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Executives

Michael P. O'Donnell - Chairman, Chief Executive Officer and President

Arne G. Haak - Chief Financial Officer, Executive Vice President and Corporate Secretary

Analysts

Jason West - Deutsche Bank AG, Research Division

Ruth's Hospitality Group, Inc. (RUTH) DbAccess Consumer, Retail, Gaming & Lodging Conference March 6, 2013 11:20 AM ET

Jason West - Deutsche Bank AG, Research Division

Everyone, my name is Jason West, I'm the restaurant analysts at Deutsche Bank, and we're pleased to have Ruth's Hospitality Group with us today. We have Michael O'Donnell, Chairman and CEO; Arne Haak, the CFO. Just to give you a little background on the company, as you all know, Ruth Chris is a leader in the upscale dining space. They've got about 160 units, about 130 or so are on the Ruth's side, sort of 50-50 franchise in company. And then 22 of the Mitchell's brand, which is a little more of a seafood focus.

Ruth has had a really nice recovery last several years, entering fourth year positive comp this year, still running solid in the first quarter, which is not what most of the other restaurants are saying. They've seen a significant improvement in margins and the balance sheet since the recession in '08, '09. They are starting to dip their toe in the water a little bit on unit growth, again, so we'll touch on that a bit. And we did have Del Frisco's also here as well, I just wanted to let you guys know they canceled the presentation because of the secondary.

Question-and-Answer Session

Jason West - Deutsche Bank AG, Research Division

But just kind of kick it off, I'll start with a couple of questions and then let the audience jump in if you guys have questions as well. But Mike and Arne, if you guys could talk a bit about just the overall consumer environment and I guess, from your perspective, it's a little more on the upscale end. But 2 things, one, kind of where you think we are in the cycle now. I mean, we've had 4 year -- now we're in the fourth year of a recovery, are things kind of back to normal or is there still a lot of your restaurants that are not at the levels that you'd like to be or that you were, maybe, at the peak of the last cycle '05, '07? If you could talk about sort of that level and if you could also dive in a little bit more on the first quarter, why you think your business has kind of held up better than maybe what we've heard from some of the other chains out there?

Michael P. O'Donnell

Okay. I think a couple of things, Jason. One, we really look at our business from a segmentation standpoint, 3 sort of distinct customer bases and 1 is sort of business-to-business customer, basically, where somebody else is paying, sort of a traveling and entertainment kind of expense, that's roughly about 30% of our business. About 30% of our business is special occasion business, where we are really not selling steak as much as we are selling -- making memories on 500 degree sizzling plates, where we are celebrating birthdays and anniversaries and special occasions and then really, an aspirational sort of visit in many cases. And the third piece of the business, segmentation-wise, is really the people that are just because they like what we do, it's relatively expensive, but they can afford it and they're at the higher end of the income chain. And what we've seen, really, across all of those segments had been really consistent growth and a consistent return to -- of that customer back to us on a frequency basis. The notion of, can we get back to where we were pre-2008, is really a question of the average unit volumes. Our average unit volumes at one point were up to $5.5 million. We reached a low watermark at $4 million, we're back in the $4.9 million range. But that really has a different portfolio to it. So if you really adjusted that, I'd say, and Arne and I were talking about this earlier, we're probably 85% to 90% of the way back to what we think we can get to. Our strategy has really been one of being very price adverse; we have not been doing any discounting. It's all brand development over the last 4 years. We introduced our Ruth's Classics in '08 and have continued to do that, and that's a prix fixe opportunity at either -- it started at $39.95 and $49.95, it's now -- it's moved up over the years to $42.95, $52.95, and we're still seeing that represent about 20% of revenue. But all of those segments, our private dining business, our alcohol business, is improving. We're seeing a solid return in terms of spending habits that look like, and are starting to behave more like, it was back, say, in pre-'08. But I don't -- I'm not smart enough to know where the cycle is and then I say that because I keep thinking that we clearly have a correlation or trading effect between the consumer confidence in the stock market and our customers. And so you see something like the sequester come and you think that's going to be bad, the Dow hits an all-time high, and our sales continue to be pretty good. And I keep waiting for something to say, "Well, wait a minute, that shouldn't be." And fortunately, and you were kind enough to mention it, we worked hard in the last 4 years to put our economic position -- we're in a great position, economically, our balance sheet is in great shape. We're in a position to return value to the shareholders as we have been for the share price, but equally, we're in a position to weather whatever might come our way. And fortunately, so far, and I can't talk a whole lot about the first quarter other than what I said relative to when we announced our earnings, that we were still seeing things in the mid-single-digit range. And I don't -- I haven't seen anything that would cause me to change that position. Now why others are not seeing that? If they're in a segment that's at a lower price point than where we are, then I can kind of understand there's more sensitivity around payroll tax and things like that. But it's the higher end, we're not seeing as much of that as a challenge. We're still bullish.

