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Luby's (NYSE:LUB)

Q4 2013 Earnings Call

November 07, 2013 11:00 am ET

Executives

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

Analysts

James Fronda - Sidoti & Company, LLC

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to Luby's 2013 Fiscal Fourth Quarter Earnings Conference Call. This call is also being webcast and can be accessed through the audio link on Luby's website, lubysinc.com. Information recorded on this call speaks only as of today, November 7, 2013.

Before we continue, I'd 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.

Those statements include risks and uncertainties, including, but not limited to, general business conditions, the impact of competition, success of operating initiatives, changes in commodity costs 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

Thanks, Steve. Good morning, everyone, and thank you for joining us on our 2013 fiscal fourth quarter and year end earnings conference call.

With me today are Scott Gray, our Chief Financial Officer; and Peter Tropoli, our Chief Operating Officer.

Fiscal 2013 was another exciting and productive year for Luby's. We expanded our restaurant count, enlarged our geographic footprint and continued our momentum to grow the business. As always, our team focused on enhancing the customer experience through quality target marketing promotions and enhanced menu items. Although the economic environment was challenging and consumer confidence remained low, we made significant progress executing our strategy to enhance our core operations, expand our brand footprint and grow our development pipeline. We experienced pressure on store level profits at our core brands in fiscal 2013 due to same-store sales levels not fully achieving the growth we were anticipating and certain upticks in the expense areas that Scott Gray will review in greater detail later in the call.

In fiscal 2013, we continued the progression of our brand growth strategy by opening new restaurants, acquiring new stores, entering into new culinary services contracts and growing our new store development pipeline. We opened 7 new locations in fiscal 2013, including a combo unit, Luby's Cafeteria and Fuddruckers that sit side-by-side, as well as 6 new stand-alone Fuddruckers. Our new stores, especially the combination units, are coming out of the gate strongly and exceeded our first year revenue expectations, which gives us confidence for our future development plans.

Near the end of our fiscal year, we relocated 1 cafeteria from its location inside a shopping mall to a pad site in front of the mall. This restaurant is located in the town of Pharr, P-H-A-R-R, which is in South Texas near the border with Mexico. So far we are very encouraged to see a surge in business. This is similar to the experience we had with another relocation we had a year ago in the Houston area. At Fuddruckers, we ended the year with 116 franchise locations. During fiscal 2013, we increased our franchise pipeline to 35 units, including 6 openings to take place in fiscal 2014.

In the second quarter of fiscal 2013, we acquired Cheeseburger in Paradise, a 23-unit restaurant chain, for approximately $11 million. We've made progress integrating Cheeseburger in Paradise, including conversion of all 23 restaurants to our food distribution network and introducing best-in-class restaurant processes and systems in what we call the Luby Way.

Today, at Cheeseburger in Paradise, our guests are assured a better burger, a better bun and a better overall dining experience. As we discussed before, Cheeseburger in Paradise represented an opportunity to gain entry into a full-service brand with 23 attractive and well-located restaurants. Rebuilding the brand is still in progress. In the fourth quarter, we promoted Sam Peters [ph] to VP of Operations at Cheeseburger in Paradise. Sam [ph] brings over 20 years of restaurant leadership and experience to Cheeseburger in Paradise, with over 5 years at Luby's Cafeterias and 15 years at Ruby Tuesday's. We also are currently in the process of converting 1 Cheeseburger in Paradise to a Fuddruckers restaurant in Algonquin, Illinois. We believe the demographics of that market will be better served through this conversion, and our combined organization will generate higher returns.

Finally, we entered into 6 new Culinary Contract Service agreements in fiscal 2013 and are pleased to have improved the mix and margin of this business line. But the momentum didn't stop in fiscal 2013. In fact, during the past week, we signed an agreement with the system of 3 hospitals in our home base of Houston. This agreement includes food service for over 750 beds in the hospitals, as well as a large retail food court component. These operations are expected to start around March of 2014. We're excited to be chosen again as a trusted partner to provide our well-recognized menu offering in a hospital setting.

Now I'd like to review the fiscal 2013 progress of our core restaurant initiatives. During the past 12 months, we've invested approximately $5.3 million to remodel 10 Luby's Cafeteria and also to refresh 4 Fuddruckers and a complete full remodel of 10 Fuddruckers restrooms. Over the past 2 years, we've remodeled 24 cafeterias and 21 Fuddruckers. These remodeling efforts will continue each year to ensure that our brands remain relevant and appealing to our guest. We also increased our marketing efforts and believe they are necessary investments to maintain and grow our customer base over the long term.

At various points throughout the year, we ran fun and engaging television spots. We supplemented these with targeted direct mail pieces with promotions that entice our customer to increase frequency. In our larger markets, we expanded our billboard advertising. And to expand our local store marketing initiatives instituted in prior years, we increased our sponsorship of local sports teams in fiscal 2013. These activities, combined with the personal attention of our restaurant managers, strengthens our partnership with the local communities that we serve.

