Chuy's Holdings, Inc.
Q2 2017 Earnings Call Transcript

Published: 4 Aug 2017

[Operator:]

Good day, everyone, and welcome to the Chuy's Holdings Incorporated Second Quarter 2017 Earnings Conference Call. Today's call is being recorded. At this time, all participants have been placed in a listen-only mode and the lines will be opened for your questions following the presentation. On today's call, we have Steve Hislop, President and Chief Executive Officer and Jon Howie, Vice President and Chief Financial Officer of Chuy's Holdings, Incorporated. At this time, I'll turn the conference over to Mr. Howie. Please go ahead, sir.

[Jon Howie:]

Thank you, operator, and good afternoon. By now, everyone should have access to our second quarter 2017 earnings release. It can also be found on our website at www.chuys.com, in the Investors section. Before we begin our review of formal remarks, I need to remind everyone that part of our discussions today will include forward-looking statements. These forward-looking statements are not guarantees of future performance and, therefore, you should not put undue reliance on them. These statements are also subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. With that out of the way, I would like to turn the call over to Steve.

[Steve Hislop:]

Thank you, Jon, and thank you to everyone for joining us on the call today. I’ll start the call with an overview of our second quarter and then share our thoughts on development for the remainder of 2017. Jon will then review our second quarter financial results before we open up the call for your questions. For the second quarter of 2017, revenues grew 7.5% compared to last year, while comparable restaurant sales decreased 1%. Comparable sales in the second quarter of 2017 were negatively impacted by approximately 30 basis points from the shift of Easter to the second quarter and a 40 basis points due to the strategic cannibalization of two high volume restaurants in Austin. We continue to face restaurant level operating margin pressure, driven largely by labor pressures and to a lesser degree commodity costs. Overall, net income for the quarter was 5.3 million or $0.31 per diluted share. While we continue to face a challenging consumer environment, we remain focused on the core fundamentals of taking care of our guests. We will continuously look to enhance the customer experience through a long term lend and stay away from so-called civil bullets or short term initiatives including cheapening our high core offerings through discounting our cost cutting. We believe our service standards are made from scratch offerings and our unique atmosphere of our restaurants are our most valuable assets. That being said, we are continuing to look for ways to improve our marketing efforts. As you know, we have historically spent only a modest amount on marketing and that will not change. However, we are doubling our local store marketing activities, including revealing and updating plans for each store on a quarterly basis, we're also continuing with social media campaigns to promote various store events, both on a local and systemwide basis, including our upcoming Green Chile Festival. The 29th annual Green Chile Festival kicks off Monday, August 14 and runs through Sunday September 3. As many of you know, Green Chile’s, our annual crop only picks during the peak season starting in August. Our co-founders Mike Young and John Zapp were the first to bring Hatch Queen Chiles to Central Texas and this year we're bringing in over 3 million pounds of peppers from the fields of Hatch, New Mexico to our restaurant. For the three week festival, we will feature five special menu items made with legendary Hatch Queen Chile and limited time signature drinks including our famous New Mexican martini made with Green Chile infused tequila. This is one time during the year that we run specials to our menu and I hope you get a chance to enjoy where it’s becoming a fantastic tradition for Chuy’s and our guests. Turning to development, we opened three new Chuy’s restaurants during the quarter of 2017 and one in West Chester, Ohio just outside Cincinnati, in Olathe, Kansas, part of the Kansas City DMA and in Westminster, Colorado outside of Denver. Additionally, just last week, we opened a new Chuy’s restaurant in Warrenville Illinois, our first restaurant in the Chicago area. For the second half of 2017, we expect to open two additional restaurants in the third quarter and four restaurants in the fourth. Combined with the six restaurants we have opened year to date, that will give us 12 new restaurants for the full year. We're also taking a hard look at our 2018 development pipeline. While we are pleased with our development plans and have already locked in a number of high quality sites for next year, we believe it makes sense to balance the speed of our new unit development with the uncertainty on industrywide sales with an eye towards creating the best returns for our shareholders. We are still in the early stages of scrubbing the current portfolio, however we currently expect 2018 openings will range between 8 and 12 unit. As we review our growth plans, I’d point out that even at a very early stage in Chuy’s growth curve, we have a strong balance sheet that gives us the flexibility to thoughtfully manage our development in the near term with the ability to use our excess capital and other ways to create value to our shareholders. All in all, we continue to believe we have a very long runway for expanding the Chuy’s brand. With that, I'd like to turn the call over to our CFO, Jon Howie, for a more detailed review of our second quarter results.