Jason West - Deutsche Bank AG, Research Division

And when you look at the business, you guys -- because you've got the biggest chain within the upscale space, you've got a more little geographic balance, but you also have more residential, probably, exposure than some of the other chains. You've got the big California, Florida exposure on the company side, those were markets that were down, probably more severely, particularly, in some of the residential stores than the rest of your business. I mean, can you talk about -- are you even seeing those residential kind of up and coming places where you maybe got there at the wrong time, that have really come back and is that sort of leading the charge or still lagging?

Michael P. O'Donnell

Yes. I think -- I do -- yes, we're seeing improvement. I mean, we're doing well in California, we're doing well in Florida and basically so, we're doing well across the country. I mean, some pockets are a little stronger than others, but as the housing challenge seems to be solving itself and people are feeling like their net worth is either gaining or not as far down as it once was, I think we're seeing some favorability to that. I think that's very true in Florida, which was really challenged early on. But I, we don't -- we're not really seeing any one pocket of the country as being an outlier either way up or down, it's fairly stable.

Jason West - Deutsche Bank AG, Research Division

Anybody out there have questions?

Unknown Analyst

[indiscernible] Could you talk a little bit about [indiscernible].

Michael P. O'Donnell

Right. So the question is, would we talk about a little bit about some of the restaurants that we have, they're a little older that we can relocate. And that's a great question, and we have actually, we're in the middle of -- when you're 47 years old, which is how old we are, you have the chance to change a few neighborhoods. We had great success in relocating our restaurant in Portland, almost 2 years ago now, and revenue and making it. We really view it as building a new store because it's -- we go through all the challenges of opening a new store. And revenues are running north of 40% higher than they were in the old restaurant. Obviously, that's one of the reasons why we moved, but it is now -- that restaurant exceeds our average unit volume and the profitability is fabulous. So we're excited about that. And we have a restaurant in Houston that had gone through a less than desirable neighborhood. We have concluded the sale of that property, we're actually leasing it back for a period of time while we build a relocation and we're moving closer into Post Oak. And again, we are reviewing any restaurant that is coming up for lease renewal. One of the processes we go through, is there a preferred location or is there some place we would rather go. And we have a number of those that we'll see over the next couple of years.

Unknown Analyst

So you have any specific [indiscernible]?

Michael P. O'Donnell

Well, of the ones that could get relocated, I think that's probably more -- that's probably a very small number. I can probably -- I won't name them because I don't want to get into a public discussion with the landlord about renegotiations, but there are some restaurants that are still -- they're in the right neighborhood on the wrong street, so to speak. But it's not a substantial amount. And to follow on your question, we're very proud of the fact that over the last 8 quarters we've generated $65 million worth of free cash. And what's important for us is that, not only have we managed to put the balance sheet back in a great place, we have continued to invest substantially into the restaurants. And so we have done significant major and minor remodels, we average 10 or 12 of those a year. So I mean, when you start to look at that and you say that our base of restaurants, 65 restaurants, let's say, we're upgrading those, redoing those restaurants almost every 4.5 years, and we continue to do that. So I don't want anybody to get the impression that we're not spending money on the business, because we are and we are happy. If you've been in our restaurant in Manhattan, we spent $1 million in that restaurant last year. It took us a little while to get that done because we needed the landlord to give us the lease extension to be able to pay for it, but we're excited about being able to reinvest back in the business.

Jason West - Deutsche Bank AG, Research Division

Just on the industry overall, there was a period in there, I have to relate, where that was growth kind of shut down in the high-end steak chains and probably a lot of that on the private side as well. We're starting to see folks like you guys and Del Frisco's picking up the pace again on unit growth. Does that worry you at all that we're going to get back in the cycle of people sort of fighting for real estate and maybe having to get a little more competitive from a pricing standpoint or we're really not anywhere close to where we were on that issue?

