Kona Grill Inc. Q1 2010 Earnings Call Transcript

May. 3.10 | About: Kona Grill, (KONA)

Kona Grill Inc. (NASDAQ:KONA)

Q1 2010 Earnings Call

April 27, 2010 05:00 am ET

Executives

Mark Robinow - EVP, CFO, and Secretary

Marc Buehler - President and CEO

Analyst

Rob Brown - Craig-Hallum

Mickey Straus - Straus Asset Management

Shawn Bitzan - Feltl & Company

Operator

Ladies and gentlemen, thank you for standing by. And welcome to today's the Kona Grill first quarter 2010 earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, you will be invited to participate in a question-and-answer session. As a reminder, this call is being recorded.

I would now like to turn the conference over to Mr. Mark Robinow, Chief Financial Officer. Please go ahead, sir.

Mark Robinow

Thank you and good afternoon, everyone. By now, you should have access to our first 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'll turn the call over to Marc Buehler, our Chief Executive Officer.

Marc Beuhler

Thank you, Mark and thank you all for joining us today. During this call we’d like to cover several items. First I’ll open with some comments about the first quarter and some of the initiatives that we are implementing in 2010. Mark will then discuss in detail our financial results as well as our guidance for the second quarter. Then I’ll wrap up the call with some final thoughts before turning the call back over to you for questions and answers.

With that, let me begin. As previously disclosed first quarter sales were 21.1 million, which exceeded the high-end of our initial revenue guidance of 19.4 million to 20.4 million by $700,000. Same-store-sales declined 2.5% during the first quarter compared to being down 9.6% and 8.1% in the first quarter and fourth quarter last year respectively. We experienced positive traffic during the first quarter of this year, as well as positive comps of 3.6% in March.

We are encouraged by the improved traffic trends and these trends have held up this far in April. As mentioned on our last call, we continue to experience check average compression with our average check down about 5% due to menu-mix shifts. We appreciate the importance of value and our recent successful new drink and menu offerings reflect this.

Our net loss for the period was $900,000 or $0.10 per diluted share, which also exceeded our previous expectations of a net loss between $0.12 and $0.19 per diluted share and included special charges of approximately $300,000 as Mark will walk through in a moment.

Over the past few months, we have rolled out several initiatives to create more buzz around the concept and fill top-line sales. We’ve successfully engaged with our customers in new and exciting ways over the past 90 days. We are very pleased with the excitement generated by our first Extreme patio parties, which included Green Sake Bombers, draft beer specials, $5 mint martinis and a get lucky promotion. We are gifting in each of our restaurants one free dinner for a year.

On April 1st, we celebrated the start of spring again on our patio with our spring kick of parties which included the launch of our "Get the Skinny" Spring/Summer Menu featuring three cocktails under a 115 calories and three entrée at or under 200 calories.

The results for these two events far surpassed my expectations and more importantly our co-workers and guest feedback was overwhelmingly positive. While we may not repeat these events in the same manner, we are in the market place with new and different ideas, designed to drive incremental traffic and top line revenue. We continue to move forward with marketing and branding initiatives including our new Konavore loyalty program, which today has over 60,000 members in just 90 days. We are in the process of transitioning to a card based program. So we can be very targeted and understand more about our users and reach them with specific messages designed to drive them in for additional dining occasions.

We are also re-launching our company website and konagrill.com which actually launched yesterday. And the design has a much better feel that aligns with our unique and differentiated brand positioning.

On the operational front, we recently hired a fourth district manager to enable each of our multi unit managers to devote their attention to a smaller base of restaurants. Our district managers are now responsible for an average of six restaurants, compared to be 8 or 9 previously.

We believe that these investments will go a long way in providing the best experience possible for all our guests, in addition to helping us better manage each individual P&L. We will begin a comprehensive menu rework over the next three quarters to return some of the “wow” back to our presentation.

The ground work is laid for about 50% of the menu tweaks. And we will begin testing these changes over the next three to four weeks. Once we have comprehensive guest and operator feedback we will systematically roll these changes into the Kona system.

In addition to refining some of our long time menu items, we have a few new items that will roll on to the menus as well. We are also adapting our local favorites program to leverage the culinary talent and allow more flexibility or rotate and change these offerings at the restaurant level on a more frequent basis.

The beverage program is in the midst of a total rework as well to ensure that we are forward leading and not following in the category. During the quarter, we launched a Sunday happy hour program, our bubbles and brews featuring sparkling cocktails and several premium beers at attractive prices. And we have seen a growth in our Sunday business as a result. We recently added new table top merchandizing for our patio bar and lounge areas that will allow us to better sell not only our important happy hour items, but allows to up-sell into some better margin items as well.

