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

Q2 2018 Kona Grill Inc Earnings Call

SCOTTSDALE Aug 20, 2018 (Thomson StreetEvents) -- Edited Transcript of Kona Grill Inc earnings conference call or presentation Thursday, August 9, 2018 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christi Hing

Kona Grill, Inc. - CFO

* James Kuhn

Kona Grill, Inc. - President, CEO & COO

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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 Second Quarter Ended June 30, 2018.

With us are Jim Kuhn, Kona Grill's President and Chief Executive Officer; and Christi Hing, Chief Financial Officer. Following the 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 sales, profitability and use of capital, 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'd now like to turn the call over to Kona Grill's President and CEO, Mr. Jim Kuhn. Sir, please go ahead.

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James Kuhn, Kona Grill, Inc. - President, CEO & COO [2]

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Thank you, James. Good afternoon, and thank you all for joining us. Profitability significantly improved compared to the prior year quarter as cost-savings initiatives implemented earlier this year are taking hold. For the first half of 2018, Kona Grill has more than doubled last year's first half numbers by generating $4.5 million in adjusted EBITDA. This compares to $2.2 million in adjusted EBITDA for the first 6 months of 2017 and $4.8 million in adjusted EBITDA for the entire year in 2017. The higher profitability is a result of our continued focus on driving EBITDA as earnings are the key factor in meeting our bank covenants and the ultimate success of Kona Grill.

In order to achieve higher profits, we strategically made adjustments to reduce the amount of promotions within our restaurants. We adjusted days and hours of happy hour times for each restaurant to maximize impact, while also balancing profitability with guest appeal. We also evaluated the closing times of each of our restaurants and adjusted hours to align with sales and productivity targets.

With the cost-savings initiatives in place and sustained, and they are sustainable for the future, we are focused on execution and building sales for the long term.

Given these strategic changes to happy hour and closing hours, we should see improved profitability on a lower overall sales base on a year-over-year basis. As we lap these changes in 2019, we expect to build same-store sales and continue to improve the profitability of the brand.

In order to build sales, we have several initiatives in place or are in the works to drive frequency and traffic within our restaurants. The first one is we rolled out a great new menu on June 27, with a whole new design and layout, and we added about 30 food and drink offerings. We recently upgraded our Konavore e-mail club to a loyalty program, which adds points -- which added a points-based component to drive guests' frequency. I'm really proud of the talented senior restaurant personnel that we've created in the marketing team, the training team and the culinary team, and all the departments in the corporate office that support these restaurants as they continue [their efforts] to build sales and make money.

In late July, we implemented various marketing efforts, including media relations support with the new public relations firm, targeted e-mail and mobile marketing. We also have unveiled a new web -- will be unveiling a new website, which is scheduled to roll out next week. The updated website features a more contemporary design to align with the uniqueness of our global menu, has all our updated graphics, and increased functionality will make it easier to navigate and use on a variety of devices.

We have our 20th anniversary coming up in September, and we're very excited to roll out some great promotions around that.

We continue to see positive results from several of the initiatives implemented earlier this year. These initiatives are framed around our mission to make every experience exceptional for our guests. We are focused on elevating all aspects of operations through great service and hospitality in an appealing environment. Our initiatives regarding menu innovation involve introducing new menu items, while also making updates to existing items to allow for consistent execution across all of our restaurants.

Rolling out the new menu in June with a great contemporary design highlights the freshness and quality of our scratch kitchen. The new menu includes the addition of 30 new food and drink offerings, but we also introduced the brand-appropriate beverage book that features our extensive beer, wine and cocktail offerings and showcases our signature cocktails, each of which is handcrafted and appealing to a broad range of demographics.

For our Konavore loyalty program, we have significantly upgraded the program by introducing a points-based component that rewards guests for more frequent visits and allows for guest engagement with our brand. Guests earn points based upon their spend and can choose to redeem their points for rewards or save their points for higher values.

