Kona Grill Inc. Q2 2010 Earnings Call Transcript

| About: Kona Grill, (KONA)

Kona Grill Inc. (NASDAQ:KONA)

Q2 2010 Earnings Call Transcript

July 27, 2010 5:00 pm ET

Executives

Mark Robinow – CFO, EVP and Secretary

Marc Buehler – President and CEO

Analysts

John Dravenstott – KeyBanc Capital Markets

Rob Brown – Craig-Hallum

Shawn Bitzan – Feltl & Company

Operator

Ladies and gentlemen, welcome to the Kona Grill second 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, Melisa. Good afternoon, everyone. By now, you should have access to our second quarter earnings release. It can 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 second quarter and provide an update on some of our current initiatives. Mark, will then discuss in detail our financial results as well as our guidance for the third quarter. And I will then wrap up the call with some final thoughts before turning the call over for questions and answers.

And with that, let me get started. Second quarter sales were $22.7 million, which was at the high-end of our revenue guidance of $21.7 to $22.7 million for the quarter. Same-store sales declined 0.3% during the second quarter compared with being down 9.5% last year and 2.5% last quarter. For the second consecutive quarter, we experienced positive traffic which demonstrates that our sales initiatives are working and they were building guest loyalty.

Over the past nine months, our check average has fallen about 7% due to a cautious guest spending pattern. We continue to stress the importance of value on our menu and have not taken any menu pricing during 2010. As a part of our menu evolution process that I will speak about momentarily, we are re-engineering several areas of the menu which will deliver more top line revenue while still being more mindful of the guest value that the guests are requesting.

Our net income for the period was $0.3 million or $0.03 per diluted share, which exceeded our previous expectations of a net loss between $0.01 and $0.06 per diluted share. If we exclude special charges of $160,000 in our G&A, net income was actually $0.4 million or $0.05 per share.

Either way, our second quarter marks the first time we’ve reported net income in almost three years. As we’ve discussed over the past few conference calls, our marketing initiatives are designed to create more buzz around our concept and thereby build top line sales. We have successfully engaged our customers through the use of Facebook, Twitter, Yelp, Urbanspoon and Foursquare and are leveraging these relationships to bring in new guests and increase the frequency of current guests.

During the second quarter, we held a very successful Sushi & The City event where guests were able to experience an extension of the onscreen excitement and glamour of the Sex and the City Sequel with a walk down the red carpet, specialty Samantha, Carrie, Charlotte and Miranda sushi rolls and door prizes.

We also held a raffle, which raised over $10,000 for Dress for Success, an international not-for-profit organization that promotes the economic independence of disadvantaged women. Our Konavore loyalty program continues its substantial growth and in just over 180 days has over 75,000 members. Considering our total footprint of 24 restaurants, this amounts to an average of over 2,500 loyal guests per location.

Once we complete our transition to a card based program, the program will become even more effective as we will be able to learn more about our users and target them with specific messages designed to encourage additional dining occasion. Due to the coming legislative changes related to card based loyalty programs and gift cards, we now anticipate this transition to incur in early 2011.

We are also in the midst of a comprehensive menu evolution project to improve the wild factor and enhance the flavor profile of many food items. We’re almost complete with phase one, which include tweaks to appetizers, salad and the introduction of a couple of new desserts. The menu updates have undergone comprehensive guest feedback in fixed restaurants over the past month and are scheduled to rollout system-wide in early August. Phase two of this project involves refinement to our pieces and sandwiches and the addition of several new menu items which will begin testing next week.

Our alcoholic beverage program, which as you know, accounts for approximately 31% of our total sales is in the midst of a total rework to ensure that we are forward leading with our beer and cocktail offerings and that we are not following in that category. Our wine and sake programs will also be rework as a part of the menu evolution process.

We are also testing new menu designs for both food and beverage offerings designed to help us drive top line results. We recently enlisted the services of an outside purchasing group to help us streamline and consolidate our purchasing power. We’re viewing all products currently purchased and looking for potential savings on all items through better use of forward contracting and negotiating. We expect to see positive results from these efforts beginning in late fourth quarter and into 2011.

Taking together, our purchasing, marketing, and culinary initiatives are essential building blocks in driving profitability for our company. The increased sales generated by these programs will allow us to leverage our costs and generate sustainable improvement in our bottom line over time.

