Kona Grill CEO Discusses Q4 2010 Results - Earnings Call Transcript

Feb.10.11 | About: Kona Grill, (KONA)

Kona Grill, Inc. (NASDAQ:KONA)

Q4 2010 Earnings Call Transcript

February 10, 2011 5:00 pm ET

Executives

Mark Robinow – CFO

Marc Buehler – CEO

Analysts

Mike Malouf – Craig-Hallum Capital Group

Mark Smith – Feltl

Operator

Good afternoon, everyone and thank you for joining us today to discuss Kona Grill Results for the Fourth Quarter ending December 31, 2010. Joining us today are Marc Buehler, Kona’s Chief Executive Officer and Mark Robinow, the chiefs – I’m sorry the company’s Chief Financial Officer. Following their remarks, we will open the call to your questions. (Operator Instructions)

Before we begin, I would like to remind everyone that this will be available for replay through February 17, 2011 starting later this evening. I would now like to turn the call over to Chief Financial Officer of Kona Grill, Mark Robinow. Please go ahead, sir.

Mark Robinow

Thank you, Dave. Before we begin formal remarks, I need to remind everyone that the financial guidance, the company provides versus first quarter 2011 results, statements regarding the company’s future sales, future profit or loss and expectations regarding same store sales are forward looking.

We have attempted to identify these statements by using forward-looking terminology such as may, will, anticipate, expects, believes, intend, should or comparable terms. All forward-looking statements made during this call are based on information available to the company as of today and the company assumed no obligation to update these forward looking statements for any reason.

These statements are subject to risks and uncertainties that could cause actual results to differ materially from those described in the statements. Investors are referred to the full discussion of risks and uncertainties associated with the forward-looking statements and the discussion of risk factors contained in the company filings with the SEC.

With that, I’ll turn the call over to Marc Buehler, our Chief Executive Officer.

Marc Buehler

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 general comments about the fourth quarter then I’ll turn the call back over to Mark, who will discuss the financial details for the quarter as well as provide some guidance for the first quarter of 2011. I will then wrap up the call with an update on the some of our current initiatives and then provide some final thoughts before turning the call over for Q&A. With that, let’s get started.

We ended 2010 on a strong note delivering solid top-line results fueled by a 6.4% increase in same-store sales. This compares to a decline of 8.1% in Q4 of last year and flat same-store sales in the third quarter of 2010. These results are encouraging and we have certainly enjoyed increased momentum over the past several months driven by menu improvement and marketing initiatives aimed at building awareness and guest frequency.

The recent quarter was also the fourth consecutive quarter that we experienced positive traffic trends, which we believe demonstrate the strength and popularity of the Kona Grill brand. Our food based promotions helped increase guest check marginally, however, we continue to see check management in this uncertain, but improving economic environment. We took minimal menu pricing to help mitigate some of the impact of rising commodity cost.

Now before we go much further, I'll turn the call back over to Mark who will take us through the financial details for Q4.

Mark Robinow

Thanks Marc. For the fourth quarter ended December 31, restaurant sales increased 11.2% to $22.2 million, reflecting additional revenue from one restaurant opened during the quarter and a 6.4% increase in comparable restaurant sales.

As Marc mentioned, strong guest traffic throughout the quarter holstered by marketing and menu improvement initiatives drove higher comparable sales. While we do not report monthly comparable restaurant sales, comps for all three months of the quarter were solidly positive with over 75% of our comp based stores reporting positive comp sales. Many of these restaurants turned in double digit growth.

We took about 1.7% in price during the quarter. Going forward, we believe we have the ability to take additional pricing to offset higher commodity cost. We also intend to continue rolling out new products with high quality ingredients, which maybe at higher price points.

Overall, we have seen our comps improved sequentially in each of the last four quarters and are optimistic that this momentum can continue. We are pleased to report an increase in comparable restaurant sales of 0.9% for the full year aided by strong Q4 numbers.

Cost of sales as a percentage of restaurant sales increased 220 basis points to 28.4% during the fourth quarter from 26.2% last year. As discussed during our Q3 call, we continue to see significant year-over-year increases for beef and chicken, while salmon and sea bass prices also spiked during the quarter.

We estimate half of the 220 basis point increase was due to higher commodity prices and the other half driven by upgrading the quality of ingredients. We're beginning to contract prices for certain commodities for 2011. However, as you are probably aware, no contracts are available for certain seafood products.