Michael P. O'Donnell

A good question, Jason. We've built, in the last 4 years, we've built or relocated 16 -- the last 2 years, 16 restaurants between the company and franchise stores. So we've been active. There's this notion that we haven't been doing anything, and it's really not true. Do I -- I think that good real estate is good real estate, and therefore it's expensive. And I don't think anybody -- I think the days of people taking a flyer on real estate and hoping are gone, I hope. I know that they're not in our discussion. We don't feel -- I feel pressured to get a return to the shareholders, and I can do that in a lot of ways, one of which is building restaurants. But I also can destroy value by building bad restaurants. So our diligence around the real estate and the way we go about it and what we're thinking about is about as tough as it gets. I don't know what our competitors are going to do. We are not running into situations and deals that we're looking at where somebody is saying, "Well, if you don't do it, these guys are going to." I mean, we did pass on a deal that Del Frisco took. Maybe if fits better for a Del Frisco Grille than it fit for a steak house, we just didn't see the fit. But it wasn't like we ended up in a bidding war for a piece of property, I mean, it's -- I don't think that's going to happen. I think, we're getting out of bed everyday as the largest private -- or it's the largest public company focused on the steak business, on the upscale steak business. And we got out of bed everyday trying to figure out how to sell more steaks, and that's our sort of singular focus. Most of the other companies are talking about now, Del Frisco's has a similar situation, but most of our competitors are parts of bigger organizations and it may not be their primary focus. I think that some of our competitors have challenges around other parts of their brands and their real estate and focus probably is more appropriately placed there. So we're not seeing it, but I -- we're fortunate, I think, that we can look at -- because we know our opportunity to return value to shareholders, we can build restaurants, which we'd love to do if we can find the right real estate. We can buyback franchisees, if that opportunity presents itself in the right way and the franchisee has additional developments, so that kind of an acquisition, we're certainly buying a business we understand and to the extent it can be accretive and then build restaurants, so that's clearly an opportunity for us. And we said publicly and we did it, last year, we bought back shares. When we took out the preferred, that's an opportunity to return value to shareholders. And ultimately, at our current debt level and the amount of cash flow that we're generating, we will, at some point, be at a very low, if not 0 debt position. And then the question is, are we -- do we do something like pay a dividend? And we've talked about that before, there's not been anything definitive there. But what it says is that I don't have to go build a bunch of restaurants lever up to do something. I have other options to create value for the shareholders. And we've been around for 47 years and the idea is how we'll make sure we're around for the next 47.

Unknown Analyst

[indiscernible]

Michael P. O'Donnell

Yes. The question is about our marketing/advertising strategy for the second half of last year and what the impact was on the fourth quarter. That would have been our second year in a row of running what we ran with 70 -- we ran 7 weeks of television in advance of the holiday season. We can do that on a national -- our footprint is big enough, we can do it national, cable buy, and it's efficient. There's some inefficiencies to it because we're advertising in Wichita, Kansas working out of the store, but the ability to do that, vis-a-vis network is highly efficient. We did it 2 years ago and it was very successful. The strategy was to do it in advance of our busiest time of the year so that we sort of have a buildup of 7 weeks and then we actually are off air through the end of November and Christmas when it would be most expensive anyway. And there's already people that are out using us, but we sort of prime the pump. And we did it again for the second year and realized the increase -- an incremental increase, a substantial incremental increase in sales over the first year, so we're very pleased with the way that, that behaved. Advertising can be a dangerous drug. We recognize it, we're an operating business not a marketing company. We think that we win the war because we operate better. We have fabulous people in the field that do great work for us, our franchisees do great work for us. And what we do is brand advertising. It is not discounting. It's not any sort of limited time offer called to action. It is brand positioning, talking about the quality of what we do. We clearly see that as an opportunity to look at -- and to continue to use that as a way to keep our brand top of mind. But the idea that we would do it again in the third year, I don't know that we've determined that we can use it in some other way. But it's clearly an effective medium for us.

Unknown Analyst

[indiscernible]

Michael P. O'Donnell

The question is how do we market to the people that we accumulate in terms of a database? So the e-mail, social media, all of that. I mean, I think, it's more than -- in today's world it's much more than just whose name do we have on an e-mail list. We have -- I would say that it's a broad and comprehensive plan around a social media strategy that has to do with search, that has to do with search optimization, that has to do with identifying who we use, who our customers are, specifically, who are the tendency are for our customers to be, so that we have a very targeted approach from a social media standpoint, whether it's e-mail, whether it's online or however that is, that actually is quite effective for us. And that, in combination with the television stuff that we do, the brand awareness stuff that we've done with Women In Business, things like that, that combination of things is very effective. Some of it is, frankly, proprietary to us, so we don't talk a whole lot about it. We like to think that it's a bit of a competitive advantage. I can just tell you that we are deeply immersed in how all that works.

