Chuy's Holdings, Inc.
Q2 2015 Earnings Call Transcript

Published: 5 Aug 2015

[Operator:]

Good day, everyone, and welcome to the Chuy's Holdings, Incorporated Second Quarter 2015 Earnings Conference Call. Today's conference is being recorded. At this time, all participants will be 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 will turn the conference over to Mr. Howie. Please go ahead, sir.

[Jon W. Howie:]

Thank you, operator, and good afternoon. By now, everyone should have access to our second quarter 2015 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 conditions. 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. At a high level, we were pleased to see our operating momentum continue into the second quarter. Highlights from our financial results included; a 3.2% increase in comparable restaurant sales, a 19% increase in revenues, and a 52% increase in EPS to $0.32 per share. In addition to solid revenue growth driven by new unit growth and our 20 consecutive quarter of positive comparable restaurant sales growth, we saw continued improvement in our restaurant operating margins as a result of better than expected food cost and increased labor related efficiencies gained from internal initiatives. Our margin improvement in the quarter is a direct result of the hard work and dedication of our entire team as they execute on these initiatives, as well as, our ongoing consistency of our business driven by improved habits and routines. With regard to our labor initiatives, we continue to benefit from our labor scheduling best practices and manage our rationalization plan at not only our lower volume stores but all our stores, which we have completed earlier than originally planned. While we are seeing some labor margin improvement at our comparable restaurants, we are seeing a much larger improvement at our non-comparable and lower volume restaurants. While we are very pleased with our progress during the first half of 2015, I would caution you that as we have now implemented the majority of our major initiatives, we would not expect to see the same magnitude of improvement year-over-year in our restaurant operating margins during the second half of the year. Additionally, I'll remind you that the back end loaded nature of our 2015 development schedule will likely result in increased inefficiencies in our cost of sales and labor lines during the second half as well. We will however, as always, continue to look for ways in which we can continue to improve our business. Switching to development. We opened one new Chuy's restaurant during the second quarter in Dayton, Ohio. Subsequent to the end of the quarter, we opened one new restaurant in El Paso, Texas. To-date we have opened five new restaurants during 2015 and are very pleased with the performance so far. We are still on plan to open 10 to 11 new Chuy's restaurants this year and our 2016 plan is already shaping up nicely. We continue to focus on getting into larger denser markets more quickly as we grow our restaurant base. We are currently focused on the same geographical footprint that was historically discussed. We will make a quicker leap in to major densely populated markets like Chicago and Southeastern Florida similar to our entry into DC market, which includes our openings in Fairfax and Springfield, Virginia. Although our focus is on larger markets, we'll continue to backfill the existing markets which we believe will provide a boost to awareness and branding in those markets. We continue to believe we have a huge runway for growth ahead of us. Now, I'd like to turn the call over to our CFO, Jon Howie, for a more detailed review of our first quarter results.

[Jon W. Howie:]

