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Executives

Mark Robinow - EVP, CFO and Secretary

Mike Nahkunst - Interim President and CEO

Analysts

Ross Licero - Craig-Hallum

Conrad Lyon - B. Riley & Co

Lee Giordano - Imperial Capital

Kona Grill, Inc. (KONA) Q2 2011 Earnings Call July 27, 2011 5:00 PM ET

Operator

Good afternoon everyone and thank you for joining us today to discuss Kona Grill’s Results For The Second Quarter Ended June 30, 2011. Joining us today are Mike Nahkunst, Kona’s Interim President and Chief Executive Officer and Mark Robinow, the Company's Chief Financial Officer. Following their remarks we will open the call up for your questions. (Operator Instructions)

I would now like to turn the call over to the Chief Financial Officer of Kona Grill, Mark Robinow. Sir please go ahead.

Mark Robinow

Thank you Ron. Before we begin our formal remarks, I need to remind everyone that the financial guidance the company provides for the third quarter 2011 results statements regarding the company's future sales, future profits and expectations regarding same-store sales are forward-looking.

We have attempted to identify these statements by using forward-looking terminologies such as may, will, anticipate, expect, believes, intends, 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 assumes no obligations 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 statement. Investors are referred to the full discussion of risks and uncertainties associated with forward-looking statements and the discussion of risk factors contained in the company's filings with the SEC.

I would like to take a few moments to introduce Mike Nahkunst, our Interim President and Chief Executive Officer. Many of you know Mike from his days at Chilies during their early growth period, as well as his executive level operating roles at BJ’s, Cheesecake Factory and Max & Erma. Mike joined our board in November 2010 and was asked by our board to take on the CEO role when Mark Buehler resigned last month. We are happy to have Mike is with us and appreciated his knowledge and experience in guiding us as we re-initiate growth and profitability.

With that, I’ll turn it over the call to Mike, welcome Mike.

Mike Nahkunst

Thank you, Mark and thank all of you for joining us today. I’ll start with some general comments about our second quarter results and then Mark will discuss our financial details for the quarter as well as provide some guidance for Q3. I will then ramp up the call with an update of some of the current initiatives and then provide some final thoughts before turning the call over for Q&A. Now with that, let’s begin.

We continued our strong sales momentum delivering solid top line results driven by a 9.1% increase in same-store sales. The strong increase in same-store sales follows the 7.6% increase in Q1 and a 6.4% increase in Q4 of last year and represent the seventh consecutive quarter of sequential improvement in our same-store sales.

We continue to experience favorable sales momentum, that is driven by our many improvement, our restaurant remodels, and marketing initiatives aimed at building awareness and guest frequency. The recent quarter was the sixth consecutive quarter that we experienced positive traffic trends, which we believed demonstrates the strength and the popularity of the brand in multiple markets. During the second quarter, we were able to leverage higher average weekly sales to drive stronger earnings for the quarter. We continue to believe, we will be profitable for 2011.

I would now like to turn the call over to our CFO, Mark Robinow, who will take us to the financial details for Q2. Mark?

Mark Robinow

Thanks, Mike. For the second quarter ended June 30, restaurant sales increased 13.6% to 25.8 million reflecting additional revenue from the Baltimore locations over the last fall.

Higher sale for two restaurants not in the comp base and a 9.1% increase in comparable restaurant sales. The increase in same store sale is attributed to strong guest traffic and higher average guest check aided by our new food and beverage items rolled out in May for a Slim Chance promotion. The sales increase includes about 2.2% in pricing as we took about 150 basis points in June to offset higher commodity cost. As Mike mentioned our comps have improved sequentially in each of the last seven quarters.

We believe that we can continue strong sales momentum throughout the remainder of 2011, however the continued sequential improvement becomes more difficult as we roll over last year strong fourth quarter.

Cost of sales as a percentage of restaurant sales increased 90 basis points to 27.4% during the second quarter from 26.5% last year. We continue to see higher year-on-year cost for Salmon and Sea bass, while certain produce and dry good items also were higher compared to last year.

We improved cost of sales 80 basis points from the first quarter this year as we continued to work diligently with our vendors to ensure the best pricing is available and reasonable delivery charges are set. Labor expenses as a percentage of restaurant sales decreased 110 basis points to 33.2% during the second quarter from 34.3% last year.

