Chuy's Holdings' (CHUY) CEO Steve Hislop on Q2 2014 Results - Earnings Call Transcript

Aug. 5.14 | About: Chuy's Holdings (CHUY)

Chuy's Holdings, Inc. (NASDAQ:CHUY)

Q2 2014 Earnings Conference Call

August 5, 2014 5:00 pm ET

Executives

Jon Howie - VP and CFO

Steve Hislop - President and CEO

Analysts

Will Slabaugh - Stephens

Imran Ali - Wells Fargo

Andy Barish - Jefferies & Co.

David Tarantino - Robert W. Baird

David Carlson - Keybanc Capital Markets

Conrad Lyon - Wedbush Securities

Operator

Good day, everyone, and welcome to the Chuy's Holdings Incorporated Second Quarter 2014 Earnings Conference Call. Today’s conference is being recorded. At this time, all participants have been placed in listen-only mode and the lines will be opened for your questions following the presentation. On today’s call, we have Steve Hislop, President and Chief Executive Officer, and Jon Howie, Vice President and Chief Financial Officer of Chuy's Holdings Incorporated.

At this time, I’ll turn the conference over to Mr. Howie. Please go ahead, sir.

Jon Howie

Thank you, operator, and good afternoon. By now everyone should have access to our second quarter 2014 earnings release. It can also be found at www.chuys.com in the Investors section. Before we begin our review of the formal remarks, I need to remind everyone that part of our discussions today will include forward-looking statements. These forward-looking statements are not guarantees of future performance and therefore you should not put undue reliance on them. These statements are also subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial conditions.

Also during today’s call, we will discuss non-GAAP financial measures which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP, and the reconciliation to comparable GAAP measures is available in our earnings release.

With that out of the way, I’d like to turn the call over to Steve.

Steve Hislop

Thank you, Jon, and thank you all for joining us today on the call. Our second quarter was highlighted by a 2.4% increase in our comparable store sales. This is our 16th straight quarter of comparable sales growth, which is even more impressive in the light of the challenging casual dining environment in the second quarter. We believe the general consistency of our sales growth reflects the quality of our made-from-scratch food prepared fresh every day and our commitment to value which has allowed Chuy's to maintain a solid business momentum during the last few years despite a challenging macroeconomic environment.

While our second quarter results include a number of positives related to the long-term health of our business, our results were negatively impacted by lower than expected sales in our 2013 class of restaurants. The combination of our sales shortfall and the corresponding labor and fixed cost inefficiencies at these particular units resulted in our falling short of our internal plan.

As we have previously noted, our development in that year included nine new units in eight new markets located within six new states, and because of the low brand awareness in these new markets these units have been slower to reach our targeted new store metrics. In contrast, at least 50% of our new units in any given year have typically favored development in existing markets with more brand awareness.

Strategically during 2014 and 2015, we will target 80% of our new development largely around backfilling these markets and other existing markets, which we believe will continue to enhance the awareness of the Chuy's brand and ultimately have a positive effect on the performance of the 2013 restaurants.

Also we continue to place extra effort on local store marketing and focused branding at our new stores, which we believe in the long run drives heightened loyalty to our business including new menu covers listing all our defining differences, in-store product demonstrations during our openings that show our freshness, and local community organization's meet-and-greets just to name a few. These initiatives are desired to highlight our points of differentiation that we believe have been key drivers to the success of our business for over 30 years.

In contrast, I'm pleased to note that our 2014 stores, while admittedly early, have to-date exceeded our targets and our comparable to the classes of the restaurants opened prior to 2013. We remain confident that our 2013 units can over time reach profitability levels that are in line with the balance of our unit base. However, based on our performance year-to-date, we believe it makes sense to take a more cautious approach to our second half's expectations, of which Jon will provide more detail in a second.

During the second quarter we opened three new restaurants, in Noblesville, Indiana, outside Indianapolis; Jacksonville, North Carolina; and Midlothian, Virginia near Ritten. Subsequent to the end of the quarter, we've opened our seventh and eight new restaurants of 2014 in San Antonio, Texas and Kennesaw, Georgia outside of Atlanta. We will open three more restaurants during the remainder of 2014 which will bring the total stores to be opened during 2014 to 11 new restaurants from previous guidance of 10 to 11 new restaurants.

