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Kona Grill Inc,. (NASDAQ:KONA)

Q1 2012 Earnings Call

April 30, 2012 05:00 pm ET

Executives

Berke Bakay – President, Chief Executive Officer & Director

Christi Hing – Secretary, Chief Financial & Accounting Officer

Analysts

Mike Malouf – Craig-Hallum Capital Group

Conrad Lyon – B. Riley & Co.

Shawn Patrick Bitzan – Feltl & Company

David Khan – Raymond James

Lee J. Giordano – Imperial Capital, LLC

Operator

Good afternoon. Thank you for joining us to discuss Kona Grill’s results for the First Quarter of 2012. Joining us today are Berke Bakay, Kona’s President and Chief Executive Officer; and Christi Hing, the company’s Chief Financial Officer.

Following their remarks we will open up the call for questions. (Operator Instructions) Before I begin, I would like to remind everyone that the financial guidance the company provides for its second quarter 2012 results, statements regarding the company’s future sales, profits, and expectations regarding same-store sales are forward-looking.

All forward-looking statements made during this call are based on information available to the company as of today and the company assumes no obligation to update these statements to reflect events or circumstances after the date of this call.

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 discussion of risks and uncertainties contained in the company’s filings with the Securities and Exchange Commission.

I would now like to turn the call over to Kona Grill’s President and CEO, Mr. Berke Bakay. Please go ahead, sir.

Berke Bakay

Thanks, Vince. Good afternoon, and thank you all for joining us. The momentum we gained last year rolled into the first quarter of 2012. Our 8.7% same-store sales growth during the quarter represents Kona Grill’s sixth consecutive quarter of positive same-store sales. We were able to leverage this strong sales growth to drive 19.9% unit level margins, which we believe are some of the best in polished casual segment of the restaurant industry.

For today’s call, Christi will walk us through the financials for the first quarter and provide guidance for the second quarter of 2012. Afterwards, I will discuss some of the initiatives we’re working on for the future development of Kona Grill and then wrap up the call with Q&A.

Before passing the call over, I would like to welcome Christi to our first call as CFO of Kona Grill. Christi has been with Kona Grill for over six years now, where she most recently served as a Vice President and Controller. For increasing levels of financial responsibility and leadership skills make her the perfect fit for this position and we are excited to have her on the executive management team.

With that, I would like to turn the call over Christi. Christi?

Christi Hing

Thanks, Berke. For the first quarter ended March 31, 2012, restaurant sales increased 8.6% over the same year-ago period, $24.2 million, reflecting an 8.7% increase comparable restaurant sales. Q1 comps were favorably impacted by 90 basis points due to the extra day in February and by a 170 basis points for the calendar shift resulting in 13th Friday in Q1 versus 12 last year.

If you normalize those three items, same-store sales would have been about 6%. Although, it is difficult to quantify the warm winter weather throughout the country positively impacted same-store sales as we saw double-digit increases in sales generated from the bar and patio. Patio sales from our East Coast and Midwest restaurants increased on average over 20%, compared to last year.

If you normalize our comps for weather and the above mentioned items, we estimate our comps would have been near the 4% range that we guided to you on our last call. The sales increase also includes about 1.5% in pricing that we took last year. Our comps continue to remain strong as this quarter represents our sixth consecutive quarter of comps greater than 6%. On a trailing two-year basis, our Q1 comps are up over 16% or a 11.6% if you normalize for the items discussed above.

For Q2, the comp compares and becomes increasingly more difficult, as we left 9.1% comp in Q2 of last year and well over the pricing we took last year. On a trailing two-year basis, we estimate our comps would be over 10%, which we believe this among the best in our segment.

Cost of sales as a percentage of restaurant sales decreased a 110 basis points, 26.9% during the first quarter from 28% last year. The decrease reflects lower year-over-year pricing for produce, efficiencies in the kitchen resulting from higher sales volumes, and the benefit of various purchasing initiatives implemented over the past 12 months.

