O'Charley's Inc. Q2 2010 Earnings Call Transcript

Aug.12.10 | About: O'Charley's Inc. (CHUX)

O'Charley's Inc. (NASDAQ:CHUX)

Q2 2010 Earnings Call Transcript

August 12, 2010 11:00 am ET

Executives

Gene Marbach – IR

Phil Hickey – Chairman and Interim CEO

Larry Hyatt – CFO and Treasurer

Analysts

Robert Derrington – Morgan Keegan

Jeff Omohundro – Wells Fargo Securities

Bryan Hunt – Wells Fargo Securities

Operator

Good morning ladies and gentlemen. Thank you for standing by. Welcome to the O'Charley's second quarter 2010 conference call. (Operator instructions) I would now like to turn the conference over to Gene Marbach. Please go ahead sir.

Gene Marbach

Thank you Brendy. Good morning all and thank you for joining O'Charley's fiscal 2010 second quarter conference call. On the call today are Phil Hickey, the company’s Chairman and Interim Chief Executive Officer; and Larry Hyatt, the company’s Chief Financial Officer.

The order of business this morning will be some brief remarks from Phil and Larry about the second quarter. We will then open the call to questions. In the time allotted we will take as many questions as possible.

Before we begin, I would like to note that certain statements made by O'Charley's management on this call may be deemed to constitute forward-looking statements made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements may be affected by certain risks and uncertainties, including risks described in the company's filing with the Securities and Exchange Commission. In light of the significant uncertainties inherent in the forward-looking statements included in the company's comments, you should not regard the inclusion of such information as a representation that its objectives, plans, and projected results will be achieved and the company's actual results could differ materially from such forward-looking statements.

I would now like to turn the call over to Mr. Phil Hickey, Chairman & Interim CEO of O'Charley's. Please go ahead sir.

Phil Hickey

Thank you and good morning everyone. This is my first quarterly earnings call in my role as interim CEO of O'Charley's, and it is an honor to serve in this capacity until David Head, our incoming CEO arrives.

While there are clearly competitive and economic challenges that exist in our industry, I believe in the potential of each of our three concepts here at O'Charley's Inc, and I’m confident that our company’s best days lie ahead of us.

Speaking of David Head, he will be joining us as President and CEO of O'Charley's Inc. around September 1. David is a proven leader, whom I have known for 15 years, and he brings with him strong leadership skills, deep operational experience in the restaurant industry, and an impressive track record refining and repositioning restaurant concepts.

I look forward to working closely with David to improve our financial performance and grow shareholder value by building guest loyalty through consistent delivery of great food and great service. While the economic environment continues to provide challenges for casual dining companies, two of our three concepts, the Ninety Nine and Stoney River experienced a positive shift in momentum in the quarter.

At the Ninety Nine concept, we continue to strengthen our ties to our core guests, who appreciate a friendly environment that offers generous portions of high-quality traditional fare at moderate prices. Ninety Nine outperformed its relevant Knapp-Track averages in the quarter, and had its first quarter of positive guest count growth in more than four years.

Our ‘Real-Sized Entrees for $9.99' offering continues to prove popular with our guest, and profitable for us. So we will continue to refresh these items. Our guests continued to respond favorably to the opportunity to upgrade their entrée into a full meal for an additional three bucks, and our ‘Red Sox Win Kids Eat Free’ promo continues to be popular.

During the quarter Ninety Nine improved its guest satisfaction scores by 200 basis points versus the prior year quarter. Summer [ph] at Ninety Nine means lobster rolls, and we have been selling between 12,000 and 14,000 of them per week, an increase of about 20% compared to last summer. We believe that we can continue our current sales momentum at Ninety Nine for the rest of the year. Through the first four weeks of the current quarter, same-store sales have been positive.

At our Stoney River Legendary Steaks concept, same-store sales showed improvement over the trends of the past three years, and guest counts have been positive for three consecutive quarters. It appears that the repositioning of the Stoney River concept that we initiated last year continues to show progress. We are striving to increase our relevance to a broader guest market. In order to achieve this objective, we have reduced prices of certain menu items, added menu items and more affordable wine choices to the wine list, while continuing to offer our loyal Stoney River guests, the same great guest service experience in all their signature favorites.