With 56 Chuy's restaurants as of today, we continue to have a tremendous amount of white space development ahead of us. Our brand strategy of having unchained look and feel allows our restaurants to establish their own identity and provide us with a flexible real estate model. Keep in mind that with comparable average unit volumes for the trailing 12 months of approximately 4.9 million, we serve approximately 7,000 customers per location per week or 365,000 customers per location per year, which continues to make Chuy's a highly desirable tenant for real estate developers.

Now, for a more detailed look at our second quarter results, I'd like to turn the call over to our CFO, Jon Howie.

Jon Howie

Thanks, Steve. For our second quarter ended June 29, 2014, the revenue increased 18.4% to $63.3 million from $53.4 million in last year's second quarter. The increase was due primarily to $10 million in incremental revenue from an additional 129 operating weeks provided by 13 new restaurants opened during and subsequent to the second quarter of 2013. The increase is partially offset by units opened prior to the second quarter of 2013 that are not yet in the comparable store base and are lasting their honeymoon period.

Total operating weeks for the second quarter of 2014 were 683. As Steve noted, comparable restaurant sales increased 2.4% in the quarter. Our comparable sales growth also included a 0.3% negative impact related to the shift of Easter from the first quarter of last year to the second quarter in the current year. Overall, average check increased 1.5% and traffic increased 0.9%.

There were 38 restaurants included in the comparable store base during the first quarter of 2014 which included three new restaurants added to the base at the beginning of the quarter. We consider a restaurant to be comparable in the first full quarter following its 18th month of operation. I'd like to remind everyone that our restaurants can open at volumes greater than their eventual normalized run rate.

In the case of our strongest openings, this honeymoon period may last longer than the 18 months we allow before a restaurant enters the comparable store base. Given the small number of restaurants currently in our comparable store base, the timing and strength of our new unit openings may create a headwind in our comparable restaurant sales percentage in some quarters in the near-term. To-date, that headwind has reduced our comparable store sales percentage ranging from 0.5% to 1.2% in any given quarter.

Switching over to expenses, cost of sales as a percentage of revenue increased 100 basis points to 28.4%, toward the higher end of our expected range of 28.1% to 28.5% for the quarter. The increase was driven primarily by higher beef, dairy and produce costs, specifically the increase in cost of limes during the quarter.

Based on our first half results and expectations for the remainder of the year, our outlook for food inflation for the full year of 2014 remains between 3% to 4%. However, because of the continued elevated beef and dairy prices, we now expect to be at the higher end of that range. This would put our cost of sales as a percentage of revenue in excess of 28% for 2014.

Labor cost as a percentage of revenue increased 160 basis points to 32.9%, and as Steve noted, was impacted by lower sales volumes on fixed labor and increased training and staffing levels in our 2013 units in addition to normal new unit inefficiencies at our most recent openings. Labor in our comparable restaurants as a percentage of revenue was flat over the comparable period in 2013. We continue to believe, with a focus on local store marketing in our newer markets as well as backfilling these markets with additional stores, we believe we'll see our labor costs as a percentage of sales return to normalized levels over time.

Restaurant operating costs as a percentage of revenue decreased approximately 50 basis points to 13.6%. The improvement was largely attributed to lower liquor taxes as a result of the impact of the new Texas liquor tax law which went into effect on January 1 of 2014, and a continued increase in the number of new store openings outside of Texas which generally has lower liquor taxes than Texas, if any. The improvement was partially offset by higher utility costs as a percentage of revenues.

Occupancy costs as a percentage of revenues increased 20 basis points to 6%, primarily due to higher rent at certain new restaurants as we continue to expand and backfill into new markets, as well as the deleveraging impact of the fixed expense over all the lower volumes at certain of our consumer locations.

General and administrative expenses in the [first] (ph) quarter increased to $2.9 million from $2.5 million last year. As a percentage of revenue, G&A expenses improved approximately 10 basis points to 4.6%. The increase on a dollar basis was driven by higher stock-based compensation as a result of changes in our long-term incentive program, increases in headcount since last year and higher legal and professional fees, partially offset by lower performance-based bonuses.

Restaurant pre-opening cost increased $255,000 to $1.3 million in the second quarter due to the timing of the opening days and the stage of development for new restaurants in our current pipeline. We now expect our pre-opening expense for the year to be approximately $4.4 million as we have now confirmed the opening of our 11th restaurant to finish our 2014 development, and slightly higher pre-opening costs as we obtain possession of the properties earlier in the construction process.

Depreciation and amortization increased approximately $300,000, primarily driven by the increase in equipment and leasehold improvement cost associated with our newer restaurants. As a percentage of revenue, depreciation and amortization decreased approximately 10 basis points to 3.9%.

