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Luby’s, Inc. (NYSE:LUB)

F2Q08 Earnings Call

March 20, 2008 5:00 pm ET

Executives

Rick Black – Director of Investor Relations

Christopher J. Pappas – President, Chief Executive Officer & Director

K. Scott Gray – Chief Financial Officer & Senior Vice President

Analysts

Will Hamilton – SMH Capital

Chris Terry – Hodges Capital Management

Todd Cohen – MTC Advisors

Operator

Good day ladies and gentlemen and welcome to Luby’s second quarter earnings conference call. My name is Jahida and I will be your coordinator for today. At this time all participants are in a listen only mode and we will be facilitating a question and answer session towards the end of this conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call Mr. Rick Black, Director of Investor Relations. Please proceed.

Rick Black

Welcome everyone to Luby’s second quarter fiscal year 2008 conference call. This call is also being webcast and you can access the audio replay on our website at Lubys.com. Before we continue I would like to remind you that statements in this discussion including statements made during the question and answer session regarding Luby’s future financial and operating results, plans for expansion of the company’s business including expected financial performance of the company’s new prototype restaurant and future openings of new or replacement restaurants are forward-looking statements. Forward-looking statements involve risks and uncertainties including but not limited to general business conditions, the impact of competition, the success of operating initiatives, changes in the cost and supply of food and labor, the seasonality of the company’s business, taxes, inflations, governmental regulations and the availability of credit as well as other risks and uncertainties disclosed in the company’s periodic reports on Form 10K and Form 10Q.

I would now like to turn the call over to Luby’s President and CEO, Chris Pappas.

Christopher J. Pappas

Welcome to our second quarter conference call. During my opening remarks I will review the quarter and comment on the current restaurant operating environment before I turn the call over to Scott Gray, our CFO to review our financial results in more detail. I will then discuss initiatives taking place at Luby’s to enhance our store level execution and improve our facilities. I will also provide an update on our culinary contract service business. Finally, I’ll review our new restaurant development before opening the call to your questions.

The economy has challenged us today that we didn’t see at this time last year and consumer confidence is down because of it. Gasoline prices are up across the board and subprime lending and the ups and downs of the stock market have customers concerned and they are thinking about their budget and how to stretch their dollars. Luby’s has seen downturns in the past in the 60s, 80s and after 9/11 in 2001. We’ve weathered these times before and have even grown during tough times in the past. Our meal prices are $3 to $5 below most casual dining meals of a similar selection and we know our taste better. Our goal is to present our guest with a pleasing dining environment with friendly service and delivery them great tasting food for a great value. If we can deliver on that we’ll be in good shape during these times.

During the quarter we initiated construction development on new sites and hired additional staff to support these efforts. We invested approximately $6.9 million on capital expenditures of which $1.5 million was used to upgrade our restaurant facilities including dining room updates, restroom remodels and the addition of new furniture at many locations. Our entire team remains committed to operational procedures, policies and initiatives designed to strengthen and grow our business. These programs are focused on customer service, menu innovation, food quality assurance, technological enhancements and staff training and development. The long term consistent execution of these programs is designed to enhance the overall customer satisfaction and increase our profitability. We remain committed and confident that our long term strategic growth plan to enhance and grow the Luby’s brand will optimize our competitive value proposition to the market and enhance shareholder value. Later on today’s call I will discuss our growth plan and competitive position.

I’d now like to turn the call over to CFO, Scott Gray to review our financial results.

K. Scott Gray

Good afternoon everyone. I’ll now take you through our financial results for the second quarter fiscal 2008 starting with the income statement. Income from continuing operations in the second quarter was $354,000 or $0.01 per diluted share compared to $2.1 million or $0.08 per diluted share in the second quarter last year. Second quarter 2008 income from continuing operations was reduced by approximately $0.03 per diluted share by the after tax impact of expenses related to the company’s contested proxy election in January and a reduction in interest related income taxes partially offset by net gain on disposition of property and equipment in the quarter.