We are also focused on bringing Stoney River cost structure in line with the lower check average, and this quarter’s 530 basis point improvement in restaurant operating margin indicates that we continue to make progress in this area. Through the first four weeks of the current quarter, Stoney River was positive as well. While we were disappointed with the second quarter financial performance of the O'Charley's concept, we believe that our enhanced focus on innovative food offerings, service improvements and value will resonate with the O'Charley's guest, and lead to a shift in sales trends later on this year.

O'Charley's guest satisfaction scores in the quarter improved 300 basis points versus the prior year quarter, and was at the highest level since we started measuring it six years ago. We believe that our brand positioning efforts will also require fresh thinking from our advertising agency. We are close to selecting a new advertising agency, expecting to make announcement about this shortly. As a first step towards improving sales and profitability, we need to attract new guests to O'Charley's, increase frequency among our current guests and provide every guest the great food and service that will make them want to return.

We believe that the recently reintroduced ‘2 Meals for $14.99’ provides a compelling value that will attract guests within our proven favorites. By combining this offer with value-priced beverage and appetizer choices, and an opportunity to complete the perfect meal with a super salad and dessert for 2.99, we believe that we can limit the impact on average check and profit margins.

With our retraining and recertification effort driven by Wilson Craft underway, we believe that we can provide the service and execution to convert new and returning guest into loyal O'Charley's users. While it is still early, we saw a change in trend last week as we began our ‘2 for $14.99’ program and guest counts were positive for the first time since we stopped the program in March.

We continue to aggressively seek feedback from current and last [ph] O'Charley's guest. The response confirms what we already knew from our market research. In recent years, the O'Charley's concept has lost many of its long-term loyal guests, who no longer perceive O'Charley's to have better food and service than our competitors. However, we also learnt that many of our formerly loyal guests still have a strong attachment to O'Charley's and are looking for a reason to give us another try. All of us at O'Charley's are committed to providing the great food, service and value that will win these guests back.

We believe that we know the recipe for success for O'Charley's, and are confident that we are taking these steps to achieve it. While we expect to begin seeing results of these efforts later on this year, I want to caution this turnaround will not happen quickly.

Before I turn the call over to Larry for this comments, I just like to acknowledge the dedication of our 24,000 team members, who strive everyday to build guest loyalty through delivering superb guest experiences.

Now here is Larry to share with you the rest of the story.

Larry Hyatt

Good morning everyone, and thank you Phil. I would like to discuss our financial performance for the second quarter of 2010, some items that impacted that performance and our outlook for the current quarter. Additional information is available in our Form 10 Q, which we filed this morning with the SEC.

For the second quarter of 2010 revenue declined 5.9% to $194.1 million from $206.2 million in last year’s second quarter. Our restaurant level margin, which we define as restaurant sales minus cost of food and beverage, payroll and benefits costs, and restaurant operating costs was $27.4 million, or 14.1% of restaurant sales compared to $33.8 million or 16.4% of restaurant sales in the prior year quarter.

Loss from operations was $0.5 million, or 0.3% of revenue compared with income from operations of $5.2 million or 2.5% of revenue in the prior year quarter.

Our adjusted EBITDA for the quarter was $12.4 million or 6.4% of revenue compared to $18.9 million or 9.2% of revenue in the prior year quarter. Reviewing our performance on a concept by concept basis, same store sales at our company operated O’Charley’s restaurants decreased by 7.9%, which was the result of a decrease in guest count of 5.7% and the decline in average check of 2.4%.

Restaurant level margins at the O’Charley’s concept declined to 14.6% of restaurant sales from 17.2% in the prior year quarter. Cost of food and beverage increased by 70 basis points as lower food commodity costs were offset by high alcohol and beverage cost, and the impact of promotional offerings on product mix and average check.

Payroll and benefit costs increased by 50 basis points, as the deleveraging impact of reduced average weekly sales was partially offset by lower employee benefit and restaurant bonus expenses. Restaurant operating cost at O'Charley's increased by 140 basis points due primarily to the deleveraging impact of reduced average weekly sales.