We continue to work diligently with our vendors to ensure the best possible pricing. As discussed on our last call for 2012, we expect a modest increase in beef cost year-over-year, but we’re optimistic that improvements in seafood purchasing will help mitigate any material impact to our food costs.

Labor expenses as a percentage of restaurant sales decreased 90 basis points to 32.9% during the first quarter from 33.8% last year. So lower labor costs percentage is attributable to the leveraging of fixed wages from the 8.7% increase in comp sales. Restaurant operating expenses as a percentage of restaurant sales decreased 170 basis points to 14% during the first quarter from 15.7% last year.

The lower operating expense percentage resulted from a 60 basis point reduction in marketing expenses. We use credit card processing fees resulting from the change in law last fall and lower utilities resulting from the warm winter weather. We will also able to leverage the fixed portion of operating costs due to higher sales volume.

Occupancy expenses as a percentage of restaurant sales decreased a 110 basis points to 6.3% during the first quarter from 7.4% last year. As mentioned on our last call, the decrease reflects the amendment of a lease provision for one restaurant and the leveraging of the fixed portion of the costs from higher same-store sales.

Combining these four line items, restaurant operating profit increased $1.5 million to $4.8 million for the first quarter of 2012. As a percentage of restaurant sales, restaurant operating profit increased 480 basis points to 19.9% during the quarter, compared to 15.1% last year. With the expectation of tough comp comparisons in Q2, we expect our margins to remain strong. However, we do expect to see the same level of year-over-year improvement that we saw in Q1.

General and administrative expenses increased 203,000 from the prior year quarter, primarily due to higher legal fees, costs associated with our general manager and executive chef pinnacle meeting, and the write-up of certain costs as we refined our design in the core specs. As a percentage of sales, G&A increased 10 basis points to 8.6% compared to 8.5% last year. We expect G&A to run in the low 8% range for the full year 2012.

Net income increased $1.3 million for the quarter to $1.2 million, or $0.13 per share, compared to a net loss of $92,000 or $0.01 per share in the prior year quarter.

When looking at net income on a sequential basis, net income increased 58.1% when compared to the fourth quarter of 2011. The 8.7% comps and tight labor and operating expense management contributed to the significant decrease of the expectation.

We ended the quarter with $5.8 million in cash and investments. During the quarter, we purchased and retired 430,000 shares at an average cost of $5.97 per share, for a total cost of $2.6 million and completed the current $5 million share repurchase authorization. In total, we purchased 859,000 shares at an average price of $5.88 per share.

For our second quarter 2012 financial guidance, we are forecasting sales of $24.7 million, and net income of $1.25 million, or earnings of $0.14 per share. Our guidance reflects the expectation of same-store sales increase of approximately 1% for the second quarter, as we rollover the 9.1% comp last year. In addition, you will not have the favorable impact of weather and the calendar shift in Q2 that we had in Q1. We believe our guidance is reasonable based upon sales results to-date.

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

Berke Bakay

Thanks, Christi. As I briefly mentioned in my opening remarks, we are very pleased with the first quarter as it represents the sixth consecutive quarter of positive same-store sales, which we believe is amongst the top of polished casual dining space for the trailing two-year period.

The first quarter was also the ninth consecutive quarter that we experienced positive traffic trends, which we believe demonstrates the strength and momentum of our brand in multiple markets. While we are pleased with our first quarter results, we know that we must continue to innovate to remain relevant with our guests.

To this end we have several initiatives in place that are designed to track guests traffic and increase average guests check.

During the quarter, we implemented several programs that contributed to our strong results. We continue to build on the success of our food-based promotions by introducing two promotions during the quarter. These food-based promotions showcase new items such as our half plate chicken caprese sandwich and carrot cake, while allowing us to source a guest feedback that is valuable and helping us to ensure, our menu is relevant.