Thanks, Steve. Revenues increased 19.1% year-over-year to $75.4 million for the second quarter ended June 28, 2015. The increase included $11 million in incremental revenues from an additional 133 operating weeks, produced by 12 new restaurants opened during and subsequent to the second quarter of last year. We had a total of approximately 816 operating weeks during the second quarter of 2015. Comparable restaurant sales grew 3.2% during the second quarter, driven by a 3.9% increase in average check offset by a 0.7% decrease in traffic. There were 46 restaurants in our comparable base during the second quarter of 2015, including two new restaurants added to the base at the beginning of the quarter. 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 210 basis points year-over-year to 26.3%, primarily resulting from the combination of lapping last year's inflationary spike in dairy and limes, which has now decreased to more normal levels, as well as the benefit from recent price increases taken in September of 2014 and February of 2015. As we noted on our Q1 call, we were expecting higher prices in chicken, limes and other produce as we moved into the second quarter. While we did see price escalation in these items, it did not occur to the extent expected. For the first half of 2015, we have experienced commodity deflation of approximately 4%. Looking ahead, we expect continued deflation in the back half of the year, but on a more modest basis, plus we expect cost of sales inefficiencies related to our second half opening schedule. As a result, we expect our full year 2015 cost of sales as a percentage of revenue to range from 26.7% to 26.9%. Labor cost as a percentage of restaurant revenue improved 90 basis points from last year to 32%, as we benefited from labor initiatives and manager rationalizations in all stores, but particularly in our non-comparable stores. Keep in mind that our second quarter is historically our highest indexing sales quarter, and therefore our most efficient from the margin standpoint. Similar to our cost of sales, we also expect that labor margin benefit from our current initiatives will be partially offset in the second half of the year due to the concentration of store openings during the end of Q3 and into Q4. As a result, we do not expect the same magnitude of year-over-year labor margin improvement going forward that we had in Q2. Restaurant operating costs as a percentage of revenue improved slightly by 10 basis points to 13.5%, largely due to decreases in liquor taxes as we build more stores outside of Texas and travel-related expenses, partially offset by an increase in insurance costs related to the Affordable Care Act. Occupancy cost as a percentage of revenue increased approximately 50 basis points year-over-year to 6.5%, driven by higher rental expense and property taxes as a percentage of sales in our newer locations as we continue our expansion in larger markets in the East and Northeast. General and administrative expenses increased $1.4 million to $4.3 million in the second quarter. As a percentage of revenue, G&A increased approximately 110 basis points year-over-year to 5.7%. The increase was driven primarily by an increase in performance based bonuses, stock based compensation and legal expense, in addition to investments in new employees. Pre-opening expense during the second quarter of 2015 was approximately $700,000 compared to approximately $1.3 million in last year's second quarter. This lower expense was primarily the result of opening only one store during the current quarter versus three during the same period in 2014. Our 2015 development schedule is more back-end loaded this year and we expect our pre-opening expenses to increase in the second half of this year, including approximately $1.3 million to $1.4 million in the third quarter. Depreciation and amortization expenses increased approximately $0.8 million to $3.2 million from a $2.4 million in the second quarter of 2014, primarily driven by increases in equipment and higher gross leasehold improvement costs associated with new restaurants. Net income in the second quarter of 2015 increased 55.9% to $5.4 million or $0.32 per share as compared to $3.4 million or $0.21 per share in the second quarter of last year. Finally, we ended the quarter with $7.6 million of cash on the balance sheet and no debt as compared to $6.8 million of cash and debt of $8.5 million at the end of the first quarter of 2015, a positive net cash swing of $9.4 million during the quarter. Based on our performance in the first half of 2015, we are revising our annual guidance with diluted net income per share of $0.82 to $0.85 versus our previous range of $0.76 to $0.79. This compares to the diluted net income per share of $0.69 in 2014. Our net income expectation for fiscal year 2015 is based in part on the following annual assumption. Comparable store sales growth of approximately 2.5% for the balance of the year, restaurant pre-opening expenses of approximately $4.2 million and $4.7 million, we now expect G&A expenses to run between $15.8 million and $16.3 million. Our pro forma effective tax rate for the full year to remain between 28% and 30%. We continue to expect our annual weighted average diluted shares outstanding of 16.7 million to 16.8 million. Our development plans for 2015 remain on track with 10 to 11 new Chuy's restaurant, of which five have already opened. Lastly, our capital expenditures net of tenant improvement allowances are projected to be approximately $27.5 million to $30 million. Now, I'll turn the call back over to Steve to wrap up.

[Steven J. Hislop:]

Thanks, Jon. In closing, we are pleased with the start of 2015 and are excited about the short- and long-term prospects of our business, including the continued growth of our restaurant base, with sales volumes and returns well ahead of industry norms. Our freshly-prepared crave-able Mexican inspired offerings, tremendous value and energetic atmosphere has led to industry leading average unit volumes and a long history of same-store sales growth. We continue to tackle the near-term challenges. We believe that sales driving and operational enhancing initiatives put in place along with the continued backfill of these developing markets will drive those results towards the company's average. We are using the learnings from all recent openings to optimize our new unit model going forward. 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're happy to answer any questions. Thank you.

[Operator:]

And we'll take our first question from Jeff Farmer with Wells Fargo.

[Jeff D. Farmer:]

Thanks and good afternoon guys. Just as it relates to the COGS favorability you saw in Q2 and even Q1, you did call out that commodity basket deflation. But I am just more curious what role was played by that more sustainable cost control effort across inventory, waste management, whatever else you're doing. I know there is more to it than just the basket deflation. So can you help us understand some of the efforts there to control costs beyond just the pure deflation?

[Steven J. Hislop:]

Sure. And you're specifically talking on COGS.

[Jeff D. Farmer:]

Yes. I'm sorry.