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

Mark Robinow

Thanks, Marc. For the second quarter ended June 30th, restaurant sales increased 5.7% to $22.7 million reflecting additional revenue from two restaurants opened since last September. Sales comparisons continue to be impacted by the economy that as Marc noted, traffic trends have consistently been positive this year.

Overall, same-store sales declined 0.3% which represents a 220 basis point improvement from the first quarter and a 920 basis point improvement from the year ago period. Cost of sales, as a percentage of restaurant sales, increased 110 basis points to 26.5% during the second quarter from 25.4% last year as price increases for certain seafood, meat and produce items resulted in higher average food costs.

These price increases are part commodity driven and part quality driven by our culinary team as we upgrade to specifications dictated by our new menu evolution. The increased cost of sales is also attributable to a higher volume of promotional mailers and discounted product offered as part of our Konavore loyalty program, a portion of the cost of these programs are recorded in cost of sales.

The long-term investments we are making in the concept through the loyalty program and improved food quality are well worth the short-term impact on cost of sales. Labor expenses, as a percentage of restaurant sales, increased 40 basis points to 34.3% during the second quarter from 33.9% last year. The higher labor cost percentage is attributable to de-leveraging of fixed manager salaries and hourly labor expense due to the modest decline in same-store sales.

Initial high labor costs from our recently open restaurants also contributed as labor expenses are typically higher than normal during the first several quarters of operation. We do not expect labor, as a percentage of sales, to substantially improve until we are able to leverage these costs through higher sales.

Restaurant operating expenses were flat at 15.1% during both the second quarter for 2010 and 2009. We expect these costs to increase 100 to 150 basis points in the second half of this year due to planned repair and maintenance and remodeling expenditures. Occupancy expenses, as a percentage of restaurant sales, increased 60 basis points to 7.8% during the quarter compared to 7.2% last year. The increase, as a percentage of restaurant sales, is due to an increase in common area cost charges at many locations and de-leveraging as a fixed portion of occupancy costs.

Combining these four line items, restaurant operating profit was $3.7 million or 16.3% of restaurant sales compared to $4 million or 18.4% of restaurant sales last year. Depreciation expense, as a percentage of restaurant sales, decreased 230 basis points to 6.1% of restaurant sales during the second quarter from 8.4% a year ago.

The reduction reflects lower depreciation expense due to the asset impairment charge we took in the fourth quarter of 2009. We will continue to experience a positive comparison of approximately $500,000 per quarter from the 2009 impairment charges for the balance of the year.

General and administrative expenses, decreased $800,000 from the prior year quarter primarily due to several unusual charges in the year ago period. During the second quarter, we spent about $160,000 for legal and other expenses associated with the contested Board of Director election held in late April.

In total, we spent about $370,000 for this year’s proxy content. As a percentage of sales, G&A decreased 410 basis points to 8.3% during the quarter compared to 12.4% last year. Net income for the quarter was $260,000 or $0.03 per share. This represents our first profitable quarter in almost three years. Last year, we posted a loss of $200,000 or $0.03 per share.

We ended the quarter with $3.3 million in cash and investments. At the end of the quarter, we sold our auction rate securities at par value and repaid the outstanding balance under our credit line. Our available cash and cash flow from operations allows us to complete construction over the Baltimore, Maryland restaurant later this year.

During the second quarter, net cash provided by operating activities was $1.5 million. We spent about a million during the quarter for construction of our Baltimore restaurant. We expect to spend a total of 3 million in CapEx for the remainder of this year, which includes remodel of our Kansas City and Denver restaurants.

For our third quarter financial guidance, we are forecasting sales of $20.5 million to $21.5 million and a loss of $0.5 million to $1.0 million or $0.05 to $0.11 per share. Our guidance reflects the current economic uncertainty and same-store sales of approximately minus 2.5% for the third quarter.

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

Marc Beuhler

Thanks, Mark. Our entire team is focused on delivering outstanding guest experience, every guest, every day at every restaurant. We remain laser-focused, not only on the top line but also at the bottom line. And while we did achieve profitability this quarter, much work remains to drive consistently higher sales and margins in all of our restaurants.