[Jon Howie:]

Thanks, Steve. Revenues increased 7.5% year-over-year to 94.5 million for the second quarter ended June 25, 2017. The increase included 10.9 million in incremental revenues from an additional 134 operating weeks produced by 14 new restaurants opened during and subsequent to the second quarter of last year, partially offset by the loss of 13 operating weeks due to the closing of the Charlotte, North Carolina location. We had a total of approximately 1083 operating weeks during the second quarter of 2017. As Steve noted, comparable restaurants sales decreased 1% during the second quarter, driven by a 2.4% decrease in traffic offset by a 1.4% increase in average check. Comparable restaurant sales were negatively impacted by approximately 30 basis points due to Easter falling in the second quarter of 2017 compared to the first quarter of 2016 and negatively impacted by approximately 40 basis points as a result of the strategic cannibalization of two high volume restaurants in Austin. Effective pricing in the second quarter was approximately 1.5%. There were 64 restaurants in our comparable base at the end of the second quarter of 2017. We consider restaurants to be comparable in the first quarter following 18 months of operations. Turning to a discussion of selected expense line items, cost of sales, as a percentage of revenue, increased 40 basis points year-over-year to 25.9%, driven largely by unfavorable commodity pricing related to produce, dairy, chicken and grocery, partially offset by favorable beef prices. We continue to anticipate an inflation rate of between zero and 2% for the full year of 2017 with cost of sales steadily increasing as the year progresses. Labor cost, as a percentage of revenue, restaurant revenue, increased 90 basis points to 33.6%, driven by operating inefficiencies from new unit development, ongoing wage rate pressures and the de-leverage of management labor, particularly our managers in training as a result of construction delays on the 2017 new restaurant opening scheduled. We continue to expect labor pressure for the balance of the year. Restaurant operating cost, as a percentage of revenue, increased 20 basis point to 13.9%, primarily due to de-leverage from negative comparable restaurant sales and higher utility costs and higher year-over-year maintenance costs. Occupancy cost, as a percentage of revenue, increased approximately 30 basis points year-over-year to 6.7%, driven by higher rental expense as a percentage of sales in our newer locations as well as reduced operating leverage on our existing locations. General and administrative expenses decreased approximately 166,000 to 4.7 million in the second quarter, driven primarily by a decrease in performance based compensation and payroll taxes from the vesting of stock compensation, partially offset by an increase in management salaries and equity compensation due to an additional headcount to support our growth. As a percentage of revenue, G&A decreased approximately 50 basis points year-over-year to 5%. Preopening expenses during the second quarter of 2017 increased to approximately 188,000 to 1.7 million, resulting from the timing of expenses related to our new restaurant opening schedule, which has been delayed due to the construction delays. In summary, net income for the second quarter of 2017 was 5.3 million, up $0.31 per diluted share compared to 5.8 million or $0.34 per diluted share in the year ago period. We ended the quarter with 19.7 million of cash on the balance sheet and we currently have no debt. Turning to our 2017 outlook, given the current challenging retail and consumer environment, we're taking a more cautious approach to our expectations for the back half of the year. As a result, we are lowering our annual diluted net income per share guidance to a range of $1.04 to $1.08 per share. This compares to our previous range of $1.11 to $1.15. As a reminder, 2017 is a 53-week year and our guidance includes an extra week, which will occur in the fourth quarter. Our adjusted annual diluted net income per share guidance for 2017 is based on the following revised assumptions. We now expect comparable restaurant sales growth of negative 1.5% to positive 0.5% on a comparable 52-week basis. Our full year comparable store sales growth still incorporates a negative 50 basis point impact, resulting from the strategic cannibalization of two high volume restaurants in Austin. While this will help our system both from an operational and a return standpoint over the long term, we continue to expect it to have a near term impact on comparable sales. We now expect restaurant preopening expenses of 6 million to 6.5 million. We now expect G&A expenses of between 19.5 million and 20 million. Our effective tax rate is now estimated to be between 28% and 30%. We continue to expect annual weighted average diluted shares outstanding of 17 million to 17.1 million shares and we now expect to open 12 new Chuy’s restaurants this year, which is at the low end of our previous 12 to 14 range. Lastly, our capital expenditures, net of tenant improvement allowances, are now projected to be between 36 million and 41million. With that, I'll turn the call back over to Steve to wrap up.

[Steve Hislop:]

Thanks, John. Despite a challenging external environment, we continue to be excited about the opportunities ahead for Chuy’s. Our ultimate focus remains simple, to continue to deliver high quality made from scratch food offerings and hand crafted cocktails to our guests at a tremendous value in a unique upbeat environment. Before I turn the call back over to the operator for questions, I would like to thank all of our Chuy’s employees for their hard work and dedication again to earning the dollar every single day. With that, we are happy to answer any questions.

