Kona Grill, Inc. Q3 2009 Earnings Call Transcript

Oct.27.09 | About: Kona Grill, (KONA)

Kona Grill, Inc. (NASDAQ:KONA)

Q3 2009 Earnings Call Transcript

October 27, 2009 5:00 pm ET

Executives

Mark Robinow – Chief Financial Officer

Mark Bartholomay – Interim Chief Executive Officer

Analysts

Robert Brown – Craig-Hallum

Mark Smith – Feltl and Company

John for Brad Ludington – Keybanc Capital Markets

Operator

Welcome to the Kona Grill third quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the conference call over to Mr. Mark Robinow, Chief Financial Officer.

Mark Robinow

Good afternoon everyone. By now you should have access to our third quarter earnings release. It may also be found on our website at konagrill.com under the investor relations section. Before we begin formal remarks, I need to remind everyone that part of our discussion today may include forward-looking statements. These statements are not guarantees of future performance and therefore undue reliance should not be placed upon them.

We refer all of you to our recent filings with the SEC for a more detailed discussion of the risks that could impact our future operating results and financial condition.

With that, I’d like to turn the call over to Mark Bartholomay, our Interim Chief Executive Officer.

Mark Bartholomay

Thank you all for joining us today. We’d like to cover several items during the call. First I’ll open with some brief comments about the third quarter. Mark will then discuss in detail our financial results as well as our guidance for Q4. I will then wrap up the call with some final thoughts before turning the call over to Q&A.

Third quarter sales were $20.2 million which was at the low end of our guidance. Same store sales declined 9.9% during the third quarter which is consistent with the first two quarters of the year, but still a disappointing figure which is reflective of the current economy in the local markets in which we operate. Net loss was $0.11 which was also within our guided range.

With sales difficult to predict and promote, we believe that providing a memorable guest experience while managing costs is where we should focus our operation. During the quarter we were able to achieve savings through continually managing our food costs while also benefiting from favorable pricing in the overall commodity environment.

Our restaurant level contribution declined due to lower average weekly sales that resulted in a deleverage of fixed labor, operating and occupancy costs. Restaurant operating profit margin was 14.1% for the quarter compared to 17.8% last year.

While the overall environment is likely to remain challenging for the foreseeable future, we continue to focus on the things we can control to improve the guest experience and drive the top line. At many of our mature stores we are remodeling and making improvements in the rest rooms, patios, dining room and other areas.

These efforts reflect modest capital expenditures that go a long way in keeping our restaurant fresh while presenting a new and better guest experience.

In November we plan to roll out a new menu which includes a local favorite section to each menu. We experienced early success with the local favorite offerings at our Eden Prairie location which was our first implementation and believe that granting limited and improved menu authority to our local management is a key part of enhancing the guest experience.

This will add to changes that we made during the second and third quarter of this year where we expanded the number of options at our restaurants and allowed local management to choose a number of beer and wine options to meet the local guest taste.

Our same store sales for the quarter includes only a 1% increase in price versus last year, one of the lowest in our industry. The November menu roll out will include a price increase of approximately 1.7% spread throughout our day part.

We tested several promotions during this third quarter designed to drive sales and several of these were quite successful. We’ll be using those again in the fourth quarter on a broader scale. Our efforts were partially offset by our competition which discounted aggressively in August and September, a trend we see continuing in October.

While we continue to believe that our menu and offering provide great value, given the competitive landscape we will also become more aggressive in our advertising. In addition, we are planning frequent promotions in the fourth quarter focused on building guest frequency and new trial.

With that I’ll turn the call over to Mark Robinow, our CFO.

Mark Robinow

For the third quarter ended September 30, restaurant sales increased 3.7% to $20.2 million, reflecting additional revenue from five restaurants opened since last November. Sales comparison continue to be negatively impacted by reduced traffic of about 6% and an approximate 12% decline in average check.

Overall, same store sales declined 9.9% inclusive of a 1% increase in pricing year over year. This compares to a 10.3% decline in same store sales for the same period in 2008 and a 9.5% same store sales decline in the second quarter this year. It’s worth noting that even though our same store sales base experienced negative comps, these 17 restaurants contributed over $2.6 million in restaurant operating profit during the quarter.

