The ONE Group Hospitality, Inc. (STKS) Q2 2018 Earnings Report, Transcript and Summary

Greetings and welcome to The ONE Group Hospitality’s Second Quarter 2018 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host, Ms. Linda Siluk. Interim Chief Financial Officer. Thank you. You may begin.

Thank you, operator, and good afternoon. Manny Hilario, our President and CEO, joins me today. Before we begin our formal remarks, we must remind you 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 place 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. Please also note that these forward-looking statements, including projections, reflect our opinion only as of the date of this call. We undertake no obligation to revise or publicly release any revisions to these forward-looking statements in light of new information or future events. We refer you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. During our call, we will refer to certain non-GAAP financial measures, which we believe can be useful in evaluating our performance. The presentation of these measures or other information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP and reconciliations to other GAAP measures. For reconciliations of these measures, such as adjusted EBITDA and total food and beverage sales at owned and managed and licensed units to GAAP measures and a discussion of why we consider these measures useful, see our earnings release issued earlier today. With that, I’d like to turn the call over to Manny.

Thank you, Linda. And thank you all for joining us today and for your continued interest in The ONE Group. Our second quarter results clearly demonstrate the continued progress we’re making in 2018, executing against the four points of our long-term strategy plan. In fact, based upon our strong performance to-date and expectations for a solid back half of the year, we are pleased to be raising our annual outlook for comparable store sales and adjusted EBITDA as Linda will explain shortly. During the second quarter, domestic comparable sales for STK restaurants grew a robust 7.5% and restaurant level profitability increased over 360 basis points as we leverage to strengthen our topline and cost savings initiatives put in place, and more than offset an increase in minimum wage across most jurisdictions where we operate. We also grew adjusted EBITDA an impressive 70% to $2.5 million. For those of you that might new to the Company, I want to reiterate our commitment to deliver on our strategy for driving shareholder value. As a reminder, the four points of our strategy plan consist of: One, improving operational efficiencies in our restaurants; two, driving comparable sales; three, reduce G&A at the corporate level; and four, focusing on growth through license and management deals. Within our restaurants’ four walls, we have and we will continue to seek opportunities to drive better performance, enhance margins and increase profitability. We have already made significant headway streamlining our menus, which has reduced waste, and we have become more adapt at effectively managing labor scheduling, reducing unnecessary hours which has mitigated our cost pressures. We have also evaluated our various service contracts to see where we can optimize costs and eliminate waste. Next, our numerous sales driving initiatives which are focused on delivering an exceptional dining experience to each guest at each everyday have yielded growth in comparable sales, primarily through higher guest counts. Example of these initiatives includes extending our operating expenses hours to begin at 3:30 p.m. compared to 5:00 p.m. previously; our launch of Happy Hour or Social Hour by STK in our restaurants to promote offering some limited time drinks and small plate food options; offering brunch at select restaurants; centralizing our leadership around events management, which has held grow our business; driving frequency to our higher social media scores, and tying GM [ph] compensation to these higher social media scores; building relationships with guests [ph] at high-profile hotels near our restaurants; and last but not least, promoting STK Gift Cards. As a reminder, we have also been testing delivery at select restaurants with several different delivery partners over the past year. While the percentage of sales stemming from this channel is obviously very small, it is profitable and truly incremental to our business since in no way it replaces an authentic STK experience. We believe there’s a lot of potential to expand awareness of our brand, the delivery without cannibalization our in-restaurant business. So, we remain encouraged by what it could potentially mean for us in the long term. With respect to reducing G&A at the corporate level, our second quarter and year-to-date comparisons demonstrate, we have clearly made some meaningful headway, rightsizing this brand item. But, there are still yet untapped opportunities including professional service fees, headcount reduction, and office space consolidation. In terms of the development. After much anticipation, we opened STK San Diego in the historical Gaslamp Quarter at the Andaz Hotel last month. This restaurant is in addition to the already existing license and operating STK hotel rooftop. The Gaslamp Quarter is incredibly lively desirable area that is well known for its nightlife and we believe STK San Diego fits in seamlessly with the local seen [ph] and cultural offerings of the Gaslamp Quarter, evident by the encouraged start for this restaurant. As a remainder, over the long-term, we are focusing on growth on asset light management and license deals that enable us to bring our signature vibe and dining experience to the cities around the world, but without significant capital investment. Restaurant guests everywhere appreciate unique and differentiated full dining and hospitality, our STK brand offers. Our experiences, which combine a superior quality steakhouse with innovative menu and a vibrant lounge last longer than other concepts because guests want to hang around after dinner to enjoy more drinks, listen to our DJs and extend their evening far into the night, just to the open dining experience that we call fine dining. The STK [indiscernible] fine dining is therefore and a defining competitive advantage, setting us apart from our peers and leads to strong demand for STK brand and global hospitality program from top-rated hotels and upscale developers. We believe this is very large addressable market that we estimate includes over 100 global locations. We are therefore confident that we can efficiently manage three to five licensed deals and one to two food and beverage hospitality projects per year. And this year, we are on track to open five STK restaurant locations. In July, we opened a licensed STK in downtown Dubai, located in the heart of Dubai’s dining and entertainment district at Address Downtown hotel. This marks the second of our STK’s intended for the region. STK Doha located in the new renovated Ritz-Carlton hotel will open later this year and STK Abu Dhabi is slated for 2019. Recently STK Dubai was voted by Time Out Dubai as the best new fine dining restaurant in Dubai 2018. We are excited to have partnered with the highly successful Solutions Leisure Group to operate our STK branded restaurants in the Dubai market. Additionally, during the third quarter we will expand our footprint into Mexico, with one of the four licensed STK planned for the region. First location is expected to open in Mexico City on Presidente Masaryk later this month. The remaining two locations are slated for 2019 and 2020. Our license partner in Puerto Rico continues to work hard, recovering from the two major hurricanes that occurred in 2017. However, we now believe that both of our planned restaurants will open in 2019. Finally, we signed a letter of intent to open a new STK restaurant Nashville, Tennessee in the area which is between Music Row and downtown. This will be a company owned and operated location, but it will still be asset light since we’re taking over an existing upscale property and in conjunction with meaningful landlord contributions we will have minimal investments to make this into an STK. In fact, we estimate that we can be up and running for approximately $600,000, including preopening expenses. We hope to be hosting guests in STK Nashville as soon as the end of 2018, but no later than the first quarter of next year. With that, now, I would like to turn the call back to Linda who will provide more detail and the financial performance for the second quarter as well as discuss our guidance for 2018. Linda?

