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Luby's (NYSE:LUB)

Q2 2013 Earnings Call

March 21, 2013 11:00 am ET

Executives

Steve Goodweather

Christopher J. Pappas - Chief Executive Officer, President, Executive Director and Member of Executive Committee

K. Scott Gray - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Operator

Good day, ladies and gentlemen, thank you for standing by. Welcome to the Luby's Second Quarter Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Thursday, March 21, 2013. I would now like to turn the conference over to Steve Goodweather, Vice President of Financial Planning and Analysis. Please go ahead, Sir.

Steve Goodweather

Thank you, and welcome, everyone, to Luby's 2013 Fiscal Second Quarter Earnings Conference Call. This call is also being webcast and can be accessed through the audio replay of Luby's -- on Luby’s website, lubysinc.com. That's lubysinc.com. Information recorded on this call speaks only as of today, March 21, 2013.

Before we continue, I would like to remind you that the statements in this discussion, including statements made during the question-and-answer session regarding Luby’s future financial and operating results, as well as plans for expansion of the company's business, including the expected financial performance of the company's prototype restaurants and future openings, are forward-looking statements. They include risks and uncertainties, including, but not limited to, general business conditions, the impact of competition, success of operating initiatives, changes in commodity cost and supply of food and labor and seasonality of the company's business, taxes, inflation, governmental regulations and availability of credit, as well as other risks and uncertainties disclosed in the company's periodic reports on Forms 10-K and Forms 10-Q.

I will now turn the call over to Luby's President and CEO, Chris Pappas.

Christopher J. Pappas

Good morning. Thanks, Steve. Welcome to all of you, and thank you for joining us on our 2013 second quarter earnings conference call. With me today are Scott Gray, our Senior Vice President and CFO; and Peter Tropoli, our Chief Operating Officer.

The fiscal second quarter, which ran from November 22, 2012, to February 13, 2013, presented a number of opportunities, as well as a few challenges.

I'll speak about our new acquisition, Cheeseburger in Paradise, as well as our new Fuddrucker openings and other units in development later in the call.

But first, I'll address the challenges.

We saw a reduction in consumer discretionary spending. We attribute this to escalating gas prices, higher payroll taxes, and sequestration concerns. This soft demand has been reported by other retailers as well. As the quarter progressed, it became apparent that these factors were having a manageable impact on our business and that they were more than the usual week-to-week variability in our business. Long term, we believe we're well-positioned to succeed. We believe that we can overcome these headwinds. As we have done before, we are developing initiatives to drive guest traffic and we're tackling each expense line to ensure we are properly navigating through the economic landscape.

We began the fiscal year focused on expanding our store operating margins, and we will remain determined to make progress on this goal. Our income from continuing operations declined to $603,000 in the fiscal second quarter from $1.4 million in the comparable quarter last year.

Adjusting for special items, we lost $37,000 from continuing operations in this fiscal year's second quarter. As you've already read in our press release, we're lowering our sales and earning guidance for 2013. This is mainly due to external economic issues. We choose not to raise prices -- we chose not to raise prices this quarter in light of the current environment as we more focused on maintaining the frequency of our guest visits. As we see among our restaurant peer group, others have also seen a fall in traffic recently. In order to compete better going forward, turn year-over-year comparable sales positive, and improve cash flows and enhance shareholder value, we will continue to focus on the following: First, we plan to accelerate our sales through menu development programs, as well as marketing and advertising initiatives. Based on the redemption rates, we believe that many guests respond to our newspaper inserts and mail outs resulting in incremental increased visits to our restaurant. We're expanding the frequency and range of markets, where we utilize direct marketing in order to encourage top of mind awareness. We also found that carefully placed and crafted television advertising is another advertising medium that resonates with a number of our guests. As such, we will soon be back on cable television on a range of targeted channels. Supporting our local marketing initiatives, we also plan to re-up a couple of our sports sponsorships. Back in our restaurants, we will continue to feature targeted limited time offers, which allows to focus more on compelling products and unique or creative menu items.

We are also presenting our value proposition with offers such as our $5.99 and $6.99 manager specials in our cafeteria units in lieu of our lower price limited time offerings at $3 and $4 as previously done. We plan to utilize billboards as a cost-effective means of communicating our message with a wide range of customers in our key markets. We've utilized billboards messaging in the past with success, especially when we have special offers such as these. We also continue to concentrate on our catering business, where we can bring the traditional Luby's and Fuddruckers fare right to our customers' offices and other venues.

