and thank you all for joining us. We’re pleased with our results for the fourth quarter in light of challenging economic environment. Same-store sales increased 10 basis points, excluding the impact of our Chandler, Arizona store remodel, which we will discuss in more detail.

We experience a choppy sales environment during the quarter as political and economic headlines distracted consumers. Restaurant closures related to Hurricane Sandy and adverse weather during the holidays contributed to a slight decline in sales for the quarter.

However, our positive comps during the quarter represent Kona Grill’s ninth consecutive quarter of positive same-store sales. For the year, same-store sales were up 2.7%, successfully lapping an 8.8% increase in 2011.

Traffic was down slightly during the fourth quarter due to weather-related closures, but was up 2.5% for the year, which demonstrate the strength of our brand even in challenging times.

We delivered solid bottom-line results in the fourth quarter given the sales environment. Q4 was our weakest sales quarter of the year so we did see a bit of deleveraging on the cost side. For the year, restaurant operating margins were 18.8%, 100 basis points improvement from 2011.

For 2012, income from continued operations increased 127% to $5.3 million or $0.59 per share from $2.3 million, or $0.24 last year. This strong earnings improvement is attributed to our focus on building sales while also being disciplined with our cost. More importantly, with average unit volumes of $4.2 million and 19% operating margins we generated 33% cash on cash returns.

But before I go further, I like to turn the call over to Christi who will take us through the financials for the fourth quarter and full year, and provide guidance for the first quarter of 2013. Afterwards, I will provide an update on some of the initiatives we are working on before wrapping up the call with Q&A.

With that, I would like to turn the call over to our CFO, Christi Hing. Christi?

Christi Hing

Thanks, Berke. For the fourth quarter ended December 31, 2012, restaurant sales were $23 million, compared to $23.1 million in the fourth quarter of 2011. Same-store sales increased 10 basis points, with higher average guest check partially offsetting a slight decline in guest traffic. The 10 basis point increase laps a 7.8% increase in the fourth quarter of 2011.

For the same-store sales calculation consistent with previous practice we have taken a restaurant out of the comp base for remodel results restaurant being closed for construction. Due to the extensive remodel at our Chandler restaurant including vast sales from the removal all booth and a few close days we have taken them out of the comp base for both October and November.

As we mentioned on our Q3 call, sales trends in October and early November were choppy as political debate and a Presidential election kept guests at home and a fiscal cliff uncertainty wait on consumer’s minds in December.

Weather also negatively effected sales during the quarter as Hurricane Sandy impacted our four restaurants in the Northeast and snow storms during the holidays hamper traffic. We estimate that weather negatively impacted Q4 comps by approximately 80 basis points. If you normalize sales taken in account the impact of adverse weather and the Chandler remodel same-store sales would have been up about 1%.

Cost of sales as a percentage of restaurant sales increased 70 basis points to 27.8%, compared to 27.1% last year. The increases due to higher beer and wine costs associated with the systemwide rollout of our Wine Down Wednesday program, along with higher year-over-year pricing for beef and chicken. In addition, waste associated with the loss of power at our New Jersey restaurant impacted cost of sales by approximately 15 basis points.

We continue to work diligently to negotiate contracts to lock in the best possible pricing given the inflationary pressures on certain commodities. As we look at 2013, we continue to be optimistic that some of the purchasing initiative we have implemented over the past year will help mitigate any material impact of food costs.

Our variety of menu items helped insulate us from some inflationary pressures as over 54% of our sales are from alcohol and sushi.

Labor expenses as a percentage of restaurant sales increased 110 basis points to 33.8% as we experienced deleveraging of our hourly labor cost due to softer than anticipated sales volume.

Also insurance claims under our medical plan negatively impacted labor costs as the company is partially self-insured for medical. In addition, higher workers compensation costs contributed to the deleveraging of labor costs by approximately 70 basis points.

Occupancy expenses as a percentage of restaurant sales increased 70 basis points to 7% during the fourth quarter. As we laps the benefit of a significant change in a lease provision for one restaurant.

In addition, under GAAP accounting, as we exercise options to extend the lease on our restaurants we are require to spread the unamortized tenant improvement allowance and straight-line rent over the extension period which result in a smaller deferred rent credit each period and therefore higher occupancy expense.

