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Edited Transcript of KONA earnings conference call or presentation 22-Mar-18 9:00pm GMT

Q4 2017 Kona Grill Inc Earnings Call

SCOTTSDALE Mar 23, 2018 (Thomson StreetEvents) -- Edited Transcript of Kona Grill Inc earnings conference call or presentation Thursday, March 22, 2018 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Berke Ibrahim Bakay

Kona Grill, Inc. - President, CEO & Director

* Christi Hing

Kona Grill, Inc. - CFO & Secretary

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Conference Call Participants

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* Christopher Walter Krueger

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Good afternoon, and thank you for joining us today to discuss Kona Grill's results for the fourth quarter ended December 31, 2017. With us are Berke Bakay, Kona Grill's President and Chief Executive Officer; and Christi Hing, Chief Financial Officer. Following their remarks, we'll open up the call for your questions. (Operator Instructions)

Before we begin, we would like to remind everyone that the financial guidance provided by the company, including statements regarding future growth, sales and profitability, 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. Sir, please go ahead.

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Berke Ibrahim Bakay, Kona Grill, Inc. - President, CEO & Director [2]

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Thank you, James. Good afternoon, and thank you all for joining us. During the fourth quarter, revenues were down 2.5%, while same-store sales declined 6.5%. The industry remains competitive as we continue to fight to drive sales and improve the profitability of our restaurants, especially those that are significantly underperforming. To lead this turnaround, we hired Jim Kuhn as our Chief Operating Officer in December. Jim has over 25 years of restaurant industry experience and most recently served as Chief Executive Officer of Chalak Mitra Group, where he was responsible for 79 domestic and international Genghis Grill locations and several other brands during his tenure. From 2007 to 2014, Jim served in various roles at Ignite Restaurant Group, including President of Brick House Tap + Tavern and Senior Vice President of Operations at Joe's Crab Shack. In Jim's first 3 months with us, he's brought a renewed focus on service, hospitality and cleanliness, and he's reenergized our company with relentless pursuit of elevating all aspect of our restaurant operations.

We have many initiatives in place or plan to make Kona Grill the destination of choice for guests. These initiatives are framed around our mission to make every experience exceptional for our guests. From the host that welcomes you with a warm smile to the bartender who masterfully crafts your cocktail, to the skilled sushi chefs who delight and excite you with artistic creations, our focus, first and foremost, needs to be on taking care of the guests. We are revamping our training program and zoning of our managers within the restaurants to provide better coverage and focus on managers on orchestrating one great shift at a time. By cross-training managers on all aspects of restaurant operations, we are developing our people into skilled leaders who are armed with the knowledge to provide genuine hospitality to each guest. With a greater focus on hiring the right people, training them to perform their job duties and developing them into great leaders, we believe we can improve retention and, therefore, reduce the high cost of turnover.

We also have several initiatives in place regarding menu innovation. We have reviewed every recipe and are making enhancements to improve the flavor profile and consistency of our menu items. We are focused on recipe adherence and consistent execution across our 46 restaurants in 23 states. We strive to be forward thinking in our menu offerings and be leaders in menu innovation. To this end, we're working on new menu items that will be rolled out in the spring.

We are also making some changes to our happy hour times and offerings to ultimately benefit the long-term success of the brand. We are introducing a Kona mai-tai to our menu and updating our sushi items on the happy hour menu to showcase what we offer and drive guests into restaurants for dining occasions other than just happy hour.

We continue to see an uptick in sushi sales, which is great to see given that sushi on average has a lower food cost than items from our scratch kitchen. Also, we're evaluating everything that we do and the service offerings provided by different partners. We believe there are opportunities to consolidate the products and services we purchase from multiple vendors and ultimately realize cost savings from these efforts.

We continue to evaluate the underperforming restaurants. To this end, we recorded $9.3 million in noncash asset impairment charges to primarily for 3 restaurants that performing below expectations. The 3 restaurants are entering the comp base during 2018, and based upon current sales trends and performance, the impairment charges were required under generally accepted accounting principles. We believe that these 3 restaurants, combined with the 5 restaurants impaired in 2016, encapsulate the extent of our underperforming units. All of these restaurants remain open and operating, and our focus is improving their performance and/or strategic alternatives.