For Ninety Nine, same store sales decreased by 0.5% in the quarter as a 0.4% increase in guest count was offset by a 0.9% decline in average check. Restaurant level margin at Ninety Nine had declined to 13.2% of restaurant sales from 15.5% in the prior year quarter. Cost of food and beverage increased by 80 basis points, as lower food commodity costs were offset by increased alcohol and beverage cost and the impact of promotional offerings on product mix and average check. Labor and benefit costs increased by 10 basis points, while restaurant operating costs increased by 140 basis points, due to higher repair and maintenance, supply and insurance costs, and the deleveraging impact of reduced sales.

For Stoney River, same store sales declined 0.7% in the quarter as a 7.8% increase in guest count was offset by an 8% decline in average check. Restaurant level margin at Stoney River improved by 530 basis points in the quarter, compared to the prior year quarter, which we believe reflects the success of our efforts to align Stoney River’s cost structure with its lower prices.

On a consolidated basis, advertising and marketing expense was $7.9 million or 4.1% of revenue in the quarter compared with $8.1 million or 3.9% of revenue in the prior year quarter.

Our general and administrative expenses were $10.2 million or 5.3% of revenue in the second quarter, and include severance and other charges relating to our recent organization changes of $2.4 million or 1.2% of revenue. In comparison, G&A expense was $8.1 million or 3.9% of revenues in the prior year quarter. We continue to tightly control all G&A cost centers.

Our interest expense for the second quarter was $2.9 million compared with $2.7 million in the second quarter of 2009. On a year-over-year, the impact of reduced debt level was more than offset by a $0.4 million impact from changes in the value of deferred compensation balances. At the end of the quarter we had $115.2 million of senior subordinated notes outstanding, a cash balance of $25.9 million, and no drawings on our revolving credit line.

Our capital expenditures in the quarter were $4.7 million compared to $4.5 million in the prior year quarter. While debt reduction remains a priority use of our free cash flow, we will make decisions about future bond repurchases based upon the future financial performance of the company, the financial requirements of our turnaround effort, and our desire to maintain conservative cash balances. Therefore, we cannot predict at this time whether we will repurchase additional bonds during the remainder of the year or the potential magnitude of any such purchases.

Our results for the quarter include an income tax benefit of $0.9 million compared to an income tax benefit of $0.3 million in the prior year quarter. Included in this quarter’s tax provision is a credit of $1.3 million for a change in estimates relating to net operating losses, which we can now carry back and realize due to the provision of the Worker, Homeownership & Business Assistance Act of 2009.

Our loss attributable to common shareholders in the quarter was $2.5 million or $0.12 per diluted share compared to earnings available to common shareholders in the prior year quarter of $2.8 million or $0.13 per diluted share. We continue to believe that we do not have sufficient visibility to offer a full year projection of our sales or financial performance. However, I would like to share some information that may be helpful when thinking about our prospects for the balance of the year.

With respect to food and beverage costs for the remainder of 2010, we have locked in our pricing for approximately 85% of our estimated beef requirement, approximately 75% of our estimated pork requirement, almost all of our estimated poultry requirement, and approximately 40% of our estimated seafood requirement.

Based upon this locked in pricing, and our current forecast, we expect a percentage [ph] in our food commodity costs on a constant mix basis in the low single digits, while we expect our alcohol and beverage costs to increase in the mid-single digits. We project depreciation and amortization expense of approximately $10 million per quarter for each of the remaining two quarters of the year. We expect capital expenditures of between $14 million and $16 million.

We have completed the role restaurant remodels planned for the year, and currently have no plans for new restaurant development. For the third quarter of 2010, we forecast total revenue of between $186 million and $192 million, and a loss from operations of between $1 million and $4 million. We also are projecting adjusted EBITDA for the third quarter of between $7 million and $10 million based upon estimated depreciation and amortization expense of approximately $10 million, and estimated stock compensation expense of approximately $1 million.

And with that, I will turn the call back over to Brendy so that we can answer your questions. Thank you very much.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of Robert Derrington with Morgan Keegan. Please go ahead.