The food-based promotions also provide opportunities to generate excitement among our guests and give them a reason to come back more frequently. These promotions continue to drive new traffic and capitalize on the success of our preliminary initiatives over the past 18 months. In late March, we rolled out our spring menu update, including a menu vehicle that improves reliability, durability, and sophistication, while reducing the cost associated with menu changes by moving to a plastic sleeve or new menus can be inserted and replaced with minimal cost.

The menu update includes several changes to existing offerings and we introduced a handful of new items several of which were successful food-based promotion items in the past, such as our Thai beef noodle salad or Spanish top brand.

Feedback from the new menu has been positive and many engineering analysis indicate a modest improvement average check. In early April, we rolled out our Wine down Wednesday program in eight restaurants. This promotion place off of our successful Valentine’s Day promotion and includes half of followers of wine throughout the restaurant every Wednesday.

Initial guests feedback has been very favorable and we’re seeing a significant increases in the average number of products sold in comparison to last year for these restaurants and also moderate increases in average check for those guests participating in the promotion.

We continue to monitor the program and its impact on traffic and margins. We are also testing happy hour initiatives at various restaurants to drive traffic and increase frequency of loyal customers.

The philosophy behind the happy hour initiatives is to ensure that our award-winning happy hour remains relevant to our guests for years to come, just as it was in the past. These programs are in their early stages and we will provide an update on our next earnings call.

Also as of last Tuesday, we rolled out our improved take-out program after testing it for several months in select restaurants. The program includes an improved IT component, which should facilitate faster service, better packaging quality, and improved internal training to provide a better guest experience. We feel that this initiative has significant outside potential as our take-out sales are approximately 2% of our total sales, which is well below those of our peer group.

With the recent promotion of Jenny Elkins to VP of Operations, and Chris Moran to VP of Food & Beverage, we have completed our senior leadership team and believe we have the right team in place to take the concept to the next level.

Our strategy as an organization is clear. We plan to build a premier polish casual concept that is distinguished by our award-winning sushi and new American cuisine, as well as our significant bar business. We differentiate ourselves from our competitors by successfully executing three distinct businesses in four different day parts. As of today, we operate 23 highly profitable restaurants in 16 states.

Kona Grill as stands today as industry leading operating margins and same-store sales momentum and has a great platform for further unit expansion. Our vision as the new management team of Kona Grill is to take this brand to the next level of its growth base, while we maintain a disciplined return investment strategy.

In summary, we are very excited about the growth potential of our brand, especially evidenced by our recent results. We’re diligently working to build our pipeline and build continue to evaluate sites in both new and existing markets that meets our return investment targets. We are confident that we will be able to build a strong pipeline that will enable us to choose the best sites for our concept. We will update our target for new restaurant openings when new leases are executed.

In an effort to better align with our high-quality food and service offerings, we are updating the design and decor specifications for remodels and future restaurants. The design will be modern and attractive while relevant for the next stage of our growth.

This new design pallet includes variations of materials, fixtures, furniture and decor that can be used interchangeably depending upon location and trade area. We are incorporating some of these elements into the remodel of our Chandler, Arizona restaurant, which is selected for this well. I’m very eager to see how our guests and employees respond to new design elements.

It’s been an exciting three months since I stepped into this role and I continue to be amazed by the talent and committed individuals that contribute to the success of our company in everything.

In conclusion, our momentum is stronger than ever. I firmly believe that we have the people and programs in place to drive additional profitability in 2012. Thank you for your continued support.

Now, with that, I would like to open the call up for any questions you might have. Vince, please open the line for questions.

Question-and-Answer Session

Operator: Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions) Our first question is from the line of Mike Malouf with Craig-Hallum Capital Group. Please, go ahead.

Mike Malouf – Craig-Hallum Capital Group

Hi, Berke, and a great job on the quarter.

Berke Bakay

Thank you.

Mike Malouf – Craig-Hallum Capital Group

A question about G&A, I was actually pretty impressed that G&A was just a little bit over $2 million in the quarter. I was expecting the spending to be a little bit higher. And I’m just wondering if you could give us a little bit color on how that numbers kind of trend going forward? And whether or not we might see some seasonal jumps throughout the year or whether our spending is pretty well contained? Thanks.

