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Edited Transcript of KONA earnings conference call or presentation 8-Nov-18 10:00pm GMT

Q3 2018 Kona Grill Inc Earnings Call

SCOTTSDALE Nov 21, 2018 (Thomson StreetEvents) -- Edited Transcript of Kona Grill Inc earnings conference call or presentation Thursday, November 8, 2018 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christi Hing

Kona Grill, Inc. - CFO

* Marcus E. Jundt

Kona Grill, Inc. - Co-CEO & Director

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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 third quarter ended September 30, 2018. With us are Marcus Jundt, Kona Grill's Co-Chief Executive Officer; and Christi Hing, Chief Financial Officer. (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 would now like to turn the call over to Kona Grill's Co-CEO, Mr. Marcus Jundt. Please go ahead.

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Marcus E. Jundt, Kona Grill, Inc. - Co-CEO & Director [2]

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Thank you. Good afternoon, and thank you all for joining us. Profitability continues to improve. For the first 9 months of 2018, adjusted EBITDA increased 66% compared to the same period last year. The higher profitability is a result of our continued focus on driving EBITDA as earnings are the key factor in determining the ultimate success of Kona Grill.

With the cost-savings initiatives in place and sustainable for the long term, we are focused on execution and building sales. Our sales have been impacted by some of the changes we have made earlier this year to Happy Hour times and offerings.

In appointing Steve Schussler and myself as Co-CEOs, the board's directive is to revitalize the Kona Grill brand with what has made us successful over the years. These areas include becoming once again America's best Happy Hour with items that provide a great value proposition without significantly impacting gross margin.

Our focus is on genuine hospitality and a passion for service. We will elevate our food and menu items such that every plate or cocktail is Instagrammable. We will also return some of the recipes for long-time favorite items back to the recipes that our guests know and love. The items are pillars of what made Kona Grill successful in the past and what we believe are the necessary elements to get guests to return to us over and over again.

In addition to the items noted above, we recently introduced several programs to drive frequency and traffic within our restaurants. In July, we launched our Konavore Rewards program, a comprehensive loyalty program that rewards guests for more frequent patronage and should result in increased loyalty. We also rolled out a mobile app in conjunction with the loyalty program that makes it easy for guests to track their rewards and redeem points. We're very excited about that program and the additional ways that we are able to engage with our guests.

We rolled out our newest menu on October 24. With this menu rollout, we expanded the global appeal of our branch with unique items from our scratch kitchen. We believe that constant innovation with our menu will help guest trial and frequency.

We implemented various marketing efforts, including advertising and media relations support as well as targeted e-mail and mobile marketing. We also launched our new website with a more contemporary design to align with our creative food and drink offerings. We also increased functionality to make it easier to navigate and use on a variety of devices better optimized for search functionality.

We continue to evaluate our underperforming restaurants and are focused on either improving their operating performance through some of the aforementioned items and/or strategic alternatives. As part of this evaluation, we made the difficult decision to close 2 underperforming restaurants during the quarter. We are evaluating alternatives for the others. We are diligently evaluating what we do and how we market to set this company up for long-term success.

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

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

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Thanks, Marcus. Revenues were $37.4 million in the third quarter. Same-store sales declined 14.1%, driven primarily by a double-digit decrease in customer traffic. As previously mentioned, we implemented changes as part of our strategic decision to improve profitability by reducing the amount of promotional activity.

With our new menu rollout on October 24, we added some old favorites to our Happy Hour menu to help drive sales. As Marcus alluded to, we will be updating our Happy Hour menu to further boost the value proposition and drive guest trial and frequency.

We've had 15 restaurants or about 1/3 of our restaurants coming to the comp base over the last 2 years. These restaurants are still early in their life cycle. The initiatives described earlier are intended to build sales and generate profitability levels that we are accustomed to seeing in our mature restaurants.

Cost of goods sold continues to be strong at 25.9%, a 120 basis point improvement over last year. For the first 9 months of 2018, we have seen a significant improvement in COGS. COGS as a percentage of revenues decreased 190 basis points to 25.6% compared to 27.5% last year. The decrease is attributed to streamlining recipes and processes to enable better consistency in execution of our menu. Also, a favorable commodities environment and less promotional activity contributed to the year-over-year improvement.