Robert Derrington – Morgan Keegan

Thank you. Phil, could you give us a little bit of color on how you look at your brands and the positioning of those, O'Charley's Ninety Nine, Stoney River, you know, is there some risk that essentially you are training consumers to expect lower prices and how does that affect your strategy going forward?

Phil Hickey

Well, there were about three or four questions in that Bob. First of all, the positioning of the brand, just in one sense, the Stoney River, our intent is to make that a polished casual steakhouse in the $25 check average range, and be the best in the US. The Ninety Nine strategy is to be a reasonable powerhouse, honoring its roots of high quality food, great portions and great prices. And O'Charley's is to be a move towards the place that used to occupy in the consumer’s mind, which is more in the dinner house end of the casual dining, great venue casual dining segment. Not to move far away from our check average, but just move up the ladder a little bit to where we used to occupy.

So that is where the strategy is for each of them. To your question about value, Bob, we think that the consumer is still under duress. It appeared that the first part of this year that we were moving in the right direction. The economy is recovering some. We think that there are some risks right now. So we think that the idea of having a value proposition in all of our concepts right now to encourage trial, and correspondingly encourage conversion of a new guest to a regular guest by having great experiences is the key to success.

Robert Derrington – Morgan Keegan

Okay. Then my follow up on that is when we look at the O'Charley's current ‘2 for $14.99’ promotion, it certainly seemed to work pretty well 6 or 7 months ago or so. As you look at that now, are you confident that you can get a little bit less, I guess, there was a negative impact to your earnings the prior time, what gives you confidence that in fact it will be more beneficial unless negatively impactful?

Phil Hickey

Bob, it was negative to earnings short-term when we were still in kind of experimental stage, and ironically, we started the program last August, and we went through a number of iterations, we adjusted it in October, we adjusted it in December, we adjusted it again in January. And as I said in my remarks, the sweet spot that we finally achieved in March was one where we had the value proposition for the guest, we had check average growth that enable us to preserve and grow margin, and then again we stopped doing it.

So our intent, and I can tell you that everyone in the O'Charley's team has been very focused on achieving this balance is to do the same thing we did in March, and do it even better, which is again providing a high-quality experience at a great value, and the key is the conversion. It doesn’t take a lot to get people in the door, it is a stronger effort to convert someone from a new trier or a lapsed user into a regular guest. So we feel that we are right on track with our plan.

Robert Derrington – Morgan Keegan

All right. Very good, I will jump back in the queue. Thank you.

Operator

Thank you. (Operator instructions) And our next question comes from the line of Jeff Omohundro with Wells Fargo Securities. Please go ahead.

Jeff Omohundro – Wells Fargo Securities

Thanks. I think my first one is for Larry. On that 2.4 million severance charge, I wonder if you could tell us what the tax impact related to that might be either on a dollar basis, or the tax rate on that.

Larry Hyatt

Yes, Jeff, as I am sure you recall, because we have discussed this for a number of quarters. The company tax situation in terms both of the cash taxes that we pay, and the way that we account for our tax provision is very complicated. But sort of the simplistic answer to your question is the marginal dollar still bears a rate of 35%, so that in round numbers the tax savings from the $2.4 million charge order of magnitude is in the zero – is in the $0.8 million range.

Jeff Omohundro – Wells Fargo Securities

Perfect. And then, in thinking about O'Charley's and the desired positioning more towards the dinner house side of casual dining, can we expect to see in the next few quarters, some sort of more significant menu update and/or reinvestment in training. Thanks.

Phil Hickey

Well, answering the second part of your question first, the reinvestment and training is already happening, and we are basically taking every single general manager through a recertification in the kitchen training, and we are pleased with the progress so far. And as far as the menu innovation, you can expect to see with the subsequent quarters a little more aggressive menu innovation that have the balance of great value and the opportunity for us to grow our check a little bit as well.

Jeff Omohundro – Wells Fargo Securities

And then lastly, if I might, have you started any contracting on 2011, where do you stand on that?

Larry Hyatt

Jeff, this is the very start of the time that we would typically begin to consider contracting our commodities for the next fiscal year. So, we have not yet actually started to sign contracts.