Thank you, Manny. For the second quarter ended June 30, 2018 total GAAP revenues were $20.3 million, representing 2.1% increase for the comparable quarter last year. As Manny mentioned earlier, domestic comparable store sales increased by 7.5% for the quarter. Included in our total revenues for the second quarter of 2018 is our owned restaurant net revenue of $17.6 million which increased approximately 5.7% compared to $17.1 million in the second quarter of 2017. The increase was primarily due to an increase of 6.2% comparable store sales for Company owned STK restaurants. Management license and incentive fee revenues decreased approximately 2.7% to $2.7 million in the second quarter of 2018, compared to $2.8 million in the second quarter of 2017. The decrease was driven by the timing and estimation of incentive fee revenue in the prior year. This was partially offset by the launch of the licensed STK in Dubai in December 2017. Owned restaurant cost of sales as a percentage of owned restaurant net revenues decreased to 26% in the second quarter of 2018 compared to 26.1% in the comparable quarter last year. The year-over-year decrease was primarily driven by the cost savings initiatives put in place at the restaurant level, partially offset by an increased cost for commodity items, particularly, beef prices. Owned restaurant operating expense held flat at $9.4 million in both the second quarter of 2018 and the second quarter of 2017. As a percentage of owned restaurant net revenues, operating expenses decreased, approximately 350 basis points to 86.6% in the second quarter of 2018 compared to 90.2% in the second quarter of 2017. This decrease in owned restaurant operating expenses as a percentage of owned restaurant net revenue is due primarily to the maturing of several of our owned restaurants and the cost savings initiatives put in place at the restaurant level, primarily in labor management, partially offset by the impact of minimum wage increases. On a total reported basis, general and administrative expenses for the second quarter of 2018 decreased $676,000 to $2.6 million compared to $3.3 million in the second quarter of 2017. As a percentage of revenues, general and administrative expenses decreased to 360 basis points to 12.9% of total revenue. The decrease in the G&A rate is a result of reductions in the overhead structure over the last year and additional leverage as a result of an increase in revenue. On a go forward basis, we continue to expect annual G&A to be about $9 million, excluding non-cash stock-based compensation. Restaurant preopening costs for the second quarter 2018 was $671,000, a decrease of $51,000 followed from the $722,000 incurred in the second quarter of 2017, as a result of the timing of the opening of STK San Diego. Interest expense net of interest income was approximately $290,000 in the second quarter of 2018 compared to $220,000 in the second quarter of the prior year. Income tax expense for the second quarter of 2018 was approximately a $169,000 compared to an income tax expense of $203,000 for the second quarter of 2017. For the second quarter of 2018, net income attributable to The ONE Group Hospitality, Inc. was a $181,000 or $0.01 per share compared to the net loss of $2.3 million in 2017 or $0.09 loss per share. Adjusted EBITDA attributable to The ONE Group for the second quarter was $2.5 million, an increase of 70.3% over the prior year adjusted EBITDA of $1.5 million. We have included as we have in the past, a reconciliation of adjusted EBITDA to GAAP net income from continuing operations and GAAP revenue to total food and beverage sales at owned and managed properties in the tables in the second quarter earnings release. I’d like to provide some forward-looking commentary on our business. This commentary is subject to risks and uncertainties associated with forward-looking statements as discussed in our SEC filings. We as always, remind our investors the actual numbers and timing of new restaurant openings for any given period is subject to a number of factors outside of the Company’s control, including weather conditions and factors under the control of landlords, contractors, licensees and regulatory and licensing authorities. Based on information available now and expectations as of today, here’s our updated outlook for 2018. Beginning with the top line, we continue to predict our total GAAP revenues to be between $80 million and $85 million. We also continue to estimate that total food and beverage sales at our owned and managed units will be between $170 million and $180 million. However, we now expect comparable store sales to grow at about 3% to 4%, which is up from the 2% to 3% previously guided. We continue to estimate total food and beverage costs to be approximately 25% to 26% for 2018. As approximately 70% of our base is under contract and the current estimate is based on negotiations with suppliers coupled with current and expected market conditions concerning fresh and other commodity items that we are either unable or currently elected not to contract for longer periods of time. We are modeling our adjusted EBITDA to be between $10 million and $10.5 million in 2018, which is up from our original expectation of between 9 million and $10 million. Putting all this together and if these target can be achieved, we now expect to generate growth in adjusted EBITDA of 40% to 50% in 2018, which is up from our previous guidance of 30% to 40% level. We now expect total capital expenditures, net of allowances received from landlords of approximately $3 million in 2018, which is related to one company-owned restaurant in San Diego, our intention to open in Nashville, and maintenance capital expenditures at existing venues. This is significantly less than prior years and reflective of our capital-light strategy. I will now turn the call back to Manny for closing remarks.