The lease extension notice period for a handful of our restaurants is in 2013, so we will see about a 40 basis increase in this line item going forward due to this accounting treatment.

Restaurant operating expenses as a percentage of restaurant sales decreased 60 basis points to 14.3% during the fourth quarter from 14.9% last year. The lower operating expense as a percentage of sales was primarily attributed to lower advertising spending, lower negotiating utility rates and reduce printing and uniform costs.

Combining these four line items restaurant operating profit in the fourth quarter of 2012 decreased 10.8% to $3.9 million compared to the year ago period. As a percentage of sales, restaurant operating profit decreased 200 basis points to 17.1% compared to 19.1% in a year ago quarter.

For the year, restaurant operating profit increased $1.4 million or 8.3% to $18 million. As a percentage of sales, restaurant operating profit improved 100 basis points to 18.8%. We are pleased with operating performance of our restaurants during 2012 and believe that we can sustain margins in the high 18% to 19% range with modest increases in same-store sales.

General and administrative expenses in the fourth quarter decreased $575,000 or 26% from the prior year quarter, primarily due to higher cost incurred in the fourth quarter of 2011 for severance and legal fees. Excluding these severance charges, G&A as a percentage of restaurant sales in the fourth quarter decreased 80 basis points to 7.3% compared to 8.1% in the year-ago quarter.

For the year, G&A as a percentage of restaurant sales was 7.3% compared to 9% for 2011. For 2013, we are making investments in G&A to support our growth, including adding head counts in construction and development along with operations to enable us to successfully meet our growth objective. We expect G&A to increase by about 100 basis points in 2013 but we believe these investments in people will pay off in the long-term.

For the quarter, we recorded an income tax benefit of $84,000 to true up our 2012 tax provision based upon actual results. In addition, the statute of limitations expired on certain FIN 48 items and the income tax benefit for the quarter reflects this. We have about $2.7 million in NOLs that we can use to offset taxable income. So we will start to pay some federal income taxes in 2013.

During the fourth quarter, we recognized the gain of approximately $215,000 as a result of business interruption proceeds related to the Troy fire. Also during its Q4, we recorded additional tax expense based upon our mixed beverage gross receipt tax audit borne by the State of Texas.

Income from continuing operations in the fourth quarter increased 18% to $884,000 or $0.10 per share, compared to $747,000 or $0.08 per share in the same quarter last year. For the year, income from continuing operations increased 127% to $5.3 million for 2012 compared to $2.3 million during 2011.

On a per-share basis, income from continuing operations was $0.59 per share, compared to $0.24 last year. Net income in the fourth quarter increased 14% to $851,000 or $0.10 per share, compared to net income of $747,000 or $0.08 per share in the prior year quarter.

During the fourth quarter, we purchased and retired 76,000 shares at an average cost of $8.43 per share under our $5 million stock repurchase authorization, which was initiated in May 2012. In total, we have purchased 363,000 shares for $3 million under our current program.

At December 31, 2012, we had $8 million in cash and cash equivalent compared to $6.3 million at December 31, 2011. The year-end cash balance reflects 5.5 million in share repurchases during the year.

At December 31, 2012, total debt was $370,000 compared to $132,000 at December 31, 2011. We spent $700,000 on capital expenditures for the quarter, primarily for the Chandler remodel and the City North menu remodel. For the year, we spent $1.8 million on CapEx. We do not have any borrowings outstanding on our $6.5 million line of credit.

For the first quarter 2013 financial guidance, we are forecasting flat same-store sales excluding the impact of the extra day in the first quarter of 2012 from leap year. As you may recall, our comps were 8.7% last year and were favorably impacted by warm winter weather, which allowed us to open our patios earlier than normal in the Midwest and East Coast markets.

We’ve experienced some inclement weather to date including about 30 basis point of loss sales associated with the Nemo blizzard. Also the shift of Easter into Q1 this year versus Q2 last year negatively impact sales by about 40 to 50 basis points. So the Q1 comp guidance fix these items into consideration.