We continue to monitor the impact of both short and longer term commodity pricing for all seafood and intend to adjust menu offerings and price accordingly. Labor expenses, as a percentage of restaurant sales, decreased 210 basis points to 34.8% during the fourth quarter from 36.9% last year. The lower labor cost percentage is attributable to the leveraging of fixed management wages, hourly labor and benefit costs from the 6.4% increase in comp sales.

We expect labor as a percentage of sales to improve incrementally as we leverage these costs through higher sales. Restaurant operating expenses as a percentage of restaurant sales decreased to 120 basis points to 16.7% during the quarter from 17.9% last year. The lower operating expense percentage is primarily due to lower repair and maintenance expenses compared to the prior year and a leveraging of the fixed portion of these operating costs through higher sales volumes.

We expect these costs to remain approximately 15% of sales during 2011 due to the plant repair and maintenance and remodeling expenditures for older restaurants. Occupancy expenses as a percentage of restaurant sales decreased 70 basis points to 8.0% during the fourth quarter from 8.7% last year. We continue to pursue abatements and rent reductions at certain of our lower volume restaurants.

Combining these four line items, restaurant operating profit increased 624,000 to 2.7 million for the fourth quarter. As a percentage of restaurant sales, restaurant operating profit was 12.0% during the quarter compared to 10.3% last year. While restaurant operating profit improved 170 basis points over the prior year quarter, we are focused on further margin improvement to improve profitability in 2011.

Depreciation expense as a percentage of restaurant sales decreased 300 basis points to 6.7% of restaurant sales during the fourth quarter from 9.7% a year ago. The reduction reflects lower depreciation expense due to the asset impairment charge we took in the fourth of quarter of 2009.

Preopening expenses were 58,000 in the fourth quarter compared to 353,000 last year. These costs relate to the October 5 opening of our Baltimore restaurant. Our cash cost for preopening expenses remains approximately $400,000 for restaurant.

General and administrative expenses decreased 446,000 from the prior year quarter primarily due to a reduction in severance and legal fees partially offset by an increase in bonuses. As a percentage of sales, G&A decreased 300 basis points to 7.3% during the quarter compared to 10.3% last year.

Net loss for the quarter was 491,000 or $0.05 per share compared to a net loss excluding asset impairment and special charges of 1.6 million or $0.18 per share last year. Net loss for Q4 2009 was 19.2 million including 16.9 million or $1.85 per share of non-cash asset impairment charges for underperforming restaurants and 0.7 million or $0.07 per share for special charges including separation costs and legal fees associated with our ongoing shareholder derivative suit. We ended the quarter with 2.7 million in cash and investments.

During the fourth quarter, net cash provided by operating activities was 1.5 million and we spend about 800,000 during the quarter for construction of our Baltimore restaurant and remodeling costs for our Kansas City restaurant.

For our first quarter 2011 financial guidance, we are forecasting sales of 21.6 million to 22.6 million and a loss of 400,000 to 900,000 or $0.04 to $0.10 per share. Our guidance reflects positive same-store sales of approximately 4% for the first quarter.

Now, I'll turn the call back to Marc before we go to Q&A.

Marc Buehler

Thanks, Mark. Our entire team is excited by the positive momentum we've built over the last several months. As Mark reported, margins were affected by commodity cost increases. So mitigate these rising costs, we've been working on ways to streamline and consolidate our supply chain and leverage our purchasing power.

As a result of our work over the past six months, we are making changes to our distribution network to better control our costs and improve the service and consistency of products availability. We expect to see positive results from these efforts in Q3, although we still foresee cost of sales as a percentage of sales to be unfavorable on a year-over-year basis.

We've recently hired Chris Moran, as our Senior Director of Culinary & Purchasing. Chris is a CIA graduate and has prior experience with Redstone and with Olives. He is a great addition to the team and will help ensure we get the best products available at the lowest price.

Over the past eight months, we have been working on a comprehensive menu evolution project to improve the wild factor and enhance the flavor profile of many of our food items. During the fourth quarter, we rolled out phase III of this four phase process, which included the addition of several new odd trays, including a fresh fish option to give our chefs the flexibility to bring in local fish at reasonable prices.

We also make changes to our sights to improve the quality and flavor profile of these items. Guest reaction to these menu enhancements continues to be extremely positive.

We were in the process of testing the final phase, sushi phase and playing to role this out system wide before the end of this quarter. We continue to measure this process with comprehensive guest feedback and menu analysis.

We had a very successful holiday gift card promotion with sales of our gift cards up over 50% from last year. We leveraged the use of our KONAVORE loyalty database to spread the world about our Black Friday and holiday card promotions. And we also introduced e-gift cards.