We will test and then launch new menu vehicles for both food and beverage over the next five months. Again with the aim to simplify to simply enhance the experience for the guest and help us build top line sales and deliver better bottom line results.

Taken together these programs and menu initiatives are essential building blocks in returning Kona Grill to profitability. As the increase sales generated by these programs allow us to leverage our cost and generate sustainable, improvements in our bottom line over time.

And with that, I’ll turn the call back over to Mark Robinow.

Mark Robinow

Thank you Marc, for the first quarter ended March 31st, restaurant sales increased 8.2% to 21.1 million, reflecting additional revenue from three restaurants open since last April. Sales comparison continued to be impacted by the economy. But as Marc noted traffic trends have recently started to improve.

Overall, same-store-sales declined 2.5% which represents our best quarterly results in two years. It also represents a 560 basis points sequential improvement from the 8.1% decline posted in the fourth quarter and a 710 basis improvement from the year ago period.

Cost of sales as a percentage of restaurant sales increased 30 basis points to 26.5% during the first quarter from 26.2% last year, as price increases for certain seafood and seafood items and produce resulted in slightly higher average food cost.

Labor expenses as a percentage of restaurant sales increased a 130 basis points to 36% during the first quarter from 34.7% last year. The higher labor cost percentage is attributable to de-leveraging of fixed manager salaries.

And hourly labor expense due to the decline in same-store-sales, initial higher labor cost from our two recently opened restaurants also contributed as labor expenses are typically higher than normal during the first several months of operation.

We expect labor as a percentage of sales to improve as our newer stores continue to mature and we refine our labor staffing models. Restaurant operating expenses increased 80 basis points as the percentage of restaurant sales, primarily due to increase, repair and maintenance expenses. Personal property taxes and de-leveraging of the fixed portion of operating cost.

First quarter 2010 repair and maintenance expenses include about 80,000 of re-modeling cost. We plan to do major remodels of our Kansas City and Denver restaurants later this year, which are expected to cost $600,000 in aggregate. The locations are between six and eight years old in our high performing restaurants.

Occupancy expenses of percentage of restaurants sales increased 70 basis points to 8.5% during the quarter, compared to 7.8% last year. The increase as a percentage of sales is due to an increase and commentary and cost allocations at many locations and de-leveraging of the fixed portion of occupancy cost.

Combining these four line items restaurants, operating profit was $2.7 million or 12.6% of restaurants sales compared to 3.1 million or 15.7% of restaurant sales last year. Depreciation expense as a percentage of sales decreased 230 basis points to 6.6% of restaurant sales during the first quarter from 8.9% a year ago. The reduction reflects lower depreciation expense.

Due to the asset impairment charge we took in the fourth quarter of 2009 for six under-performing restaurants. General and administrative expenses increased 250,000 during the quarter, primarily due to the $300,000 spent during the quarter for legal and other expenses associated with the contested proxy solicitation and the on-going derivative suit.

As a percentage of sale, G&A increased 50 basis points to 10.2% during the quarter compared to 9.7% last year. If these special charges are excluded G&A expenses would have decreased 100 basis points from last year to 8.7%.

Net loss for the quarter was 900,000 or $0.10 per share. Last year we posted a loss of 1.1 million or $0.14 per share. We ended the quarter with 8.7 million in cash and investments partially secured by our auction rates securities credit line. At March 31st, we had net 2.9 million of cash and investments available to fund capital expenditures and operations.

During the first quarter, net cash provided by operating activities was $800,000. We spent $600,000 on investing activities during the quarter for our recently opened restaurants and design of the Baltimore restaurant. We expect to spend a total of 4 million remainder of this year for capital expenses.

Our available cash and cash flow from operations allows us to complete construction of the Baltimore, Maryland restaurant later this year. We will pursue additional leases based on significant economic opportunity and the available of affordable debt capital or sufficient cash flow from operations. We have no lease commitments beyond Baltimore at this time.

For our second quarter financial guidance we are forecasting sales of 21.7 million to 22.7 million and a loss of 600,000 to 100,000 or $0.6 to $0.1 per share loss. Our guidance reflect modest recovery in consumer spending and same store sales of approximately minus 2% for the second quarter. Guidance does not include legal and proxy solicitation expenses incurred to like Kona Grill’s board slate of directors at the company 2010 annual meeting scheduled for tomorrow.