Jeff Omohundro – Wells Fargo Securities

Thank you.

Operator

Thank you. Our next question comes from the line of Bryan Hunt with Wells Fargo Securities. Please go ahead.

Bryan Hunt – Wells Fargo Securities

Thank you. I was wondering if you could Larry talk about your cost of your average remodel this year, and what type of sales lift you all achieved from the – I believe 12 models that you completed?

Phil Hickey

Yes, Bryan, our average cost for a remodel order of magnitude is about $0.25 million, and most of those remodels were completed in the spring in the second quarter. So it is really too early to reach any conclusion as to sales lift.

Bryan Hunt – Wells Fargo Securities

Okay, great. And then looking at future CapEx, is there – and you’ll have been maintaining a relatively low Capex over the last couple of years. Do you see, or where do you think the biggest need is for Capex on a go forward basis, is it beginning to remodeling Ninety Nine, or do you think it is still good on the path of remodel of O'Charley's stores.

Phil Hickey

Yes. Let me answer that one a couple of ways. We have remodeled when we were going through the remolding program 62 Ninety Nine and 62 O'Charley's, and we subsequently have been remodeled about another 12 O'Charley's. So, we’re up to about 74. If you take the 62 Ninety Nines, and if you add those to the restaurants that we constructed new over the last 5 to 7 years, the conclusion is that Ninety Nine, although there certainly are restaurants that require some remodel investment, but we are much further along in the remodel process than we are in O'Charley's.

Given the continued uncertainty and the lack of future visibility of our future performance, we will continue to be cautious about our capital investment.

Larry Hyatt

And Larry, I also like to add to that Bryan that we are – one of the initiatives that we are undergoing and have been undergoing for a little while now is looking very closely at ROI, and knowing that we need to keep our restaurants fresh, and looking at how we spend the dollars in the very best possible way, one of the advantages of David Head coming in is that he has done a really nice job over his last four years at having some very strong ROI, freshening up programs in the restaurants that he has come from.

So, we are bringing a strong mindset of that we want to spend the money wisely and spend it where the guests will appreciate it.

Bryan Hunt – Wells Fargo Securities

Thank you for your comments.

Operator

Thank you. And we have a follow up question from the line of Robert Derrington with Morgan Keegan. Please go ahead.

Robert Derrington – Morgan Keegan

Yes, thanks. Phil, coming back to the fact that you mentioned you have got an agency review or an agency search, you know, can you give us a little bit of color, the agency, I believe that the Company has used for quite a while for O'Charley's has been in place. I’m just wondering what you are looking for out of your new agency? Is there a better recipe of medium mix that could reach a little bit more refined audience for the O'Charley's brand? Or, you know, how should we think about that?

Phil Hickey

Oh, Bob, we should think about it that we have had diminishing average (inaudible) sales for about five years in a row.

Larry Hyatt

Right.

Phil Hickey

And so, we enjoyed a long-term relationship with the previous agency, but we think it is time for a change and a fresh set of eyes. So, the agencies that we are looking at are we think strong value added groups, and we are looking not only at the advertising strategy and allocation of resources and money, divided up between the electronic, et cetera, but also concept positioning, and where we can fit in the guest mindset.

So, there will be no – while we expect no overnight miracles in the first week or two of the agency’s work, but we think that we are going to have a more precise messaging to our guest, and a call to action. And a little bit more of a broader, less electronically driven approach.

Robert Derrington – Morgan Keegan

Okay. And will they serve each of the three brands?

Phil Hickey

The company that we’re hiring is for O'Charley's.

Robert Derrington – Morgan Keegan

Okay. Got you. Thank you.

Operator

Thank you. (Operator instructions) And at this time, there are no further questions. I would like to turn the call back over to management for any closing comments.

Phil Hickey

Well, thank you. And we would like to thank everyone for listening in. We appreciate your support in O'Charley's.

Operator

Thank you. Ladies and gentlemen, this concludes the O'Charley's second quarter 2010 conference call. If you would like to listen to a replay of today’s conference, please dial 303-590-3030, or 1-800-406-7325, followed by the pass code of 434-186. ACT would like to thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!