Total sales in the quarter increased .6% to $72.6 million and restaurant sales declined $1.1 million. The decline in restaurant sales was offset by the $1.7 million increase in culinary contract services. On a same store sales basis, sales declined 1.6%. Last year same stores sales declined 3.6 which approximately half or 1.5 to 2% was related to severe winter weather. To put our sales results into perspective, part of the recent quarter of same store sales decline, we had 12 consecutive quarters of same store sales growth that average 4.7% positive. Since that time we have experienced five consecutive quarters of same store sales decline and have averaged 2.3%. During this period of sales decline management has focused on store level profit which we define as restaurant sales minus cost of food, payroll related costs and other operating expense declined 15.4% of restaurant sales in the current quarter compared to 16.6 in the second quarter fiscal 2007 due to the higher food costs as a percentage of sales and a decline in sales negatively impacting labor leverage during the quarter partially offset by lower operating expenses. Year to date our store level profit was 16% down 30 basis points from 16.3 during the same period last year. For the two quarter period year-over-year restaurant sales declined 3.6.

Food costs in the second quarter as a percentage of restaurant sales were 28.1% an increase of 100 basis points compared to the second quarter last year. This increase in food costs as a percentage of sales is primarily due to higher commodity and energy prices being reflected in the cost of food partially offset by menu price increases. Assuming commodity prices continue to rise over the second half of our fiscal year, we expect our food cost as a percentage of restaurant sales to trend 75 to 150 basis points higher in fiscal 2008 versus 2007. Payroll and related costs in the second quarter as a percentage of restaurant sales were 34.5% an increase of 80 basis points compared to the second quarter last year. The increase was primarily due to higher store management and training costs partially offset by lower workers’ compensation expense including the effects of reduced actuarial estimates of potential losses resulting from favorable claims experience. The favorable claims reserve reversal in the quarter was 48 basis points as a percentage of restaurant sales. These changes in actuarial estimates may continue to fluctuate in the future up or down based on changes that may occur in our claims experience. If sales continue to decline payroll and related costs are expected to increase as a percentage of sales.

Other operating expenses in the quarter as a percentage of restaurant sales were 21.9% a decrease of 70 basis points compared to the second quarter last year. Other operating expenses decreased primarily due to approximately $1 million reduction in marketing and advertising expense due to our use of a mix of lower cost marketing mediums and geographically consolidated markets and an approximately $300,000 reduction in insurance expense which included the effect of reduced estimates of potential loss from general liability claims. These favorable expense items were partially offset by an approximate increase to $600,000 in repair and maintenance expense associated with our efforts to further improve the appearance of our existing restaurants. We expect our other operating expense dollars in fiscal 2008 to be relatively flat and consistent with 2007.

General administrative expenses in the second quarter of fiscal 2008 as a percentage of total sales were 9.5% compared to 6.9% last year. The increase was primarily due to approximately $500,000 increase in corporate salaries and expense related to staffing costs supporting our culinary services and other departments to support our strategic growth plan and an approximately $1.1 million increase in professional service fees related to the cost incurred for the proxy contest in the second quarter of fiscal 2008. We expect general and administrative expenses for the fiscal year 2008 to range between $25 to $26.5 million.

Moving on to the balance sheet we ended the quarter with $35.6 million cash and short term investments compared to $26.1 million in cash and short term investments at fiscal yearend 2007. $17.6 million of our short term investments in the quarter are in AAA rated auction rate municipal bond securities. Subsequent to the end of the second quarter the company repurchased 500,000 shares at $9.50 per share for $4.75 million. These shares will be held by the company as treasury shares. We continue to expect our capital expenditures for fiscal 2008 to be between $35 to $40 million.

I’ll now turn the call back over to Chris.

Christopher J. Pappas

As I mentioned earlier our team spends a great deal of time and effort in the field designing and developing internal programs focused on customer service, menu innovation, food quality and consistency, technological enhancements and staff training and development. With the current market conditions it is important that we execute these programs to be successful. In many respects the focus remains back to the basics. The long term consistent execution of our programs will improve overall customer satisfaction and increase Luby’s profitability. In the second quarter we developed several initiatives to enhance store level training, recognizing and reward crew members, strengthen our store management teams and improve our restaurant technology and facilities. Our hard working and dedicated crew members and store management are the backbone of our organization. To be successful we have to train, develop and reward these valuable team members.

