Luby's F3Q08 (Qtr End 5/7/08) Earnings Call Transcript

Jun.10.08 | About: Luby's, Inc. (LUB)

Luby's, Inc. (NYSE:LUB)

F3Q08 Earnings Call

June 10, 2008 5:00 pm ET

Executives

Rick Black - Director, Investor Relations

Christopher J. Pappas - President, Chief Executive Officer, Director

K. Scott Gray - Chief Financial Officer, Senior Vice President

Analysts

Will Hamilton - SMH Capital

Operator

Good afternoon. My name is Stephanie and I will be your conference operator today. At this time, I would like to welcome everyone to the Q3 fiscal year 2008 earnings conference call. (Operator Instructions) I would now like to turn the call over to Rick Black, IR Director. Please go ahead, sir.

Rick Black

Thank you, Stephanie and welcome, everyone, to Luby's third quarter fiscal ’08 conference call. This call is 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 the 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 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, and the seasonality of the company’s business, taxes, inflation, governmental regulations, and the availability of credit, as well as those risks and uncertainties disclosed in the company’s periodic reports on Form 10-K and Form 10-Q.

With that said, I would now like to turn the call over to Luby's President and CEO, Chris Pappas. Chris.

Christopher J. Pappas

Thank you and welcome to our third quarter conference call. During my opening remarks, I will review the quarter and comment on 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 operations and facilities. I will also provide an update on our culinary contract services business and our new store development before opening the call to your questions.

Let me begin by saying that I believe we are currently experiencing one of the toughest times our industry has faced in many years. Our financial results reflect these challenges and while we are not satisfied with our third quarter results, we do believe that our team is doing a good job in this tough market environment. Luby's is profitable, debt free, and generating cash flow, which we are investing back into our business to grow new units, expand our culinary services business, and refresh and remodel our existing units.

The restaurant industry remains under pressure from a number of economic factors which include higher gasoline prices, rising commodity costs, and in general negative economic news that we see every day on the news.

The continued rise in gasoline prices is having an impact on how our consumers eat out and at what frequency, as evidenced by the declines in same-store sales and the consumer confidence index. While our restaurant sales declined during the third quarter, our team managed food and labor costs well in a difficult environment. We remain confident that our long-term strategic plan to improve our food, labor, and service and grow the Luby's brand with new stores and culinary contract services will enhance shareholder value.

As we have discussed before, Luby's value proposition to provide great cook from scratch offerings served in convenient, fast casual environment and priced below casual dining restaurants should allow us to weather this macroeconomic storm. Our belief is that once the economic weather clears, Luby's should be well positioned to perform better than many of the industry averages.

In many ways, the key of our business is to remain focused on perpetually improving our ability to deliver great food, service, and value to our customers on a daily basis. So while we are excited about our growth plans, we know that the key to our long-term success is to drive sales and profitability in our existing stores, as well as to grow our business with new restaurants and new culinary contract accounts.

In tough times, organizations tighten up their focus on blocking and tackling and that’s exactly what we’re doing at Luby's.

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

K. Scott Gray

Thank you, Chris and good afternoon, everyone. I now would like to take you through our financial results for the third quarter fiscal 2008, starting with our income statement. Income from continuing operations in the third quarter was $1 million, or $0.03 per diluted share, compared to $3.9 million or $0.14 per diluted share in the third quarter last year. Third quarter 2008 income from continuing operations was reduced by approximately $0.01 per diluted share by the after tax impact of store opening costs and asset charges.

Total sales in the quarter decreased 2.1% to 74.6 compared to $76.2 million in the same quarter last year. Restaurant sales were $72.8 million, a decrease of 4.1% compared to last year. Approximately 0.8% of the decline relates to the net effect of sales from closed stores in the prior year, partially offset by new store sales in the current year.

On a same-store sale basis, which includes 121 units, our same-store sales declined 3.3% in the third quarter compared to the same quarter last year. Same-store sales in the third quarter last year were down 1.9%. Year-to-date, same-store sales have declined 2.8%.

