Chuy's Holdings, Inc.
Q3 2016 Earnings Call Transcript

Published: 1 Nov 2016

[Operator:]

Good day, everyone, and welcome to the Chuy's Third Quarter 2016 Earnings Conference Call. As a reminder, today's conference is being recorded. At this time, all participants have been placed in a listen-only mode and 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.

[Jon W. Howie:]

Thank you, operator, and good afternoon. By now, everyone should have access to our third quarter 2016 earnings release. It can also be found at 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'd like to turn the call over to Steve.

[Steven J. Hislop:]

Thank you, Jon, and thank you to everyone for joining us on the call today to discuss our third quarter 2016 results. All-in-all, we're pleased with our performance that came in the face of a challenging external environment. Looking at the highlights for the quarter, revenues increased 15.8% to $85.6 million, comparable restaurant sales increased 0.3% and adjusted net income increased 19.7% to $4.9 million or $0.29 per diluted share. Despite the short-term headwinds, our ultimate focus remains simply to deliver high-quality, made-from-scratch food offerings and hand-crafted cocktails to our guests at a tremendous value in a unique and upbeat atmosphere. The long-term formula has now resulted in 25 consecutive quarters of positive comparable restaurant sales and an average unit volume of $4.7 million. As I said before, if we continue to take care of our guests, I believe the current environment provides us with an opportunity to increase our market share. During the third quarter, we also opened three new Chuy's restaurants in Chattanooga, Tennessee; Winter Park, Florida in the Metropolitan Orlando area; and San Marcos, Texas, just South of Austin. We also closed one restaurant in Charlotte, North Carolina, which we expect to relocate by the end of the year. Subsequent to the quarter, we have opened one additional restaurant in Rockville, Maryland, bringing our year-to-date development to 10 new Chuy's restaurants in 2016. We continue to be pleased with the performance of our new restaurants, not only as it relates to their initial sales volumes, but also with regard to their initial profitability. For 2016, we expect to open 12 new Chuy's restaurants, including our new location in Charlotte. Looking ahead, our 2017 development plan is coming together nicely and we continue to believe we have a huge runway for growth ahead of us. With that, I'd now like to turn the call over to our CFO, Jon Howie, for a more detailed review of our third quarter results.

[Jon W. Howie:]

Thanks, Steve. Revenues increased 15.8% year-over-year to $85.6 million for the third quarter ended September 25, 2016. The increase included $13 million in incremental revenues from an additional 166 operating weeks produced by 15 new restaurants opened during and subsequent to the third quarter of last year. We had a total of approximately 990 operating weeks during the third quarter of 2016. Comparable restaurant sales grew 0.3% during the third quarter, driven by a 1.1% increase in average check combined with a 0.8% decrease in traffic. Effective pricing in the third quarter was approximately 1.5%. There were 58 restaurants in our comparable base at the end of the third quarter 2016. As a reminder, we consider restaurants to be comparable in the first full quarter following 18 months of operation. Turning to expenses, cost of sales as a percentage of revenue improved approximately 30 basis points year-over-year to 26.3%, driven largely by lower grocery prices. Looking at the balance of the year, we have experienced sharp increases in produce and to a lesser degree in dairy. As a result, we expect cost of sales as a percentage of revenue in the fourth quarter of 2016 to increase 20 basis points to 40 basis points, compared to the prior-year quarter. Labor costs as a percentage of restaurant revenue increased 130 basis points to 33.3%, driven by ongoing wage rate pressures and inefficiencies from new unit development. We would expect labor pressure to continue in the fourth quarter. Restaurant operating costs as a percentage of revenue increased 20 basis points to 14%. The increase was primarily related to higher general repairs and maintenance costs. Occupancy cost as a percentage of revenue increased approximately 20 basis points year over year to 6.7%, driven by higher rental expense as a percentage of sales in our newer locations. General and administrative expenses increased approximately $59,000 to $4.1 million in the third quarter. As a percentage of revenue, G&A decreased approximately 70 basis points year over year to 4.8%. This primarily related to lower performance-based bonuses, our bonus estimate offset by normal increases related to infrastructure to support our growth. Pre-opening expenses during the third quarter of 2016 was largely flat at approximately $1.2 million compared to approximately $1.1 million last year. We expect pre-opening in the fourth quarter to be similar to the third quarter levels. In summary, net income for the third quarter of 2016 increased to $4.6 million or $0.27 per diluted share compared to $4.1 million or $0.24 per diluted share a year ago period. Third quarter 2016 results included a $0.4 million of a one-time pre-tax – of pre-tax expenses related to the closure of one restaurant. Excluding the expenses related to the closure, adjusted net income increased 19.7% to $4.9 million or $0.29 per diluted share in the third quarter of 2016 compared to net income of $4.1 million or $0.24 per diluted share in the third quarter 2015. We have included a reconciliation from GAAP net income to adjusted net income in the accompanying financial tables of our earnings release. We ended the quarter with $13.9 million in cash on the balance sheet and currently have no debt. Switching to our 2016 outlook, we expect annual adjusted diluted net income per share of $1.05 to $1.08, which excludes the net effect of the previously noted closure costs. Our annual diluted annual income per share guidance for 2016 includes the following assumptions