Jason West - Deutsche Bank AG, Research Division

I'm going to give Arne a chance to jump in here. Mike, you mentioned the balance sheet and sort of $45 million debt you have now, I think pretty low interest rate on that. Is the plan, because you guys are still generating a decent amount of free cash flow even with stepping up the growth a bit, is the plan to kind of take that $45 million down to 0, and then sort of go from there on the next step, whether it's buybacks or dividends or franchise acquisitions. Or maybe that's not the right way to look at it, if you could talk about the thought on free cash flow?

Arne G. Haak

Sure, Jason. We spent a fair amount of work in late 2011 and then 2012, first, renegotiating our bank credit facility, so that's our debt facility. It's a $100 million facility, it's a LIBOR plus sort of around 3% money. And as Mike talked about all the accomplishments coming away from 2008 and kind of -- if I liken it to the bank group, we were put on a leverage diet and you go over here and time out and pay back your loan, get yourself in shape again. And we've kind of committed ourselves if you read through our SEC filings and look at it, we've kind of committed in our bank facilities that we're 2.5x maximum levered. We have $100 million facility, we have $25 million accordion if we need more. It's priced very, I think, competitively. I still think it could go lower, but that's the ongoing sport of bank negotiations. But our first priority is really going to be, I think, organic growth is what we would like to do. But if you look at our facility and how we've approached it, we've created a lot of flexibility. We didn't have the ability to do buybacks before, we do today. We didn't have the ability to do dividends, we do today. We had very limited ability to do CapEx or we have limitations on what we can do with CapEx and acquisitions, those are much broader as well. And so if I had to summarize our strategy in whole, it's to support Mike, give ourselves the flexibility that we need to grow the business organically and to return value to our shareholders in whatever form it may come at us. And I think, we are at a great point here today in terms of our flexibility of what we could do and that's how we've approached it.

Michael P. O'Donnell

I think, Jason, specifically, one of the questions you asked, and I think you asked this is, do we have to go to 0 to do something else? And the answer to that is no. If there were an attractive acquisition of a franchisee that would not preclude us from doing -- we're going to for making our other investments. I mean, as you said and Arne has echoed, we generated a substantial amount of free cash and I don't see that changing. So we can be opportunistic in terms of that. But we really, we're going to return value to shareholders. So what can we do that makes the most sense on a long-term basis, that's really where our focus is.

Unknown Analyst

[indiscernible]

Michael P. O'Donnell

Right. The question is, can we talk a little bit about Mitchell's, and I'll be happy to. Mitchell's was acquired in February '08, which precedes either Arne or myself in terms of that acquisition. I think the intent of the acquisition was a very good one. The notion was how much runway is there with Ruth's Chris, and here's this concept that was in the Midwest that was showing very good volumes with really pretty good returns. It's a small number of restaurants. There was still a lot of development taking place at the tail end of that acquisition. But that clearly demonstrated success. The idea was while we can build Ruth's and we can then start having another growth vehicle that would kind of step into place. So as things sort of unwound, there was some difficulty in the transition of that business from a very entrepreneurial-owned business. Kevin Mitchell [ph] is a great guy, he's a great restaurateur, had developed that business and then it was now being run by sort of corporate entity and that, that -- there were some struggles around that. There was the buildout of restaurants that were under development that were all new and they were mostly East Coast restaurants where there was not the sort of success. What we found in retrospect was that Mitchell's performed best when they were in smaller towns in the Midwest and they really behaved like independent restaurants not like a chain of restaurants. And having said all that, we've got -- we actually have, Jason, 19 of the restaurants are actually Mitchell's Fish Market, the others are actually Mitchell's Steakhouses. But of those 19 restaurants, we have a good chunk of those restaurants that would be equal to Ruth's Chris in terms of their returns. But the dependability of building that, at this point, is not as high as we would like to be. So we continue to work on it. We've seen some increase in top line sales. We had leadership change there, people [indiscernible] come on board and have done a great job and there's early initiatives. It's a little more challenging space, because I think it has sensitivities to things like payroll taxes and things like that, because it's just not as far up the food chain. And we're doing a lot of work around finding out what are the real characteristics that make that business work and how we make it an equally profitable business, because it's a very labor-intensive business, far different than Ruth's businesses. So we have -- we're optimistic about the existing business getting better, but I can't tell you today that this is some big growth vehicle. It's a positive cash contributor, we don't have losing restaurants in that segment. It's just that if, I guess as Arne says, that's the [ph] -- and Mitchell's has a big brother called Ruth's that gets better returns, so they get more attention. But I'm very pleased with the progress that, that management team is making.