Labor costs as a percentage of sales increased slightly to 37% during the quarter compared to 36.8% last year. Our teams did a great job at adjusting labor to align with sales during the quarter. The slight increase is attributable to deleverage of fixed labor and benefit costs on the lower sales volume.

Restaurant operating expenses were flat at 16.5% as a percentage of revenues. Higher spend associated with digital, social and direct mail advertising were offset by lower travel and relocation costs.

Overall, restaurant operating margins were 9.8% during the third quarter compared to 10.2% in the same period last year. We saw a slight reduction in adjusted EBITDA compared to last year at $1.1 million. We are diligently working on sales-building initiatives and evaluating all components of our business to identify incremental cost saving opportunities.

For the first 9 months of 2018, restaurant operating margins improved 170 basis points to 12.1% compared to 10.4% in the same period last year. The improvements in operating margins is attributable to the cost-savings initiatives discussed earlier.

Adjusted EBITDA improved by $2.3 million or 66% to $5.7 million during the first 9 months of 2018 compared to the same period last year.

For the third quarter, we lowered G&A expenses by $763,000 or 23% on a year-over-year basis. The decrease is attributable to headcount reductions and our overall evaluation of service providers and contracts. The savings are also a testament to the hard-working efforts of our team.

As Marcus mentioned, we closed 2 restaurants during the quarter and recorded $2.2 million in expenses. These expenses represent an estimate for lease termination costs, a $1.8 million noncash charge for the write-off of fixed assets and the write-off of deferred rent balances. We had $3.9 million in cash and $33.5 million in debt outstanding at September 30, 2018. We were in compliance with our debt covenants.

Capital expenditures net of insurance proceeds were $1.3 million for the first 9 months of 2018 as we have significantly reduced our spend from previous years. We made investments in technology initiatives during the quarter, which are aimed at improving the overall operations of our restaurants.

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

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Marcus E. Jundt, Kona Grill, Inc. - Co-CEO & Director [4]

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Thanks, Christi. As one of the founders of Kona Grill, I take great pride in this company. The board's decision to make the change in leadership was not taken lightly. Our focus is to revitalize Kona Grill brand and drive guests return to our restaurants for what they love and know us for. Thank you for your continued support.

With that, I'd like to open the call up for questions you might have. Operator, 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 our question is 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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I have several questions. I may be kind of jumping around a little bit, but anyways. So you closed 2 units during the third quarter, do you expect any closures in the fourth quarter?

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Marcus E. Jundt, Kona Grill, Inc. - Co-CEO & Director [3]

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The answer is, I believe, it's no. Christi, would you confirm that?

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Christi Hing, Kona Grill, Inc. - CFO [4]

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I mean, there's nothing in the works at this time, but as always, we talked about with landlord discussions, evaluating strategic alternatives. So Chris, we can't give you a definitive answer. And always there's things that happens. If there's negotiations that come into play and we enter into a termination agreement, then that could change that answer. But as of right now we have 44 restaurants opened as of today.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [5]

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Okay. Just want to make sure. When I try to make my projections, not to assume there's another closure or 2 near term. So same-store sales down 14.1% in the quarter. Can you tell us how the fourth quarter is trending? I know that kind of did -- got worse in the previous quarters. Or can't you comment on the fourth quarter?

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Christi Hing, Kona Grill, Inc. - CFO [6]

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I think, Chris, that's why we're making some of the changes that we're making. I think we made some changes to Happy Hour. We do see some of the items some of the times. And so I know with the appointment of Marcus and Steve as co-CEOs, we're really looking at revitalizing the brand with what we had become known for was vibrant Happy Hour, lively bars and patios, and so there's just things that we're going to do to try to increase guest traffic. So for the fourth quarter, it's not much different than what it was for the third quarter as far as what we've seen today. But that's exactly why we're making these changes.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [7]

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Are you implementing some of these pretty much immediately, or we might see some positive impact by holiday season or December maybe?