Berke Bakay

Sure. Mike, in terms of G&A, the G&A number that you saw in the first quarter, actually we do expect that number as an absolute dollar amount to decrease here for the second quarter, third quarter, and the fourth quarter, for the rest of the year. I guess, it’s a function of – you mentioned, you said you were expected that number to be higher, it’s a function of tight expense controls that we tried to always do a good job at controlling that line item. So and we do expect that number to go down as an absolute dollar number going forward for the rest of the year.

Mike Malouf – Craig-Hallum Capital Group

Okay, great. Well, that’s certainly good news. And then, if I look out the growth, I obviously get asked by investors all the time about expansion, and you touched a little a bit on the pipeline. Can you give us any kind of color on whether the pipelines are starting to get pumped back up again or you out there looking at site just haven’t signed any leases, I mean and maybe if you are, can you give us a little bit of insight and how the market seems for a new concept outlook you expect? Thanks.

Berke Bakay

Sure. Well, we are out there, both Mark and I were in very different locations last week and looking for site. As I said in the prepared remarks, I will be hesitant to do give any color or unit level data to you in terms of what we’re looking at doing. But here is what I would tell you, which is exact same thing I said on the last call.

We reported almost 20% operating margins. We have started 23 successful restaurants in 16 different states. So the data that we see indicates very strongly that we need to have more restaurants, assuming that we can source deals that make a great return on invested capital sense. So to accomplish that goal, we are off there, working diligently to build our pipeline, so we have the luxury to choose locations that actually make sense, but we are not honored to make decisions just because we told you guys that we were going to open stores.

So that’s the mentality that we have, that’s the philosophy that we have, we’re very excited about it, but also we’re very diligent and working very hard about it. The next piece of news that you will get from us on that will be when we execute leases to give more color. I hope this answers.

Mike Malouf – Craig-Hallum Capital Group

That’s helpful. And just if I could just a quick follow-up on that. You’d mentioned that maybe the new restaurants would have a slightly different look or layout maybe slightly more modern. Can you give us a sense of as you cost that out, how much would an average restaurant cost now under the new style to the law? Thanks.

Berke Bakay

Sure, and we are definitely going to valid engineer, our new design. So I don’t want anybody to assume that we’re going to spend significantly more capital for our new remodels and new store openings. We are still expecting the same range of around $2.5 million net of TI allowance for our new store openings.

Mike Malouf – Craig-Hallum Capital Group

Okay. Thanks a lot, Berke.

Berke Bakay

Thank you.

Operator

Thank you. Our next question comes from the line of Conrad Lyon with B. Riley & Company. Please go ahead.

Conrad Lyon – B. Riley & Co.

Thanks. Yeah let me follow on, a nice job there, Berke. Question about your development guidance, let me ask at different way. Obviously, fantastic job with margins, fantastic job with the same-store sales, as you begin the lap these margins might stay up but, I think same-store sales might come down a little bit. Mike, you try to layer in some new stores as you start to lap these perhaps in the early part of 2013 or is it just still are you just going to try to find the best quality if that is possible to get the best ROIs?

Berke Bakay

Well, let me make it very clear one more time. The strategy behind store openings is to ensure that we have great return investment capital on these projects. We’re not going to rush into something so that, we are quickly opening stores, because we have concerns about same-store sales momentum.

I mean there are two different issues. And as you indicated, our margins are very healthy, we have on the two-year basis, we have very healthy same-store sales increases. So the primary goal and concern is to establish our pipeline that has very high likelihood of generating very successful stores for us over the course of many years. So that’s the primary goal and that’s what we’re trying to accomplish.

Conrad Lyon – B. Riley & Co.

Okay. So I guess it differently that there is no real-time pressure from your perspective, correct?

Berke Bakay

Absolutely no.