We have negotiated rent abatements for 5 of these restaurants to help reduce the cash burn while we seek to turn them around. You don't see the full impact of the abatement in our results as accounting rules require that rent concessions be amortized over the term of the lease. So while the full impact isn't seen in the P&L immediately, the cash savings are realized in lower rent paid. We currently have 3 international units open within our partners in U.A.E., opening their first restaurants in Dubai on November 16. And our partner in Canada opened their restaurant in Vaughan, outside of Toronto, in December 11.

We continue to engage in discussions with potential partners in several countries and are excited by the long-term opportunity that this initiative can have in building our brand across the world.

We are working diligently on all aspects of the business to improve our financial performance and put us in a better financial position for the long term.

With that, I now like to turn the call over to Christi, who will take us through the financials for the fourth quarter. Christi?

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Christi Hing, Kona Grill, Inc. - CFO & Secretary [3]

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Thanks, Berke. Restaurant sales declined 2.5% to $42.5 million in the fourth quarter compared to $43.6 million last year. The decrease was due in part to a 6.5% decline in same-store sales, including a 50 basis point impact from the Hurricane Maria-related closure of our Puerto Rico restaurant during a part of the quarter. The restaurant is back up and running. Although as you can imagine, traffic has been impacted given the devastation caused by the hurricane. We also lapped honeymoon periods for restaurants that opened last year, which contributed to the sales decline.

Cost of sales decreased 140 basis points during the quarter to 26.1% compared to 27.5% last year, which is great to see given some of the COGS challenges we experienced in the back half of 2016 and first half of 2017. On a sequential basis, COGS improved 100 basis points from Q3 as we continue to see cost savings from the August menu rollout in which we streamlined the menu to provide better consistency and execution of our offerings.

Labor costs as a percentage of sales decreased 100 basis points to 36.7% during the quarter compared to 37.7% last year. We are evaluating how we do things in the kitchen to identify opportunities to streamline our operation and therefore, save time and money.

As our restaurant base matures, we expect our management team to become more proficient at managing hourly labor cost in spite of the wage inflation for minimum wage increases and the competitive wage environment.

There is a high level of competition for management talent. By cross-training managers on all aspects of restaurant operations, we are developing our people to be great leaders, which should ultimately improve retention of key people.

Overall, restaurant operating margins were 11.4% during the fourth quarter, a 70 basis point improvement from last year and 120 basis point improvement from Q3. While it is good to see the improvement, our operating margins reflect the challenging sales and operating environment and the large impact that some underperforming restaurants have on dragging down overall company margins.

Our core base of restaurants still generate healthy margins. If one were to remove the margin drag of the 8 restaurants that we impaired during 2016 and 2017, our operating margins would improve by about 360 basis points for the quarter.

We think that this statistic demonstrates the substantial impact that the underperforming restaurants have on our company performance.

Now turning to our balance sheet. We had $5 million in cash and $37.8 million in debt outstanding at December 31, 2017. Our credit agreement was recently amended subsequent to the end of the quarter to, among other things, provide relief on our financial covenants to allow time for the many initiatives Berke spoke about to take effect. The amendment reduced the total facility by $5 million to $39 million. The revolving credit facility is now $25 million, and this amount is gradually reduced to $20 million by the end of 2018, which effectively requires $3.75 million in pay down during 2018. For further details on the terms of the amendment, refer to the 8-K filed with the SEC. We are thankful for the support of our lenders as we work through these difficult times.

Even with the difficult sales environment, we have seen an improvement in operating margins during the first few months of this year, which shows that the initiatives discussed earlier are making a positive impact on our overall profitability. As we slow growth in 2018, capital expenditures will significantly reduce from previous levels as our spend will be primarily for maintenance CapEx and technology initiatives designed to enhance the guest experience.