To put our sales results into perspective, prior to the recent quarters of same-store sales decline, Luby's had 12 consecutive quarters of same-store sales growth that averaged 4.6%. Since that time, we have experienced six consecutive quarters of same-store sales declines that have averaged 2.6% decline.

The decline in restaurant sales has been partially offset by an increase of $1.5 million from our culinary contract service business during the same period.

Going forward in the fourth quarter, assuming that current same-store sales trend is consistent and removing closed stores revenue and including new store revenue, we expect restaurant sales in the fourth quarter to decline in the range of 2% to 3% off of last year’s quarter.

Store level profit, which we define as restaurant sales minus cost of food, payroll related costs, and other operating expenses, were $10.3 million, or 14.3% as a percentage of restaurant sales compared to $14.3 million, or 18.9% last year. This decline is primarily due to the decline in customer traffic and reduced sales volume and higher cost. Year-to-date, store level profit was 15.4%, down 170 basis points from 17.1 during the same period last year.

For the three quarter period year over year, restaurant sales declined $6.2 million.

I will now step through our expense lines for the third quarter and provide some guidance going forward for the fourth quarter. Food costs decreased approximately $200,000, or $0.2 million, or 1.2% in the third quarter of fiscal 2008 compared to the same quarter last year, due to lower sales. Food costs as a percentage of restaurant sales increased to 27.4% in the third quarter fiscal 2008 from 26.6% in the third quarter last year.

Food commodity costs increased in the most -- in most categories, with oils and cheese having the greatest impact on food costs, partially offset by lower produce prices.

Assuming commodity prices remain at current levels, we expect food cost as a percentage of restaurant sales to trend 75 to 100 basis points higher in the fourth quarter compared to last year.

Payroll related costs were relatively flat in the third quarter of fiscal 2008 compared to the same quarter last year. Payroll related costs as a percentage of restaurant sales increased to 34.8 in the third quarter fiscal 2008 from 33.5 in the third quarter of last year, primarily due to lower sales.

Claim reserve costs were 40 basis points unfavorable in the quarter compared to last year.

Assuming the sales trend I mentioned earlier for the fourth quarter, and due to higher wage rates, payroll related costs are expected to increase 100 to 150 basis points over the fourth quarter of last year.

Other operating expenses primarily include restaurant related expenses for utilities, repairs and maintenance, advertising, insurance, supplies, services, occupancy costs. Other operating expenses increased by approximately $1.2 million, or 7.4% in the third quarter of fiscal 2008, compared to the same quarter last year.

As a percentage of restaurant sales, other operating expenses increased 250 basis points, primarily due to $0.6 million increase in repairs and maintenance expense focusing, which was a result of focus on improving the appearance and functionality of the cafeterias for our guests and employees over the quarter and $0.8 million increase in utility expense, resulting from higher utility rates and more favorable costs in the prior year.

Going forward, assuming -- and given that our third quarter operating expense being up well over mid-7% over last year, and then also factoring in the forward curve for natural gas prices, which the current year is expected -- the current quarter, fourth quarter is expected to be in the mid-12s versus $6 per MCF for natural gas, we see operating expense could be as much as 12% higher than the prior year’s fourth quarter.

Operating costs were approximately $0.2 million in the third quarter of fiscal 2008 and reflects the labor, supplies, occupancy, and other costs necessary to support the unit through its opening period.

Our cost of culinary contract service line increased by approximately $1.2 million in the third quarter of fiscal 2008 compared to the same quarter last year. This increase was related to food, labor, and other operating expenses associated with the increase in revenue for this line of business.

Depreciation and amortization expense increased approximately $0.4 million, or 10.6% in the third quarter of fiscal 2008 compared to the same quarter last year, due to higher depreciation resulting from new restaurant openings and existing restaurant upgrades and remodels.

General and administrative expenses include corporate salaries and benefits related costs, including restaurant area leaders, share-based compensation, professional fees, travel and recruiting expenses and other office expenses. General and administrative expenses increased by approximately $0.4 million, or 7.3% in the third quarter of fiscal 2008, compared to the same quarter last year.