Speaking of our KONAVORE loyalty program, it continues its exceptional growth and in just over the years, it grows to more than 130,000 members. We are continuing to evaluate the potential of this program but have determined that a card-based solution is not cost effective at this time.

We will, however, be adding a bar code tracking system to all messages and this will allow us to better capture usage data at target guests who have not visit us – visited us in a while. We are very mindful that as the program evolves, it should become even more effective in driving frequency.

Finally, during November, we completed the remodel of our Kansas City restaurant. The remodel incorporated some of the new design elements of our Baltimore restaurant including lighting, fixtures and brighter interior finishes. We spend about $400,000 on the remodel including hosting a grand reopening party that generated significant local publicity.

Guests are responding favorably to the new look and initial same-store sales results indicate a very strong ROI on this project. We plan to do similar remodels at five of our older restaurants during 2011 while updating painting, artwork and music at most of our other restaurants to give them a consistent new look and feel.

While we turn the page to start a New Year, our goal to deliver an outstanding guest experience, every guest, every day in every restaurant haven't changed. We believe that this past year's investments in marketing, menu development in people are starting to pay off an increased guest loyalty and in top-line sales growth. While we are encouraged by the positive same-store sales results, we know that we have more work to do to leverage the flow through of these incremental sales dollars to the bottom line.

We have no leases signed for 2011 development and while many of you would like to see us open new restaurants this year, we believe that taking a measured approach to growth is the most prudent for the company at this time. We will instead reinvest dollars in five of our older proven restaurants to ensure the brand remains on the cutting edge.

We will continue to pursue additional leases based on significant economic opportunity and availability of affordable debt capital or sufficient cash flow from operations. In the normal course of business, we are also in discussion with lenders for equipment leases or lines of credit that will provide additional financial flexibility.

Now with that, I'd like to open up the call for any questions that you might have. Dave, go ahead.

Question-and-Answer Session

Operator

Thank you, Mr. Buehler. (Operator Instructions) Our first question is from Mike Malouf with Craig-Hallum Capital Group. Please go ahead.

Mike Malouf – Craig-Hallum Capital Group

Great. Thanks, guys. I have a question with regards to the food cost. If you could just touch a little bit on that as we go into 2011, you had 28.4% obviously that's a little higher than I would imagine you guys are comfortable with. Where do you think that it will trend in 2011 and do you think that it could actually go higher than where it is in the fourth quarter? Thanks.

Marc Buehler

Mike, we don't expect it to go higher than it was in the fourth quarter. And as we mentioned during the scripted part of our comments that we're working diligently to bring that down. With that said, we probably will see during the first quarter, a pretty high food cost in the neighborhood of where it was in the fourth quarter.

And I would expect that our efforts to both contract and our new distribution systems to start to show financial results in the third quarter of this year. So we're probably in for a little bit tougher first and second quarter on those costs and then with some relief in the third and fourth.

Mark Robinow

Now, let's add back the last piece, Mike, of the concept evolution, the menu evolution is sushi and that's where we will take price and really second quarter is when you'll see the impact of that. So there will be some benefit there. Compared to the marketplace, we're under priced on sushi but we're also conscious that we don't want to take too much price and drive traffic away.

Mike Malouf – Craig-Hallum Capital Group

Okay. Great. And then, maybe kind of a 50,000 food question, when Kona was just getting started in first public, I know that the goal was sort of $5 million per restaurant and 20% restaurant margins. Do you have any restaurant, so there was sort of add that level now and is there more of a new target of say, I don't know 4 million per restaurant and you know, I don't know, 16%, or 18% or whatever the percent that do you want to throw over that. And as we look forward at these, do we still have the profitability that they once had a few years ago?

Mark Robinow

I think that several restaurants that are above that mark, both on the volume standpoint and then also on the restaurant level operating profit margin. And to tell you that our goal has shifted a little bit, it has shifted because the world has changed dramatically in the last three or four years. $4.5 million is the new target that we really measure ourselves against and be very high teens on a restaurant level operating profit, which would put us at the – really the top of the class in the polish casual arena.

Mike Malouf – Craig-Hallum Capital Group

Great. Thanks a lot.

Mark Robinow

You bet. Thanks Mike.

Operator

Thank you. (Operator Instructions) The next question is from Mark Smith with Feltl. Please go ahead.

Mark Smith – Feltl

Hi, guys. First, Mark Robinow, can you just go over quickly again, I just missed the numbers on cash and debt at end of the quarter?