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Marcus E. Jundt, Kona Grill, Inc. - Co-CEO & Director [8]

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This is Marcus. So we are implementing those changes before the holiday season, that is correct. Our objective is to create America's best Happy Hour. You'll see significant price reductions. You'll also see a reprint of the Happy Hour menu and there will be some items taken off and there will be some items added. And the food will be -- it will be -- the presentation of the food will be different too, with the idea of making it more of a wow impact when the customer sees it.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [9]

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So if you look ahead to 2019, you'll be going up against 2 years of negative comps with some pretty heavily negative comps in there. With all these changes you're immediately doing and your focus on driving traffic, do you anticipate positive same-store sales in 2019 at some point? I know it's hard to say, but...

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Marcus E. Jundt, Kona Grill, Inc. - Co-CEO & Director [10]

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I'll speak on behalf of both Steve and myself. We will be greatly disappointed if we don't see an impact in some of the changes we will be making to our sales numbers and projections for same-store sales, yes.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [11]

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Right. Maybe back to the -- you're talking about Happy Hour. I don't know if you can break this out, but how has -- or how the same-store sales kind of performance for Happy Hour band versus overall comps, if you know what I'm trying to say, in recent quarters?

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Marcus E. Jundt, Kona Grill, Inc. - Co-CEO & Director [12]

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I think historically Kona Grill was known as the starter bar, known as a place that had one of the best Happy Hours in America. And in fact, if you look at some of the units when they had fabulous numbers, you almost had a spillover from the patio and the Happy Hour areas of the restaurant into the dining. So as Happy Hours declined, I think, it's also affected the dining experience. I think if we can rejuvenate the Happy Hour, there'll be a positive spillover for some of the dining.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [13]

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Okay. I've asked this question in recent quarters, but if you remove the underperforming units, I don't know if you want to say there are 8 of those or if there's 6 of those, are restaurant-level margins 5, 6 points ahead of your overall margin rate again?

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Christi Hing, Kona Grill, Inc. - CFO [14]

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Yes, Chris, I don't have the exact numbers, but, yes, I mean, the underperforming units definitely are impacting our overall profitability. Even though our profitability is up year-over-year, again if you take those out, they would be definitely up even more. So we're at 12.1% for the first 9 months. So you're probably talking somewhere in the mid-teens, if you take out those underperformers.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [15]

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Okay. Got it. I see that G&A is $2.5 million in the quarter. Should we look for a similar level in fourth quarter and first quarter?

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Christi Hing, Kona Grill, Inc. - CFO [16]

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So yes, we definitely have gone down through a good run rate. With Jim Kuhn leaving, we'll record some severance charges in the fourth quarter. But absent that, the run rate that we ran for Q3, I think that's a pretty good run rate. There's sometimes some one-off items. But I think, with our headcount with what it is, call it, we were at $2.6 million, call it, $2.6 million, $2.8 million probably for the fourth quarter absent any unusual charges.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [17]

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Got it. That includes severance or does not?

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Christi Hing, Kona Grill, Inc. - CFO [18]

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Does not.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [19]

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Okay. Just a couple more questions. Can you provide an update on this Alex Zheng from China, and whether he's still looking into a potential franchise agreement?

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Marcus E. Jundt, Kona Grill, Inc. - Co-CEO & Director [20]

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At this moment, we have nothing to announce.

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Christopher Walter Krueger, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [21]

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Okay. And last, any update on your franchising, both internationally and domestically?

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Marcus E. Jundt, Kona Grill, Inc. - Co-CEO & Director [22]

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That is -- we may have some potential domestically, but for the most part, I would not count on any future franchises signed for next year. And as far as the international, we only have 2 license, the Mexican closed, and we have no future prospects, in my opinion, in the near term for new units to be open.

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Operator [23]

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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.

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Marcus E. Jundt, Kona Grill, Inc. - Co-CEO & Director [24]

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Thank you.

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Christi Hing, Kona Grill, Inc. - CFO [25]

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Thank you.