[Steven J. Hislop:]

Thanks, Jon. In closing, we remain confident in our long-term plan. The broad appeal of Chuy's concepts, our historical unit economics and flexible real estate strategy, combined with our modest store-based size, presents us with a large runway of opportunity for continued expansion. Before I turn the call back over to the operator for questions, I'd like to take a moment to thank all of our Chuy's employees. Our success has always been a testament to their hard work and dedication to earning the dollar every single day. With that, we are happy to answer any questions. Thank you.

[Operator:]

Yes. Thank you. And we'll go first to Chris O'Cull with KeyBanc.

[Chris O'Cull:]

Hey. Good afternoon, guys.

[Jon W. Howie:]

Hey, Chris.

[Chris O'Cull:]

Jon, I was hoping you could give us a little color on the commodity contract that you have in place for 2017 and maybe how much of beef is locked up. Kind of give us some expectation for commodity inflation or deflation next year.

[Jon W. Howie:]

Well, I'd tell you, Chris, we are currently now working on our contracts here in the fourth quarter. We have locked up our fajita beef through the end of next year at about 6% lower prices. So we're pretty happy with those. We have not locked up yet the ground beef yet. But I think that's going to be a little more favorable than last year as well. But the other ones are still kind of in process. We'll have better information by the year-end call.

[Chris O'Cull:]

Okay. And then, Steve, does the company plan to take pricing in February, given you've had several quarters of deflation?

[Steven J. Hislop:]

Well, we're looking at, Chris, over the last seven, eight years, we've averaged about one and a half over that period of time on average. Right now, as we're studying it, that'd be something I'd probably be looking at right around that range again.

[Chris O'Cull:]

Okay. Do you plan to put caloric information on the menu in February? Or do you plan to have maybe reprint in May?

[Steven J. Hislop:]

Look, that's been changing so much. But right now we're set to go whenever we want to, and we probably won't jump the gun at it.

[Chris O'Cull:]

Okay. Okay. And then lastly, Jon, could you help us understand the labor deleverage in the quarter? Can you break that out between like new store inefficiencies versus wage inflation? And then maybe give us a little understanding of what the overtime rule could do to the labor line?

[Jon W. Howie:]

Well, I will tell you, there's probably about 20 basis points to 30 basis points in there related to wage inflation. Most of the rest of it is the new stores. If I was looking at the existing stores, they were up around 30 basis points to 40 basis points and then the new stores is the rest of it.

[Chris O'Cull:]

And the overtime rule?

[Jon W. Howie:]

The overtime rule, right now, we're still – we're at the final stages of trying to decide what we're going to do. We know it's going to have an impact on us. I don't think it's going to have a significant impact, but it could have 20 basis points to 30 basis points.

[Chris O'Cull:]

Great. Thanks, guys.

[Operator:]

We'll go next to David Tarantino with Robert W. Baird.

[David E. Tarantino:]

Hi. Good afternoon. A couple questions here. First on the comps, Jon, did you see any sort of notable changes throughout the quarter as the quarter progressed? And then maybe as a related question, were there any negative weather impacts with all the rain in Texas?

