Kona Grill's CEO Discusses Q3 2013 Results - Earnings Call Transcript

Oct.30.13 | About: Kona Grill, (KONA)

Kona Grill, Inc. (NASDAQ:KONA)

Q3 2013 Earnings Call

October 30, 2013 5:00 PM ET

Executives

Berke Bakay – President and CEO

Christi Hing – CFO

Analysts

Mark Smith – Feltl and Company

Conrad Lyon – B. Riley & Company

Jason Goins – Wellington Management

Operator

Good afternoon and thank you for joining us today to discuss Kona Grill’s Results for the Third Quarter ended September 30, 2013. 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 your questions. (Operator Instructions)

Before I begin, I would like to remind everyone that the financial guidance the company provides for its fourth quarter and full year 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 risks 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 sir.

Berke Bakay

Thanks, Cowen. Good afternoon and thank you all for joining us. For the third quarter ended September 30, 2013 we exceeded our expectations and outperformed many of our industry gears with strong same-store sales growth of 2.6%.

We’re encouraged by these results as it demonstrates the strength of our brand in this challenging economic environment. While many in our industry segment experienced traffic decline during the quarter we saw guests traffic increased as a result of innovative food and drink offerings. During the quarter we content to take market share as a 2.6% increase in same-store sales posts a 2.5% increase in Q2 2013. With our positive same-store sales of 2.6% and Navtrak reporting Q3 same-store sales of negative 2.5%, the gap between us and overall industry has widened to over 5%.

Average weekly sales increased 12 of the 13 weeks during the quarter with only negative week due to the July [4] calendar shift. Traffic was up 1.6% during the quarter while average check increased approximately 1% due to the price increase we took earlier in the year. However, the increase in average check was partially offset by the success of our promotional offerings such as additional Sunday happy hour in many of our restaurants in 2013.

During the third quarter we experienced some food cost pressure which cut into our operating margins. However, we were still able to deliver restaurant operating margin of 18% for the seasonally stored third quarter and stand at 19.1% year-to-date. Finally, we’re very excited to return to growth mode with the grand opening of our Boise restaurant that took place a little over a week ago. The restaurant has gotten off to a great start and we’ll provide more color on this restaurant’s performance during our Q4 earnings call.

I’m very pleased with the design and the feel of this restaurant and I’m confident that our management team and coworkers will be able to deliver a great experience to our guest in this market,

With that I would like to turn the call over to our Christi who will take us to the financials for the third quarter and provide guidance for the fourth quarter and full year. Afterwards I will discuss our development pipeline and current operational initiatives 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 third quarter ended September 30, 2013 restaurant sales increased 2.6% to $24.5 million compared to $23.9 million in the third quarter of 2012. Sales were strong throughout the quarter, fueled by a 1.6% increase in guest traffic and 100 basis points increase in the average check, which was driven by the 3% price increase we took at the end of Q1.

Revenue for the third quarter included a full quarter sales from our Scottsville and San Antonio restaurants as the timing of the respective remodels has shifted for both from starting in mid-September to October. I’d like to note that our Q3 guidance assumed that the remodels of these two restaurants would start in mid-September. Therefore, the remodels for both locations has shifted to starting in October and being completed by Thanksgiving.

Due to the expensive nature of both remodels, we expect to lose 6 full operating weeks from these restaurants during Q4 and naturally will experience the sales decline at these restaurants during a portion of their remodel period due to last week. Both restaurants are currently closed due to the extensive work being performed which Berke will discuss later on.

Cost of sales as a percentage of restaurant sales kicked at 20 basis points to 27.6% compared to 27.4% last year. As many of peers have reported, inflationary pressures [we two] [00:00:33] were experiencing similar cost increases attributed to higher beef, chicken and produced prices compared to last year as long as the significant escalation in shrimp prices due to early mortality syndrome.