[Operator:]

[Operator Instructions] We’ll have our first question from Will Slabaugh with Stephens Inc.

[Will Slabaugh:]

I had a first question around the unit development. You talked about modestly slowing down for the year and then even more so in the next year. As we look at the P&L, first wanted to ask if you could think about any benefits that we might be able to see come through in a way of fewer inefficiencies or otherwise, just from building through your restaurant?

[Steve Hislop:]

I think you're going to see the benefit next year from an EPS standpoint for sure. You’re going to have the lower pre-opening cost for one and like you were saying, you're going to see just kind of a lower proportion of inefficiencies per year comp stores. So that ought to moderate as well.

[Will Slabaugh:]

Okay. And you did talk a decent amount about just sort of uncertainty in the marketplace, that also leading to that reduction in unit development and you mentioned a fairly wide gap in the back half in terms of same store sales and the outlook. So I’m wondering if you’d be willing to talk anymore about what you’ve been seeing either early on in 3Q or sort of any further expectations on trajectory as we look into the back half of ’17.

[Steve Hislop:]

It's hard to get a reason, it is popping up and down. I will tell you [indiscernible] a little bit there, it was just a slowdown and definitely because of the weather we think, because of the heat, but also it's just the patio weather, it's just hard to predict right now. That's what I’m looking at and so that's why the range is as wide as it is. Obviously, if it comes back quicker, then I'm thinking we could increase it and if it doesn't, you’re going to the lower end of that.

[Will Slabaugh:]

And last thing, wanted to ask you about the new markets, you mentioned you’re pretty pleased with those so far. I’m curious more on the larger markets, actually Denver, where you’ve opened up, what you're seeing, those obviously are becoming a bigger piece of the growth story going forward. So just curious any more commentary you might have on some of the larger markets you’re going to?

[Steve Hislop:]

Yeah. We opened Denver, so little roughly about a month ago and we’re excited and the reason we went to Denver, there was a lot of awareness of Chuy’s and it’s bode very well for us. So again, we're excited, it's really too early to even say, but we're excited about the first month up and over there and the second one was Chicago and we actually opened that last week and we're pleased with that entrant into that market already, but again it's only a week. So we’re excited, very excited about both markets.

[Operator:]

We’ll go next to Andrew Strelzik with BMO Capital Markets.

[Andrew Strelzik:]

If I look back over time, Chuy’s has done a very nice job, navigating different types of industry environments, but that doesn't seem to be the case now. So I guess I'm wondering what's different this time, is it the intensity of the industry weakness or as you've expanded across markets, are you not viewed the same way in those newer markets as you are now and that's why you're talking about the brand recognition, maybe if you could offer some commentary about comps maybe in markets open in the last several years versus your legacy markets or store closures or things like that would be helpful. Thanks.

[Steve Hislop:]

Yeah. Andrew, the key to the sales drop it's really evenly across all market including Texas and Houston markets and all over in Dallas. It was pretty wide range as far as the softening of sales throughout the market. So, it’s not anything -- there is no one thing to put your finger out on any of it.

[Andrew Strelzik:]

And I guess, asking about the development pace, why eight to twelve for next year, why do you think that's the right number as of right now . What was the process you went through as you kind of whittle that down and I guess as you said that you're still reviewing it, does that mean that it could move lower from there?

[Steve Hislop:]

I think I'm pretty uncomfortable with. We’ve been looking at it for a little bit now. And as we move forward - that's why I kept such a wide range and again it could go to the top end or could go to the bottom end depending on the visibility of the sales as we move forward. So I’m pretty comfortable with that eight to ten. And just with the cloudy environment, I was uncomfortable doing more than that spread.

[Andrew Strelzik:]

I guess my question is, when you were looking at the markets did you choose the markets where you felt like you had the best sites or more legacy markets or newer markets, how did you prioritize those eight to twelve over what maybe the pace would have been otherwise?

[Steve Hislop:]

We want to continue obviously, you don't want to leave one sitting in Chicago and one in Warrenville, I mean one in Denver. So you're going to see us add stores in those markets. Then all the rest would be back so more to you know a couple in Texas and a couple in markets that we know very, very well.

[Operator:]

[Operator Instructions] We’ll go next to Brian Vaccaro, Raymond James.

[Brian Vaccaro:]

Wanted to ask about the comps to circle back to couple of quick clarification. In the second quarter, last call you were talking about a shift in single day [indiscernible] did that have much impact on the second quarter?