I will now turn the call back to Berke for some additional remarks before we go to Q&A. Berke?

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Berke Ibrahim Bakay, Kona Grill, Inc. - President, CEO & Director [4]

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Thanks, Christi. After 6 straight years of positive same-store sales, 2017 was a very challenging year. The hiring of Jim Kuhn as our Chief Operating Officer has brought a renewed focus and accountability within our restaurant operations that should pay dividends in the future as we seek to make Kona Grill a successful company once again. As expected with any turnaround, it takes time for these initiatives to take hold and to realize tangible results. In the short time that Jim has been on board, we have experienced some traction on operational and cost savings initiatives, and we'll continue to monitor and provide updates on our next call. Thank you for your continued support.

With that, I'd like to open the call up for any questions you might have. James, please open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

And we'll take our first question today from Chris Krueger with Lake Street Capital Markets.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [2]

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Christi, you just mentioned that your operating margins have been up in the first few months of 2018. Is that on a year-over-year basis?

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Christi Hing, Kona Grill, Inc. - CFO & Secretary [3]

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Yes, that is correct.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [4]

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Okay. And can we assume the same-store sales are still trending negative low single digits or something like that in the first quarter?

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Christi Hing, Kona Grill, Inc. - CFO & Secretary [5]

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Yes. We mentioned the difficult sales environment. So yes, you would imagine something, what we [are] trending for Q4.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [6]

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Okay. Then we look at your like any shifts in your consumer trends, whether like they're going after more of the lower menu prices than during happy hour sales? Or anything -- has anything changed in that regard?

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Berke Ibrahim Bakay, Kona Grill, Inc. - President, CEO & Director [7]

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No, not that we can see. And the happy hour reference we made on the prepared remarks is more optimizing some of the opportunities that we have, with the menu offering, pricing and available times, but not towards a reaction on anything else that we see out there.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [8]

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Okay. I don't think you mentioned any new units. I think most recently, we're expecting one new unit in 2018 as far as company-owned ones go. Is that still the plan? Or is that not going to happen?

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Berke Ibrahim Bakay, Kona Grill, Inc. - President, CEO & Director [9]

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No, our focus is really generate cash flow and lower our debt load and bring the financial flexibility for the company. So at this point in time, we do not expect to open a restaurant in 2018.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [10]

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Okay. Then back to sales. Any new thoughts on your catering efforts and your Costco gift cards?

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Christi Hing, Kona Grill, Inc. - CFO & Secretary [11]

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We have many sales initiatives in place. The couple that you mentioned are just some of them that we've done. And as we go through the year, we evaluate the ROI on each of these initiatives. So we still have a big focus on catering, to go. We use still a lot of the delivery services out there, so that still remains an important part of the company. We sell gift cards through many channels. So gift cards, they're still a small piece of our total revenue base. But overall, I think some of the exciting things we have with new menu offerings coming out this spring, we've been promoting on Easter. We'll be doing a brunch, so we'll offer brunch on Easter for the very first time. And then we'll also probably test that on Mother's Day and Father's Day. So we have a lot of items in the pipeline. And as we mentioned, Jim's been on board a little over 3 months now. And we're very excited about just all the opportunities that we see for Kona Grill for the future.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [12]

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All right. Last question on your -- your gross margins were the strongest they've been in quite some time. Any particular commodities playing a role there? Are you seeing benefits in certain areas or pressure in other areas?

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Christi Hing, Kona Grill, Inc. - CFO & Secretary [13]

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For us, knock on wood, the commodity environment has been pretty benign. I mean, last year, we had gotten hit pretty hard with the seafood line. This year, definitely seeing favorability across all lines, a lot of stabilization. So at least, nothing at this time that concerns us for 2018.

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Operator [14]

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(Operator Instructions)

And at this time, this concludes our question-and-answer session. I like to remind everyone that this call will be available for replay later this evening. A webcast replay will also be available via the link provided in today's press release as well as available on the company's website at www.konagrill.com. Thank you, ladies and gentlemen, for joining us today. You may now disconnect.