McCormick & Schmick’s Seafood Restaurants, Inc. Q1 2010 Earnings Call Transcript

Executives

William Freeman – Chief Executive Officer

Michelle Lantow – Chief Financial Officer

Analysts

Jeff Farmer – Jefferies & Company

Jeff Omohundro - Wachovia

Analyst for Matt DeFrisco – Oppenheimer

Nicole Miller – Piper Jaffray

McCormick & Schmick’s Seafood Restaurants, Inc. (MSSR) Q1 2010 Earnings Call May 5, 2010 5:00 PM ET

Operator

Welcome to the McCormick & Schmick’s Seafood Restaurants, Inc. first quarter 2010 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Michelle Lantow, McCormick & Schmick's Seafood Restaurants, Inc. CFO. Please go ahead, Ma’am.

Michelle Lantow

Good afternoon everybody and thank you for joining us today. By now everyone should have access to our first quarter 2010 earnings press release. It may also be found at www.mccormickandSchmicks.com under the investment relations section.

Before we begin our formal remarks, I need to remind everyone that part of our discussion today will be forward-looking statements. These statements are not guarantees of future performance and therefore you should not put undue reliance upon them. We refer all of you to our recent filings with the SEC for more detailed discussion of the risks that could impact our future operating results and financial conditions.

I would now like to turn the call over to our CEO, William Freeman, to review some of the highlights from this past quarter.

William Freeman

Thank you Michelle. I would like to begin our discussion today with some highlights of this past quarter as well as touch on our primary areas of focus. Afterwards Michelle will review our financial results for the first quarter as well as discuss our 2010 annual guidance.

In the middle of last year I outlined a series of initiatives as part of a long-term platform for the company that would allow us to enhance the viability of our company for the future. These initiatives were designed to increase traffic during a difficult economic time, expand our connection to a broader audience and in the long-term strengthen our positioning as the leading national affordable, upscale seafood concept. We knew some of these initiatives would challenge our short-term results from a traditional, comparable viewpoint. We also believed and continue to believe this platform will provide the long-term results needed to deliver the increases in shareholder value required to maintain our leadership position in the industry.

In the past quarter we continued to make great progress on implementing and executing these initiatives as part of our long-term strategy and continue to hear positive feedback from our guests related to these enhancements. For the first quarter we continued to sequentially improve our comparable sales and traffic trends while narrowing our net loss per diluted share to $0.03 compared to a net loss of $0.08 in the year-ago period. Our team remains highly motivated and committed to balancing the needs of our guests while employing prudent cost management techniques. Our continued focus of execution in both of these important areas is reflected in our financial results for the first quarter.

Comparable sales and traffic for the quarter ending March 27^th were down 9.6% and 6.2% respectively which are sequential improvements of 330 basis points and 80 basis points from what we reported in the fourth quarter. Weather conditions had a significant adverse impact on our results for the period as more than 1/3 of our portfolio and many of our higher volume restaurants were affected by unprecedented severe winter weather. This was most readily apparent in the D.C., Baltimore Metro area where there were a number of convention and private event business cancellations along with multi-day closings at 12 of the 13 restaurants we operate in this market.

Taking into account the mid-Atlantic winter combined with worse than typical winter weather in the Midwest and Northeast resulted in multi-day closings, we estimate we lost approximately $1.5 million to $1.7 million in sales due to snow related issues. Despite the temporary weather setback we are seeing signs of stability characterized by steady progression across our restaurant portfolio. In fact, we have now reported improving sequential traffic trends for three consecutive quarters. This gives us confidence the measures we have taken to improve connectivity to our existing guests while also attracting new guests are working.

As we have said in the past we believe that driving more traffic through deliberately managing our check average down, driving higher guest satisfaction and broadening our guest base will result in higher sales levels on a long-term basis. This long-term strategic decision in the middle of last year to drive our average check down had a negative impact on our short-term comparable sales results but had a positive impact on our traffic results.