We are mainly strived on purchasing initiative and have several plans to try to mitigate pricing pressures that we have seen over the past few months. But expect the cost pressures we experienced in Q3 to continue into Q4 to some extent. However, due to the diversity of our menu, and our 30% alcohol mix we are somewhat insulated from significant increases in commodity costs except in our overall cost of goods.

Labor expenses as a percentage of sales increased 10 basis points to 33.8% during the quarter compared to 33.7% last year. The uptick in labor expenses is attributed to the rebalancing of our teams as we prepare for growth. As we have discussed previously, our goal is to open each new restaurant with a mix of seasoned Kona Grill managers and local management talent.

Occupancy expenses as a percentage of restaurant sales increased 30 basis points to 6.9% during the third quarter which was in-line with our expectations. As we stated throughout the year we expect to incur higher occupancy cost in 2013 as compared to 2012. Under GAAP accounting we are required to spread the unamortized tenant improvement allowance and straight line rent for a longer period as we exercise lease extension options. This result in a smaller deferred rent credit each period and therefore higher occupancy expense.

Restaurant operating expenses as a percentage of restaurant sales were flat at 13.8%. We expect to see restaurant operating expenses increase as a percentage of sales in the fourth quarter as we incur a remodeling cost for our Scottsdale and San Antonio locations these costs don’t qualify for capitalization. Four-wall margins were 18% during the third quarter compared to 18.5% last year. As we’ve discussed on previous calls we target our restaurant operating profit in the 18% to 19% range. And has been our historical seasonal trend we typically experience lower operating margins in the third and fourth quarters of this year. On an absolute dollar basis, restaurant operating profit was flat year-over-year at $4.4 million.

General and administrative expenses in the third quarter increased by $144,000 or 8.2% compared to the prior year. As discussed on previous calls the increase is attributable to plan human capital investments in 2013 to support our growth initiatives. We forecast our G&A as a percentage of sales to be under 8% for the full year 2013 and expect to leverage G&A spend as we execute upon our growth strategy and open new restaurant.

We spent $356,000 or $0.04 per share on pre-opening expenses during the quarter primarily for our restaurants in Boise and the Woodlands. On average we had spent just been approximately $400,000 in cash for each new restaurant opening which primarily consist of training, travel, relocation and other expenses associated with opening a new restaurant as well as $50,000 to $100,000 in non-cash pre-opening rent.

F or the quarter we recorded income tax expense of $34,000, compared to $0 in the year ago quarter. The current quarter income expense reflects a $26,000 tax refund related to NOL carry backs for previous tax years, including this benefit the effective tax rate for the third quarter was 4.9%. For the full year 2013 we estimate our effective tax rate to be between 10% and 12% compared to less than 1% in 2012. Net income in the third quarter of 2013 was $660,000 million or $0.08 per share compared to $984,000 million or $0.11 per share in the year-ago quarter.

At September 30, 2013 we had $9 million in cash compared to $8 million at December 31, 2012. During the first nine months of 2013 we generated $6.8 million in cash flow from operating activities and also spend $5.2 million on capital expenditures primarily for Boise and the two Texas restaurants we currently have under construction. We did not purchase any shares under our buyback program during the quarter.

Now turning to our fourth quarter 2013 financial guidance. We are forecasting restaurant sales at $24.5 million, our Q4 sales guidance incorporates our Boise restaurant which opened on October 18, and the planned opening our other restaurant in the Woodlands in mid-December. The scheduled opening has been delayed a few weeks from originally anticipated as we are constructing on the first floor of an office building that is currently occupied.

Our Q4 sales guidance also reflects approximately $0.5 million in lost sales associated with the Scottsdale and San Antonio remodels. Scottsdale closed on October 21, and is expected to be closed for four weeks. Well San Antonio closed on October 28, and is expected to be closed for two weeks. In addition, sales have been impacted during the remodel due to lost seats including the closure of the patio in Scottsdale since October 7.

Our Q4 guidance reflects positive same-store sales are approximately 3% excluding the impact of remodels as we continue to build upon the positive traffic trend we saw in Q3. The 3% cost guidance that based upon quarter-to-date sales trend and what we forecast for the remainder of the quarter.