Conrad Lyon – B. Riley & Co.

Gotcha. Okay, that’s helpful.

Berke Bakay

More Pressured

Conrad Lyon – B. Riley & Co.

Gotcha, okay. Digging into just the trends, I’m looking at your revenue guidance for the second quarter. If my math is correct, I think about a 4% growth in average weekly sales. Is there a more just because of the timing issues relative to the first quarter that you might see a slightly lesser amount compared to the first quarter?

Christi Hing

Conrad, this is Christi. Earlier in our prepared remarks we said comp guidance of about 1%. That’s kind of where we are at today April 30th, and I know a lot of our peers that have kind of lowered their comp guidance due to the headwinds and some of the other things that we are seeing. We feel comfortable with the 1% guidance that we are giving today.

Conrad Lyon – B. Riley & Co.

Gotcha, okay.

Berke Bakay

All right, just to add on what Christi had said, in our prepared marks, we shared – we were actually pretty detailed in terms of giving you a flavor of how our comp store sales performance in Q1 was. So if you look at that and you take away kind of the shift from extra day and if you take that extra day in February and you adjust for the calendar shift, our comps would have been really on 6%. And that what we look is, we look at our patio sales, because we’ve seen dramatic increases, average 20% give or take on the patio sales, and we have comp stores that we’re way over 20%, that’s really helped same-store sales.

And as you all of you guys know, the warm weather in East Coast, I mean our ability to open patios in our East Coast restaurant in January, February, and March, really helped us. So if you normalize for that impact, we were right around 4% range for the first quarter, which was clarified in our guidance on same-stores sales.

So couple of things from that point on just to be a little bit more granular and give you guidance, we have a 1.5% pricing increase that we have taken in June. As of today, we have no plans in words to take another price increase in the month of June. So basically double rollover, so there is an impact of that. And also there is a fact that our same-store sales comparisons in the second quarter are harder than our first quarter.

So if you look all of these factors, our guidance of 1% really doesn’t indicate any slowdown in business in absolute dollars, but it is really always comps against a week before and eliminating some of the external factors. So on normalized levels, I know it’s a little long in that answer, but we wanted to provide some clarity on why the guidance was, what it was.

Conrad Lyon – B. Riley & Co.

That’s fine, that’s helpful. How about the alcohol mix, maybe with the warm weather did you get any margin benefit maybe people drinking more as well?

Christi Hing

Conrad, we’ve really didn’t see any insist in our alcohol mix, it’s always been around the 30% and that has continued to remain the same for Q1.

Conrad Lyon – B. Riley & Co.

Gotcha, okay. Final question here, you mentioned some of the turnover that we had commented up here, and then you had some new initiatives. How do you feel, I mean you’re quick, let’s state this way, how do we know that the newer initiatives that you’re putting out are going to generate the same level of success? Are you doing the same level of testing as what was done before or is it composing new type of method for, say, looking at new on-trays, new promotions, or is it pretty much the same method as before?

Berke Bakay

Sure, well as a philosophy, I believe in testing on everything we do. So when we talk about Wine down Wednesday, that’s something that we currently have in testing. We have about one month of data on that and we’re not going to get too granular on the specifics for competitive reasons, but we have seen a significant increases as we mentioned on both of our guests comps or wine sales overall and our average check, even excluding the wine of sales, same thing on our happy hour initiatives, it’s something that we are testing.

We have tested that to grow sales, so to answer your question, yes, everything we test first and we get feedback both from our field and from my guest, and then we make for a positive rollout to the field fully ones that are successful and we eliminate the ones that are not if that’s the case.

Conrad Lyon – B. Riley & Co.

Gotcha, okay. That’s all I have. Thanks, Berke.

Berke Bakay

You’re welcome.

Operator

Thank you. (Operator Instructions) And our next question is from the line of Mark Smith with Feltl and Company. Please go ahead.