Marketing investment for the fiscal year 2013 was 1.1% of restaurant sales, an increase from the more modest 0.7% of restaurant sales for fiscal year 2012.

In fiscal 2013, we also continued to enhance our menu offerings and options. Our enhanced menu options include our healthier, Livin'Smart offerings, which have been hits with our guests. Menu items such as our balsamic chicken, Jamaican jerk tilapia are paired with a side and a bread to offer a complete, healthful and tasty meal for under 600 calories. Also popular with our guests this year has been our daily Manager's Special, where a Luby's favorite item is featured each day in our cafeterias.

As of today, all 3 of our restaurant brands, Luby's, Fuddruckers and Cheeseburger in Paradise, are ordering their key food and inventory supplies from 1 distribution consortium, providing better quality, pricing and consistency.

We're also generating more efficiency in the ordering process. Although our food cost increased during the year due primarily to inflation, we believe our systems and moving to one provider has allowed us to manage our cost more effectively.

Turning now to the guest experience. One way we measure our success is through frequent guest surveys at each of our brands. Over the past year, our customer satisfaction scores have improved significantly at Fuddruckers and have trended upward from an already high level at Luby's Cafeterias. The customer feedback from our Cheeseburger in Paradise guests has been positive, reinforcing our belief that the changes that we've made and continue to make at the brand are welcomed by guests at this brand. Customer satisfaction among our loyal customer base and newcomers will always be a primary focus.

I'd like to now walk you through an overview of our performance by brand. At Luby's Cafeterias, same-store sales rose 1% in the fourth quarter. Traffic was up 0.5%, combined with an average spend per customer up 0.4%. We are encouraged by the continued menu development, coupled with our marketing and advertising promotions that are being received well by our customer.

Our Fuddruckers brand had a same-store sales decline of 0.4% in the fourth quarter, but finished the year with 0.2% increase for the full year. During the fourth quarter, customer traffic declined 2.9% and average customer spend rose 2.4%.

In our Culinary Services business, we increased the number of locations we serve to 21, up from 18 at the end of the last fiscal year.

During the fiscal year, we attracted 6 new accounts, and 3 contracts expired without renewal. Our focus on management fee-based accounts is paying off, as our margin in this business line expanded to 10.9% in fiscal 2013 from 6.6% last year.

And finally, last December, we purchased Cheeseburger in Paradise, a 23-unit brand, for approximately $11 million. We made progress rolling out new restaurant processes, enhancing the level of operating and upgrading the menu. But we still have much to do with this brand, including realizing efficiencies and improving margins and possible conversions. We're excited about the future of our company. Our core brands are performing well, and we're working hard to control costs and drive increased traffic.

Cheeseburger is taking longer to transition than we originally anticipated, but I feel confident that we've identified the issues and developed plans to improve that brand and increase its profitability.

And finally, I'd like to thank all of the employees for their dedication to providing our guests with a memorable dining experience.

With that, I'll turn the call over to Scott Gray, who will elaborate on our financial results. I'll then provide an update on our growth strategy and 2014 outlook before opening the call up to your questions.

At this time, Scott?

K. Scott Gray

Thank you, Chris, and good morning, everyone. Since Chris has gone over our sales results, my comments this morning will focus on our expenses for the fiscal fourth quarter.

Let's begin with our cost of food in the fourth quarter. As a percentage of restaurant sales, food costs rose 100 basis points to 28.8% versus 27.8% in last year's fourth quarter. Excluding Cheeseburger for an apples-to-apples comparison, food costs, as a percentage of restaurant sales, rose 50 basis points to 28.3% compared to 27.8% in the fourth quarter last year.

By brand, Luby's food cost was 28.3%, consistent with -- consistent with 28.2% last quarter and increasing from 27.6% in the comparable quarter last year. The majority of the increase was due to the year-over-year rise in our basket of food commodities, which were up about 1%.

At Fuddruckers, food cost was 28.3% compared to 28.1% in both the prior quarter and in the comparable quarter last year. This year-over-year increase in food cost was primarily due to an approximate 2% increase in our basket of core food items at Fuddruckers.

At Cheeseburger in Paradise, food cost was 32.2%, up slightly from 31.9% last quarter. As mentioned -- as we mentioned last quarter, we are not expecting significant improvement in food cost as we test new items and introduce new offerings. We expect food cost to remain much higher during the completion of the rollout in Q1 2014.

Food cost will also be higher due to limited time promotions we are featuring to drive traffic at these locations.