In addition we are encouraged by the sequential improvement in our monthly sales trends during the quarter. Our early-week sales trends on Mondays, Tuesdays and Wednesdays are also starting to rebound which suggests the business guest base is beginning to strengthen as well. We are continuing our efforts to drive traffic by creating more value for our guests through initiatives such as our $19.95 entry price point to our culinary promotional offering and 10 under $10 lunch platforms, both of which continue to make up a high percentage of menu mix.

The combined 3.4% decrease in net pricing we saw during the first quarter and the fact that our check average was down 6.5% compared to the year-ago period were both reflective of these initiatives. We believe that improving traffic which is being accomplished in part by reducing our average check provides us with a great opportunity to drive increased financial performance as the economy stabilizes, consumers become less price sensitive and spending levels increase.

On the cost side we continue to make great progress managing controllable costs despite a 7.7% decrease in revenues. In fact, we held restaurant level expenses to an increase of 10 basis points as compared to last year and improved our G&A expenditures in both absolute dollars and by 60 basis points versus the prior year. This was a significant accomplishment for our team and allowed us to narrow our net loss.

As we have continued to reiterate, all of the cost saving initiatives we have undertaken have been implemented with great care not to cut costs that would negatively affect the exceptional guest experience that McCormick & Schmick's has consistently delivered on a day in and day out basis over the past 38 years.

Now let’s review our primary areas of focus in further detail. As mentioned, in the first quarter we continued to make progress in our three major categories of focus; our culinary offerings, our bar program and our marketing efforts. On the culinary side we continue the rollout of our new menu platform and successfully converted 12 additional locations to the new format in the first quarter for a total of 44 restaurant locations now operating with the new menu platform.

As we have discussed in previous quarters this new platform includes unbundling the traditional starch from the plate and the addition of a new shareable side-dish section. It also includes the introduction of more contemporary plate ware to enhance the presentation of the entrée and the inclusion of seasonal vegetables to complement the protein as part of the entrée. This new format has enabled us to reduce our average entrée price of approximately $2-3 bringing more value, flexibility and decision making power to our guests.

The new menu platform also includes sections for traditional seafood, small plates, sushi, seafood by the piece and raw bar selections, some of which have tableside service elements. We continue to receive positive reaction from our guests with these culinary enhancements. We anticipate completing the menu conversion in all of our restaurants by the end of the third quarter of this year.

As part of our continued efforts to deliver more creative and value driven culinary offerings we launched our Explore New Zealand culinary promotion during the quarter in partnership with the New Zealand Trade and Enterprise Board which provides our guests the opportunity to be culinary tourists, discovering species and preparations that are uniquely New Zealand. The integrated New Zealand promotion also features New Zealand wines and signature New Zealand themed cocktails as well as a sweepstakes for a trip to New Zealand which received more than 9,000 in-restaurant entries and more than 20,000 online entrees, increasing our guest email database and enhancing our search engine optimization.

Continuing our tradition of offering our guests unique and value oriented special occasion dining experiences for Valentine’s Day weekend this year we offered a variation on our successful Perfect Combination menu promotion with a Create the Perfect Pair menu offer featuring choice of soup or salad and a combination filet or lobster tail paired with a crab cake, grilled salmon or skewered shrimp served with seasonal vegetables for $29.95. This menu offering gave our guests a choice and flexibility they have shown to appreciate on our menu. The popular culinary feature combined with the unique offering in all of our locations of customized concierge style flowers, note cards and personalized menu message services led to an improvement in Valentine’s Day weekend sales year-over-year.

In March we kicked off our Discover America’s Crab promotion featuring a variety of preparations highlighting crab species from different regions across the country. With a range of entrée prices starting at a value oriented $19.95 for lobster ravioli topped with blue crab, up to a premium selection of a 1.5 pound King Crab Leg dinner for $38.95. Guests have responded well to these crab menu specials demonstrated by featured crab entrees making up approximately 20% of our menu mix during the promotion.

