Ignite Restaurant Group's (IRG) CEO Robert Merritt on Q2 2016 Results - Earnings Call Transcript

| About: Ignite Restaurant (IRG)

Ignite Restaurant Group, Inc. (NASDAQ:IRG)

Q2 2016 Earnings Conference Call

August 3, 2016 5:00 pm ET

Executives

Brad Leist - CFO

Robert Merritt - President and CEO

Analysts

Michael Gallo - C.L. King & Associates

Operator

Good afternoon, ladies and gentlemen, and welcome to the Ignite Restaurant Group Second Quarter Conference Call. Today's conference is being recorded and a replay will be available starting today for those who cannot attend this live event.

Before I turn the call over to management, I would like to note for you that portions of this call deal with forward-looking information. These statements reflect management's expectations for the future. The Company's actual results may differ materially from these expectations. Management refers you to today's press release and the Company's recent filings with the SEC for a more detailed discussion of the risks that could impact the future operating results and the Company's financial condition.

During this call, management may present non-GAAP financial information. Non-GAAP financial information appears in the Company's press release for the quarter and related current report on the Form 8-K filed earlier today with the SEC.

On the call today from the Company we have Robert Merritt, Chief Executive Officer, and Brad Leist, Chief Financial Officer. At this time, I would like to turn the floor over to Mr. Brad Leist, Chief Financial Officer of Ignite Restaurant Group. Please go ahead, sir.

Brad Leist

Thank you, operator. Good afternoon and thank you for joining us today. By now, everybody should have access to our press release, which we issued this afternoon. The release, which covers our second quarter of 2016, can also be found on our Web-site under the Investor Relations section. Additionally, I'd like to encourage everyone to review our related 8-K and 10-Q filings with the SEC for greater detail on the information included in our press release and on today's conference call.

Our agenda for today's call will be as follows. Bob will provide an overview of our business and the results for the quarter and I'll discuss our financial results and provide an outlook for the remainder of the year. We'll have time at the end for any questions that you may have for Bob or myself.

So with that, I will turn the call over to Bob.

Robert Merritt

Thanks Brad. Look folks, I'll be as candid as I can be. We're not happy with the operating results. In fact, we're a bit embarrassed about the operating results. But there are some positive things going on. Our biggest challenge is sales. Texas and the oil and gas fields are obviously having a significant effect on us. With 30% of our sales coming from Texas, we're definitely feeling the effect of the economic climate there.

In addition, restaurants that we have in the Northeast continue to perform poorly and they really reflect an attempt to transition the brand to a more upscale, the Joe's brand in particular, to a more upscale casual dining environment, which frankly the consumer didn't respond well to. So we're taking steps to reverse that. And we're pulling every lever and pushing every button we can think of in Texas.

We are very pleased that we're seeing positive movement in sales in almost every other region in the country, particularly in the last six to eight weeks. So, some of the things we're doing are having a positive effect and we will continue to fight the fight in those areas where it's not.

On the other hand, we did not manage variable costs as well as we should have in the quarter. We have already taken steps to ensure that that happens going forward, and Brad is going to talk about some other things. We've made G&A cuts in addition to some controls we've put into place operationally.

So, look, from our standpoint, we continue to work on menu and operational changes to improve execution. This is execution business, it's the only competitive advantage that anybody can have, and we will continue to work to improve execution and we're confident that we can see a reversal of some of the trends in Texas as well as in the Northeast with some of the steps that we're taking. So, I'm not going to try to sugarcoat it, but there are a lot of positives that we see on the horizon.

And with that, I'll turn it back to Brad.

Brad Leist

All right, thanks Bob. For the second quarter, we generated total revenues of $130.8 million, which is 8.7% less than the second quarter of last year. The decrease was primarily caused by a decline in comparable restaurant sales and a net decrease in operating weeks due to the closure of 11 Joe's restaurants since the second quarter of last year.

Revenues at Joe's decreased $14 million, down to $108.4 million, in the second quarter. This reduction was due to a 6.8% decrease in comp sales and also the restaurant closures. The decrease in comp sales was comprised of 7.1% decrease in traffic, 0.8% decrease in mix, and that was partially offset by a 1.1% increase in price.

Brick House revenues increased 7.6% in the second quarter up to $22.4 million, primarily due to the three new Brick Houses opened during the first quarter, and that was partially offset by a 6.3% decrease in com sales. The decrease in comp sales was comprised of a 6.9% decrease in traffic and mix, partially offset by a 0.6% increase in price.

During July, comparable restaurant sales were still negative at both brands, with Joe's being down in the low single digits and Brick House being down consistent with what we saw in the second quarter. We have continued to experience sales challenges at our Northeast and Texas markets, but have started to see some positive trends in several of the other markets in the Joe's brand.

Cost of sales increased to 32.6% as a percentage of revenue. From last year, the increase is primarily related to the All-You-Can-Eat Snow Crab promotion that we have running as well as some slight commodity price inflation.

Labor expenses, as a percentage of revenue, increased to 29.2%. That's up from 27.9% last year. The increase was primarily due to labor inefficiencies and some sales deleverage. As Bob mentioned earlier, we have initiated a plan that we believe will help improve our labor costs going forward.