Mark Robinow

Yeah. It is 2.7 million in cash and investments, Mark.

Mark Smith – Feltl

Okay. And that debt number, was that still the 600,000 or whatever it is?

Mark Robinow

I'm sorry, I didn't catch that.

Mark Smith – Feltl

Oh, just total debt is at still the just 600,000 in change.

Mark Robinow

Right.

Mark Smith – Feltl

No change there.

Mark Robinow

Going down to a couple of 100,000 at the end of this year.

Mark Smith – Feltl

Okay. Perfect. Can you guys talk about your mix and any changes that you saw this year and even in the Q4 in alcohol and also the sushi mix and Mark, I guess, we're looking at sushi really as you take some pricing there? How much win impact that could have on your total comp, I guess?

Mark Robinow

Yeah. Again, we really didn't see any mix shift last year. We've maintained that 31%, 32% beverage alcohol mix. Sushi was still 20% of the mix and then the rest of it was the polished casual grill side of the business. So again you have some item – item shift as we repositioned menu items as we removed some items, introduced some food-base promotions last year. Part of the – part of what we saw as we did get some check average movement with our food-base promotions last year, when we featured some higher price point items, those also have had higher costs which was a piece of the food cost piece in the fourth quarter.

And the food-base promotion in first quarter of this year features items that fall more in the mid range from a check average standpoint but also have very favorable food costs as well. As we move into the sushi piece, we start testing that next week, it's got a five to six week test run on it where we'll actually really be able to see what the impact of the price is and see if we do get shift in the menu. I don't foresee it. I just looking back historically and I've have done a lot of research watching our numbers since I've been here. We've been pretty consistent on that – on those numbers. So I don't see a big shift.

Mark Smith – Feltl

Okay. And then any insight you can give us on your ability to continue taking prices, I don't know when you are looking at another menu and then if you have had any pushback from consumers in the price increases that you have taken?

Marc Buehler

Yeah. Surprisingly and I see every guests complaint that rolls through and guest comment. We have not had one knock on wood pushback and again I still talking with managers in the field. They are really not seeing it either. We're not seeing as much check growth. So you still see, again, check management out there, whether it'd be I'm going to have domestic instead of an import beer. I may trade down a glass of wine to a cheaper glass of wine but again, it's really been amazing that we haven't had the pushback.

That being said, we are still conscious that we don't want to take price too quickly too much. And so I think we have the opportunity later this year. We just switch menu vehicles which gives us a little more flexibility to highlight items, feature items, move some items on and off and as you heard me say before, I'd like to be able to offer the guests something better. We're different at the time that we take price on the menu and not just pass along $0.50 across the board price increase.

So you'll see price with sushi that will hit like I said at the beginning part of Q2 and we will not be taking any other price at that point, but again, I think we have the opportunity to come back in August, September, depending on how the commodity market stacks up and depending on how the marketplace in general from the economy standpoint stands and how our guests are spending and what they have is – we have the opportunity to come back again this year and I can't tell you what the percent would be at this point in time.

Mark Smith – Feltl

And last question, it sounds like you guys did a great job, selling gift cards in Q4. Can you talk it all about what you've seen on redemption on those gift cards and I guess, how much of that's worked into your guidance here in Q1?

Mark Robinow

Yeah, it's a – it takes us probably six months before we see all of that redemption. We never see the full redemption. Again, it's part of our guidance for sure along with price and again the traffic. And traffic last year, we saw it slowed somewhat as we got into the fourth quarter from where it was at the beginning part of the year, where we were very high single-digit. So I can't tell you exactly where we are and get card redemptions today. But again, when you sell 50% more, you are, that's certainly a part of our January results.

Mark Smith – Feltl

Perfect. Thank you.

Mark Robinow

Thanks, Mark.

Operator

Thank you. At this time, this concludes our question-and-answer session. I would now like to turn the call back over to Mr. Buehler. Mr. Buehler, please go ahead, sir.

Marc Buehler

Great. Again, I'd like to thank you all for joining us today and especially want to thank you for your questions and your comments. We look forward to an exciting 2011 and executing the initiatives and continuing to build Kona Grill into one of the great names in polished casual dining. It's been a pleasure working with our team during the past year and we look forward to an exciting 2011. Thanks everybody.

Operator

Thank you. Again, I would like to remind everyone that this call will be available for replay through February 17, 2011 starting later this evening. A webcast replay will also be available via the link the provided in today's press release as well as available on the company's website at www.konagrill.com. Thank you, ladies and gentlemen, for joining us on our call today. You may now disconnect your lines.

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