In January, we began a regional training program designed as a cascading training method to focus on key restaurant competencies in the front and back of the restaurant. Our regional trainers and area leaders conduct one to two day training sessions with store management at their restaurant working on a particular area of focus such as recipe consistency, customer service and cleaning procedures just to mention a few. After the session is complete there are a number of store follow ups to reinforce the training session.

We have also developed and are rolling out a new employee recognition program for crew employees to incentivize and reward their fine performance. Under this recognition program crew members will be recognized for outstanding performance and will receive a compensation reward. The goal of this program is to strengthen team loyalty and increase crew member longevity while improving customer service. Our experience has shown us that stores that work better as a team and understand the concept that the customer is king, always perform better.

In addition, our recruiting efforts continue to strengthen and we recently hired several new area leaders that are responsible for seven to eight restaurants each on our team. We’re finding there are a number of multiunit managers from casual dining and fast food operations searching for a new organization and they find that Luby’s has a lot to offer them. We are benefiting from numerous ideas that these managers bring with them from their past experiences. These are some ideas and advantages of tightening market that we are actively monitoring to add strength and depth to the company team.

During the quarter we also continued our capital improvement projects and completed our kitchen technology roll out at all our stores. We performed upgrades and remodel programs on 12 of the stores and 16 units received new furniture. Our plans are to complete 20 to 25 remodel projects and 16 more furniture remodels in this coming year.

Moving on to sales and market, it would be difficult to find a restaurant operator in the field today that wouldn’t say that customers are tending to eat out less. Our challenge as operators is to remain or become a customer preferred choice when they go out to eat. We have found that while soft consumer demand has impacted same store sales there are positive trends within our portfolio of restaurants. We see positive and improving sales trends in many of our high volume locations resulting from price increases and improved store level execution. We also see many of our lower volume locations continued to be challenged.

Turning to the competitive landscape we believe our brand remains well positioned, residing below casual dining in ticket price and only slightly above quick service prices. From a quality standpoint we would argue that our made from scratch food and wide variety make us a much better value than our competitors. Currently value is one of the primary concerns for consumers and that is evidenced by guest comments and surveys as well as the direction most restaurant companies are taking with their advertising. We believe that cafeteria concepts have always stood for value with quality offerings variety and reasonable pricing. So much of the menu is available a al cart. Many of the items we serve on our line today are of higher food quality yet cost much less than customers will find at other casual dining restaurants. In addition, our brand has a strong reputation in our market. We believe that with the growth of new stores and the publicity we’re receiving that it generates, our loyal customers become even more excited about our brand.

Last quarter we told you about a new customer feedback tool that we implemented to gather data based on our customer experience. Customers can visit a website or call our 800 number provided to them on their cash receipt or credit card receipt where they will fill out a survey and can provide comments. This program encourages and gages our customers and lets them know that we are listening to them. Our managers access and utilize this data to improve the stores’ performance. During the second quarter alone 14,000 guests took part in our online survey and over 40% of them also provided written comments. Customers are telling us that they come to Luby’s because of our great food. The survey results identify two factors where Luby’s excels and those are taste and the great portion sizes that they see. They see us as a food value because our food taste good and we don’t skimp on the portions. We believe that by listening to our guests and focusing on executions we can retain current customers and potentially take share from other casual diners seeking value, quality offerings and convenience.

From a marketing and advertising perspective we continue to manage our costs closely. We identified a number of trends in the marketplace during the first quarter and based on those trends we shifted our advertising focus more to radio and away from television. We continued this trend in the second quarter. While this move reduces cost it may also be more effective at the current time. In addition, we utilized a number of mediums to communicate with our guests including billboards, sponsorships, charitable organization involvement and in store marketing.

In regard to our culinary business where we provide food service at healthcare facilities continued to grow in the second quarter compared to last year. During the quarter we entered into one new service contract at a healthcare facility in Dallas, Texas. Currently we provide healthcare services at nine facilities. We view our culinary business as a solid area of growth for the Luby’s brand and we continue to identify and cultivate new opportunities in this segment.