Shawn Bitzan – Feltl and Company

Hi, this is Shawn Bitzan sitting in for Mark Smith. Going back to operating expenses, I think you’ve touched on it a little bit in your commentary, Christi. What do you expect going forward, I’m sorry if I missed it for 2012 and op expenses since it’s overall this quarter, is that something that you think can continue?

Christi Hing

Shawn, we believe that it provide guidance, a couple of things that I did mention the lower credit card processing fees that will continue throughout the remainder of the year. And also we mentioned the 60 basis point reduction in marketing expenses. Now, I’ll let Berke talk a little bit about, more about that, but marketing is something that when Berke, first came on, he took a really hard look at.

Berke Bakay

Yeah, I mean you should expect the marketing expense leverage that we have to continue. So when I work in here, we made some significant changes on our marketing plan before we used to have a type of spending that I was in personally comfortable with, what I mean by that is couple of spending, we have no way of quantifying. So I would include that’s the billboards and other things.

So, we have reallocated some of those marketing dollars, which actually is performing really well, one of that example is that direct mail initiative that we have in Tampa. We have seen significant guest count increases with that program. But overall absolute dollars, we have cup marketing and we have also reallocated type of the marketing spend that we have. So from that piece, you should expect the leverage going forward on the restaurant operating expenses level.

Shawn Bitzan – Feltl and Company

Okay. Will you say the same goals for natural gas and we can expect something similar to the reduction as we saw here or....

Berke Bakay

Well, I don’t control the way, assuming that the seasonal patterns are holding. We obviously benefited from natural gas because of the warm winter weather, but that’s something that is out of our control.

Shawn Bitzan – Feltl and Company

But as a whole, you’d say operating expense were trending fairly similar to Q1?

Berke Bakay

We’re not going to get too much granular on that, but we don’t talk line item specific. But I wanted to give you a color at least, you should look at marketing as something that is sustained and then we will continue, because all that programs that be able to cut and we feel very comfortable with it.

Shawn Bitzan – Feltl and Company

Thank you so much.

Operator

Thank you. (Operator Instructions) And our next question is from the line of David Khan with Raymond James. Please go ahead.

David Khan – Raymond James

Fantastic start for a great quarter, great numbers. Well, with respect to the new take-up program, can you give us any idea on what your expectations are?

Berke Bakay

Sure. Well, David to be fair, program has started last week, so we have very limited data. And I don’t want to start guessing things, but we have seen significant improvements on our take-up business or the test restaurants that we have seen. So we have – and we have gotten great feedback in terms of knowledge of our staff, the packaging, the technology piece that goes into the restaurant. So, I’m excited about it, but I will be hesitant to give you any color just because I have six days of information on it.

David Khan – Raymond James

Excellent. Once again really good start for running a business, Berke. Good quarter.

Berke Bakay

I Appreciate it.

Operator

Thank you. And our next question is from the line of Lee Giordano with Imperial Capital. Please go ahead.

Lee J. Giordano – Imperial Capital, LLC

Thanks, a great quarter guys. Can you talk a little more about the Konavore program? How you see that working out, you’d still be continuing to grow that program in the future? Thanks.

Christi Hing

Our Konavore program remains strong. We have, I believe, over 230,000 members. From that data base, we are able to message different promotions regarding happy hour initiatives, anything we do for holidays like Mother’s Day. So we will continue to use that as a vehicle to communicate to our loyal guests.

Lee J. Giordano – Imperial Capital, LLC

Thank you.

Operator

Thank you. And at this time I’m showing no further questions. I’d like to turn the conference back over to Mr. Bakay for any closing remarks.

Berke Bakay

Well, thank you Vince. As always, I wanted to thank each of you for joining us this afternoon and thanks for your continued support of Kona Grill.

Operator

Thank you, sir. I’d like to remind everyone that this call will be available for replay at later this evening. A webcast replay will also be available via the link provided in today’s press release, as well as available one the company’s website at www.konagrill.com. Thank you very much, ladies and gentlemen for your participation and you may now disconnect.

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