On the people front, I continue to be pleased with our progress in developing outstanding restaurant level management talent. We recently added a fourth District Manager, tightening the span of control to allow for better training and development in our existing portfolio. Our multi-unit managers are able to spend more one-on-one time in each of their restaurants ensuring that we are delivering the great Kona experience in all of our locations.

We also recently launched a President’s panel of (inaudible) managers who serve at an advisory role to the senior management. Their input is invaluable as we look to move Kona grow forward.

We are excited to be opening our Baltimore restaurant at the end of this quarter as a part of our commitment to measured growth. We have no lease commitments beyond Baltimore at this time and we will only pursue additional leases based on significant economic opportunity and availability of affordable debt capital or sufficient cash flow from operations.

At our normal course of business, we are in discussion with lenders for equipment leases for lines of credit that will provide additional financial flexibility. With the proxy context behind us, we are looking to fill our open-board seat with an industry veteran that will provide added value to the entire team.

In closing, Kona Grill has experienced senior leadership and a talent of team of restaurant managers and co-workers who are committed to taking this concept to the next level. Our company is energized by a renewal of the Kona spirit and culture. We are pleased with the guest acceptance of the initiatives we’ve implemented so far this year and I look forward to communicating our continued progress in these areas over the coming quarters.

Thank you for your continued support. We would now be happy to answer any questions that you might have.

Melisa, you can open the lines.

Question-and-Answer session

Operator

Thank you, sir. (Operator instructions) And our first question comes from Brad Ludington from KeyBanc Capital Markets.

John Dravenstott – KeyBanc Capital Markets

Hi guys, this is actually John Dravenstott on line for Brad.

Mark Robinow

Hi, John.

Marc Beuhler

Hi, John.

John Dravenstott – KeyBanc Capital Markets

My first question was on your operating expense guidance, I think you said 100 to 150 basis points higher. So you’re saying in the back half of the year, you’re saying that’s above the 2H 2009 level?

Mark Robinow

Well that’s above that – 100 to 150 basis points above the 15.1 million that we experienced in Q2.

John Dravenstott – KeyBanc Capital Markets

Okay. All right, that makes more sense. All right. Second question, you mentioned that there is a Konavore loyalty impact into the COGS line, some of those – some of that couponing you did. Did you make an effort to quantify any of that this quarter?

Mark Robinow

Yeah. We did, it’s about 25 basis points, 25 to 30 basis points.

John Dravenstott – KeyBanc Capital Markets

Okay. And there were expenses incurred in the 1Q also with this right?

Mark Robinow

They were, not as many. The numbers were significantly smaller.

John Dravenstott – KeyBanc Capital Markets

Okay. And is that going to – is that going to continue like throughout the rest of the year as we lap the introduction of the program then?

Mark Robinow

It will normalize.

John Dravenstott – KeyBanc Capital Markets

It will normalize in the back half?

Mark Robinow

It’ll – in the first quarter 2011. So you – yeah it could have some impact in Q3 and Q4.

John Dravenstott – KeyBanc Capital Markets

Yes. All right. Okay. And did you offer a – you said traffic was positive, did you quantify the mix effect and the price effect? I guess price was zero, right? You said you didn’t take price.

Mark Robinow

Price was zero. Traffic was 5% to 6% positive.

John Dravenstott – KeyBanc Capital Markets

Great. Fair enough. I’ll hop of if anybody else doesn’t get on.

Mark Robinow

Thank you.

Operator

Our next question will come from Rob Brown with Craig-Hallum.

Rob Brown – Craig-Hallum

Good afternoon. Could you say a little more color on your guidance in the quarter? Do you see – do you see – what are your trends you see in the quarter and so – and so what sort of the reasoning in the step down from the Q2 level?

Mark Robinow

Well, Rob, we do; I mean we have seen – July is not over yet but we’re kind of seeing July down right around the 1.5% to 2% level for same-store sales right now. It has softened a little bit from June where we were about 1.5%. So it’s – we obviously had a better beginning of the second quarter than we did at the end. And we have seen some slight improvement lately but we just don’t know how to call the quarter. They – they seems to be going up and down from month to month and it’s a pretty difficult call as to trend right now. So we’re being conservative in our guidance.