Now, I would like to discuss our new store development. As we mentioned in today’s press release the new prototype restaurant we opened in August continues to perform well and remains on pace to generate annual revenues in excess of $3.25 million an increase of 30% compared to the restaurant system average of $2.5 million. We remain committed to our strategic growth plan to build and operate new Luby’s cafeteria style restaurants and will open our new location in Port Arthur, Texas just next week. We’re actively searching for new site locations in a number of markets. In the second quarter we continue to identify additional locations for future development. Currently, we plan to open a completely new build out location which is a replacement space for an additional store in Houston. We also have five additional new store locations in development that we expect to open during this calendar year.

Now, I’d like to open up the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Will Hamilton of SMH Capital. Please proceed.

Will Hamilton – SMH Capital

Just a first question on menu pricing, what kind of increases have you taken recently? Maybe what percentage of run rate you’re running right now to help offset some of these costs pressures?

K. Scott Gray

Will, we generally haven’t discussed that. We tend to just focus on our net sales. Probably not enough to really offset our traffic I would say but we’re trying to offset some of the costs we’re seeing in our food and we feel is still a value looking at the quality of our product.

Will Hamilton – SMH Capital

Okay. Can you give us a little bit of flavor on how same store sales are running so far this quarter? I mean, you had a small incremental sequential improvement from the first quarter. I’m just trying to get a sense whether you’re seeing any trade down benefit in some of these recent trends or not?

K. Scott Gray

As we mentioned in our comments that last year we had some severe weather so we feel like part of the improvement is related to the easy comp. We continue to focus on store execution and we feel like we’re going to hopefully win guests back in that way.

Will Hamilton – SMH Capital

Okay. Can you repeat how many remodels have you done so far and what you expect to do for the full year?

K. Scott Gray

During the quarter we did about 12 locations and that’s kind of a combination of full and some full restroom and then other appointments whether its booths or replacing furniture. We’ve done approximately 23 year-to-date and we plan on an additional 20 to 25 remodels for the remainder of the year and included in that will be a number of locations that might just get new furniture to switch out with the new furniture that’s at the new prototype and booth installations.

Will Hamilton – SMH Capital

Okay. So, that’s slightly more than what you were originally planning? Is that right?

K. Scott Gray

Right. We’ve got, again as you see in our G&A, we’ve brought in some more staff to make sure we can accomplish all our desires. We feel it’s what is needed at this time given the age of our units.

Will Hamilton – SMH Capital

Okay. In regards to the openings, you have the one that’s opening next week. The five additional restaurants can you give us a sense maybe by quarter when those expect to open? Maybe just in 08?

K. Scott Gray

I can kind of give you for fiscal, I’ll give you a range on the sales from our new stores which include the existing location. Probably it’s a range between – based on what we expect at the current time between $4 and $4.5 million for the balance of the fiscal from new stores.

Will Hamilton – SMH Capital

Okay.

K. Scott Gray

Does that answer the question Will?

Will Hamilton – SMH Capital

Well you’re saying $4 to $4.5 million extra this year for sales?

K. Scott Gray

In total for the year – at the last call I think we’ve given a range of kind of for the year total in new stores sales probably.

Will Hamilton – SMH Capital

I was trying to get a sense though when you expect these openings, the five additional openings to open? Should we expect two to three in the fourth quarter?

K. Scott Gray

What we’ll have completed this year right around four just at the end of August, it’s going to tail over probably in September for the fourth one. So, what we wanted to focus on was to indicate for the calendar balance which would include part of the first quarter next year is that we have a total of five new locations and one relocation that will open up total.

Will Hamilton – SMH Capital

Right.

K. Scott Gray

So they’re really going to be back ended in the fourth quarter really except for the location that we’re about to open next week.

Will Hamilton – SMH Capital

Okay. Lastly, can you just talk about where these locations are? I assume they’re in Texas.

Christopher J. Pappas

One of them will be in the Plano area in Dallas and the remainder in the Houston market.

K. Scott Gray

We’re in a point where we’re focusing our existing markets at the current time and for the next several openings in our plan. So, the current markets before moving on.

Operator

(Operator Instructions) Your next question comes from the line of Chris Terry with Hodges Capital Management. Please proceed.