Interest expense was $19,000 in the quarter and our total outstanding debt under our credit facility at the end of the [first] (ph) quarter was $7.5 million. Our effective tax rate for the second quarter of 2014 was approximately 29.9% compared to 33.9% the second quarter of last year. Last year's effective rate was negatively impacted by the non-deductibility of secondary operating costs. After excluding the effect of these costs, last year's pro forma effective tax rate was approximately 30%.

Net income in the second quarter of 2014 was $3.4 million or $0.21 per diluted share compared to $3.2 million or $0.19 per diluted share in the second quarter of 2013. Net income in last year's second quarter included $508,000 in costs associated with two separate secondary offerings of the Company's common stock. Adjusting for this one-time item and the related tax effect, pro forma net income for the second quarter of 2013 was $3.7 million or $0.22 per diluted share. Attached to our press release is a reconciliation of GAAP results to our pro forma financial results.

As Steve noted our performance in the first half of the year, we believe it is prudent to temper our outlook for the balance of 2014. We now expect our fiscal 2014 diluted net income per share in the range of $0.76 to $0.78 per diluted share. This compares to pro forma diluted net income per share of $0.69 in 2013.

Our net income guidance for fiscal 2014 is based in part on the following annual assumptions. We expect comparable restaurant sales to increase between 2.3% to 2.6% for the full year which implies a 1.5% to 2% increase during the last two quarters of 2014. We expect restaurant level EBITDA margins to range between 18.4% and 18.6% for the full year of 2014. We now expect our restaurant pre-opening expenses to run slightly higher than our previous range or approximately $4.4 million for 2014.

We continue to expect G&A expenses to run between $12.5 million and $13 million which includes the approximately $1.4 million in incremental expense related to the Company's changes and its compensation and long-term incentive programs. We also continue to expect our pro forma effective tax rate for the full year to range between 29% to 31% and annual weighted average diluted shares outstanding of 16.7 million to 16.8 million.

Lastly, our development plan for 2014 now calls for 11 new Chuy's restaurants, which as of today eight have already opened. Our capital expenditures net of tenant improvement allowances are projected to be approximately $27.5 million to $30 million.

And now I'll turn the call back over to Steve to wrap up.

Steve Hislop

Thanks Jon. In closing, we are very excited about the long-term potential of our business. A combination of freshly prepared, craveable, Mexican inspired offerings, tremendous value and a fun energetic environment has led to industry-leading average unit volumes and a long history of consistent comparable sales growth. Additionally, we have a flexible real estate strategy with wide-open development potential that gives us the opportunity to grow our unit base approximately 20% a year for the foreseeable future. Our 2014 units continue to perform well and we are pleased with our 2015 opening schedule and we are working hard on 2016 development.

Before we go to the question-and-answer portion of our call, I'd like to take a moment to thank all of our Chuy's employees. Our successful results are a testament to their hard work and dedication again to earn the dollar every single day. And with that said, we thank you for your interest in our Company. We'll be happy to answer any questions you might have. Operator, please open the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll take our first question from Will Slabaugh with Stephens.

Will Slabaugh - Stephens

I wanted to ask about the unit productivity. It looks like average unit sales picked up pretty nicely quarter to quarter for you guys, and [I'm going through] (ph) your release and earlier comments that you're pretty pleased with the backfill units you open up in 2014, so just wondering if it's safe to assume here that two things, one that you're seeing honeymoons even in some of your 2014 openings, so very pleased with those, at least from a high level, and then also that you're pleased with the growth you're seeing in the sales from the 2013 group of openings, it opened up a little bit lower, given their revenue in the markets?

Steve Hislop

Yes, we are pleased. If you look at it – again I was very cautious to make sure that everybody understands, the indexing of our second quarter is our best quarter of our year as far as average unit volumes. But again, those new stores from 2013, basically the new stores are outpacing the average volumes sequentially of all our comparable stores. So what you're saying is exactly right. We are very, very pleased with the movement of those stores from the fourth quarter of last year through the second quarter of this year.

Will Slabaugh - Stephens

Got it. And then as far as the '14 units, very pleased with those as well?

Steve Hislop

Very, yes. Right now as I said it's awful early to talk about them. We are only going into the third quarter. We opened six in the first half of the year. As we mentioned, we open two more. And they're probably a little bit above our expectations at this point. So we're very, very pleased. And as we mentioned to you, last year we seated all the new markets actually last year, which you have to do in a young growing company, but most of it, 80-20 now, with 80% in our existing markets and 20% new, we're very, very pleased with those.