We expect restaurant sales to be $23.9 million, compared to $24.2 million last year, which includes the extra day. We also expect net income of $900,000 or $0.11 per share, compared to net income of $1.2 million or $0.13 per share in the first quarter of 2012. Our guidance reflects the challenging economic environment as lingering concerns about the economy and other external factors affect consumer dining decisions.

I will now turn the call back to Berke before we go to Q&A. Berke?

Berke Bakay

Thanks, Christi. During the fourth quarter, we continue to execute on various initiatives designed to drive guest traffic and increase guest frequency. We continue to keep our menu fresh and innovative with our highly successful food-based promotions.

During the quarter, we introduced our steaks promotion of the year called Tempt which featured Island Poke, Ahi Tuna Sliders and my personal favorite carrot cake. We also on New Year’s eve Surf & Turf promotion that was very successful. As such, we run a similar promotion program on Thursday, weekend to capitalize on appropriate sales of this promotion. In fact, last Saturday, this proportion helped us achieve record sales day in our company’s history.

In September, we rolled out our Wine Down Wednesday! promotion nationwide. As mentioned on our previous calls, this promotion consists of half off bottles of wine throughout the restaurant every Wednesday. We have seen significant increases in the number of bottles sold on Wednesday compared to last year, which is in addition to moderate increases in the average check for guest ordering a bottle.

Guest feedback continues to be very favorable and we will continue to monitor the program and its impact on guest traffic and margins. We are also testing happy hour initiatives at various restaurants to drive traffic and increase frequency of our guests.

This test includes expanding happy hour to some days in select markets to help drive traffic on what is otherwise one of the slowest sales to week for us. We will continue to evaluate this program to determine their effectiveness.

We had a successful holiday gift card season, increasing sales by over 10% from the prior year. Our Black Friday gift card promotions both online and in store were a large factor to this increase and we can thank our thousands of loyal konavore members for making this program so successful.

On the development front, we are excited about the prospects of our Boise, Idaho location that is planned to open in the fourth quarter of 2013. The lease signed is for an approximate 6,600 square feet restaurant located in one of the most significant commercial projects ever developed in this state as well as one of the most powerful areas with daily traffic of more than 90,000 cars.

We are working diligently to build our pipeline and are evaluating sites in both new and existing markets, including multiple sites in the state of Texas. We currently expect to open two new restaurants in 2013.

We continue to trade paper on several locations, and are confident that the results of our efforts over the past year will payoff as it put Kona Grill back on the map as a growth company. As Christi mentioned the competitive remodel of our Chandler restaurant in November and celebrated with a grand reopening party with over 300 guests.

We are very pleased with the look and feel of this restaurant and have received very favorable guest feedback. The remodel restaurant incorporates modern design elements, including a lounge area, a revamp bar and patio area with additional TVs and eye-catching water worlds that separate the bar and dining area while still allowing some of the energy from the bar to transfer to the dining room.

We also completed a menu remodel at our restaurant in North Phoenix, which included removing the wall between the bar and the dining room to give the restaurant a more open look and provide more energy throughout the restaurant.

We added 103-inch TV in the bar and 90-inch TV on the back patio that has helped re-energize our staff and guests. While it is too early to evaluate the return investment on these remodels, we believe that dollars invested are above worth it.

With that, I would like to open the call up for any questions you may have. Lorenzo, please open up the lines for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) The first question is from the line of Mike Malouf with Craig-Hallum Group. Please go ahead.

Ross Licero - Craig-Hallum Group

Hi, guys. This is Ross Licero on for Mike. Just had a question about the restaurant operating margins, you said you thought you could get to 18% and 19% given modest same-store sales growth. What do you mean by modest? Could you just give us a little color on that?

Christi Hing

Yeah. When we talk about modest, about 2% I would say is kind of in the range that we’re modeling.

Ross Licero - Craig-Hallum Group

Okay. Great. And for the new restaurant that you’re planning on opening, can give us a little more color on that? Is that going to be built from the ground up, are you close to signing a lease and I guess a little more color would be helpful?

Berke Bakay

Sure. So, as we mentioned in our prepared remarks, we expect to open two locations during the year 2013.

Ross Licero - Craig-Hallum Group

I’m sorry the additional restaurant, not the existing ones.