The second initiative we continue to pursue is we seek to expand our guest base and better connect with our guest with the rebranding and evolution of our bars. This past quarter marked the first full quarter of implementation of our new wine program featuring wines under $30, ranked over 90 points by Wine Spectator and local organic and sustainably produced wines. The increased value and selection on our wine list has been well received by our guests.

We saw a healthy increase in our bottled wine sales over the same period last year and as we continue to more prominently market our new wine program we anticipate we will see the program continue to grow. We also continue to test a wine tasting program, a featured wine of the month program and a selection of local wines to further improve our overall wine offering. In addition we are including wine pairing selections on the menu with each of our featured culinary promotions.

We also launched a newly designed cocktail program and bar menu during the first quarter which features six signature classic cocktails, six seasonal cocktails and several local selections. We completed our first rotation of seasonal cocktails during the first quarter and intend to continue to update those cocktails four times during the year. The new, more trend centric cocktails are appealing to our guests and the new program appears to be moving more guests to premium brands.

As part of the bar evolution we continue to upgrade the audio/visual packages in many of our locations to eliminate the [veto vote] during key sporting and other television viewing events. We completed upgrades in 15 additional restaurants in the first quarter and have plans to upgrade AV packages in another 10-20 restaurants during the second quarter of this year. The overall guest response to the new AV package has been very positive in the units where we have completed the upgrade.

Our third area of focus designed to expand our guest base is our marketing platform which we continue to evolve to feature social and digital marketing as a complement to traditional marketing strategies. We use both digital and traditional marketing vehicles to promote our New Zealand and crab culinary promotion as well as dining room and bar holidays including Valentine’s Day, Fat Tuesday and St. Patrick’s Day. We launched our first Facebook photo contest promoting our traditional Irish roots during St. Patrick’s Day and we are pleased with the results and reaction from participants.

We are continuing to deploy a marketing strategy that integrates the use of platforms like Facebook, Twitter, Yelp and the blogosphere to promote our programs to a younger audience. In terms of development we now expect to open 3 new locations in 2010 up from the 2 previously reported, the first of which we successfully opened in West Palm Beach, Florida in February. This location despite a weakened South Florida economy is off to a strong start. Among other things, it is getting very high guest satisfaction scores for ambience demonstrating positive response to some of the design enhancements we put into place including more contemporary lighting, softer furniture and an expanded open air bar lounge area.

We intend to open a new restaurant this summer in Houston, Texas in the Town and County Village Shopping Center which will be our third McCormick & Schmick's restaurant in that city. Our new Houston location will feature the updated design elements we have been looking at to better connect with a broader audience including a significantly expanded bar with a patio layout with a fire pit, more contemporary lighting, upgraded AV and other unique features designed to enhance the overall ambiance.

Finally we are also pleased to announce we recently completed a deal to open a new Boathouse restaurant at Kitsilano Beach, Vancouver B.C. This is our first expansion of our Boathouse plan since 2007. The restaurant is a conversion of an existing restaurant located directly on the water with panoramic views of English Bay and the North Shore mountains. We are currently in the process of renovating the building and intend to open this summer. This beachfront location is an ideal fit for the Boathouse portfolio with prime waterfront views and a strong guest demographic.

We have a well seasoned team in Vancouver with strong local knowledge and connections which allowed us to move quickly and seize this time sensitive real estate opportunity. In addition to these three new restaurants we have identified a number of existing locations that we feel would benefit from upgrades particularly in patio and bar space. Our scheduling is for these projects for the remainder of this year. We believe that reinvestment in our current portfolio of restaurants will provide attractive returns on our capital and will improve our long-term success.

For the balance of this year we intend to remain focused on execution at the restaurant level while completing the implementation of the strategies launched in the middle of last year as we continue to evolve our concept further connecting with our current guests and broadening our appeal to a wider audience. We will do so through the value we offer on our daily printed menu by continuing to increase brand awareness through traditional and social marketing along with our Preferred Guest program and our mail club database.