Rob Brown – Craig-Hallum

Okay, thank you. And then, on the director kind of spending that that is done now right in that. You should see that in Q3, you should expect any unusual kind of charges like that in Q3?

Mark Robinow

We certainly don’t expect any.

Rob Brown – Craig-Hallum

Okay, good. And then what’s the timing of Baltimore, you said by the end of the year is that now a Q4 event or can you – could you see it fall in the Q3?

Mark Robinow

It’s going to happen probably on the last day of Q3 and the first day of Q4. We’re shooting for the 30th of September right now.

Rob Brown – Craig-Hallum

Okay. Great and then, last question on the cash number. Did you say you paid-off all of your kind of debt and the auction rate security backed at so you’re – is your net debt would be then your year-over-year total debt would be there?

Mark Robinow

Well, we paid-off all the auction rate security debt and we are able to receive par from our auction rate securities. The debt that we have remaining is about $900,000 of our old GE debt which goes down quarter-by-quarter.

Rob Brown – Craig-Hallum

Okay. Good. Thank you.

Mark Robinow

All right. Thanks, Rob.

Operator

(Operator instructions) Our next question will come from Mark Smith with Feltl & Company.

Shawn Bitzan – Feltl & Company

Hi guys. This is Shawn Bitzan stepping in for Mark Smith.

Mark Robinow

Hi, Shawn.

Shawn Bitzan – Feltl & Company

Can you talk a little bit about the sales mix of new items and promotions in particular with kind of the skinny menu?

Mark Robinow

Sure. Skinny launched at the beginning of the quarter and I didn’t mention it because we talked about it on our last call. But, early in the quarter we saw wide acceptance of those items in the neighborhood of 15 to 20% of product mix depending on the restaurant out of fixed items. So we got outstanding trial. That – that held well during the quarter. It dropped off from those initial launch levels but their products continue to sell well and we’ll find a permanent home on the menu. We will launch another food-based offering in the second week of August and these feature more of the American Grill Classics, we have a Hawaiian Rib-Eye, a Fresh Mahi and a Tuna Tartare appetizer. So again, those products are designed to help us drive check average and drive top line sales where the skinny items were $12 to $14 items. So they didn’t necessarily help us on the check average side of things.

Shawn Bitzan – Feltl & Company

Okay. And could you talk a little about the alcohol mix throughout the quarter as well?

Mark Robinow

It’s now stable at about 31%. So we haven’t seen it go down and hasn’t – has not gone up so.

Shawn Bitzan – Feltl & Company

Okay. Thanks guys.

Mark Robinow

Yeah.

Operator

And next we’ll go back to Brad from KeyBanc Capital Markets.

John Dravenstott – KeyBanc Capital Markets

Hi, John Dravenstott again. So when you talked about the same-store sales, we were positive in April right and then we ended up down 1.5% in July, so was that – do that sequentially decline throughout the quarter then?

Mark Robinow

We had – it was a rollercoaster for quarter. We were – we were up 3.5 in April, we were down 2.5 and then up 1.3 or excuse me, down 1.3 in June and now that that deal was a – it’s really been all over the board.

John Dravenstott – KeyBanc Capital Markets

Okay. And then with CapEx, did you say that you’ve spent 1.5 million to-date and you have 3 million for the remainder of the year expected.

Mark Robinow

Now we – in round numbers, we expect CapEx for the year to be about 4 million.

Marc Buehler

4 million in total.

John Dravenstott – KeyBanc Capital Markets

Okay. All right. And then finally, are those – is that West Palm Beach in Phoenix or is that – are those rolling into the comp base next quarter?

Marc Beuhler

Yeah.

Mark Robinow

Yeah. West Palm Beach is – and it corrects us and Phoenix – non-Phoenix will also.

John Dravenstott – KeyBanc Capital Markets

And that’s not expected to have any major effect on that same-store sales number?

Mark Robinow

Not material.

John Dravenstott – KeyBanc Capital Markets

Okay. Great. Thank you.

Marc Beuhler

Yeah.

Operator

And at this time, we have no further questions in the queue. And I’d like to turn it back over to you gentlemen for any additional or closing remarks.

Marc Buehler

That’s all we have. Thanks everybody for joining us on the call. We look forward to chatting with you soon. Thank you.

Operator

That does conclude the conference for today. Thank you for your participation.

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