[Jon W. Howie:]

We did have a little, but it wasn't much to note. I mean, it's like 20 basis points or 30 basis points, David. But as far as the consistency, it was really consistent. It was like 33.3% throughout the quarter. So there was really no fluctuation from period to period.

[David E. Tarantino:]

Got it. And then as we think about the setup for Q4, I know the comparison is perhaps a little easier, but you're not necessarily guiding to better comps. Is there anything, I guess, holding you back on that? Or perhaps, have you seen a change in trajectory as you've entered this quarter?

[Jon W. Howie:]

Well, I'd tell you, we've rolled over 4.2% this quarter, which was one of the largest quarters we've had since we've gone public. We're rolling over 3.2%, which is, you're absolutely right, a little easier, but not much. We have a Christmas impact coming in December that could have anywhere from 50 basis points to 70 basis points negative impact to the overall fourth quarter comp. I know we did have a little favorable lift at Halloween, but that's not enough to cover that.

[David E. Tarantino:]

Okay. Got it. And then I guess, Steve, maybe a big picture question about the development pipeline as you look into 2017. Is there any initial look at how many openings you might have next year? And then are you still on track to enter the new markets that you previously outlined?

[Steven J. Hislop:]

Yeah. Yeah, we're still – obviously, we're still putting the whole plan together and we're very good as far as numbers of sites and what we're looking for. So we're well on track on that. I'm still just fine-tuning my pencil a little bit on the number. The second thing, though, is that yes, what we have already mentioned is we'll be definitely entering into Chicago market next year. We'll be entering the Southern Florida, Eastern side of Florida market, and also Denver. So those will be my three new markets for 2017.

[David E. Tarantino:]

Got it. And then on that, Steve, what percentage do you think there will be in new markets versus existing markets, so to speak, next year? And do you have any sort of views on, I think the last time you sort of weighted a little bit more heavy on new markets. We saw a pretty negative impact on margins. Do you think that that could happen as we look at next year again? Or is this...

[Steven J. Hislop:]

No, the key thing of what you're talking about is out of nine stores, we had eight new markets in that one year. Last three years, you've seen us basically 80% backfill, 20% new. This upcoming year, you'll see us at that 35% range of new markets and the rest will be backfill also, so no, I think we're well set up with our size and so forth, with it.

[David E. Tarantino:]

Great. Thank you very much.

[Steven J. Hislop:]

Thank you.

[Operator:]

And we'll now go to Will Slabaugh with Stephens, Inc.

[Will Slabaugh:]

Yes. Thanks, Jon. Can you talk a little more about what you've seen from your most recent unit openings and then from an AUV and restaurant level margin standpoint, kind of, if you've been pleased with those? And what expectations are for next year's class versus 2016 given you'll be in some of those larger markets that you just mentioned earlier?

[Steven J. Hislop:]

Again, we're pleased with our openings as far as I mentioned in the call about the profitability and how quickly they'll come in, and the volumes as far as our model goes on the blended rate, 3.75%. And that's what we're expecting for 2016. But we're pretty pleased with the whole class this year.

[Will Slabaugh:]

Good deal. And then, Jon, on the guide, you're guiding us from, I believe it was just over 20% EPS growth in 3Q to roughly flattish for 4Q. Wondering if you could talk about what the biggest drivers are there and then if you could also talk about produce a little bit more. I know you mentioned that was supposed to be up for you. Is that still up or is it something that's corrected yet?

[Jon W. Howie:]

It's still up. It's still up, but we are starting to see some flattening in the avocados, but it's definitely up for us right now. It's trending well above our quarter three cost of sales now. So that's why I guided that. As far as the fourth quarter, it's really sales deleverage in that area. We're losing about 10 operating weeks from a slide in some of the new store openings. So our sales, in addition to the comp sales, they're going to be down another $1 million because of that slide.

[Steven J. Hislop:]

And that slide was – as someone mentioned earlier, that slide was the hurricane and some of the weather that we've had that affected down in Corpus Christi which is South Texas and over in Waverly which is over in the Carolinas, it's having a lot of weather over there.