We are confident these strategies will provide the long-term results needed to remain an industry leader. Now in terms of our financials I would like to turn the call back over to Michelle.

Michelle Lantow

Thanks Bill. For the first quarter ended March 27^th, total revenues decreased 7.7% to $84.8 million compared to $91.9 million in the first quarter of 2009. Our comparable restaurant sales decrease of 9.6% was comprised of a 6.2% decrease in traffic which was coupled with a decrease in net pricing of 3.4%.

These metrics reflected challenging weather conditions in Q1 as well as our proactive long-term strategy to increase the value proposition for our guests and drive traffic by decreasing our average guest check. Despite the reduction in total revenues from last year, as Bill said, we were still able to manage our total controllable restaurant operating costs within 10 basis points compared to the first quarter of 2009 due to ongoing cost management initiatives.

Food and beverage costs increased 30 basis points to 30.4% of restaurant sales which was largely driven by our efforts to provide greater value on our new wine list as well as some additional increases in cost of goods in the bar. Labor costs in the first quarter held steady at 33.2% in both periods. As we managed our labor costs appropriately for the decline in guest traffic year-over-year.

Our operating costs in the first quarter were 80 basis points lower than the prior year primarily due to cost saving initiatives we launched in 2009. Occupancy costs fell $0.3 million to $9.2 million but increased 50 basis points versus the first quarter of 2009 as a result of de-leveraging on the fixed portion of occupancy costs.

Total restaurant operating costs as a percentage of revenue in the first quarter were 89.3% compared to 89.2% for the first quarter last year, a 10 basis point swing. General and administrative expenses were $0.9 million lower than the prior year or 60 basis points lower as a percentage of total revenues, reflecting decreases in compensation expense and legal fees. Pre-opening expenses decreased by $0.1 million compared to the first quarter of 2009 primarily due to the timing of restaurant openings.

Depreciation and amortization decreased by $0.3 million but increased by 10 basis points to 4.5% of total revenue as a result of de-leveraging. Interest expense for the first quarter was $0.4 million which was in line with the prior year’s first quarter. As of the end of the first quarter we had an outstanding balance of $13 million on our credit facility and $6.6 million in cash. We are in compliance with all of our credit facility covenants.

Taken together, first quarter net loss was $0.5 million an improvement of 61.5% from the net loss of $1.1 million reported at the same time last year. On a diluted per share basis our net loss was $0.03 compared to $0.08 in the first quarter of 2009.

Now let’s review our 2010 financial outlook. We are reiterating our prior expectations for annual revenue of between $355-365 million. Fully diluted earnings per share are expected to be between $0.40 and $0.45. Depreciation and amortization for 2010 is expected to be approximately $16 million while G&A is expected to be between $20-21 million. We will continue to prudently apply our cash flow to strong development opportunities and debt reduction.

In terms of development, as Bill said we opened our McCormick & Schmick's West Palm Beach Florida restaurant in February and will be opening our McCormick & Schmick's Houston, Texas location in the Town and Country Village Shopping Center in June. We also will be opening a Boathouse restaurant in Vancouver this summer as well.

Rounding out the rest of our financial outlook we now expect our annualized effective tax rate to be between 10-15% compared to our previous expectation of between 5-10%. The change is due to our projection of modest taxable income for the year in certain taxing jurisdictions along with the expected decrease in our deferred tax assets and corresponding change in the valuation allowance. We note that minimal differences in our estimates for taxable income for the year have a material impact on our effective rate.

Overall capital expenditures for 2010 are now expected to be between $15-16 million versus $12-13 million previously reported. This includes three new restaurant openings; two McCormick & Schmick's and one Boathouse as well some upgrades on our existing restaurants including patios, bars and some interiors. The capital use for the new Boathouse project will be funded solely with Canadian cash we have reserved in Canada and will not require use of our line.