I will now turn the call back to Marc before we go to Q&A.

Marc Beuhler

Thanks Mark, over the past few months we have worked diligently on developing our long term strategic direction for the brand. I don’t want to tip our hand too much for competitive reasons. But I just promised last call to give you some more details on our efforts. The foundation of our plan starts with the consistent execution of the basics. Our entire team is focused on delivering at outstanding guest experience every guest, every day, in every restaurant.

We continue to evaluate staffing levels to not only maximize profitability, but more importantly to build long term winning enterprises that will contribute to the organization over the long hall.

Our operations team is the heart and soul of Kona Grill and we are working towards the common set of goals, standards and expectations. We continue to be laser focused not only on top line results, but also on bottom line profitability. I am not happy with our progress on the bottom line today and you can assured that my focus is on this area everyday.

We continue to be excited by the reaction of our raving guest with regards to our messaging and interactions through social media, the Konavore loyalty program and other branding efforts. We were very early in many of these areas. But I know that we are leading the way in our industry. As we engage with our guests rather than try to dictate why they should use us more.

We are committed to building the right team to lead this brand forward. We are almost done with that process, but is still looking for the right person to lead our training and coaching process. As I mentioned on the last call, we are also committed to measured growth, with only Baltimore slated to open this year as our teams refine what has made Kona such a unique and highly profitable venture in the past. And knowing where soon will be again.

We continue to layer end innovative product, service and marketing initiatives that energize our concept and extend our current base as well as attract new guest. Our longer term strategic growth map includes building our average unit volumes back to more historical norms.

We have several tactics to do this and the underlying theme is that we are committed to being the leaders in innovation, creativity and most importantly in execution. We are preparing the organization to be at a maximum level of competitiveness and performance within the next twelve to eighteen months. In advance of the expected return of more normalized consumer spending and restaurant usage.

We want to be prepared to take advantage of opportunities while others might still be re-working their business plans. We continue to pursue debt capitals to support potential future growth. While we currently do not have any lease assigned, we expect to continue to look for opportunistic ways to grow with internally generated cash over the short term. We are building a lean effective high capacity confidence, synergistic senior management and support center team to revive value added support to our restaurants.

I am confident that we will earn the trust and confidence of the financial community with a board that has shepherded this concept just through some extremely challenging times.

Our team is energized by the guest acceptance of the initiatives implemented in recent months. And a renewal of the Kona sprit and culture, we have an experienced senior leadership team. A dedicated and experienced board of directors and a talented team of restaurant managers and co-workers who are committed to taking this concept to the next level. And I look forward to communicating our continued progress in these areas throughout the year.

Thank you all for your continued support. And we would now be happy to answer any questions that you might have. Operator, please open the line for questions

Question-and-Answer session

Operator

(Operator Instructions). And our first question will come from Brad Ludington from KeyBanc Capital Market

Unidentified Analyst

Hi this is John (inaudible) on for Brad. Now looks like the non-comp stores, they are still down compared to the comparable stores, but it looks like the year-over-year is less of a decline than we had expected as well as the difference between the two, it seems to have lessened. Did I think material happened or is that just a matter of I saw one store went out of the comp base or we into the comp base this year. Did anything happen there at all?

Mark Robinow

John its historic, as you mentioned the stores come in moving out of that based into the comp base will affect it and kind of local market environments where the new restaurants are and as they continue to gain traction and grow but nothing notable happened in any of those restaurants that I'm aware of.

Unidentified Analyst

So we are still looking at pretty weak performance of those stores you think?

Mark Robinow

They are certainly not as strong as our restaurants to remain open longer than two years, again I think one of the challenges with the concept is brand awareness when we walk into some of these new markets and certainly moving forward when we look at Baltimore, how we plan to open that restaurant. We will open that in a much different way than we have opened the last four or five restaurants.

Unidentified Analyst

Maybe that leads into this question actually but I was wondering if there is any difference in your marketing approach to the newer location?

Mark Robinow

We absolutely have changed our approach in those locations over the last quarter, and we did implement some additional incremental marketing in those restaurants in the February timeframe and very pleased with the results of those efforts. So that did help us to a degree.

Unidentified Analyst

And then also with your April commentary, it sounds like you only commented on traffic being help holding up in April. Is there any reason to expect that, that mix would be any worse going forward or is that going to actually roll off in 2010 as we go forward, and should we expect positive same store sales? Why shouldn’t we expect positive same store sales in the 2Q, I guess this is my question?