As a percentage of total sales, general and administrative expenses increased to 7.7% in the third quarter of fiscal 2008 from 7% last year. The increase was primarily due to approximately $0.4 million increase to corporate salaries expense related to staffing costs to support the culinary contract service business and other departments to support the company’s strategic growth plan. We expect general and administrative expenses as a percentage of sales in the fourth quarter to be in the range of 7.5% to 8%.

Moving now on to the balance sheet, I would like to provide an update on our short-term and long-term investments. We began the quarter with $17.6 million in short-term investments comprised of auction-rate municipal bond securities. During the quarter, we successfully converted $3 million to cash at par and subsequent to the quarter, we successfully sold $5.1 million at par.

As of May 7, 2008, the par value of these investments are classified as follows: $5.1 million in short-term and $9.5 million of long-term investments. Given the continuing liquidity issues surrounding the auction-rate securities markets, we have classified $9.5 million as long-term and have recorded a $0.4 million temporary reduction in value based on evaluation due to liquidity. The reduction in value is charged against shareholders’ equity on the balance sheet.

The balance in long-term investments of 9.1 reflects the fair value -- the 9.5 less the temporary reduction.

Moving now to property held for sale, property held for sale is valued at the lower of net depreciable value or net realizable value. As of May 7, 2008, we had five owned properties and two ground leases recorded at $5.4 million and property held for sale, which are actively marketed in their respective locations. There are no -- there was no activity or change in the carrying value of these properties during the quarter.

As of the beginning of the fiscal year at August 29, 2007, we had one owned property and three ground leases recorded at $0.7 million in property held for sale.

Rolling it forward in the first quarter of fiscal 2008, one of the ground lease properties was reclassified from property held for sale to property and equipment. We have plans to reopen the location using our new prototype design.

In the second quarter of fiscal 2008, six restaurants were closed, five were owned and one was an operating lease. Of the five owned properties, one of the five owned properties was sold leaving a net of four to be classified as property held for sale. Property held for sale consists of already closed properties.

Regarding our capital expenditures during the quarter, capital expenditures were $10.1 million during the third quarter, which included $2.4 million to upgrade our restaurant facilities, including dining room updates and restaurant remodels and new construction of $6.1 million. We expect our capital expenditures for fiscal 2008 to be between $38 million to $40 million.

As Chris mentioned, the economic conditions are challenging. This type of operational environment will continue to challenge us to better manage our operating margins. We are focused on improving shareholder value through culinary contract services growth and focus on existing store level profitability and new store development.

I will now turn the call back over to Chris.

Christopher J. Pappas

Thanks, Scott. As I mentioned earlier, our team’s focus in the field is on executing on our policies and procedures designed to help us deliver great food quality, excellent customer service, and consistency throughout our restaurants. I would now like to discuss a few initiatives underway at Luby's to combat declining restaurant sales and to protect our restaurant level margins in a tough sales environment.

As I reported to you last quarter, the installation of our kitchen software program was completed last quarter. This system allows us to view recipes on kitchen monitors in the kitchen area, eliminating the need for our recipe binders in the kitchen. This technology displays the recipe in great detail, including pictures of the item and improves our recipe consistency company wide. This system enables our corporate shifts to push new recipes or recipe changes directly down to all our stores.

Now that this system is fully rolled out to all our units, we’re seeing additional uses and benefits to the technology, such as improved controls for product waste and inventory. The software system can also serve as a venue for teaching other restaurant policies and procedures to our crew.

As every restaurant company is currently doing, our operations and labor team are also working to improve our -- any labor scheduling that we can. Information is power and we are putting more real-time information in our management’s hands so they can deploy crew members better.

Based on some insights we are gaining from our new store operations, we have an initiative and to improve labor deployment and overtime utilization. While it’s too early to quantify these savings, we continue to exhaust efforts to improve our efficiency and utilize technology in every aspect of our business.

As I mentioned before, blocking and tackling in the restaurant business are essential. Operational excellence really comes from commitment and consistency to literally hundreds of tasks daily, weekly, and monthly. We currently have an initiative in place that is focused on how our kitchens are organized. We continue to be pleased with the layout of our new prototype kitchens and are taking some of the things we’ve learned there to help us organize other kitchens in our system.