Moving on to payroll and related cost. We experienced declines in the fourth quarter at our core brands of Luby's and Fuddruckers, and held those costs constant at our new Cheeseburger in Paradise restaurants. Payroll and related cost declined 60 basis points to 33.9% in the fourth quarter versus 34.5% in the same quarter last year. Excluding Cheeseburger in Paradise, payroll-related cost was 33.3%.

At Luby's, payroll and related cost was 34.5% compared to 35.9% in the prior year. Fuddruckers' payroll and related cost was 30.4% compared to 31.3% last year. Cheeseburger in Paradise related costs were 37.6%, similar to last quarter's 36.5%. The overall decline in labor cost were due to leveraging higher seasonal sales volumes as well as better scheduling.

Moving on to operating expenses, which now excludes occupancy cost, which will be displayed separately on our P&L, we're up 240 basis points to 19.4% in the fourth quarter of fiscal 2013. Excluding Cheeseburger, operating expenses rose to 18.7%, increasing 170 basis points from 17% in the prior year due to increases in marketing and advertising, utilities and restaurant services.

Our investment in expanding our marketing and advertising initiatives was responsible for approximately 70 basis points of the increase. We believe that this money was well spent to strengthen our brands and drive traffic to our locations. Utility rates were also up year-over-year, resulting in a 45 basis point increase in operating expenses. Services accounted for 40 basis points of the increase, mainly due to higher credit card fees, as well as an increase in equipment rental fees, including the Coke Freestyle machines at Fuddruckers.

Occupancy cost were -- rose 80 basis points to 6.3% versus 5.5% in the prior year's fourth quarter. Since a greater portion of our locations are leased facilities versus the prior year, including the 23 Cheeseburger in Paradise restaurant locations. Excluding Cheeseburger, occupancy cost at our core brands were 6.1% up versus the 5.5% in the prior year, which represents new openings. The year-over-year increase was due to a rise in the number of leased stores.

Now for our store level profit margin. Store level profit margin declined to 11.6% in the fourth fiscal quarter, including Cheeseburger in Paradise. Without Cheeseburger, store level profit margins were 13.6% in the fourth quarter compared to last year's 15.3%, due to increases in occupancy, operating expenses and food cost.

What we are excited about is our first Luby's and Fuddruckers side-by-side combo unit, which produced 19% store level profit in the quarter.

Now on to our balance sheet. We ended the 2013 fiscal year with $1.5 million in cash and up to $49.8 million available under our recently expanded $70 million revolving credit facility. Based on our trailing EBITDAR results, we have approximately $40 million available after applying our new total leverage covenant.

In August, our facility was raised to $70 million, and the maturity was extended until September 1, 2017, giving us enhanced flexibility to grow both organically and through potential acquisitions and new unit development.

Moving on to our cash flow statement. Cash flow from operations was $29.6 million compared to $29.3 million in the prior year, primarily due to a large increase in accounts payable and accrued expenses year-over-year associated with the new unit development. We invested $31.3 million in property and equipment compared to $25.8 million in the prior fiscal year 2012.

In 2014, we anticipate spending $35 million to $40 million in capital expenditures, including the following: $14 million for new store development, $6 million for remodeling of existing units and 10 -- approximately $10 million to purchase land for development of new restaurants in future years. We're excited about the opportunities that lie ahead, in particular, further development of our pipeline and new unit growth, which we believe will lead to increased shareholder value.

And speaking about our growth, consider the following: The company currently has a base operating EBITDA of about $25 million from our existing business segments, which are company-operated restaurants, Fuddruckers hamburger franchise and Culinary Contract Services, in which to grow upon. In any given year, that total company base of operating EBITDA will vary up or down $3 million to $5 million, which is about 1% to 2% of the restaurant sales base of the -- base on the -- due to the impact of the consumer environment on pricing, prices we can charge our guests and varying operating costs in the company-operated restaurant segment. Therefore, organic growth is not enough on its own to grow shareholder value over the long term. We must have a pipeline of new units, and that's what we are doing. Fiscal 2014 will be an important reference point for determining our target growth rate for future years. Using our current pro forma new unit EBITDA estimates, each new Luby's or Luby's Fuddruckers combo grows our total company operating EBITDA base by approximately 3% and each new 3,400 square foot Fuddruckers grows it 1%.

And with that, I also would like to comment a little bit on our outlook. Chris will be going over in a moment.

Our outlook for fiscal 2014 will not include a full year's EPS estimate at this time, as we believe we could experience near term earnings pressure in the first half of fiscal 2014, as we progress into a compressed holiday season and experience the impact of uncertain certain health care cost on our customers. Our focus is on our pipeline development, new unit openings and sales development from existing units in our brands, including development of domestic and international franchise sales and new Culinary Contract Services contracts.

I would like to turn the call back over to Chris, who will elaborate further on our outlook for 2014.