[Steve Hislop:]

You know Brian, it actually did not, it was pretty well flat. The information we are using was from five years ago and it was mainly Texas stores, but our marketing partner has done a great job outside of Texas, marketing that event and we've doubled up the marketing effort this year. And we just had a blowout think of. So it was pretty well matched last year even though it was in on a different day that we thought it would have some risk. But it was basically flat with last year.

[Brian Vaccaro:]

And I appreciate the quarter to date comment, does the July 4 shift have a material effect on the quarter to date and are you able to quantify that?

[Steve Hislop:]

Not materially, it’s flat to up 10 to 20 basis points. So we had flat to favorable impact.

[Brian Vaccaro:]

So you’re saying July 4 period that had a positive benefit you think to your sales in the quarter to date just to be clear?

[Steve Hislop:]

Just slightly, yeah.

[Brian Vaccaro:]

And on the unit growth plan, I wanted to ask Steven, you mentioned you’re going to continue to obviously grow in those new markets, but can you lay out the sort of what's in the pipeline through the end of ’18 at this point. How many more will be sort of in and around each of the big news three Denver, Chicago, and South Florida.

[Steve Hislop:]

I’m hesitant to sum that out at this point Brian.

[Brian Vaccaro:]

And I guess on the last one, Jon, back to the margin. We were talking about - think or trying to think about the impact of fewer new unit inefficiencies or less new unit inefficiencies last year. Can you give us a sense of the weight on the model, say in the current quarter. You obviously saw some de-leverage overall, close to 200 basis points. But can you give a little color on how the comp base performed within that?

[Jon Howie:]

Definitely, I would say most of it, probably of the, excuse me one second here. Of the 200 basis points that you're talking about, you know, probably I would say half to three fourth of that was related to the newer stores.

[Operator:]

We’ll go next to [indiscernible] Robert W. Baird.

[Unidentified Analyst:]

Just circling back to the unit growth pullback kind of here, would you characterize that sort of as a temporary slowdown and then related to that, what would make you want to reaccelerate the growth? What would you need to see them have those openings move higher going forward?

[Steve Hislop:]

The sales visibility is the key thing and as the sales visibility comps which means we're moving forward, increase in sales you'd probably see me to increase that and vice versa on the other side. But no, it's a short-term look at it. We're fully prepared for the high teen growth and then we plan on that at the end of the day. But until there is greater visibility in the marketplace we're going to be a little bit more cautious.

[Operator:]

[Operator Instructions] We’ll go next to Nick Setyan with Wedbush Securities.

[Colin Radke:]

Hi guys, this is Colin Radke on for Nick. I believe in June, you launched your first social media campaign. What were your takeaways from that? Did you see the sales lift you were expecting and what did you learn maybe in terms of how it impacted the consumers using the brand particularly in the newer market?

[Steve Hislop:]

Again, on social media isn’t not like going on TV, it's really building a brand on a long term basis. But we learned quite a few things actually from a year ago when we did it first one, where we did a lot of stuff more on 15 second type videos on Facebook and Youtube and a few other things like that. So what we've learned is we just got to keep getting the brand name out there and as far as moving the sales that's hard to say on one promotion. I'll tell you for the rest of the year, we definitely thought we did a little bit on Cinco de Mayo, we had a great day like Jon already mentioned on that. We just got done with Chuy’s AF, which is always fresh really talking about our defining differences. We’re about to go into our Green Chile as I mentioned to you earlier and that’s going to be a big campaign around that. And again you can take a long-term approach to the social media where it's really the branding and getting our defining difference out. To give you a number of appreciated sales I wouldn’t be able to do that.

[Colin Radke:]

And then just in terms of labor inflation, I think last quarter you talked about 2.5% to 3% for the year. Is that still your expectation or has anything changed there?

[Jon Howie:]

It’s still our expectation we were actually at about 2.7 for the quarter and year to date we’re right around 2.8, 2.9.

[Steve Hislop:]

And we expected to come down a little bit the next two quarters.

[Operator:]

We’ll go next to Bob Derrington, Telsey.

[Bob Derrington:]

A couple of questions if I may, Steve, as you're thinking about the little bit more marketing effect where the digital, social and otherwise coming into the back half of the year, should we be thinking a little bit higher percent of sales as we look at that? Do you anticipate raising the spend on that?