The $24.5 million in projected sales of Q4 compares to sell the $23 million in the same year ago quarter. For 2013 we are forecasting revenues as $98.3 million which incorporates full year same-store sales guidance of approximately 1.4% excluding remodels. This compares to sales of $96 million in 2012.

The timing of new restaurant openings and pre-opening expected in particular has and will continue to significantly impact our year-over-year bottom line comparisons. In addition, we anticipate that our new restaurants generally take approximately six months to achieve a majority of the operating efficiencies and therefore expect the opening of Boise and the Woodlands and pre-opening expense is related to the Q1 opening of four-wall to impact our Q4 earnings by $0.10 to $0.11 per share.

With that said, for the fourth quarter we are forecasting our loss of $600,000 or $0.07 per share at the given consideration to approximately $0.18 per share in pre-opening and other cost associated with operating new restaurants, lost sales and profit associated with the remodel of two restaurants including the write-off of the remaining book value of furniture, fixtures and equipment that will be replaced and the G&A investments we discussed earlier. On an apples-to-apples comparison, if you exclude the $0.18 and cost discussed above, net income is projected to be a $0.11 per share in Q4 compared to $0.10 last year.

I would now turn the call back to Berke before we get a Q&A. Berke?

Berke Bakay

Thanks Christi. As Christi mentioned, we’re currently renovating both of our Scottsdale and San Antonio restaurants. I want to provide some color regarding each model as they’re more expensive than what our remodels have been in the past.

Scottsdale was our first restaurant and it’s 15 years old. We’re able to negotiate a new lease on more favorable terms compared to our existing lease, which expires at the end of 2013. And also secured some tenant improvement dollars form the landlord to help it to remodel.

When we opened this restaurant we took over a previous restaurant space. So the rare and care of 20 plus years of operations has taken and installed on the building and therefore upgrades, replacements or installations are needed for HVAC and planning fire systems electrical to comply with tenant code as well as other back-of-the-house items that aren’t included in a typical remodel.

We’re also completely revamping the bar and patio area to give it a fresh in modern [indiscernible] and reinforces position as the destination of choice in this straight area. The remodel will also include a new aquarium, new bathrooms and new furniture and fixtures that consistent with our current design palette. We are very excited about the new look and have high expectations for the flagship restaurant once it reopens.

For our San Antonio restaurant the remodel is driven by the expansion of our patio area to seat an additional 50 to 60 guests. This patio is always been a popular spot and the expansion will last to better serve our guests during busy times. To expand the patio also requires us to fully reconfigure the restaurant which in influence relocating the sushi bar, aquarium and restrooms.

The cost of building a new aquarium and installing new restrooms and building a bigger sushi bar are also now part of our typical remodel. And therefore the cost including furniture associated with the new patio will be hired than our historical remodels. We believe the dollar spent are now worth it and we expect a high return invested capital from the remodel and the additional seats. Both remodels are scheduled to be completed before the holidays.

On the development front, we currently have signed leases for at least four restaurants openings in 2014 and next time two leases for 2015 openings. We continue to work diligently to create the pipeline for new restaurant expansion and achieve our target of doubling our sales over the next five years which translates the 15% compounded annual growth rate.

As we mentioned on our last call, sales growth in any given year may vary based upon the timing of new restaurant openings, but overall we are confident that the strength of our brand will enable us to meet this target. Timing of openings will vary based upon various factors including landlord delivery of the building, permitting, construction and other factors some of which may be beyond our control.

As I mentioned earlier, the Boise restaurant opened on October 18 and we expect our restaurant in the Woodlands has similar growth of our Houston to open at mid-December. Construction is continued on our four-wall restaurant which is currently scheduled to open in the first quarter of 2014. For 2014 we currently have four leases signed. The four lease – this input Fort Worth, Texas which we previously announced El Paso, Texas, Sarasota, Florida and Atlanta, Georgia. We also signed leases for new restaurants in Dolphin Mall in Miami Florida and San Juan Puerto Rico both of which are scheduled to open in 2015.