Chris Terry – Hodges Capital Management

I want to get a better understanding in the creep up in share count here for the quarter? It’s up roughly 1 million shares.

K. Scott Gray

It’s related to the exercise of some stock options that were exercised that you see relates to the influx of cash on our funds flow. You can see $11.2 million in exercise of stock options.

Chris Terry – Hodges Capital Management

Okay. For the balance of the year here should we be looking more options?

K. Scott Gray

As we mentioned what you’ll have is going the other direction 500,000 shares were purchased subsequent. So, outstanding right now is 27,911,000.

Chris Terry – Hodges Capital Management

Okay. And, that’s a weighted average or end of the quarter?

K. Scott Gray

That’s just issued and outstanding right now.

Chris Terry – Hodges Capital Management

Okay. Got it. Then also, on the remodels I wanted to dig a little deeper there, do you guys see any type of uptick in traffic following the completion there? And also, is there any type of disruption in the business when you go through one of these projects?

Christopher J. Pappas

We’re getting a lot of good comments from our guests that they like what we’re doing. And in some cases we feel like it is making a difference and in other cases it’s kind of neutral at the end of the day. But, I think what it really allows you to do is when you do need to take some pricing power into consideration your guests I think are a little bit more open to taking the pricing power because you’ve invested back into the stores and many of our stores are 20 plus years old and these are much needed improvements to the store that we’re applying. Your families really appreciate improvements in the areas that we are working on.

Chris Terry – Hodges Capital Management

Then on the disruption, is it a weekend type project?

Christopher J. Pappas

No, it’s not. It’s while we’re open while we do these so it’s not really disrupting traffic.

Operator

(Operator Instructions) You have a question from Todd Cohen with MTC Advisors. Please proceed.

Todd Cohen – MTC Advisors

As you open more of these new stores in the Houston area, will you be closing some of the older stores?

Christopher J. Pappas

We look at closing stores on a one off basis at the end of the day so it really wouldn’t be done usually in conjunction with where we’re going to put a new store in new cases unless we have a lease that is expiring in a situation where we think there is a good market and there might be a better opportunity in another location. So, that’s generally how that would take place.

Todd Cohen – MTC Advisors

Then, one of the new stores, it may be open now already but I know you were going to be doing – you were moving a store near the Galleria there, has that occurred yet?

Christopher J. Pappas

It will open in May. With the construction, if you know the location, it is under construction now and I was there today. The plans are to open it in May.

Todd Cohen – MTC Advisors

Okay. Just a couple of other quick questions, these auction rates you referred to are those failed auctions?

K. Scott Gray

We have had some, they reset every 35 days. We’ve got our sell orders in and we continue to monitor it but all of them are rated AAA. We just thought we’d make sure that we disclose that a portion of the investments were in those considering the condition of the market right now. We did have a partial on one of them that did pass.

Todd Cohen – MTC Advisors

Okay. So you’re not certain of the liquidity there at this point? Because I know most of these auction rated are AAA.

K. Scott Gray

Right, that’s the point. We feel there’s not an issue with valuation, it’s just liquidity right now. But, for the company as a whole liquidity is still not an issue with the remaining operating cash as well as our facility.

Todd Cohen – MTC Advisors

Then I guess the other question that I have is it may go back to this corporate governance issue that you were dealing with this other large shareholder but I see we’re in a pretty difficult environment right now however I see that on January 22nd the Pappas bought 600,000 shares of stock at $9 and then as the environment gets worse on February 19th the company buys back stock at a higher price. I mean, I just don’t really understand that.

K. Scott Gray

I would say that we don’t have that high of a volume. We had a particular block of volume that came, it was presented which the company acted on.

Todd Cohen – MTC Advisors

You didn’t – I mean, in this environment it seems you could have bought that a lot cheaper. I know it occurred on one day but it doesn’t look very good.

K. Scott Gray

Thank you for your comment.

Operator

At this time we do not have any more questions in queue and I would like to turn the presentation back to Mr. Pappas for closing remarks.

Christopher J. Pappas

Thank you. This is Chris Pappas and I would like to thank you all for being with us today and look forward to being with you on our next conference call. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation and you may now disconnect.

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