Will Slabaugh - Stephens

Great. And one quick follow-up to that if I could, geographically is it safe to assume you're seeing the greater traffic growth outside of your native Texas markets? I ask because it seems like with a softer opening to last year, it could be setting up for a little bit of a rebound in traffic, [indiscernible] from where you are in traffic as we get into I guess that's going to be 18 months till the end of the base but later on I guess we should look at that?

Steve Hislop

This is Steve again. I think that's fair to say. We've always told what we are out talking everybody, 2015 and 2016 we see some of these newer markets that have opened. 2012, really 2013, that we see that headwind kind of dissipating probably right around 2016, we will see some of these stores that [didn't] (ph) put up with these record volumes, actually at 18 months be flat or help us in our same-store sales.

Operator

We'll go next to Imran Ali with Wells Fargo.

Imran Ali - Wells Fargo

Just when looking at 2012 and 2013 new openings, when you entered a lot of new markets, what have been the common themes between the strongest markets versus the more challenged markets?

Steve Hislop

It's rather simple. We have a little bit of name recognition, we actually have a good little pulse, but as you go into new markets it does take you a little bit extra time to really develop your name, and as we add restaurants in the markets that helps us and that's a big thing. The key for us on those markets is the percent that we're opening in new and existing markets. As we mentioned to you in '13, it was pretty much eight out of nine new markets, in '12 it was a little bit more than 50% new markets. And then you see with us 80-20, we should have a little bit more balance than we had in the past, if that makes sense to you.

Imran Ali - Wells Fargo

Yes, it makes sense. And just a follow-up, so things like site selection or population density, factors like that, do they have an impact?

Steve Hislop

Sure, but we have a fairly good model on that and we're looking at those. We're constantly evolving but we're very, very pleased. And as you look at all the 2013 and 2012 stores, there's not one I wouldn't have done. I think long-term they are all very successful and are going to be great for us. So, I guess that's the best measure as I would've done them all.

Imran Ali - Wells Fargo

Okay, great. And if I could just follow up quickly, when you've historically entered new markets, and you touched on this earlier, how did average unit volumes trended near the first, second and third years of operations generally?

Steve Hislop

We expect them to continue to grow up. Obviously with more awareness in the market and as we add new stores without cannibalizing the existing stores, the awareness helps us very, very well. An example I could use is, I joined the Company in 2007. We had eight stores at that time, we were averaging $5 million, and five years earlier before I got here those same seven, eight stores were averaging $4 million. So again, the longer we're in the market, the more favorable our fleet becomes.

Imran Ali - Wells Fargo

Understood. Thanks very much.

Operator

And we'll go next to Andy Barish with Jefferies & Co.

Andy Barish - Jefferies & Co.

Just a comment on the real estate pipeline, is that to imply that you're basically done with the 2015 sites?

Steve Hislop

We're basically done with top 2015, we have identified all, but still a couple that we'll have to finalize. We're at 90% but that's just dotting the I's and crossing the T's, Andy. Our real effort is now on 2016.

Andy Barish - Jefferies & Co.

Okay. And then on the margin progress, Jon, in the back half of the year, obviously the food costs are coming off the peak, is there anything else we should be aware of, kind of the labor inefficiencies or new store inefficiencies, did those kind of peak in the 2Q as well?

Jon Howie

No, we're going to speak, as you know being against our biggest indexing quarter of the year, the Q2, our labor runs the lowest at that point in time. So we're going to have higher labor in Q3 and Q4.

Operator

(Operator Instructions) We'll go next to David Tarantino with Robert Baird.

David Tarantino - Robert W. Baird

Jon, I just wanted to maybe first question is a clarification of the guidance changes you're making, so could you talk about kind of at a high level what are all the factors that are driving the $0.06 reduction in the guidance? I know you mentioned some cost-factors, you mentioned the 2013 class sales. So if you could maybe just aggregate some of those factors and talk about the components of the change, that'd be helpful.

Jon Howie

As you know, we've missed the guidance a couple of pennies. So there is the start of that. And then as far as our cost of sales, our cost of sales we think is going to trend to the upwards of a little over 28%. So that's causing a little more margin pressure than what we initially thought in the back half of the year. That could come down depending upon how the commodities react, but right at this time we are expecting them to stay elevated in what we hear. The other thing is labor. As far as the stores, the 2013 stores, and as far as the volumes on those stores, that really pretty well covers the rest of that.