Average weekly sales for the five restaurants opened the entire quarter not included in the comp base was $56,138, down 28.9% compared to the same quarter in 2008. Four of the five restaurants, Gilbert and North Phoenix Arizona, Richmond Virginia and West Palm Beach Florida are in climates where third quarter sales are seasonally low.

Even though we plan for this seasonality, most of the restaurants not included in the comp base performed below our expectations, contributing $.2 million operating profit during the quarter.

Cost of sales as a percentage of restaurant sales decreased 90 basis points to 26.1% during the third quarter from 27.0% last year as lower prices for certain commodities and operational efficiencies contributed to the lower average food comp.

Labor expenses as a percentage of restaurant sales increased 190 basis points to 35.3% during the third quarter from 33.4% last year. The higher labor costs are mostly attributable to a greater percentage of restaurant operating weeks for our new stores as labor expenses are typically higher than normal during the first several months of operation as well as the deleveraging of fixed salaries due to the decline in same store sales.

We expect labor as a percentage of sales to flatten out as our newer stores continue to mature and we realize the benefits of recently implemented labor staffing models. This will be partially offset by the July Federal minimum wage increase.

Restaurant operating expenses increased 100 basis points as a percentage of restaurant sales as a result of higher advertising and market costs and the deleveraging of fixed operating costs. During the third quarter we also paid more for menu printing and taxes on personal property compared to the third quarter of 2008.

Occupancy expenses as a percentage of restaurant sales increased 170 basis points to 8.2% during the quarter compared to 6.5% last year. The increase as a percentage of restaurant sales is due to increased common area cost allocations at many locations along with a decrease in the third rent credit at several locations with rent concessions coupled with deleveraging of the fixed portion of these costs.

Combining these four line items, restaurant operating profit was $2.8 million or 14.1% of restaurant sales compared to $3.5 million or 17.8% of restaurant sales last year. Reopening expenses were $480,000 in the third quarter compared to $471,000 last year.

The majority of these costs relate to the September of our Eden, Minnesota restaurant and the scheduled opening of our Tampa, Florida restaurant in November. Our cash cost of preopening expenses is approximately $400,000 per restaurant.

Depreciation expense as a percentage of restaurant sales increased 50 basis points to 9.0% of restaurant sales during the third quarter from 8.5% a year ago. The increase reflects decreased leverage on the top line partially offset by a reduction of depreciation expense due to the asset impairment charge we took in the fourth quarter of 2008 for our Lincolnshire, Illinois restaurant.

General and administrative expenses decreased $500,000 during the quarter due to lower salary and benefit costs resulting from the January 2009 down sizing of our corporate office staff and cost containment efforts. As a percentage of sales, G&A decline 280 basis points to 7.9% during the quarter compared to 10.7% last year.

Net loss for the quarter was $1 million or $0.11 per share. Last year we posted a loss from continuing operations of $733,000 or $0.09 per share. Please note that in accordance of FAS 128 earnings per share for the purpose of computing the basic and diluted number of shares, we adjusted the number of common shares outstanding prior to June 9, 2009 by a factor of 1.2309 to reflect the impact of a bonus element associated with our offering of common stock issued to stockholders on June 9, 2009.

We ended the quarter with $8.8 million in cash and investments. Excluding the $5.8 million in student loan backed option rate securities on which we have borrowed against up to our limit; we have a net $3.0 million of cash and investment available to fund our capital investments and operations.

We continue to pursue equipment leases to provide additional capital and we are cautiously optimistic regarding our ability to secure such financing as soon as the first quarter 2010.

During the third quarter net cash provided by operations was $1 million. We spent $3.4 million on capital expenditures during the quarter for remodeling and building new restaurants.

For our fourth quarter financial guidance we are forecasting sales of $20 million to $21 million and a net loss of $1 million to $1.5 million or $0.11 from $0.16 per diluted share. Our forecast reflects continued weakness in consumer spending and uncertainty of when traffic trends will improve.

We currently expect Tampa to open in mid November.