The lower labor cost percentage is attributable to the leveraging of fixed management wages and hourly labor from a 9.1% increase in comp sales. Restaurant operating expenses as a percentage of restaurant sales decreased 10 basis point to 15.0% during the second quarter from 15.1% last year. The lower operating expenses percentage was primarily due to the leveraging of the fix portion of these operating costs through higher sale volumes.

Restaurant operating expenses include $80,000 or 30 basis points of planned un-capitalized remodeling cost for our older restaurants. Occupancy expenses as a percentage of restaurant sales decreased 50 basis point to 7.3% during the second quarter with 7.8% last year. With the higher sales volume we are paying slightly more in percent rent but this is more than offset by the leveraging of fixed costs.

We continue to pursue rent reductions or negotiated closures at certain of our lower volume restaurants. Combing these four line items restaurant operating profit increased 733,000 to 4.4 million for the second quarter. As the percentage of restaurant sales, restaurant operating profit was 17.2% during the quarter compared to 16.3% last year.

On a sequential basis, restaurant operating profit improved 320 basis points over the first quarter of 2011. The second quarter is historically our strongest quarter in terms of sales and operating margins, we believe improved overall margins in the third and fourth quarters this year compared to last year will drive profitability in 2011.

General and administrative expenses increased 276,000 from the prior year quarter, primarily due to severance and related charges for our former CEO. As a percentage of sales G&A was flat at 8.3% excluding these charges G&A as a percentage of sales would have been 7.3%.

Net income for the quarter nearly tripled from last year to 753,000 or $0.08 per share compared to 262,000 or $0.03 per share in the prior year. Net income for the quarter would have been $1 million or $0.11 per share if you exclude the special charges just mentioned.

We ended the quarter with 4.5 million in cash and investments. During the second quarter, net cash provided by operating activity was 1.6 million. We spent about 400,000 for capital expenditures during the quarter, which represents planned remodeling costs for older restaurants.

For our third quarter 2011 guidance, we are forecasting sales of 23.1 million to 24.1 million and income of $100,000 to $300,000 or $1.03 per share. Our guidance reflects the expectation of a positive same-store sales increase of approximately 6% for the third quarter.

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

Michael Nahkunst

Thanks Mark. In my first few months as Interim-CEO here at Kona, I’ve had an opportunity to visit several of our restaurants and meet with our operational teams in the field. I have been extremely impressed in my initial business with the quality of leadership and exceptional food knowledge and focus that our management teams possess. That continued focus and strong operational execution will be of paranoia importance, as we move toward our new phase of restaurant growth.

Kona presents some unique differentiation points that I think will continue to be key to our ongoing success. Our combination of flavor-full new American cuisines and favorites coupled with an award-winning sushi selection and a dynamic energizing bar environment. The indoor-outdoor architecture and design that again energizes the physical plant and encourages broad guest appeals from an equally broad demographic profile. Our scratch kitchens that deliver exceptional flavors from 40 plus signature sauces and dressings prepared daily.

With our current operating plan in place, we will continue to streamline our supply chain and purchasing levers. We will enhance our menu offerings and flavor profiles. We will continue on with a favorable remodel programs remainder of the year which improves our capacity in several restaurants. All of which help us provide more favorable productivity and profitability metrics. I am truly exited about the future prospects of this company as I see it on the threshold of remarkable growth potential.

With that, we have no lease this time for 2011 development, but we are actively pursuing leases for new restaurant openings in 2012 and beyond. We anticipate opening two new restaurants in 2012 and adding more in 2013, as we refill our real estate pipeline.

During the quarter we completed the remodel of our Omaha restaurant and also updated the painting, art work and seating at the Denver and Scottsdale restaurants to give them a consistent look and feel.

As we continue to execute on our 2011 plan, we remain focused on delivering an outstanding guest experience to improve service in restaurant remodels. We believe that the past year’s investments in marketing and mini-development continue to drive top-line growth and are paving the way for a profitable 2011 and new restaurant growth in 2012 and beyond.

With that, I would like to open the call up for questions you might have. Ron?

Question-And-Answer Session

Operator

(Operator Instructions) And now our first question comes from Mike Malouf from Craig-Hallum. Please go ahead.