We will roll out a mobile app in conjunction with this loyalty program, which will make it much easier for guests to track their rewards. We are very excited about this program and the other additional ways, so we can be able to align with our loyal guests. Also we are continuing to evaluate 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 more cost savings and streamline processes from these efforts about the restaurant and the corporate level. For example, we recently changed the armored car carrier for our restaurants and appointed new independent auditors. We'll continue to evaluate our relationships in key areas to ensure we are getting top-notch service and quality at the right price.

We continue to evaluate our underperforming restaurants and are focused on either improving their operating performance, and/or implementing strategic alternatives. As part of this evaluation, we made the difficult decision to close an underperforming restaurant in July and are evaluating alternatives for the others.

During the quarter, we entered into a lease termination agreement for 2 leases that we ultimately decided not to pursue, and therefore, now we have no lease obligations for future restaurants. We believe this was the prudent thing to do and provides us with flexibility in allocating our capital.

As mentioned on the last call, we intend to franchise the Kona Grill brand domestically and believe that a dual strategy of both company-owned and franchised restaurants will provide the best opportunity to grow over the long term. We currently have 2 international units opened by our franchise partners in Dubai and Vaughan, Canada. Unfortunately, our franchise partner closed the restaurant in Monterrey, Mexico, and we subsequently terminated the associated development agreement.

We continue to engage in discussions with potential partners in several countries and are excited about the long-term opportunity that this initiative will have in building our brand across the world. As you all know, on our last quarterly earnings call, we mentioned that we're going to introduce domestic franchising and are very excited about the responses we've received so far. We are also working with our Vice Chairman, Alex Zheng, on the potential for a master franchise agreement for China. All of these initiatives, coupled with noticeable improvements in operating margins and EBITDA during the second quarter of 2018, helps put Kona Grill in the right path for the future.

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

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

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Thanks, Jim. Revenues were $42.3 million in the second quarter. Same-store sales declined 12.1%, driven primarily by a double-digit decrease in customer traffic. As Jim previously alluded to, we implemented changes as part of our strategic decision to improve profitability by reducing the amount of promotional activity within our restaurants. We adjusted happy hour times and menu offerings, eliminated certain customer discounts and evaluated the closing hours of certain restaurants.

With our new menu rollout on June 27, we added new items to our happy hour menu to further boost the value proposition and drive guests' trial and frequency. We now have 41 of our 45 restaurants in the comp base, which represents 91% of our restaurants. So as some of the underperforming restaurants come into the comp base, they are negatively impacting our comp sales.

Cost of goods sold continues to be strong and was the biggest driver of margin improvement during the quarter. Cost of sales decreased 240 basis points during the quarter to 25.3% compared to 27.7% last year.

On a sequential basis, COGS improved 40 basis points from Q1 as we continue to see cost savings from our efforts to simplify recipes and streamline processes within our kitchens to provide better consistency and execution of our menu. We also benefited from an overall favorable commodities environment compared to last year.

Labor costs as a percentage of sales decreased 100 basis points to 35.4% during the quarter compared to 36.4% last year. The decrease is attributable to our continued focus on labor. As mentioned above, we evaluated how we do things in the kitchen to identify opportunities to streamline our operations and, therefore, save time and money.

Overall, restaurant operating margins improved 340 basis points to 14.3% during the second quarter compared to 10.9% in the same period last year. Operating margins improved sequentially from Q1 2018 by 240 basis points and Q4 2017 by 290 basis points. So as you can see, the cost-savings initiatives have resulted in overall improvements in profitability. Adjusted EBITDA improved by $1.4 million or 90% during the quarter compared to the same period last year.

Now turning to our balance sheet. We had $5.3 million in cash and $33.7 million in debt outstanding at June 30, 2018. We completed a private placement in May 2018, with net proceeds of $5.5 million. We utilized $3.75 million to pay down our revolver. We were in compliance throughout with our debt covenants as of the end of the second quarter.

For capital expenditures, we had $671,000 for the first half of 2018, as we have significantly reduced our spend from previous years. Our spend for the remainder of 2018 will be primarily for maintenance CapEx and technology initiatives.