I’ll provide a little color on each of the locations that they’re going into. We’ll start with El Paso. As we have discussed in the past, the climate and business economics makes the state of Texas a very favorable place for us to do business, and this is no exception. The restaurant will be located at Fountains at Farrah, power lifestyle center located at I-10 and Hawkins. We believe the unit economics of this restaurant built is similar to our other Texas restaurants and therefore provide a great return on invested capital. We anticipate that this restaurant will open in Q2 2014.

East Sarasota we are going into Taubman’s new project called University Town Center. Sarasota has the demographics day part and household income that fit our target market. The center will have 880,000 square feet and the anchored by the First Saks and builders in the trade area, along with the mix of retail restaurants, hotels and a movie theater.

In Alpharetta, suburb of Atlanta we’re going into a project Avalon which includes 106 acre mixed use, open air center including 750,000 square feet of class A office space and an estimated 550,000 square feet of upscale shopping and dining including Whole Foods and Regal Cinemas.

For 2015 to-date we have signed two leases. In Miami we are going into one of our – four new restaurant pads that is being added to the mall. For those of you who aren’t familiar with the Dolphin Mall it contains over 1.4 million square feet and it is one of the busiest shopping malls in the country. Over 26 million people visited this mall in 2012 which provide us a great opportunity to introduce to Kona brand in this market.

Our other currently signed leases for the mall of San Juan in Puerto Rico. We will be going into a new luxury mall that we’ll have the first Nordstrom and Saks Fifth Avenue on the island. We are very excited to go into the center given the high volumes that and they’re imported by our direct competitors in the market.

On the operational side we continue to execute on various initiatives designed to drive traffic and increase guest frequency. For example, we keep our menu fresh and interesting we are highly successful in food based promotions. We rolled out our fourth and final based promotion of the year today. These promotions continued to be very successful and are at great way to try new menu items while gathering guest feedback.

At the end of September we rolled out four menu update. Where we added several successful food based promotion items to our permanent menu and took off lower volume items. We did not take any price with this latest update. We continue to see good results with our Sunday happy hour test and to-go program. We continue to believe that our strategy as an organization remained as clear. To keep building a premier poised casual concept that is distinguished by award winning sushi and new American cuisine with a significant bar business. We differentiate ourselves from our competitors by successfully executing three distinct businesses in four different day parts and believe our growth potential is prominent.

In conclusion I continue to be very excited about the future of Kona Grill. With strong AUVs, margins, and ROI metrics we are in embarking on something very special. Thank you for your continued support. With that, I would like to open the call up for any questions you might have. Kevin, please open the line for questions.

Question-and-Answer Session

Operator

Thank you Mr. Bakay. We will now begin the question-and-answer session. (Operator Instructions) And our first – excuse me, our first question comes from the line of Mark Smith with Feltl and Company. Please go ahead.

Mark Smith – Feltl and Company

Hi guys, first Christi just want to confirm something from your piece, did you say you expect G&A to be below 8% for the year?

Christi Hing

Yes.

Mark Smith – Feltl and Company

Okay so $2.1 million or less we should have a good idea on pre-opening expense so everything else kind of in your guidance to get to that $0.07 number is coming up in the restaurant level?

Christi Hing

Yes, when the pre-openings going to be majority of those expenses we said about $0.10 to a $0.11 and then also the impact of the remodels given that we’re losing 6 full operating weeks that is significant for you know our base of 23 restaurants or 24 restaurants now.

Mark Smith – Feltl and Company

Okay. And then, can you just give us a good reminder of when restaurants open I think you guys said that it typically take about 6 months to kind of hit the efficiency if you will on a restaurant level margin basis, is that right, and could you talk about kind of honeymoon period in sales that you’re expecting on these openings?