David Tarantino - Robert W. Baird

Okay, that's helpful. And then I guess one question just to reconcile, I think you mentioned the 2013 class continues to improve quarter to quarter I guess if you seasonally adjust that, and then you also mentioned that this is part of the reason you're taking down your guidance for the year. So could you help to reconcile those two statements? Is it because it's not improving at the trajectory you thought it would improve at this point or maybe help to clarify that?

Jon Howie

Exactly. They are not progressing as much as what the normal, I guess the normal seasonally adjusted Q3 and Q4 would. So, just to be more I guess prudent, we took the sales down on the normal trends. They are progressing but not like the ones have in the past.

David Tarantino - Robert W. Baird

Okay, so just to clarify that, you're saying that they are improving on a seasonally adjusted basis but just not as much as what you've seen in those types of markets in the past?

Jon Howie

Right.

David Tarantino - Robert W. Baird

Okay, got it. Okay, that's helpful. And then I guess how should we think – I know you mentioned cost of sales and labor pressure, should we expect to see a lot of leverage on the operating line in the back half, is that the factor that's maybe going to help you drive the restaurant margin in the range that you're projecting?

Jon Howie

Say that again, David, I'm sorry.

David Tarantino - Robert W. Baird

I guess the question is, the restaurant margin of 18.5% and the midpoint of what you're projecting, with continued labor pressure and cost of sales pressure I guess that would imply that you might get a pickup somewhere else within that line. So is the operating line where you should see some leverage in the back half of the year?

Jon Howie

Yes, we're seeing a little leverage in the operating line. We're expecting labor, even though sequentially higher than the second quarter, to be in line or a little lower than last year.

David Tarantino - Robert W. Baird

Okay, so that will start to normalize on a year-over-year basis. Okay, great, that's very helpful. Thank you.

Operator

We will go next to David Carlson with Keybanc.

David Carlson - Keybanc Capital Markets

Real quick, you guys did a great job in your releases of helping us understand the volumes generated at the new stores. I was hoping maybe you could speak to the margin gap you are currently experiencing at the newest class of the newest stores relative to stores opened more than one year, then I had a follow-up question.

Steve Hislop

The margin gap as far as the newer stores that are opened, as far as the gap?

David Carlson - Keybanc Capital Markets

Yes, I'm just trying to figure out what the restaurant margin profile looks like at the stores opened less than a year versus the stores that have been opened more than one year.

Steve Hislop

As you know, our pro forma model or prototype is about 12% to 13% in the first year. Obviously with the lower volumes in the 2013, that's been in the mid to high single-digit margins for that, but we do expect as those volumes increase that it would get back into the double digits. But what we're seeing and what we're expecting into the 2014 is we're seeing those average right in line with the prototypical model.

David Carlson - Keybanc Capital Markets

So that gets to my question of, the next one of, would you expect the margin of this 2014 class then to also approximate the margins from the class of 2012 given the volumes you're experiencing at those stores?

Steve Hislop

Correct, yes.

Operator

And we will go next to Nick Setyan with Wedbush Securities.

Conrad Lyon - Wedbush Securities

This is Conrad Lyon for Nick. I just wonder if there are any learnings from your openings in the last couple of years that would lead you to change your real estate and site selection strategy or are you still comfortable with simi8lar strategy going forward?

Steve Hislop

I'm comfortable. At the end of the day, we're a small company, we were in just eight states going into '13. Part of the growth rate is making sure you've seen enough market so you can do with 20% growth rate. So it's typically at the average volumes that we want to do. So we decided in '13 to buy to that offering going to the eight new markets in the six new states out of the nine stores. As we mentioned, and then 2014 and 2015 we are going to do an 80-20 mix, which means backfilling those existing markets in existing markets and 20% new for '14 and '15, and then you'll never hear us doing more than 50% in any new market in any new year as we move forward. That's been our strategy and we are very, very comfortable with that.

Conrad Lyon - Wedbush Securities

Okay, great. And then I was just wondering sort of what percentage of your 2013 openings would you consider as sort of below your expectations?

Steve Hislop

As a group, the class was below our expectation. And again, because they are in all new markets as a group, in prior years they had more of an existing market new market mix.

Conrad Lyon - Wedbush Securities

Okay, thank you very much.

Operator

It appears there are no further questions in the queue at this time. I'd like to turn the call back over to management for any additional or closing remarks.

Steve Hislop

Everybody, thank you so much. Jon and I appreciate your continued interest in Chuy's. We always will be available to answer any and all questions. Again, thank you and have a good evening.

Operator

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

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