Furthermore, we are targeting group sales such as bus groups, which are a logical fit for our brands and believe this can continue to be an area of incremental sales improvement.

Second, we are continuing on our remodeling program. In 2012, we completed 12 cafeteria remodels, of which, 8 were extensive, as well as 17 limited remodels on our Fuddruckers. Thus far, in fiscal 2013, we've now completed 5 cafeteria remodels and 3 Fuddrucker remodels. We are experiencing headcount improvements in these units as a group so far. In addition, we have remodeled the bathrooms in 6 other Fuddruckers locations.

We're on pace to completing 14 cafeteria and 14 Fuddrucker remodels by the end of our fiscal 2013 year. Third, we'll continue to reach out to our guests through customer engagement efforts such as customer surveys, focus groups and comment cards. We're also enhancing other aspects of our customer engagement such as a new -- brand new ambassador program and suggested selling efforts. Under the brand ambassador program, motivated hourly employees in our restaurants are encouraged to devote a portion of their work week to local marketing meeting with nearby businesses, schools, religious organizations and civic groups. Once in our restaurant, the entire restaurant team led by the general manager is being focused to up their game and ensure that every guest has their expectations met or exceeded.

Fourth, we're focused on enhanced operating procedures and systems. We're rolling out new programs to measure speed of service and order accuracy such as our new kitchen display system that we are deploying at all Fuddruckers and Cheeseburger in Paradise units. All of our company-owned Fuddruckers and approximately 60% of the franchisees are now part of our food distribution consortium. Between the implementation of our back office system called CrunchTime!, which aids in properly managing food cost, labor and inventory, and consolidating purchasing, we continue to generate ongoing benefits to our cost structure.

These initiatives all support our existing restaurants. But let me continue by discussing our comments to growing our brands.

So far this year, we've opened 1 Luby's Cafeteria and 6 Fuddruckers, including 1 property with a Luby's Cafeteria and Fuddruckers positioned side-by-side. The side-by-side location, the first of this prototype, opened extremely well. We're quickly coming to the conclusion that this will be one of our key vehicles for growth.

In fact, we have 2 more in development of this type slated to break ground this calendar year.

During the second fiscal quarter, we also opened a Fuddruckers in Galveston, Texas. The other Fuddruckers locations opened so far this fiscal year include units in Kerrville; Texas; Farmington, New Mexico; Sparks, Nevada; and Houston, Texas. The locations outside of Houston were previously operated by a franchisee either recently or in years past. So the renovation cost and the time to open was significantly less than locations where we built from the ground up.

New units include the one brand-new Luby's Cafeteria and Fuddruckers side-by-side that I just mentioned, plus 2 reopened Fuddrucker units, 3 second-generation site conversions to Fuddruckers and 2 former franchisee units. We now have these units to share with the Fuddruckers system community and are serving as a basis for growth in new units. Our team is developing experience in many -- prototype configurations which will provide for a wider range of growth opportunities going forward. Although the 2 former franchisee units were recently opened, will take some time to rebuild our sales, we're pleased with the sales performance at the other new locations and we're excited about our locations in our pipeline. But we aren't stopping there. We continue to grow our Fuddruckers and Luby's brand with a pipeline that now includes 3 more Luby's Cafeterias and 5 more Fuddruckers.

We've secured the property and leases for these restaurant locations. By the end of the fiscal 2013 year, we plan to substantially complete a side-by-side Luby's and a Fuddruckers end cap. Our pipeline is gaining steam. As mentioned earlier, our new stores are being received well in the communities where they operate, so we feel well-positioned for the future growth of the new units.

We are also working to expand our franchise network. During the second fiscal quarter, we made significant strides by signing 2 multilocation development deals. The first is a domestic agreement in North Dakota, where over the next several years, our franchisee plans to open up to 5 Fuddruckers with the first to open in the fall of 2013.