With that let’s open the line to any questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Jeff Farmer – Jefferies & Company.

Jeff Farmer – Jefferies & Company

Did you touch on the impact of the events in the gulf and in Iceland on your seafood costs? What if anything will you see in terms of cost pressure from those two events?

William Freeman

We didn’t but I can give you a quick update. Clearly this happened past the end of the quarter so there was no impact to the first quarter related to our costs. As we look forward I think it is still unclear of what the long-term impact of that is going to be. I think you are going to see some price increase on seafood related to just what is happening down in the region. I think ultimately more of the impact is going to be on oysters and some of the other fin fish from that area which is not that great as compared to shrimp based on where the oil spill is now. But things could change as time goes on.

Jeff Farmer – Jefferies & Company

Following up on that and along those lines just looking at your menu that has sort of an increasing level of fixed price items, the 10 under $10 and things like that, what type of challenge if any could that present to your ability to pass along any potential commodities pressure you might see?

William Freeman

I think what has obviously been a mainstay at McCormick & Schmick's over the years is our daily printed menu and I think ultimately what we do is we manage and engineer our menu based on what we not only can find and source in local markets but also what we are sourcing on an international basis and then from our perspective we have been able to manage that to a fairly close margin and narrow margin over the years and continue to by engineering what we are offering on the menu by what we find in the local markets and international purchasing contracts. So I think we will still continue to be able to do that.

Jeff Farmer – Jefferies & Company

So just to be clear that 10 under $10 menu can be pretty dynamic? It is not sort of a static group of menu items?

William Freeman

No actually it could change every day based on what the local chef finds in the market and what they are looking at offering. I would say there is a significant amount of variety not only within the company but also location to location and day in and day out based on what is available on the market and what they can offer.

Jeff Farmer – Jefferies & Company

Again, I apologize if you are saying this a second time but I may have missed but April same store sales trends. Did you touch on that at all?

William Freeman

April got better than March. We saw about 1.5 point improvement in April over where we were in March.

Operator

The next question comes from the line of Jeff Omohundro – Wachovia.

Jeff Omohundro - Wachovia

A question regarding development when thinking about your free cash generation this year improving. We do see that you have picked up the pace a bit. I am just curious when you think beyond this year what kind of triggers would you be looking for in terms of accelerated investment or returns to further accelerate your unit development plans?

William Freeman

If I understand your question are you asking what our return on investment hurdle is or are you looking at what those triggers are that make us want to continue to develop?

Jeff Omohundro - Wachovia

I guess a little bit of both. Given your cash flow generation it appears you will have the financial capability to pick up the pace if you would like to. Are you looking for improved ROI or other factors to begin building a real estate pipeline and accelerate the pace?

William Freeman

At this point what I would say is clearly ROI is an important component to shareholder value and we are looking at minimum return on investment. Traditionally it has been 30%. We are evaluating where our portfolio is and what that should look like as we go forward coming out of the last 18 months. I think the other factor we are looking at is where do we have opportunities to reinvest back into our portfolio and generate greater returns maybe even than just building new restaurants by looking at markets and again this evolution of our concept we have been talking about we think there are some interesting opportunities within our current portfolio that could complement growth on the outside.

Jeff Omohundro - Wachovia

Regarding the average check, what are you thinking about when we will begin to see stabilization there and at what level?

William Freeman

If you go back and look at the timing of when we started the process of engineering this check down it was mid-year last year. I think we have about one more quarter we are going to have to lap over before we actually instituted a lot of these changes and this kind of engineering of the check down. If you look at the first quarter our average check being down 6.5% certainly has an impact on how we compare year-over-year on same store sales. Once we get through Q2 we will start to actually compare back against that so the comps will be significantly different in Q3 and Q4 related to the average check impact.

Operator

The next question comes from the line of Analyst for Matt DeFrisco – Oppenheimer.