Occupancy expenses as a percentage of revenue increased to 7.8% from 7.3%. That's mainly due to the sales deleverage. Other operating expenses increased to 20.9% from 19.3% as a percentage of revenue, primarily due to fixed cost deleverage and increases in marketing, repairs and maintenance and a slight increase in some insurance costs.

G&A decreased by $2.7 million or 32% compared to last year. As a percentage of revenue, G&A actually came in at 4.3% compared to 5.8% last year. The decrease was primarily due to a reduction of personnel costs, lower bonus expense and also a reduction of professional fees.

Asset impairments and closures increased to $8.2 million during the second quarter, primarily due to an $8 million impairment charge and some closure-related expenses to the three Joe's we closed during the second quarter. The impairment charge reduced the carrying value of certain long-lived assets to their estimated fair value at seven Joe's and two Brick House restaurants.

In the third quarter, we plan to close eight of these impaired restaurants along with potentially a few others due to underperformance. The decision to close these restaurants is specifically aimed at improving our operating margins as well as our current future financial covenant ratios.

So let's discuss income from operations by brand. Excluding the $5.4 million impairment charge at Joe's, operating margin was 2.5% in the second quarter compared to [6.8%] [ph] last year. The decrease here is primarily attributable to higher food cost, higher labor and marketing expenses, as well as some of the fixed cost deleverage against the lower sales volume.

Excluding the $2.6 million impairment charge and pre-opening costs at Brick House, the operating margin decreased to 7.7% from 10.1%, also partially due to higher food costs as well as increase in operating supplies and utilities.

Interest expense decreased $600,000 during the quarter down to $3.2 million, primarily due to the lower debt balance as a result of the $35 million prepayment we had made at the end of last year that was partially offset by some debt issuance costs and debt discount costs that we wrote off during the quarter related to an additional $5 million voluntary prepayment that we made in June.

Our income tax expense for the quarter was $82,000 versus $700,000 last year. The change was primarily due to a loss before income taxes during the current year versus generation of income last year. This decrease is partially offset by an increase of $4.8 million in our valuation allowance compared to only $600,000 increase last year.

Our debt outstanding was approximately $122.7 million at the end of the quarter with a cash balance of around $7 million. We are in compliance with all of our debt covenants. We have approximately $25.9 million available on our revolver net of letters of credit, and we are currently exploring opportunities to amend or refinance our current credit agreement. We'd like to get one of those done sometime before the end of the third quarter.

So let's talk about kind of our expectations for the rest of the year. We now expect revenues for 2016 to range from $450 million to $470 million, after consideration of the planned restaurant closures. That assumes full year comp sales at Joe's and Brick House of between negative 4% to negative 8%. We expect restaurant level profit to be somewhere between 10% and 11% of revenues.

G&A as a percent of revenue is projected to improve to just under 5.5% as a result of personnel and other cost reductions that Bob alluded to earlier that we initiated at the beginning of the third quarter which we estimate will provide upwards of an annual savings of upwards of $2 million. Depreciation expense is planned to be 4.9% to 5.1% as a result of the lower revenue and deleverage that we'll see on that.

We do not expect any additional preopening costs for the remainder of this year. Our interest expense is expected to be around $12.5 million for 2016. Our effective tax rate for the full year, we're projecting to be a benefit of between 40% and 50%, after considering the impact of the FICA tip credit and also excluding the impact of the valuation allowance.

So operator, with that, we'd like to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] First we'll go to Michael Gallo from C.L. King.

Michael Gallo

Bob, my question is on the menu changes that you made. It was quite a bit of menu rationalization, which was supposed to kind of reduce back-of-the-house complexity, speed up service and hopefully allow you to get more throughput. I was wondering whether you kind of look and wonder whether you went too far. Obviously the guest counts were challenged and certainly it seemed the operating costs at the restaurant level were challenged as well. So I was wondering if you can give us some thoughts on the changes, whether the issue wasn't the change in the menu itself but the execution of it, or how do you, one, what are you doing to improve guest counts being that Texas is what it is, and two, running better restaurants from an efficiency standpoint?

Robert Merritt

I'll address that as best as I can. I will tell you that we started to see strongly negative guest counts before the new menus rolled. So we don't really see any evidence that that was a causative factor. I will say that there are two places where we probably could have done a better job.

One, we may have cut too far, and in our new menu we're going to roll in September we will undo some of that. We've taken a look at the consumer research and consumer comments, we know where we want to add things back. And our culinary people are working very hard to put strong flavors back in the menu. We think that that's going to be critical to our future. Everything can't taste the same. We've got to go towards stronger flavors, bolder flavors, if you will.

The second area was, frankly, we probably did not simplify enough processes in how we prep the food and in how we cook the food. It resulted to a certain extent in savings in labor, but not as much as we had anticipated. And again, our culinary people are working extremely hard. In fact, we are rolling some things right now that we think will take some huge steps towards accomplishing what our original objective was.

So again, probably we erred in a couple of areas; A, we cut too far; B, we really didn't cut the process complexity as much as we should have; and we've made some changes in the culinary area that we think will address that.

Operator

And it looks like Mr. Gallo has nothing further. And at this time, we also have no further questions from the audience. That does conclude today's conference, ladies and gentlemen. We appreciate your participation and you may now disconnect.

Robert Merritt

Thank you.

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