[Steven J. Hislop:]

Yeah. Again, the real key thing what we did is really it's as simple as far as production sheets. What we do is we produce only for the shift and only the shift only, and we're making things all that day. So it's really eliminated all our waste with more of a closer look at all our forecasting is number one thing. And obviously, the inventory management is big on that too. Also, definitely part of the second half of the quarter, we had saw a nice little increase in our liquor mix and it's actually had some improvements in our liquor mix and that definitely helps us in the cost of sales. And also if you guys remember, about a year ago, little bit more than that, we hired an R&B guy to run food and beverage for us and also purchasing. And he's come in and just done a real nice job with some of our contracts whether they would be beef basis or beans or oils. He's done a very, very nice job of bringing that in. So I've got some low-hanging fruit that he has taken care of a little bit in the first half of the year.

[Jeff D. Farmer:]

Okay.

[Steven J. Hislop:]

And that's the basis of it.

[Jeff D. Farmer:]

Just to follow-up on that. So I know it's a difficult question to answer. But 210 basis points of COGS delivered in the second quarter. Can you handicap sort of what's just pure commodity deflation versus a lot of these cost control efforts you've put out there? So is it maybe 50 basis point, so that 210 basis points was driven by cost control? Any help there would be helpful.

[Jon W. Howie:]

Well, Jeff, remember, we are rolling over our limes issues last year as well. And we've taken a little higher price increase this year than we have in the past, which is probably causing 50, 60 basis points of that as well.

[Steven J. Hislop:]

Sure.

[Jon W. Howie:]

So those factors along with that is probably, is what's causing that 210 basis point favorability.

[Jeff D. Farmer:]

Okay. Thank you.

[Steven J. Hislop:]

You're welcome.

[Operator:]

And we'll take our next question from Will Slabaugh from Stephens Incorporated.

[Will Slabaugh:]

Yeah. Thanks, guys. Congrats on the great quarter.

[Steven J. Hislop:]

Thank you, Will.

[Will Slabaugh:]

Wondering if you could talk a little bit about the class of 2015 stores, how they've opened up so far? I know a lot of those have been in some of your more core and few in the larger markets, so curious to hear commentary on that. And then, if you could give us any update on maybe how those looked relative to what you saw from the class of 2014 early on and the class of 2013 early on to kind of, I guess, compare and contrast what you are showing now?

[Steven J. Hislop:]

Again, we are pleased with our openings. Again, it's too early to really talk a whole bunch about them. But we are very, very pleased. They probably have opened a little higher than our 2014 and 2013 stores on the average. But we're pleased and they are right on our targets. So we're very excited about the original, the five stores have opened already and the rest of the ones for this year.

[Will Slabaugh:]

Great. And if I can just touch back on the 2013 or 2014 classes, I know that's where you've been doing a lot of the work in terms of the labor and cost of goods, productivity initiatives. Can you touch on the labor side of things a little bit more in terms of what you've done so far? You mentioned you felt like most of it is sort of in place already and that benefit year-over-year should be a little bit less. Can you touch more specifically on what's been done and then maybe where we should continue to feel a bit of a benefit in the back half of the year?

[Steven J. Hislop:]

Well, the big thing is, is the base productivity standardization plan, which is basically, really looking at productivity and the best practices in every one of our restaurants based on sales increments. And using the best practices and schedules, people to hold back. And we really, as I said, that would take you probably through the third and fourth quarter to do that. We've actually jumped in and specifically the 2013 and 2014 stores and rolled those back quicker. And that's been the biggest impacts. So those are in there right now. Then obviously the thing on that is just ramping up the new stores quicker. And that will bring up our 2015. We've actually done a lot better as far as rolling the labor efficiencies in quicker. And so that should continue this year. But that might be adversely affect with them still bunched in at the back half of the year.

[Will Slabaugh:]

Got it. And just one quick one. On weather, it was pretty highly publicized as the rainiest month in Texas history in May, so just curious if you saw any hit there to your sales?

[Jon W. Howie:]

We did, Will. I mean it's not all that much to talk about, but it did affect patio sales. Our patio sales are probably down 35 basis points for the quarter. So it did have an impact, but not as significant as what you would expect.

[Will Slabaugh:]

Thanks, guys.

[Steven J. Hislop:]

Thank you.

[Jon W. Howie:]

Thank you.