Again, we remain focused on constantly finding ways to improve our efficiency for our crew and our company.

During the quarter, we also continued our capital improvement projects with upgrades and remodel projects at 18 of our restaurants. Fifteen restaurants received new tables and chairs and five received our new booth package. Overall, we have completed phases of work at 41 restaurants, including 11 full remodels and 20 new restrooms year-to-date in fiscal 2008, and nearly 70% of our restaurants now have new furniture.

Our plans are to complete an additional 20 to 26 remodel projects in the fourth quarter and install new furniture at another 11 units, including six with new booth packages.

Turning to the competitive landscape, we believe our brand remains well-positioned, residing below casual dining and 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. We believe our cafeteria format, wide variety of quality offerings, and reasonable pricing present a value to the market.

From a sales and marketing perspective, we continue to manage our costs closely. We’ve raised our menu prices to offset costs in certain areas but we are very careful to keep our pricing a value for our customers. We believe that value allows us to stay below the price of casual dining and in some cases well below their prices on certain items. We continue to concentrate our marketing dollars on point of purchase and in-store marketing, as well as radio advertising.

Moving now to our culinary contract services business, where we provide food service at healthcare facilities, we are pleased to report continued growth in this area of our business. As we mentioned in our press release, we expect to initiate two to three more contracts during the calendar year 2008.

Since starting this piece of our business about two years ago, we’ve made great progress in hiring the team we need to execute this business, and we are gaining traction in the marketplace. We are now able to compete for larger accounts and believe that our reputation and brand equity are growing in this area. We view this business as a vehicle to really franchise the brand with three clear advantages -- the cost of capital is much less than building a new store, the contracts tend to be multiple year commitments, our audience is receptive and captive -- said another way, we are not competing with every brand on the street as we are with our restaurants. And number four, probably most important, healthcare CEOs want the added value to their facilities, patients, employees, and visitors that a recognizable street brand, Luby's, brings them over non-street brand providers that they are accustomed to.

Now I would like to discuss our new store development. Our two new prototype restaurants continue to perform well and remain on pace to generate annual revenues in excess of $3.25 million a year, an increase of over 30% compared to the restaurant system average revenue 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 a new location in a northern suburb of Houston in July. We will also open one relocation restaurant in the galleria area of Houston in July that utilizes our new prototype design.

In addition to these two new construction stores, we have three additional projects underway and depending on the pace of construction, we plan to open two to three of these new stores in calendar 2008 year-end. We are actively searching or new site locations in a number of markets. Hopefully one advantage to the current economic environment may come on the real estate side as prices will likely soften and may present new location opportunities for Luby's.

I would now like to turn and open the call up to your questions. Operator.

Question-and-Answer Session

Operator

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

Will Hamilton - SMH Capital

Good afternoon, guys and thanks for the extra detail on the fourth quarter, or near-term guidance. Scott, first I was wondering if you could repeat what you said in regard to the other operating expense line, as you look out near-term. Obviously you --

K. Scott Gray

We’re looking at it in terms of what we did in the third quarter against last year. The primary, the wildcard is the utility expense and that could vary significantly. It’s about a third of the cost line, and so if you look -- what I basically had said is that if we see that it could be as high as 12% over the prior year.

Will Hamilton - SMH Capital

Okay. Previously you had some short --

K. Scott Gray

Will, let me make sure I’m clarifying, Will, is that basically just taking last year’s operating expenses for the fourth quarter to be between 7% and 12% higher.

Will Hamilton - SMH Capital

Right, right.

K. Scott Gray

Okay. I just wanted to make sure you got it. All right.

Will Hamilton - SMH Capital

Yeah. In the past, you’ve had contracts for utilities. More recently they have been short-term. What’s your view in terms of that right now?

K. Scott Gray

We’re opportunistic with that. We actually have a few in play. They haven’t -- they are not giving us that as much as we might like in terms of favorability. We have some favorability and we have the ability to buy a portion, but we are typically looking at targeting certain months of the year that are advantageous.