[Jon W. Howie:]

And then when you're looking at a margin standpoint, like I said, we've had some favorable matchups with cost of sales. We believe we're going to be above that number next year in cost of sales by 20 basis points to 40 basis points. And then labor's going to be right around that 100 basis points higher than last year.

[Will Slabaugh:]

Got it. Thank you very much. Congrats, guys.

[Jon W. Howie:]

Thank you.

[Operator:]

We'll now take our next question from Andrew Strelzik with BMO Capital Markets.

[Ryan Royce:]

Thanks for taking the question. This is actually Ryan Royce on for Andrew.

[Steven J. Hislop:]

Hi, Ryan.

[Ryan Royce:]

So we've been hearing a lot about the widening gap between food at home and food away from home and the impact that can have on restaurants. So I was just wondering, what are you guys seeing out of the consumer and do you think that holds any water?

[Steven J. Hislop:]

This is Steve, Andrew (sic) [Ryan]. I think it does to certain concepts. At the end of the day, it's no doubt that the inflation at the grocery stores has happened. I think varied menu, bar grill, I think they're at a little bit of risk because every single thing they have on their menu can easily do at home. And with the price points, I think it does affect a little bit more on the quick casual group. But we think we're in a great, great position where we're at because you really can't cook my stuff at home. So that's a good benefit for us, but I've done – seen that as far as any traffic patterns that are different or any spending habits that are different, really haven't seen any from lunch to dinner or alcohol or dessert, and it's just maybe a tiny bit slower – slowdown a little bit.

[Ryan Royce:]

Great. Thank you very much.

[Steven J. Hislop:]

Yep.

[Operator:]

And we'll go next to Brian Vaccaro with Raymond James.

[Brian M. Vaccaro:]

Good evening, and thanks for taking the question. Just wanted to circle back on the food costs and drill down on avocados a little bit. Can you remind us what percentage of your overall COGS basket is avocados? In a typical year, not right now. I should clarify.

[Jon W. Howie:]

It's a little over – let me – I don't want to talk off the top my head here. One second. I was calculating that up the other day and it's right around $20 a case, and they got up to over $90 a case on us. And that's kind of – it's kind of the like the lime situation. It had about a 60 basis point swing in overall cost of sales. But if you look at avocados today, you're looking at...

[Steven J. Hislop:]

He's quick with the calculator.

[Brian M. Vaccaro:]

Yeah. I was looking at it, Jon, and I think your produce is like 18%, rough number, 18% of your total COGS. And I thought avocados were about 25% to 30% of that in a normal year, which was getting me to somewhere in the mid-singles. I just wanted to run that high level, sort of, again, in a typical year, which I know no years are typical these days.

[Jon W. Howie:]

Brian, I was going to compare the two. So you're looking at 26% of total produce today versus last year, it was similar to 14% of produce.

[Brian M. Vaccaro:]

Okay. Okay. That's helpful. Thank you for that. And as you think about – I wanted to ask about the 2017 COGS outlook. It would seem with the fajita beef contracts in place and some of the favorability on ground beef as well, is it fair to assume – in broad strokes, I guess fair to assume that that it will be flat to slightly favorable year-on-year, your overall COGS basket next year?

[Jon W. Howie:]

No, I don't want to say that right now. I would think it's probably be flat to maybe a little negative. You just never know on produce because that's one commodity we can't lock in.

[Steven J. Hislop:]

And that's our big basket, as you know, out there.

[Jon W. Howie:]

And we have some increases coming in beans and sugars and some other things that we know of today, in rice. So groceries, we've had a great run the last couple of years. But I think that's going to turn around on us a little bit in 2017.

[Brian M. Vaccaro:]

Okay. And then just one modeling nitpick. I just wanted to confirm there is an extra operating week in 2017, correct?

[Jon W. Howie:]

You are correct.

[Brian M. Vaccaro:]

All righty. Thank you.

[Steven J. Hislop:]

Thank you.

[Operator:]

It appears there are no further questions at this time. I would now like to turn the conference back to management for any additional or closing remarks.

[Steven J. 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:]

Ladies and gentlemen, that does conclude today's conference call. Thank you for your participation.