Mark Robinow

I think there is just some uncertainly as we look at how some of the weeks roll up against each other. April started off rolling just like March and are comfortable with our guidance at this point just because there is too many unknowns I think as we move towards the second half of the year. We will actually see the difference between check average and gas get a lot closer. First quarter traffic was actually up 5.4% which is very encouraging. So again we continue to see strong traffic, but check average continues to be an issue. Once we roll over the perfect pairings rollout from a year ago and some of the other initiatives that were implemented to help drive value and drive frequency. I expect that gap to close.

Unidentified Analyst

We are hoping that’s why they will continue for you.

Mark Robinow

A nice Friday and Saturday helps our business significantly.

Operator

And next we’ll go to Rob Brown from Craig Hallum

Rob Brown - Craig-Hallum

I was just wondering if we can get a little more color on the unit margin situation. What was the kind of comp group unit margin compared to the new units? Have you seen margin improvement on both sides, or is this really an improvement in the new unit margins of Q4?

Mark Robinow

We saw some of the new unit margin improve a little bit and some of the older restaurants were flat as compared to Q4 and that’s exactly how we wanted to come because as they mature and refine their operation, that’s what we would expect to see.

Rob Brown - Craig-Hallum

And then you said your guidance doesn't include legal costs, but do you still expect legal costs in this quarter, yet kind of to the same level as Q1 or do you have any sense there?

Mark Robinow

We hope they are not quite as much as Q1, but they certainly could be and that’s why we aren’t giving guidance to that because it’s an ongoing process that can accelerate or slowdown based on various legal movements and certainly our proxy contest is still on going and we don’t have great visibility to all the cost of that, yet until we get some of the final bills in.

Rob Brown - Craig-Hallum

And on your remodel cost you mentioned, could you just go through that again in terms of your expectations? Is that a CapEx number, or does that flow into operating expenses? Maybe just clarify the costs there.

Mark Robinow

Those remodels as I said were about 600,000 total for the two restaurants will be primarily CapEx.

Operator

Next we will go to Mickey Straus from Straus Asset Management.

Mickey Straus - Straus Asset Management

My question's already been answered. Thank you.

Operator

(Operator Instructions). And our next question will come from Shawn Bitzan from Feltl & Company

Shawn Bitzan - Feltl & Company

This is Shawn Bitzan sitting in for Mark Smith. And hoping you could talk a little bit on the alcohol sales and what that was a percentage of sales this quarter.

Mark Robinow

Let me give you the quarter number, 30.4% which is actually down about 1.4% year-over-year.

Shawn Bitzan - Feltl & Company

1.4% year-over-year?

Shawn Bitzan - Feltl & Company

And was there any, sequential changes to alcohol throughout the quarter?

Marc Buehler

Yeah its just looking as pretty consistent, March wasn’t quite as drastic but of a decline or just a change. Again we have some initiative out there really [tried] our happy hour. We introduced the Sunday happy hour with new or lower priced drinks which certainly probably had an impact on that as well.

Shawn Bitzan - Feltl & Company

Can you talk a little bit about what you expect as far as commodities going forward from here?

Marc Buehler

Again we do not have many contracts at this point, something that we are actually in the midst of exploring on several front fish is really the biggest commodity that we have to deal and so we are looking at several deals right now tied into Tuna which is a huge piece of our business, obviously. And I would expect it from a modeling standpoint; we do not have that impacting us in a negative way so we really see commodities that are on a flat basis for this year.

Shawn Bitzan - Feltl & Company

And then one final question. What should we expect to model for income taxes in the second quarter?

Mark Robinow

Our taxes are pretty minimal this time and because of our size in our, obviously our operating losses, our income tax expenses really related to states where we are either profitable or have kind of fixed cost taxes so you can probably look at a dollar amount and [a set over a percentage] of sales for taxes in Q2 and it will probably be somewhere in the range of 25,000 to 50,000

Operator

(Operator Instructions). Our next question will come from Jason (inaudible) Management Partners.

Unidentified Analyst

How much of the deferred remodel for the two stores would you consider to be differed maintenance?

Mark Robinow

None of it. The restaurants have been very well maintained over the years. We don’t have a lot of old assets out there. These are restaurants that just need to be refreshed in order to drive traffic in.

Operator

(Operator Instructions). And at this time, we have no further questions. And I turn the call back over to you gentlemen for any further additional or closing remarks.

Marc Buehler

Thank you all very much for joining us. We look forward to chatting with you in July. Have a great day.

Operator

That does conclude today’s conference. Thank you for your participation.

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