Christi Hing

Yeah that is right, it takes about 6 months until we you know, typically more or so on the labor and cost of goods sold as far as scheduling efficiencies and ordering to get that to kind of our restaurant level cash flow margins that you know in the teen range. So typically about 6 months. I don’t know Berke you want to speak on Boise a little bit?

Berke Bakay

Sure well specifically again with I don’t have too much to add on what that Christi had said on the efficiencies in general what we expect but as specifically to Boise it’s been only a 11, 12 days but it is actually it’s our second biggest opening in the company so again I hate to extrapolate results just given of 11, 12 days of sales data, but you know again with a base of 24 restaurants something like Boise coming out strong initially could change those dynamics relatively speaking.

Mark Smith – Feltl and Company

And just timing and cadence of openings as we look at 2014 you know we’ll have one probably Q1, should we look at the remainder of those most likely fallen into the second half?

Berke Bakay

No, we also expect to open our El Paso restaurant in Q2, so of 2014 and rest of them I would just project that back of the year.

Mark Smith – Feltl and Company

Okay and then I think my last question just looking at some of the food inflation that I saw here in the quarter and expectations that will continue that into Q4, you didn’t take any price on this last menu and when is your next opportunity to really take price and how much of an opportunity do you think you can take?

Berke Bakay

Sure, well, let me address that. So again as we said in our prepared remarks we elected not to take pride in our rollout that we’ll take it in late September. And we always reserved a ride and you know act accordingly even outside of our window for scheduling menu plans. So to speak, if we see anything significant that requires that action but before similar patterns from last year you should expect us to roll out a new menu in March and given then we have just rolled out a new menu and haven’t taken price it’s still too early to really determine if we are going to take price or not in our March roll out.

Mark Smith – Feltl and Company

Great. Thank you guys.

Berke Bakay

Thank you.

Operator

(Operator Instructions) And our next question comes from the line of Conrad Lyon with B. Riley & Company. Please go ahead.

Conrad Lyon – B. Riley & Company

Yeah, thank you. First of all nice to see your comps best industry. Question regarding the revenue guidance for the fourth quarter, do you have the component that is being contributed by the new stores in the fourth quarter or is do you have an estimate that you could share us – with us?

Christi Hing

I guess for our guidance you can kind of extrapolate you know we did $23 million last year, we’re getting guidance as $24.5 million and we’re saying we’re losing about $0.5 million sales from the remodels and a 3% comp guidance so I believe you can extrapolate what we believe the new restaurant produced from that information.

Conrad Lyon – B. Riley & Company

Okay, fair enough. G&A, is there an average run rate that you expect to incur per store going forward or is it just too hard to estimate at this time?

Berke Bakay

Conrad, I will say that’s not – not that it’s too hard but you know we – start talking about kind of $1 million of investment last year and you know we definitely have undertaken that during this year. And all of the position if not most of the position if not all have already been filled so once we get out of this kind of year in end of this year we don’t expect another major step up in G&A so to speak until they are further into our growth in coming years. Obviously there will be here and there certain increases in G&A but we should be able to leverage the G&A with the sales increases that we’re expecting to experience.

Conrad Lyon – B. Riley & Company

Okay. Question regarding the alcohol, you may have stated this, what was the alcohol mix in the quarter?

Christi Hing

The alcohol mix was 30% and that continues to remain consistent throughout the years.

Conrad Lyon – B. Riley & Company

Okay, so again I’m just kind of got through my nose here so, was the alcohol it sound like some of the alcohol promotions or some of your items that grew like better, so I would assume then some of the other items kept up with mix, it sounds like your mix where it hasn’t changed the whole heck of a lot from what you normally see right?

Berke Bakay

Well what Conrad, what we referred to was the Sunday happy hour just rolling out in to more restaurants during the year versus last year here in north. So, and happy hour as you remember is not just alcohol but comes with food as well. So the point we were making there is really the baskets so to speak on kind of putting pressure on per person average is.

Conrad Lyon – B. Riley & Company

Okay, fair enough. In terms of commodities there was talk about some by a competitor that there is going to be some appreciation in alcohol prices, are you seeing something like that as well going into next year?