I'll now turn the call back to Jim for some additional remarks before we go to Q&A. Jim?

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James Kuhn, Kona Grill, Inc. - President, CEO & COO [4]

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Thank you. As you can see, profitability significantly improved compared to the prior year, as cost-savings initiative implemented earlier this year are taking hold. Adjusted EBIDTA is more than doubled from year-ago levels. We have seen a 250-basis-point improvement in operating margins during the year, which shows that the initiatives discussed earlier are making a positive impact on our overall profitability. With improving operating margin, the potential for a massive franchise agreement in China and the prospects of growing demand domestically through a dual strategy of both company-owned restaurants and franchise restaurants, we continue to work hard to position the Kona Grill brand for long-term success. We believe that by executing the Kona Grill brand through great service and great food in a clean and appealing ambience, we will ultimately be able to build sales and profitability for the long term.

I want to add, I'm incredibly honored to serve Kona Grill in my new role, and I thank everyone on the phone and everybody out in the field and everyone here at the office for your continued support.

With that, I'd like to open the call up for any questions that anyone may have.

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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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Congratulations on the promotion.

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James Kuhn, Kona Grill, Inc. - President, CEO & COO [3]

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Thanks, sir.

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

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I think I've asked this question in the last couple of quarters, but if you have removed, I don't know if it's 7 or 8 underperforming units from the base, does that 4-wall margin go up to kind of the upper teens? Or how should we look at that?

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

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Yes. Chris, as we've talked about in the past, the underperforming restaurants have a significant impact. I mean, I think what you've seen, some significant improvement from prior year and even in the first quarter, where we have 14.3% for the second quarter, that's our highest number in the last couple of years. So just getting back to your question, we didn't calculate the exact number, but you can assume that the underperformings have a significant impact, and we would likely be, call it, yes, somewhere in the, call it, mid- to upper teens without some of these underperforming restaurants. But we are taking action. That's the good part. We made that difficult decision to close one of these underperforming restaurants in Q3, and we have some strategic alternatives for a few others. So look for us in the second half of the year to -- you'll see some traction likely on some of these other units.

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

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Okay. And looking at the sales results. Obviously, with all the operational changes and the less promotions and discounting is having a big impact on your same-store sales, is that kind of the trend we should expect into the third quarter as well and probably into the fourth?

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James Kuhn, Kona Grill, Inc. - President, CEO & COO [7]

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I wish I had a crystal ball for questions like this, but I would expect these trends to continue for a little while longer. And then as we kind of head into the end of the year and the beginning of Q1, I think they'll significantly turn around.

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

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Got it. And you were just talking pretty fast. Did you say your Monterrey, Mexico partner closed that location and terminated that agreement?

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James Kuhn, Kona Grill, Inc. - President, CEO & COO [9]

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Yes.

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

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Okay. How recent was that?

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

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In the second quarter of 2018.

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

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Okay. And were there other issues involved there? Or is it just they underperformed so much that they just didn't want to do more of them? Or any other color you can add to that?

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James Kuhn, Kona Grill, Inc. - President, CEO & COO [13]

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Chris, I went there once and it wasn't executing up to the standards it should have been. So needless to say, they are not a partner with us anymore.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [14]

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Okay, it's probably a good thing. How about the other international units that have been opened for a while in Canada and UAE? Any update on their performance?

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James Kuhn, Kona Grill, Inc. - President, CEO & COO [15]

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I don't have any specifics around it, but I've been to Vaughan, Canada a handful of times and been really pleased with the look of the restaurant, the talent of the management team and the execution. I have not been to the UAE yet. I can't give you too much feedback on that.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [16]

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And then last, with all these changes driving higher cash flow and EBITDA, you are in compliance with your debt covenant -- covenants, correct?

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Christi Hing, Kona Grill, Inc. - CFO [17]

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That is correct, Chris.

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James Kuhn, Kona Grill, Inc. - President, CEO & COO [18]

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We are.

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Operator [19]

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(Operator Instructions) And at this time, this concludes our question-and-answer session. I would 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.