Berke Bakay

Sure. Well, one of them is we announced today and previously is in our Boise location. The other location, it’s going to be an existing market in the State of Taxes. We are actually pretty close to signing lease on it. We have not signed a lease yet, but we feel confident that it will be a 2013 opening given the fact that the shell is already completed, so we would just go in there, withdrawing and permit and construction. Our guidance reflects that it is an existing market. But for competitive reasons, we are not ready to name it yet.

Ross Licero - Craig-Hallum Group

Okay. Great. Thank you very much.

Berke Bakay

Thank you.

Operator

Thank you. Our next question is from the line of Mark Smith with Feltl & Company. Please go ahead.

Mark Smith - Feltl & Company

Hi, guys. Can you just give us a recap on the pre-opening expenses, what maybe we would expect for the two this year?

Christi Hing

Yeah, Mark. No. Historically, our cash pre-opening expenses run about $400,000, and then you take into account the non-cash rent fees and that typically ranges between $50,000 and $100,000 kind of depending upon how long it takes rest to kind of open that restaurant once we take possession.

Mark Smith - Feltl & Company

There are chances that the second one of shell is done, maybe it goes a little more quickly and pre-opening could come in a little lower than your typical pre-opening.

Christi Hing

Yeah. It’s difficult to say at this point.

Berke Bakay

I would embed on it.

Mark Smith - Feltl & Company

Okay. All right. And then second, can you give us any commentary on Chandler post remodel and what you’ve seen in traffic? I know you’ve said that you’ve got some feedback from customers that they like it, but anything that you can quantify?

Christi Hing

Yeah, Mark. We’ve kind of seen Chandler on the uptick. We are kind of in the remodel mode for probably six to eight weeks. But once kind of getting through the Christmas holiday season, especially in January and February we definitely have seen trade accounts increase and also same-store sales.

Mark Smith - Feltl & Company

And then with some success or any plans for other big remodels in 2013?

Christi Hing

Yeah. We have a couple that we plan to remodel kind of in line with historical patterns in some of our restaurants that have kind of reached the six, seven, eight year mark. We will plan to remodel, at least a couple in 2013.

Mark Smith - Feltl & Company

Okay. And then last question, can you guys just talk about consumer trends, maybe traffic and what you’ve seen as we come into this year into the payroll tax holiday going right at that, did that have an impact on your customers? Any insight you can give us on what your customer, how they are doing today?

Berke Bakay

Mark, I believe it did and also the fact that a lot of folks are getting their tax refund little bit later this year, also I believe had an impact but it’s been choppy. I think that’s the best way to describe it. As I mentioned last Saturday, we had our best sales day in our company’s history.

So you get days like that. You got sometimes more difficult days. So it makes it very hard for us to plan for labor and operations. You have to deal with the typical weather patterns in the East Coast, which -- it’s never an excuse but regardless it impacts your business. So, I would say, yeah, as an answer to your question, definitely, we believe it has an impact.

Mark Smith - Feltl & Company

Great. Thank you.

Berke Bakay

Thank you.

Operator

(Operator Instructions) And at this time, it appears there are no additional questions. I would like to turn the call back to Mr Bakay.

Berke Bakay

Thank you, Lorenzo. I’d like to finish today with 4.2 million average unit volumes and 19% operating margins and 23% return on invested capital, we are confident that we can grow this brand over the long-term. We have 23 restaurants in 16 states and all of them are cash-flow positive and we believe that with these metrics, our strategy as an organization remains clear.

And we intend to execute on our strategy to build a premier plus casual concept that is distinguished by our award-winning sushi, new American cuisine as well as our significant bar business. We differentiate ourselves from our competitors by successfully executing three distinct businesses in four different day parts and believe that we have tremendous growth potential.

In conclusion, I’m very excited about the future of Kona Grill, with strong AUVs, margins and return investment metrics, we are at the beginning of something that can become very special. Thank you for your continued support and thank you for your support of Kona Grill.

Operator

I would like to remind everyone that this call will be available for replay later this evening. A webcast replay will also be available via the link provided in today’s press release, as well as available on the company’s website at www.konagrill.com. Thank you, ladies and gentlemen for joining us today. You may now disconnect.

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