[Steve Hislop:]

It is all within the spent, Bob. Like I mentioned in my talk today, I think we said we’d keep it around the same, it’s just allocated differently and that's already been planned for all the social media. The key for me though is the social media is key, but it's the local store marketing that's really what I want to really push in the second half of the year. And as I mentioned to you, in prior years we’d look at maybe 20 to 22 real good solid what I'd consider marketing objectives from a store basis. This upcoming year and specifically quarter by quarter, we’d right in local store marketing plan for every single store in the company. And again it's really looking at the 20% of the things that we want to touch that's going to give us the 80% churn, not the other way, don't work on 80% of the stuff to get you a 20. So we're very, very focused on the local store marketing.

[Bob Derrington:]

Steve, when you look at the development plan and forgive me if I missed this, as you look at the three newer markets that you're venturing into, any kind of, you know, as you look at slower development next year, is the slowdown expected to come out of those and more into core markets, how should we think about that?

[Steve Hislop:]

Just like I’ve always said, we do better as we go into a market and dominate it in a number of units and the volume. So you don't want to leave one in a big market there by itself. So I’m going to continue to move into the Chicago market, I’ll market continue to move into the Miami market and the Denver market a little bit. And then all the rest of the development will be in the backfill market.

[Bob Derrington:]

So of the eight to twelve, what would you estimate would go into those three newer markets?

[Steve Hislop:]

Again, I'm not a whole bunch into that, I don't really want to go into a whole bunch of that yet. I'd like to finish off 2017 strong and continue to look at all of my basis as I'm continuing development. What’s really cool about the development is, I have a lot of stores that I'm ready to be able to do, so it's a pick and choose type scenario for me.

[Bob Derrington:]

And last question if I may, on the - as we look at restaurant margin, kind of broadly John, how do we think about as we're looking towards next year when we slow development, obviously you pre-op will come down, but I'm just you know and labor cost and efficiency. I'm just wondering what kind of basis point effect or benefit could we see to next year's restaurant margin?

[Jon Howie:]

I think what you’re going to see is, you could probably see about 50 basis points increase from what I’m seeing but obviously there is lot of factors and we're still looking at kind of how many stores we're opening up and things like that. But I think [indiscernible].

[Operator:]

We’ll go next to Jon Tower, Wells Fargo.

[Jon Tower:]

Just a few questions. First on the comp of the quarter, can you go over perhaps any day part weakness or geographic weakness that you saw in the comp?

[Steve Hislop:]

This is Steve. Yeah, they are in the quarter, we actually saw very midweek softness and not as much on the weekends. And that was pretty much throughout the whole second quarter. In the second period though it's kind of flipped on us and we are trying to get a handle on that, where it was more on the weekend and less on the midweek. So some puzzling things there, but that's what we are looking at.

[Jon Tower:]

And then, I don't think you mentioned this in this call, but where delivery and to go stands today as a percentage of sales and how that's tracking relative to your own expectations?

[Jon Howie:]

The delivery - we don't have a separate number for delivery. But we're at about 60% of our stores are now under delivery. And as far as to-go sales, we're right around 11% of our comp sales which is slightly higher than last quarter we’re about 10.74%.

[Jon Tower:]

And then just lastly, your comments earlier in the prepared remarks around the balance sheet and how healthy it is, it sounds like obviously you're exploring the idea of enhancing shareholder value in some form or fashion. So could you talk about how you think about that whether the dividends or perhaps buyback and where you’d feel comfortable with the leverage ratio moving if you were to take on some debt?

[Steve Hislop:]

This is Steve, I'm not 100% prepared to discuss that today. We’re in discussing with our board and certain bankers on the best avenues for shareholder value.

[Jon Tower:]

[Operator Instructions] We’ll go next to Brian Vaccaro, Raymond James.

[Brian M. Vaccaro:]

Just one quick one from me, I want to circle back on the new unit performance and looks like the gap in new units versus the comp base narrowed and the absolute AWS continues to improve and now there is moving seasonality and whatnot that impacts that, but can you speak to the performance of the new units versus your unit economic targets? Thank you.

[Jon Howie:]

Brain, right now they're hitting the target that we talked about. I mean we're looking at that 375 after a year or two, after the honeymoon period. We're still looking at those EBITDA targets in the high-single digits in that first year and low-double digits in the second year. And then in that third year that 15% to 16% EBITDA margin to get you to the, you know, close to that 30% cash on cash return. And currently that's what those stores are getting those targets on average.

[Operator:]

That does conclude the question-and answer-session. I'll turn the conference back over to Mr. Steve Hislop for any additional or closing result.

[Steve Hislop:]

Thank you so much. Jon and I appreciate your continued interest in Chuy's and we will always be available to answer any and all questions. Again, thank you and have a good evening.

[Operator:]

That does conclude today's conference. Thank you for your participation, you may now disconnect.