Now I will turn the call back to Mark before we go to Q&A.

Mark Bartholomay

I wanted to give a brief update on our CEO search. As mentioned on our last call, the Board of Directors hired HBS Executive Search to source candidates for this position. At present the Board has identified a short list of qualified candidates and they are thoroughly venting them. The Board hopes to have the process wrapped up in the next several weeks.

As Mark indicated our available cash and cash flow from operations allows us to complete construction of the Tampa, Florida restaurant this year and the Baltimore, Maryland restaurant in 2010. We will sign additional leases based on significant economic opportunity and the available of affordable debt capital or sufficient capital from operations, although we have no other commitments at this time.

Finally, I want to reiterate that while the current quarter’s results were less than stellar, we remain committed to impressing the guest’s one table at a time and operating our restaurants as efficiently as possible.

While there is great debate as to when the restaurant sector will turn around, we believe we are well positioned to navigate the difficult times we are in and generate our historically strong operating profit margins once traffic rebounds.

Thank you for your time today. We’d be happy to answer any questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Robert Brown – Craig-Hallum.

Robert Brown – Craig-Hallum

[inaudible] in your comp base units and compare to the non comp units?

Mark Robinow

I’m sorry we didn’t hear the first part of your questions.

Robert Brown – Craig-Hallum

I was wondering what the margins were in your comp units compared to your non comp units. It sounds like the non comp units were really break even, I’m just wondering what the unit level margin was in the comp units.

Mark Robinow

As a group it was in the lower single digits with most of our restaurant operating profit coming from the comp base unit.

Robert Brown – Craig-Hallum

That was my question. What was the margin in the comp base units?

Mark Robinow

It was about 17.8%.

Robert Brown – Craig-Hallum

Do you have some color on why the non comp units struggled? Are they having trouble ramping up or are they in economic areas that are weaker than your average? Do you have a sense on why those are trailing the pack?

Mark Bartholomay

The four restaurants discussed, two of the restaurants are in father out suburbs of Phoenix where the housing and the economy have been very difficult. At the West Palm Beach location we’ve heard from established operators in the market that told us the season didn’t show up due to the winter birds not showing. So we’ll see how that goes in our second.

And the last one mentioned was Richmond which we’re very happy with our acceptance there and the bonds that we’re getting through late summer. And as we anticipated, about August it really slowed down there.

Mark Robinow

As we said in the script, four of the five restaurants in the non base are in southern climates and you would expect the third quarter or summer months to be the lowest seasonal sales for that group of restaurants, and also affected their performance during the quarter.

Robert Brown – Craig-Hallum

What is your sense of how things have gone since quarter end? Have you seen any degradation or improvement relative to the trends, or how are the trends in Q4?

Mark Bartholomay

Q4 trends to this point during October are actually the same as we experienced in the third quarter.

Robert Brown – Craig-Hallum

I wanted to get your strategy on pricing in November. It sounds like you’re raising the pricing in November but you also indicated that the price of competition is affecting you. I’m just wondering why you’re choosing to raise price with the next menu increase. Do you see that as a risk?

Mark Bartholomay

We are doing it throughout all of our day parts and all of our issues. We carefully analyzed the competition and sales data to where we thought the changes would leave us with some great value. I think there’s always a risk, but we think it’s very manageable.

Also, we’re coming in basically at the end of September, we came into October 1 with a zero price increase from a year ago which is pretty aggressive versus others in the restaurant business. So we think our value is still intact.

Robert Brown – Craig-Hallum

What’s your thoughts on Baltimore opening? Is that still Q1 of 2010 or do you see that later in the year?

Mark Bartholomay

That has been Q2. However at this time we haven’t received the approvals for our design with the city so at some point in time that may begin to impact the opening day if that doesn’t proceed in an orderly fashion.

Operator

Your next question comes from Mark Smith – Feltl and Company.

Mark Smith – Feltl and Company

Can you repeat what you said about your cash position so I can make sure I jotted it down correctly?

Mark Robinow

We had $3 million in net cash and what we said about that was it was sufficient to get us through basically the Baltimore opening and the year 2010.