The second franchise agreements takes us international to Panama and Aruba. Isthmus Food Services, our newest international franchisee, will be opening up to 10 American-style Fuddruckers restaurants with the first to open in Panama City in late spring or summer of 2014. The total there are targeting up to 8 locations in Panama and 2 in Aruba. We're excited about these multilocation deals. As we've discussed in the past, growth of the franchise network will more often come in the form of multilocation deals. As I stated earlier, add-on acquisitions with growth potential are a component of our long-term strategy when the right opportunities present themselves. We see opportunities to enhance the cheeseburger brand, thereby, creating long-term shareholder value. The following speaks of how we envision Cheeseburger in being positioned and competing. Here it goes."Come to Cheeseburger in Paradise to enter a paradise state of mind. From mouthwatering, unique specialty burgers made from fresh-baked buns to our unique coastal-themed entrées, our tropical environment and music, as well as our tiki bar allows our guests to leave behind the stress of everyday life and experience a relaxing island way of life, where the food and service is awesome; the music and experience, festive; and the cocktails, cool and tasty. So come on in and enjoy time away from the real world and escape to Cheeseburger in Paradise. You're local island getaway right in your neighborhood."

Year-over-year sales in Cheeseburger in Paradise have been below our expectations so far. Comp sales during the quarter for Cheeseburger in Paradise were down 12%. While this brand's sales are not yet our same-store sales, we're mindful of this development. We attribute a portion of this decline in comp sales for Cheeseburger in Paradise in the quarter to some significant weather events, some prior-year promotions not repeated this year, as well as the overall industry negative trend in traffic in calendar 2013. We're actively proceeding with our integration and operational improvement plans. The strategic opportunities for the Cheeseburger in Paradise [indiscernible] brand fall into 3 key areas: The menu, the customer experience and real estate.

First, the menu. We're repositioning and upgrading the menu quality beginning with the core namesake product, the Cheeseburger in Paradise. We have an improved burger and bun that is rolling out to favorable reception from our guests. We're staggering this update as we focus on our core burgers while we change distributors and upgrade the product in the process. Over time, we'll add new and innovative items to this streamline menu. Our aim is to emphasize quality and product innovation with the brand and not resort to discounting these truly unique menu items.

Second, the customer experience. Our tropical environment is a fun and unique feeling. We're elevating operations to provide an even higher level of service and even more appealing and festive atmosphere. Our bar is already festive. As we have done with each of our brands, we're installing the right people, guided by the right culture and working on providing the right incentives to grow sales and cash flow.

Third, real estate. We purchased these 23 leased locations for a total consideration of $11 million. So at less than $500,000 per restaurant, we've acquired some great locations with newer buildings. The replacement cost of these locations is well above the entry point. We also plan to make investments in the decor and to bring more warmth to these restaurants. This investment, combined with a seasonal marketing plan, will help Cheeseburger in Paradise build sales in the slower fall and winter months. This we see is the opportunity for the brand.

Now at this time, I'd like to turn the call over to Scott Gray to elaborate on some of our financial results. Scott?

K. Scott Gray

Okay. Thank you, Chris, and good morning, everyone. Before I review the financial results, I just want to remind you that the results contain approximately 10 weeks of Cheeseburger in Paradise. Since December 6, the date of the first day of business and bringing Cheeseburger in Paradise into, as part of Luby's family of brand, these locations have generated $7.7 million in sales. However, seasonally, this time period historically is not profitable for this brand as we have experienced and expected in the near-term as the new owners of the brand. To explain the seasonality, consider the following: Q2 average weekly sales based on historical trends are 22% lower than our fiscal Q3 time period and 29% lower than fiscal Q4.

So clearly, as the temperature rises, the sales increase at Cheeseburger in Paradise in the warmer months. We expect this brand to contribute to profitability in the second half of the fiscal year versus the first half of the fiscal year.

As I present the results for the restaurant segment, I will call out the results, excluding CIP for comparability to our restaurant results in the prior year.

Out total same-store sales, as Chris mentioned, for the quarter decreased 0.6%. One other point is we're moving the impact of the larger -- large sales declines at 2 Koo Koo Roo restaurant, same-store sales were down 0.4%.

This negative same-store sales quarter -- the last negative same-store sales quarter for the company overall was Q4 of fiscal year 2011, which was a 0.6% negative quarter. And the second negative quarter-- only the second negative quarter in the last 10 consecutive fiscal quarters.

Our Q2 2013's negative 0.6% compares to being up last year, 2.2% in Q2. And up 2.7% in 2011 and that is also matched with the prior year being down 12.5% in Q2 of 2010.

Now for our brand same-store sales results. Luby's Cafeteria same-store sales declined 0.6%, resulting from a 2% decline in traffic, which was partially offset by 1.4% increase in average spend per person. When you breakdown that decline in traffic, we find that the core customer is actually flat to slightly positive with the declines coming from reduction in some breakfast sales and other lower-cost limited time offerings over the prior year. Luby's Cafeterias' same-store sales decrease was relative to the prior year second quarter sales comp of 2.2%. The traffic was relative to a comp decrease of 0.7% last year.