Thank you, Linda. Before we go to Q&A, I would like to reiterate the tremendous market opportunities that I see for the Company. The execution of our strategy to drive sales, enhance restaurant margins, reduce G&A, and grow our business in asset-light manner is making a real lasting impact on our organization, helping us strengthening our P&L, delever our balance sheet and enhance long-term shareholder value. None of this will be possible if not for the great efforts of our entire ONE Group team, a truly exceptional group of people who are committed to our plan as they are to provide a world-class hospitality to our guests. Thank you team and thank you all for joining us on the call today. Linda and myself are happy to answer any questions that you may have. Operator?

[Operator Instructions] Our first question comes from the line of Dave Cannon from Cannon Wealth Management. [Ph] Please proceed with your question.

So, couple of housekeeping questions for Linda. In the quarter, what was cash flow from operations and CapEx just for Q2?

For Q2, I think it was about $1.3 million for CapEx; and cash flow from operations, I just don’t have that.

It’s $2.3 million. So, David $2.3 million in cash flow and $1.3 million in CapEx.

CapEx was 1.3, okay. And as far as the -- it looks like the GAAP EPS, I guess was about a penny, but was there not one-time preopening expense for San Diego, that was what 670 -- so, should I look at that as kind of a nonrecurring item, on a go forward basis?

Yes. With opening Nashville, we will have preopening expenses, albeit it will probably be less than what we did in San Diego as we got a tremendous amount of learning on the timing of the activities for the opening. So, we will have little bit less for Nashville than we would have in San Diego.

Okay. And then, there’s a line item, owned food beverage and other net revenue. It was down year-over-year 2,083,000 versus 2,431,000. Linda, what does that relate to?

In Q1, you remember, we have the Super Bowl event. That’s the largest share of it on a year-to-date. So, in the quarter, the other location that’s included in -- the location where we have a restaurant and a food and beverage operation, and that is as well.

And that’s what’s with California. That’s a [Indiscernible] California.

I see. And then, if you could just clarify for the license fees. There was an explanation, there was some moving parts there in terms of I guess timing. Could you just explain that to me a little better? I didn’t quite grasp.

Yes. In some of our locations, we have a profit share agreement. And on a historical basis, the Company has not reported those until the end of the year. And we began to recognize that on an accrual basis last year. So, this quarter was a little choppy.

Last year’s second quarter, not this year’s.

Okay. And then, just last question, and then I’ll jump back into queue. Given that we’re at a run rate of $10 million and $10.5 million in adjusted EBITDA for the year, second half being stronger. Interest expense is actually up I see year-over-year. It looks like we are in pretty strong financial position in terms of refinancing our debt. Could you speak to that? Is there something going on there? And over the next year or so, what you see happening with your existing credit facility as well as mezzanine debt?