[Operator:]

And we will take our next question from Chris O'Cull with KeyBanc.

[Steven J. Hislop:]

Hi, Chris.

[Chris T. O'Cull:]

Steve, in the past you guys have raised menu prices roughly 2%, but I mean, this year the increase has been significantly higher. Does this reflect the change in your view of the likely pricing the restaurants will take going forward? And then if you guys could also give us kind of what you expect for pricing in the menu in the third and fourth quarter that would be helpful.

[Steven J. Hislop:]

Yeah, Chris, no, no. This year what we specifically did is in the September time in 2014 if you remember, we took a 1% and that basically was to cover all the costs from Obama Care and then I'm getting ready for that. And then this was one was around 2.5% one we took in February, which is basically, we've always been about 1.5% to 2%. I see us playing in that arena from here on out. The reason we did that Chris is we absolutely knew what was going to happen to our meat this year and the meat was significantly higher as everybody dealt with it, that's why I was a little bit more – we feel we have plenty of room in our menu. But the key thing for me is return visits. So, I really like playing in that 1.5% to 2% range every single year Chris and you'll see that as we move forward into 2016 and 2017, so right around there. And this one was just a little higher again because of what we knew what meat – on the meat side of business.

[Jon W. Howie:]

And Chris, on the last half of the year, we are expecting pricing to be around 2.8% to 2.9% for the last half, obviously a little higher in the third quarter as we had, you'll have the full 3.5%, but then during September is when that 1% rolled off that we took last September.

[Chris T. O'Cull:]

So, you don't plan to replace that September price increase with another one?

[Steven J. Hislop:]

No, sir.

[Chris T. O'Cull:]

Okay.

[Steven J. Hislop:]

Again, that was a one kind of deal really to deal with Obama Care that came in and I just didn't want to – and the reason we did it in September are not added on to February as I was scared of going over at anytime, one time over 2.5% price in February.

[Chris T. O'Cull:]

That's very helpful. Thank you. And then, Jon, how much – I think you said deflation was expected to be less in the third and fourth quarter. Can you give us a little bit of more color as to what you expect deflation to be in the third and fourth quarter and how confident you are based on your contracts and with your floating?

[Jon W. Howie:]

Well I am expecting for the last half of the year, if you look sequentially for inflation of probably 1% to 2% of where we are today. So that would give you in the back of the year somewhere around 2.5%, 3% deflation.

[Chris T. O'Cull:]

Okay. And you guys have – in most of that, is there any risk to that deflation or what are the commodities that would put that at risk or that you are buying on the spot market?

[Jon W. Howie:]

There is a little risk in meat, not all that much. We are still short a few loads that we need to price in there. We're locked for the rest of it. So there is a little risk there. There is a little risk in produce. We've seen that come up a little bit and those are – and dairy have come up a little bit since the second quarter.

[Steven J. Hislop:]

It's bumped up a little bit in the third quarter.

[Jon W. Howie:]

Chicken we expect that. I guess we expect that to come down a little bit from where it's at to a more normal trend. Obviously, last year was not a normal trend.

[Chris T. O'Cull:]

Okay. Thank you.

[Steven J. Hislop:]

You're very welcome.

[Operator:]

We'll take our next question from David Tarantino with Robert W. Baird.

[David E. Tarantino:]

Hi, good afternoon and congratulations on the strong earnings performance.

[Steven J. Hislop:]

Thanks, David.

[Jon W. Howie:]

Thanks, David.

[David E. Tarantino:]

So my question is about some of the labor productivity initiatives that you've implemented. And I just want to clarify, are those generating greater than expected savings or are those savings just coming earlier than expected?

[Steven J. Hislop:]

A little bit earlier than expected. We implemented it a little quicker. So it's really earlier than expected. And also, one thing that I'm really proud of our guys, is are flow-through from our price increase has really, really, done well. They've really flowed through price increase very, very well from a labor perspective in all stores, not just the 2013, 2014, 2015 stores.

[David E. Tarantino:]

And so, I guess the follow-up, thank you for that. And the follow-up I have is, how do you think that 2014, 2015 classes are now tracking relative to the targets you've laid out? Is it looking like the margins are going to come into that 15% to 16.5% range or do you think there is a chance that you could be above that given the savings that you've achieved?