Ross Licero - Craig-Hallum

This is Ross Licero in place of Mike. You said you were guiding towards 6% same-store sales in Q3 which I just wanted to see what's the breakdown in terms of price increases and just the traffic that you are getting, that's implied in that same-store sales growth.

Mark Robinow

We are rolling over about 3% price in Q3, so the rest is really traffic and an increase in average check.

Ross Licero - Craig-Hallum

And for the one time special charges, are we going to, should we expect any of that going forward?

Mark Robinow

No, the special charges that we referred to in G&A for the departure of Mark Buehler were all taken in Q2.

Ross Licero - Craig-Hallum

Okay, and that's an after tax number, is that right?

Mark Robinow

Well, for us it’s really, before and after tax since we are not really paying federal taxes yet.

Operator

Your next question comes from Mark Smith from Feltl & Company. Please go ahead.

Unidentified Analyst

This is [inaudible] for Mark. I just have a couple of questions, can you give me some updates on the sea food costs and outlook.

Mark Robinow

We continue to still see pricing pressure on sea food items.

Unidentified Analyst

Any outlooks?

Mark Robinow

Sorry?

Unidentified Analyst

No, yeah, that's great and second question, what was the alcohol mix for this quarter?

Mark Robinow

We’ve continued to do about 32% alcohol which had been very consistent for us on a quarter-to-quarter and almost year-to-year basis.

Operator

Your next question come from Conrad Lyon from B. Riley & Co.. Please go ahead.

Conrad Lyon - B. Riley & Co

I have a question regarding the quarter nice quarter. Question regarding the distribution of same-store sale, I'm assuming there is still some choppiness but how widespread was that increase through your system?

Mark Robinow

It was pretty wide Conrad, we just had a couple of restaurants that experienced negative same store sales for the quarter.

Conrad Lyon - B. Riley & Co.

In terms of your restaurant level margin, like what you did for the quarter, what type of comp do you typically will need a plus 9% comp to generate a 17 plus percent restaurant level margin or might you need a lesser one going forward? Just give some color around that.

Mark Robinow

Well, our restaurant margins will improve due to food and labor cost improvements. So as we improve those, we don’t need like the same-store sale lift that we had in this quarter to maintain or improve those margins and we’re also getting a nice flowthrough result. You know, last year’s third quarter was about flat, you know fourth quarter was about 6.

So as we roll over those, we will start to see more sales or lesser and lesser same store sales increase and being able to continue to leverage our fixed costs as well as make some variable cost improvement.

Operator

(Operator Instructions) Your next question comes from Lee Giordano from Imperial Capital. Please go ahead.

Lee Giordano - Imperial Capital

Can you talk a little more about the marketing strategy heading into the second half of the year and also what’s been working, what has been driving that I think?

Mark Robinow

I tell you what, what’s been working real well for us, is we have been focusing a lot more on our social media aspects and grassroots marketing. We have really put more emphasis in several programs around those framing it. I think what we have found to not be as helpful as the more a larger scale typical traditional type advertising campaign in the past.

What you are really seeing now is more grassroots and you will continue to see that with our group. We want the guests to really feel part of our restaurant and we want them to feel more localized in that regard. I think the KONAVORE program has also been a big success for us reaching out for people where I believe 160,000 plus members at this point. We have been very happy with that program, but the [carnivore] program has been, has been a help to us as well. So, anyway once again I go back to, I think it’s more grassroots of marketing approach that you are going to see throughout remainder of this year.

Operator

(Operator Instructions). At this time this concludes the question- and-answer session. I would now like to turn the call back over to Mr. Robinow. Please go ahead sir.

Mark Robinow

Actually I will turn it back over to Mike who has got some parting comments and we will sum up the call. Thank you.

Michael Nahkunst

Yeah. Thank you, Ron. As always I want to thank each of you for joining us on this call this afternoon. We look forward to great second half of the year and believe me we are working extremely hard to build Kona Grill and one of the great names in polished casual dining. Thank you all once again for your continuous support of Kona Grill. Have a nice afternoon. Thanks.

Operator

I would like to remind everyone this call will be available for replay through August 26th 2011 starting later this evening. A webcast replay will also be available via the link 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 today. You may disconnect.

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