Unknown Analyst

[indiscernible]

Michael P. O'Donnell

Yes. I don't think it's fair to characterize it that we have less focus on it because it has less returns. I mean, we own this. We paid $170 million for it. We have the sunk cost in it. We clearly would like to see this to be a very successful winner. So we're investing a lot of time, energy and effort in it. But in the existing business, we're not in the place where we are with Ruth's where we're saying let's go build more of these. We actually are looking at a couple of opportunities in the Midwest to possibly build some, but that's a little further down the road. We're really -- we're doing a lot more work inside the restaurant in terms of menu innovation, in terms of how the line is processed, in terms of what the labor costs are, in terms of -- if you look at the big 2 contributions in terms of the costs, how that cost structure, what that needs to be, how that needs to work. If it doesn't do $4.5 million or $5 million, can this business give us the kind of returns that we need. So we're doing a lot of work on it and we like the business. I mean, as a consumer -- and it's great. It just, it doesn't get the returns currently at all levels of the business. We look at it in 3 different tranches. The top tranche of restaurants is very well and with equal to Ruth's. The middle is not as good, but still probably an acceptable return. And the bottom tranche is just bringing it down and saying "Why would you ever build another one of these?" You wouldn't. And some of it is real estate, some of if concept and there's a lot of work going on, but we've got, like I said, great leadership within that. I'm optimistic that we'll have better answers as we move.

Arne G. Haak

I mean, Pete, had a very successful record as an operator and in terms of growing businesses. And I think, from a financial perspective, where he sees the opportunities in the business are very much aligned with where if he did analytics around the business. And the finance people come over here and say, "Here's what we think, but we don't know how to tell you how to do it." He's very much aligned and knows where the opportunities are. And as Mike said, I think the thing that's really intriguing about it, is that when you look at the brand characteristics and the customers that find it and you look at this top tier of restaurants, they perform great. And if we can identify with a high degree of confidence that here's the formula for building them that are in the top part and not -- and then we understand what went wrong with the ones -- some of them are -- they were brand new, like what Mike said, it's a bad real estate deal and you're never going to fix that until -- because you took a lot of money to do the deal until you have a high rent rate. So but -- I think Pete's initiatives are working and I think he's aligned with financially where you think it should go and we're encouraged by what we've seen him do so far.

Jason West - Deutsche Bank AG, Research Division

We only got a couple of minutes, but I do want to touch on the international story and I know -- had you guys in town a couple of years ago and you didn't seem all that eager to do anything in Asia or China and then somehow you've got some stores in Asia, but it doesn't seem like that was going to be a big focus. And then now you announced recently you're opening some stores in China through an HIV [ph]. Sort of talk about how that developed, what changed for you there and what kind of leg work you've done to evaluate that market?

Michael P. O'Donnell

Right. Well, the philosophy of it, Jason, really hasn't changed. I mean, it's very expensive for us or for anyone to go do international development. And unlike, say, a young -- who's going to build 1,000 Pizza Huts, we're going to go like China, we currently think there's a 4-store opportunity in China. And so for us, fly enough people over to China, we'd spend more than we'd make in a year. So really, our international development is really then through existing franchisees and things that have really come over the transit. So we get a lot of interest from folks, very highly qualified folks, that are interested in developing the brand. And so we can afford to be highly selective and be rather passive in terms of international. So a gentleman that came to us wanted to open in Dubai and now has a second store in Dubai, a highly successful entrepreneur. We have great expectations for what's going to happen there. The Cole family, who had been franchisees of ours in Japan for the last 20 years, very successful. Have been a really stellar franchisees. Have partnered with folks in China and came to us and said, "You know, we think we can make this work." We're very excited about it, we went through the analytics with them and did work around it. And we agreed that they have the opportunity to do it, they are partnering with the right people, they know what they're doing. That development cost for us is rather de minimis because they're existing franchisees. We have a situation, a franchisee in Mexico, we just had a franchise meeting -- we have 2 restaurants in Mexico today and he's talking about stepping up his development in Mexico. We have every bit to have loyalty to him because, again, we don't know that there are -- there's another reason to go out and start to find a bunch of new franchisees to try and bifurcate something, I'd rather have those restaurants, those operators have a massive restaurants that was substantial and therefore, very meaningful to them. So we're happy with the franchise development that we have, and internationally, we have great presence in Canada. I think that at some point, Europe and other parts of the world will open up in a meaningful way. But currently, we're happy to focus our development domestically from a company standpoint, primarily, from a franchise standpoint and to be highly selective to what we do in the international space.

Jason West - Deutsche Bank AG, Research Division

Thank you. Thanks, everybody.

Michael P. O'Donnell

Thanks. Thanks for coming.

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