Now for Fuddruckers same-store sales. Fuddruckers same-store sales declined 0.2% with a 2.5% decline in customer traffic, offset by an average spend per -- partially offset by an average spend per person rising 2.3%.

Fuddruckers' same-store sales decrease was relative to the prior year's second quarter sales comp of a positive 6.8%. The traffic -- relative traffic comparison was an increase of 2.3% last year.

Now let's move on to our total restaurant sales. Total restaurant sales grew 11.9% or $8.8 million to $82.2 million compared to last year's second quarter of 73.4%. Rolling the dollars forward, we've added $7.7 million from Cheeseburger in Paradise in the quarter; $2.8 million for new units that have been opened less than 12 months, there's 8 of those; less $1.3 million in foreclosed units; and then, a flat contribution from 2 units that have been opened longer than 12 months but not yet included in same-store sales; minus the balance of same-store sales decline of minus $0.4 million to arrive at the $82.2 million for the quarter.

Total Fuddruckers sales rose 4.6% to $21.9 million due to the contribution from the 8 locations that opened over the past year, partially offset by the loss of sales from 2 closed Fuddruckers. Before we elaborate on our Culinary Contract Services and other restaurant revenue -- excuse me, revenue sources, let's continue with the major expense line items from our restaurant segment of the business.

Cost of food, as a percentage of restaurant sales, rose approximately 60 basis points to 28.9% versus last year's second quarter of 28.3%. Excluding Cheeseburger in Paradise, food cost as a percentage of restaurant sales was 28.8%. And this compares to 28.2% last quarter, sequentially, on a comparable basis.

Now for the food cost of food by brand. Luby's cost of food was 29% compared to 28.3% last quarter and 28.1% last year. The year-over-year rise in food cost stems mainly from inflation of beef, chicken and seafood prices at our -- seafood prices. We also were affected by the change in mix of menu offerings served, including an increase in the participation of free kids meals.

Food cost inflation on our basket of core food items at Luby’s was up 2.8% in the quarter. Fuddruckers' food costs was 28.1% compared to 27.9% last quarter and 28.8% last year. This year-over-year decrease in food cost was partially due to the food cost prices on our basket of core food items being down 1.6% at Fuddruckers. The remaining is due to the effective utilization of our CrunchTime! tool.

Cheeseburger in Paradise cost of food was 30.6%, which is consistent with their historical results. We have begun testing our new menu at selected test stores, and we'll be monitoring the impact on food cost as we proceed forward.

Payroll and related cost as a percentage of restaurant sales were 35.1% in Q2. Excluding Cheeseburger in Paradise, it was 34.6%, the same as last year. Luby's payroll and related cost was -- Luby's Cafeterias payroll and related cost was 35.5% compared to 35% last quarter and 35.9% last year, an improvement over year-over-year where the sales declined.

Fuddruckers payroll and related cost were 32.2% compared to 32.6% last quarter and 31.2% last year. The year-over-year increase is due in part to new store openings. As discussed on our last conference call, during the first several weeks of the operations at a new location, we frontload staffing to make sure our guests receive an exceptional experience so that they will want to return. We also conducted more training during the initial timeframe as our staff moves up the learning curve. These elevated post-opening labor costs are not classified as opening expenses. Our team is continuing to increase effective utilization and organization of our system tools to drive results and accountability going forward.

Cheeseburger in Paradise payroll and related costs were 39.5% compared to historical annual results, which were trailing October 2012 trailing 12 months results of 32.7%. The higher labor percentage in this quarter is primarily due to seasonality, as I mentioned earlier. Our new team members at Cheeseburger in Paradise are beginning to utilize Luby’s systems more frequently on a daily and weekly basis to get the KPI tools, as well as restarting implementation of existing tool features that they had in place but not yet utilized going forward. We expect Q3 and Q4 labor percentages to improve as a percentage of their sales as the sales increase seasonally.

Overall, payroll-related cost for the company were also impacted by an increase of $181,000 in our workers' compensation estimated liability due to a change in our insurance deductible for our fiscal 2013 claims. And this compared to the prior year where we had a reduction in workers' comp expense last year of $100,000 resulting in a 30 basis points impact on labor cost as a percentage of Luby's and Fuddruckers restaurant sales.