Berke Bakay

Yeah we are seeing a minimal increases in beer prices.

Conrad Lyon – B. Riley & Company

Okay.

Berke Bakay

But again I’ll just refer you to our commentary in general on COGs you know shrimp has been hurting I’m sure you heard from our competitors their comments but we’re locked in right now we have visibility and that’s I’ll leave it at that.

Conrad Lyon – B. Riley & Company

Okay. Remodels real quick here. Can you – two questions really can you talk about the list at the Chandler store and then what kind of if would expect from the upcoming remodels?

Berke Bakay

Sure, the list on the Chandler remodel it’s gone into almost year now it’s a low double-digits.

Conrad Lyon – B. Riley & Company

Okay.

Berke Bakay

And from what the run rate was and where it is today. So if you kind of run the numbers on what we spent you will see that similar return on invested capital matrix that we will expect from a brand new restaurant that’s what we have experience in Chandler.

And what the second part of your question I’m sorry?

Conrad Lyon – B. Riley & Company

Yeah, just what you expect for the upcoming remodels what type of list you would expect?

Berke Bakay

Sure well, I rather not get to granular on that but obviously we are adding some seat in San Antonio so, and Scottsdale just as we said it’s more early models so, we didn’t experience similar results or better results than Chandler I would always be disappointed.

Conrad Lyon – B. Riley & Company

Got you, okay. Last question here, depreciation and that doesn’t talk about general allowance is there inside I know is a little bit different from the development costs, but can you give us an idea what the depreciation more broad I guess this is going to baked into your guidance for the fourth quarter I’m just trying to get a sense of what’s been capitalized per store it sounds like you’re getting I don’t know if there is an average run rate of allowances that you’re getting or what do you expect but just trying to get a better handle of what we have to expect next year and so that can?

Christi Hing

Yes I met an investment cost Conrad is about $2.5 million in our TIs I think historically a range anywhere from you know $700,000 to may be $1 million, $1.2 million. So, you know you can figure growth investment costs of you know somewhere and you know 3.2 million to 3.5 range.

Berke Bakay

Conrad, one thing that I would add to Christi’s point are for the 2014 location that we have announced we don’t expect those metrics to change from the TI allowance we’re not going to get into details of each location and what the TI does, but we don’t expect those on net investment and return on invested capital ratios to change.

Conrad Lyon – B. Riley & Company

Okay, got it.

Berke Bakay

What we have shown in the past.

Conrad Lyon – B. Riley & Company

Got you, okay. Thank you very much.

Berke Bakay

Thank you.

Operator

And our next question comes from the line of Jason Goins with Wellington Management. Please go ahead.

Jason Goins – Wellington Management

Thanks guys. I was wondering if you guys could comment a little bit about what you’re seeing on quarter-to-date basis where obviously a third of the way through Q4 and certainly some of the industry data indicates that casual dining and family dining it seems to be trending above of what had been a pretty soft looking results industry-wide on Q2 and Q3?

Berke Bakay

Hi Jason. You know as a practice we don’t give guidance or we don’t extrapolate on our sales trends so far any quarter, but what I would like to remind is obviously we have taken to consideration of the trend that we’re seeing today and you know just given what the guidance that we have given last quarter and this quarter and the difference in that you should I mean I guess I’ll leave it to you for the rest of that, but we definitely take into consideration that we are seeing so far during the quarter before we issue that guidance.

Jason Goins – Wellington Management

Thank you.

Berke Bakay

Thank you.

Operator

And I’m showing no more questions at this time. Sir, if you’d like to continue with your closing remarks.

Berke Bakay

With $4.2 million average unit volume’s operating margin in the high 18 range and 23% return on invested capital we are confident that we can grow this brand over the long-term. So we appreciate everybody’s support and thoughtful questions and we look forward to obtaining again on our [indiscernible]. Thank you.

Operator

And that concludes today’s conference. You may now disconnect.

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