[Jon W. Howie:]

Well, that was factoring in the lower volumes, obviously, David. So, it was factoring in the lower volumes in those percentages based upon those lower volumes. What we're seeing is we're hitting those targets right now, maybe exceed them a little bit, but not much. So we're hitting the expectations that we've given out there.

[David E. Tarantino:]

Great. Okay. That's helpful. And then last question is on the same-store sales, the traffic trend was negative this quarter. I think that's second quarter in a row. Can you give us some context on why you think that is? I know you mentioned a little bit of weather, but could you also talk about the impact of the new stores coming in the comp base and what you think the right underlying trend is?

[Steven J. Hislop:]

Yeah. I think, yeah. As you know, we've always talked about a headwind of stores that roll in from their honeymoon period and for the second quarter it was roughly 70 basis points. So a lot of that obviously is customer count. If you took those out, you'd see our customer counts are really flat. I think they would be down 652 guests for the whole quarter. So we are really flat. And I'm not excited about that. That's our number one thing that we work on every single day is growing that customer comp line, but we definitely were a little affected, I think John mentioned about a little bit on the patios, it definitely would affect us 35 basis points. So that's what we're attributing to a little bit. But again, it's something that we are working really, really hard on because the life blood of our restaurants are same-store sales, but it's really customer counts. So we're continuing with our sales growth initiatives whether it be local store marketing with the TV demos, events and programs and we're going to continue very strongly with that. I won't tell you as a company – staffing is the key for us and we are better staffed now than any time over the last year and a half which bodes well for growing your volumes.

[David E. Tarantino:]

Great. And then related to that Steve, if you've seen any changes in value scores or feedback, because I guess the one thing that has changed over the last 12 months is you are running more pricing in the menu, so do you see any signs that maybe the price increases have impacted the traffic?

[Steven J. Hislop:]

No, not at all, not at all. The first thing we do on a price increase is to make sure that my value spreads compared to my competitive set is in place and that's number one in. So if you look at over the last eight years, we're still average even with this year taking a 2.5% in February, we're still under the 2% over that period of time. And my competitive set has still been more than that. So, I'm very comfortable where we are at on our value equation spot. In fact, I think we have room, but the key thing as I mentioned to you when I answered Chris's question, our key deal is frequency and that's why I look at 1.5%, 2% is my kind of my safety zone that I like to play in.

[David E. Tarantino:]

Great, that's very helpful. Thank you.

[Steven J. Hislop:]

Thank you.

[Operator:]

And we'll take our next question from Andrew Strelzik with BMO Capital Markets.

[Andrew Strelzik:]

Everyone.

[Jon W. Howie:]

Hi Andrew.

[Steven J. Hislop:]

Hi Andrew.

[Andrew Strelzik:]

Just wondering, given the speed and magnitude to which you were able to benefit from some of these efficiency initiatives, does that maybe expand the scope of things that you are willing to try? Or do you think that that's really the extent of what you are able to do in the units from an efficiency perspective?

[Steven J. Hislop:]

Well, as far as labor, I think those are things that as you're opening newer stores, I was very hesitant obviously to protect everything to move down. But what we've learned is more mature stores were actually growing volumes quicker. So that's only made the initial move for quicker reduction, as far as cross-training and so forth. So, now, I don't think I am going to do it any faster than I am doing it at all. So I think I am very comfortable with the long term growth of where we are at and what we've developed over the last 6 months.

[Andrew Strelzik:]

And then on the long term growth profile that you have outlined historically, it does sound like there are some inefficiency that are going to come in at the back half of the year and kind of limit your ability to reestablish that long term growth trajectory in line with kind of what you had outlined? What do we need to see to get here and do you think that there to the extent you are willing to comment on it, do you think we might see that reestablished in 2016?

[Jon W. Howie:]

Are you talking growth over Q4 to Q4?

[Andrew Strelzik:]

You had talked about a 20% to 25% long term – year-after-year earnings growth type of algorithm and that's really what I am talking about?

[Jon W. Howie:]

Yes. So I mean, if you look at our new guidance, I think that gives us a – on the upper side of that 23% growth. So we would continue on a long term basis to look for that 20% growth going out.

[Andrew Strelzik:]

Okay, great. Thank you.

[Jon W. Howie:]

You're welcome.

[Operator:]

This does conclude today's question-and-answer session. I will now turn the call back to management for any additional or closing remarks.

[Steven J. Hislop:]

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

[Operator:]

This does conclude the presentation. Thank you for your participation.