Moving on to operating expenses. Operating expenses as a percentage of restaurant sales were 23.8%. Excluding Cheeseburger in Paradise, operating expenses rose 120 basis points to 23.2% versus prior year's second fiscal quarter of 22% due to increases in services, utilities, restaurant supplies, insurance and marketing expenses.

Due to the lower same-store sales levels and no price increases, as Chris mentioned, we were unable to leverage our increasing operating cost. Store level profit margins declined to 12.1% in the second fiscal quarter, including Cheeseburger in Paradise. Without Cheeseburger in Paradise, store level profit margins in the second quarter was 13.4% compared to 13.1% last quarter and down from 15.2% last year. The decline in store level margins was due to the decline of same-store sales and higher cost of food and higher restaurant operating expenses. Year-to-date store level profit, excluding CIP on a comparable basis, is down 1%.

Now on to Culinary Contract Services. Revenue was down approximately 12.6% versus last year. Although our revenue declined, our portfolio of agreements has strengthened. As we have mentioned in the past, we are focusing on growing these operations by concentrating on locations that generate sufficient returns on capital invested and lower risk. During this year's second fiscal quarter, we produced $265,000 more in operating profit before corporate overhead versus last year's comparable quarter from our Culinary Contract Services segment. Our franchise revenue declined slightly to $1.5 million from $1.7 million last year in the quarter. The $113,000 decrease resulted from an $18,000 decline in franchise royalties and a $95,000 dip in franchise fees.

Since last year at this time, we have added 4 franchisees while 7 units have left the system, 2 which we had picked up, leaving us with 119 Fuddruckers franchise units. As Chris has already elaborated on, we are gearing up for franchisee expansion, both domestically and internationally.

Now onto our balance sheet. We ended the second quarter with $2.9 million in cash and $23.5 million available under our revolving credit facility. Due to the Cheeseburger in Paradise acquisition, the purchase of 2 parcels of land and the paying of our property taxes in January, we had $25.5 million outstanding on our credit facility, up from $11.5 million last quarter. We continue to actively market our remaining 7 owned real estate properties, which are estimated at $6.2 million in net realizable value on our balance sheet. Please note one 2009 closure planned property previously leased to a third-party was reclassified from continuing operations to discontinued operations in the quarter. As we have in the past, we will utilize the proceeds from property sales to pay down debt and to fund future capital expenditures for expansion, including new unit development and remodels.

Now on to our cash flow statement. During the first 6 months of 2013, we generated $7.6 million in cash flow from operations. During the first 2 quarters, we invested $11.4 million in property and equipment and $10.7 million for the purchase of CIP, Cheeseburger in Paradise. Year-to-date capital expenditures by area is as follows: Recurring capital expenditures of about approximately $3.8 million; new units of $3.2 million; land, $2.7 million; and remodels and other, $1.5 million, for a total of $11.4 million.

We have continued to update our bank group on our progress this year and have begun credit facility renewal discussions. Our credit facility matures September 1, of 2014. We expect to renew our agreement with updated terms to support our future growth requirements by the end of the fiscal year.

I would like now to go over our revised annual guidance. During the recent development of negative year-over-year sales, as Chris spoke to, combined with some margin pressure as we have reported in our second quarter and year-to-date, we're revising our annual guidance. As outlined in our press release, we now expect our same-store sales for fiscal 2013 to be flat to down 1%. And we anticipate generating earnings per diluted share in fiscal 2013 for the full year to be in the range of $0.21 to $0.25. As stated before, our projections are sensitive to same-store sales trends. And we are now believe that the risk to our projections are tilted toward downward revisions in the event that current macroeconomic environments deteriorate from current levels. Our team is as focused as ever on the current quarter to correct the unfavorable sales and cost trends as soon as possible. We have been successful before in turning traffic count and sales in the right direction and we'll be focusing on the initiatives Chris outlined. We look forward to speaking with you following our next quarter for Q3 results. And with that, I'd like to turn it over for some questions.

Question-and-Answer Session

Operator

[Operator Instructions] And I am currently showing no questions in the queue. I will turn it back over to the presenters for any closing comments.

Christopher J. Pappas

Well, this is Chris Pappas, and I'd like to thank you, all, for joining us on the call today. We look forward to speaking with you again in June for our third quarter earnings call. Thank you.

Operator

Ladies and gentlemen, this does conclude the conference call. If you'd like to listen to a replay of today's conference, please dial (303) 590-3030 and entering the access code of 4604208. Thank you for your participation. You may now disconnect.

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