Christopher J. Pappas

Thanks, Scott. Before we open up to your questions, I'll provide an update on our restaurant development growth strategy and our 2014 outlook. At our core brands, Luby's and Fuddruckers, we will continue our remodeling program and have identified 10 to 15 locations that will be remodeled in 2014. We anticipate investing approximately $35 million to $40 million in capital expenditures in fiscal 2014, including $14 million for restaurant openings, beginning construction in fiscal 2014 for openings in fiscal 2015; up to $6 million in restaurant remodels; and up to $10 million to purchase parcels of land for new restaurant development.

Now I'd like to tell you about new store development plans. Due to the strong results we've experienced at our new combo locations, as well as the improved results we've generated at our relocated restaurants, we anticipate opening as many as 8 restaurants in fiscal 2014. This will include 2 Luby's Fudds combos, equating to 4 restaurants. These locations provide economies of scale. We purchase 1 larger parcel of land, construct a single building with 1 shared wall, shared parking and typically a shared outdoor seating area.

In the kitchen, behind the scenes, the 2 restaurants operate under the direction of a single general manager. But to our guests, we present 2 distinct restaurant choices, with their own identities, their own décor and their own entrances.

Already in 2014, we opened 1 standalone Luby's Cafeterias in Eagle Pass, Texas. Previously, this community didn't have a Luby's Cafeteria. But so far, they're pleased we've arrived in town, which they have demonstrated through their patronage.

We thank all of our new Luby's Cafeteria guests for allowing us to continue the tradition.

For the remainder of fiscal 2014, we plan to start restaurant construction on a minimum of 2 additional cafeteria sites, with openings slated for fiscal year 2015. In addition to these combo units and standalone cafeteria units, we also expect to open 2 to 3 new Fuddruckers locations in fiscal year 2014.

As we begin a new fiscal year, we're excited for numerous opportunities to enhance the customer experience and to focus on managing our expenses. As we stated in our press release, we expect same-store sales to grow up to 1% during the year. And our restaurant sales to range between $375 million to $385 million, with $8 million to $10 million coming from new stores.

With that, operator, we'd like to now open the call up to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of James Fronda with Sidoti & Company.

James Fronda - Sidoti & Company, LLC

For the Cheeseburger in Paradise, is there still more cost synergies available going forward into fiscal '14?

K. Scott Gray

Well, I mean, right now -- right now, we see cost pressure as we're rebuilding guest count. And so we're doing offers. And so visibility on that, after we get through that, we'll be able to kind of -- we'll be able to see. But we're watching it closely. And again, as we see the new items, which items take hold and we have our new mix developed, we'll be able to have a better feel of what the percentage turns out to be. But right now it's about sales development.

James Fronda - Sidoti & Company, LLC

Okay. And I guess, can you -- do you guys release what the store level profits are for the combination stores?

K. Scott Gray

Yes, I did. We made a note. I made a note in my remarks about the combo, which is our first Luby's and Fuddruckers combo in the Houston metro area, at Pearland. So in the quarter, it performed at 19%.

James Fronda - Sidoti & Company, LLC

Okay. All right. And I guess just lastly on the hospital deal, can you quantify what that revenue amount might be for fiscal '14?

K. Scott Gray

We've typically -- James, typically, that business is tough to forecast. We really look at it from kind of a -- what's the impact on profits. I mean, right now, our store level profit dollars on that segment is approximately 1.8 or so at store level, and then we have G&A from that. So we're still at a slightly profit -- at a profit level. And the future is getting a large -- a very, very large account to really move the cash flow from that segment up. But on that low base, this one could have a large percentage increase on that store level base. So it's hundreds of -- as we proceed, we'll be able to comment after we get into the contract. We -- again, it's all based on estimates at this point. But we'll probably wait until we get that underway to speak about it.

James Fronda - Sidoti & Company, LLC

Okay. And the cost of food, I thought you guys were going to be able to raise prices; is that still the case, possibly in fiscal '14?

K. Scott Gray

The consumer is very price-sensitive. And yes, so we -- we're managing the mix by offering a value to our customers who are very price-sensitive every day. And we think that we're positioned in the kind of the fast casual space, which is where all of our brands are right now. And -- but we do see benefits over in the Cheeseburger side with the new menu. And we have taken some pricing. So -- but very minimum. We're very mindful. Particularly at Luby's, our largest sales base, we have daily specials that are mixed in to provide that guest with a great value at $6.99, $5.99, $7.99 price points.

Operator

[Operator Instructions] Mr. Pappas, there are no additional questions. Please continue with any closing remarks.

Christopher J. Pappas

Again, thank you for joining us on the call today. Our first quarter fiscal 2014 earnings conference call will be held in mid-December, and we look forward to speaking to you then. Thank you.

Operator

Ladies and gentlemen, this concludes our conference for today. Thank you for your participation. You may now disconnect.

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