Mark Smith – Feltl and Company

Average check I guess with and without alcohol and then any comments on adult beverage sales during the quarter.

Mark Robinow

Average check was down about 4% in the quarter to about $23.00 and it was basically no change in the alcohol/food mix and so we really saw the same span hit both alcohol and food.

Mark Smith – Feltl and Company

You talked a little bit about advertising spend being up a little bit here in Q3. Can you quantify that?

Mark Robinow

We were up about 40 basis points in advertising spend here in Q3 ’09 versus the same quarter last year.

Mark Smith – Feltl and Company

Can you give a rough dollar around that?

Mark Robinow

It was 1.5%.

Mark Smith – Feltl and Company

The G&A rate, G&A definitely came down during the quarter and I’m assuming that still had some search firm for the new CEO. Could you just talk about how sustainable that level of G&A expense, kind of all over the place this year, give us any insight to what we should be looking at going forward for G&A.

Mark Robinow

The current rate we had some expenses for the search in the third quarter. We will have more of them in the fourth quarter and we were also more normalized on our legal fees in the third quarter than obviously we reported in the second. We had some extraordinary fees and items during that quarter. So we think that our G&A is fairly normalized at the current levels without unusual items impacting us during a given quarter.

Mark Smith – Feltl and Company

Just looking at different regions, excluding seasonality, have you seen any improvement in Arizona with your customer and average spend there?

Mark Robinow

Arizona is pretty flat. We don’t see further degradation but it’s not showing rapid improvement either.

Operator

Your next question comes from John for Brad Ludington – Keybanc Capital Markets.

John for Brad Ludington – Keybanc Capital Markets

What same stores sales results are 4Q estimates being based upon? Is that at a current level or is that lower or higher than what we had in 3Q?

Mark Robinow

They’re at minus 9%.

John for Brad Ludington – Keybanc Capital Markets

What kind flow through additional sales or same store sales have on the bottom line like for an additional 100 basis point improvement? What kind of EPS flow through do you have?

Mark Robinow

At the range of where we are in our operating parameters, we can see about 40% flow through of additional sales dollars.

John for Brad Ludington – Keybanc Capital Markets

So you don’t have to get positive to get that kind of level?

Mark Robinow

No. We’re at the point where the P&L is pressured by a lot of fixed costs and so we get a high amount of flow through from additional revenue.

John for Brad Ludington – Keybanc Capital Markets

I was wondering about, you mentioned the competition with discounting thickened in the quarter and you’re kind of eyeing that going forward. Are there specific chains that are affecting that? Is this Applebee, Chili’s; is it more on the higher end? Who are these discounters?

Mark Bartholomay

We’re looking at pretty much everybody. When you look at it, a lot of people have the price fixed all the way up to the McCormick’s, the Chang. It’s pretty much everybody really, and you can go down to the dollar guys at the Burger King if you wanted to, but it’s pretty much industry wide.

I think impacting us heaviest is the Chang’s, the McCormick’s the raw sushi, the type of people that we would consider would be comparable to ourselves.

Operator

Your next question comes from Robert Brown – Craig-Hallum.

Robert Brown – Craig-Hallum

You had mentioned about lease financing. What’s your strategy there and do you intend to sign more leases next year if you get that or are you putting that in place as a buffer in case you need additional cash for some reason.

Mark Bartholomay

At this point it’s a buffer. As Mark said earlier, we would only consider leases that had absolutely great economics and were very high probability of generating a significant amount of cash flow. So the lease financing that we’re contemplating would be for additional restaurant remodels and as cushion to our balance sheet.

Operator

Your next question comes from John for Brad Ludington – Keybanc Capital Markets.

John for Brad Ludington – Keybanc Capital Markets

Could you clarify what you meant about the 4Q labor line? When you said that was kind of flat did you mean from 3Q levels or from the previous year?

Mark Robinow

From the third quarter levels.

Operator

With no more questions I’ll turn the call back over to Mr. Bartholomay.

Mark Bartholomay

Thanks a lot for being on the phone today folks, and we’ll keep swinging as hard as we can here. Have a great night.

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