Will Hamilton - SMH Capital

Okay. And then on the labor side, is there much opportunity in terms of given the sales trends to take labor off or out of the store, either on the counter or the kitchen? And then also can you comment on how you think the second phase of federal minimum wage might affect as we roll into the summer?

Christopher J. Pappas

I’ll let Scott take the minimum wage increase on the second part first.

K. Scott Gray

Well, I think that the minimum wage is -- again, I believe that date is the 26th, or 24th or 26th of July is when it will impact us, so we’ll basically have, you know, about four weeks in the quarter impacting us at the second step in the changes. I think that there’s -- you know, it’s five to 10 basis points in our current year numbers. It won’t have as -- it will have an effect but much more in 2009.

Will Hamilton - SMH Capital

Okay.

Christopher J. Pappas

And then on the first part, how can we do a better job on labor -- the whole industry’s got that on their minds and I think mostly when people come in and when they leave as opposed to reducing probably the number of people that need to be there during crunch time, it’s better managing when they come in and when they leave I think to a large extent is what we’ll be looking at hard.

Will Hamilton - SMH Capital

Okay. A couple of questions then on the unit development plans. You seemed to experience a bit more in terms of push-backs or delays with the new openings. Can you comment on what occurred there and how you are trying to rectify at least the schedule as you look out to this quarter and ’09?

Christopher J. Pappas

We are gearing up with new contractors that are getting better at what they are doing. They are getting better at hitting what they are trying to do and the timeframe and basically we’re getting our prototype continue to massage -- I can see a lot of progress that we’ve made already on this new site on 249, how fast it’s going up and the contractors understand the building a lot better and so it’s just -- it’s picking up and it’s a process that takes place.

You know, Post Oak is a relocation of an existing site that will stay open until the new location opens up and that building there is -- we had to put the prototype in a shopping center space so it required some modification to the plans and the contractor has taken a little longer than he perceived the project would take, because it’s his first time to build a Luby's for us also, so they have a learning curve that they get on. Hopefully as we kind of get into the process, when you get some contractors, they’ve done a few jobs for you, they understand the building, it moves quicker and we’ve already seen some slight price reductions in the -- going from the first building to the second building that the same contractor is building. His prices are a little better on some of the trades that he has out there.

Will Hamilton - SMH Capital

Okay. In addition to the north Houston, you said two to three -- or three projects that you are working on right now that would open in fiscal ’09. Beyond that, could you give us a little bit more of a sense as to how many in a range maybe you hope to open in ’09?

Christopher J. Pappas

We’ll probably cover that in the next call, Will, with you but this year, like I said we should finish up another two to three right close to the year, end of the calendar year.

Will Hamilton - SMH Capital

Okay. Then lastly I was just wondering in regard to the culinary service business, you mentioned two to three new contracts you are hoping to I guess secure in the next six to 12 months. Could you give us a little bit of a sense of the size or scope of those works? Are they similar to your two care facilities or are they larger like the Baylor or St. Joseph’s?

K. Scott Gray

They are large -- Will, this is Scott -- larger than the acute care, but depending on when they come online it’s going to vary within the quarter. It’s probably a small percentage, a percentage point off of last year, and if you look at our run-rate I guess for the last quarter of $1.8 million, so some percentage, small percentage above that, and depending on when they come in, it will vary. So 2% to 4%, maybe.

Will Hamilton - SMH Capital

Okay, thanks.

Operator

(Operator Instructions) Your next question comes from the line of George Greene, a private investor. Mr. Greene, your line is open.

Rick Black

Operator, it looks like Mr. Greene is not there. Are there any other questions?

Operator

I am showing no further questions, sir. Mr. Pappas.

Christopher J. Pappas

Yes, thank you for being with us today and we look forward to you on our next conference call and looking at the team that we have at Luby's, I think we have one of the best management teams in place to be in a situation and the economy like it is, I think we have great people in place and they are only getting stronger as we go. So with that, I look forward to visiting with you on the next conference call.

Operator

Thank you, ladies and gentlemen. This concludes today’s Luby's Q3 fiscal year 2008 earnings conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!