Yes. I think in the financial statements, I think we have some amount of capitalized interest that was put [ph] in last year because of the building that went on that we have less of that this year as well as some of the warrant interest [indiscernible]. As far as the financing, I mean, I think, we are openly understand how much of a cash drain our existing debt is now. So, we are depending on our -- looking at refinancing opportunities. Manny, do you want to add anything?

I think just from a general position, our trailing 12-month EBITDA is north of $8 million. So, we’re in a position now that from a credit profile, we are a very attractive company. So, the answer is, absolutely we are out looking. And I think there is lot for appetite and interest in doing something with this. So, overall, we can reduce our interest expense. And as Linda mentioned earlier, reduce our debt service per month, because right now we’re paying north of $300,000 a month in cash to service a small amount of debt. So, I think overall, both from a liquidity and long-term shareholder value, it creates an opportunity, I think it’s for the best interest that we do get a much stable and a better credit facility.

Our next question is from the line of Chris Krueger from Lake Street Capital Markets. Please proceed with your question.

When you look at your same-store sales for the quarter, was there any impact from the Easter shift that’s worth quantifying?

I mean, I think, in overall, the calendar might have been slightly beneficial to us, particularly at the end of the quarter because we’re shifting a weekend day. So, I think that was favorable. But, it wasn’t anything that’s meaningfully -- or would have changed the number, directionally in any way. So, I would say overall, the calendar was fine, nothing any material to talk about.

And then, looking at your half way through the third quarter, are same-store sales trends remaining in solid positive territory?

I mean, if you look at our guidance for the year, we’ve been doing extremely well for the first half. And I think our second half of the year outlook, if you just look at implicit in there is -- we believe it will be flat to somewhat positive. So, I would say that the momentum is good. And we came out of the second quarter with a lot of momentum, particularly in events, some of the other strategy that we’ve had in place. So, I would say that overall we feel very confident of sales. Obviously, in the fourth quarter, we are comping against a very large positive from previous year. But, overall, we have lots of confidence in the social initiative, all the stuff that we’re doing at the hotels is also very positive. So, I would say we have a tremendous amount of positive initiatives that I think will continue to carry sales for the rest of the year.

You just mentioned events, are you guys making efforts already at this time of the year for the holiday season, or is that just too early to talk about?

Yes. We don’t have -- it’s too early to talk about visibility into the fourth quarter. But, in terms of events, as we’ve described earlier, we have made structural changes late last year, early this year in terms of centralizing some of the management of those events from our New York office. And I do think that we’re seeing a payoff in terms of how that centralization is really helping and managing the field personnel here from New York. I think that’s been a net positive for us. And I believe that event business is extremely important because it exposes new people to the brand. So, as we continue building strength in that strategy, which we are, I think it really builds for strong comp sales in the long term. So, it’s very important in short-term. Long-term strategy, in terms of the fourth quarter books, we have not seen -- it’s too early to talk about. But we honestly have continuously a very robust demand for events all the year and still very robust right now. So I do think that will be a continued positive for the business.

When you look at your mix of sales, is anything changed, like for the percentage of sales coming from the bar, the high margin alcohol type of sales, or how should we look at that?

So, I think our mix is still around at 60-40 that we’ve historically seen. I do think that seasonally though, because when we you go through the summer months, I think we do pick up a little bit more bar and as well in a holiday season, we also pick very well in whine. But, it’s seasonal, but overall, the 60-40 is still the right mix.

Okay. You guys mentioned the opportunity with the hospitality deals, I think, you said you have to open one to two per year. I know, you haven’t mentioned any for this year. But, do you think -- is there pipeline visible enough to see one or two next year?

I mean, without providing guidance on that, I would say that our pipeline is super robust. We actually have some really, high-quality deals in the pipeline. So, actually, our job in turn right now, which I have spend some time with the team and is really defining which ones we want to do because we do want to make sure that we hit the higher quality from that pipeline. So, I would actually say that it’s more a rationalization of a very strong pipeline and really picking and choosing which deals we do want to do the next year, the year after. So, the answer is, I’m very encouraged by the quality of the deals that is in that pipeline. And we are just going through, as a management team, going through which one we want to prioritize.

And last question, are there any specific units that are outperforming the base by a meaningful margin or underperforming the base by meaningful margin?

I think, I’ll answer that question by saying we’ve brought the bottom up. So, our restaurants that were in markets like Denver and Chicago are really starting to come through on the sales as well as profitability, and we are super encouraged by what we saw in San Diego. It’s been incredible. People really have taken on to the brand in the city. So, it’s incredible to see how much momentum has came off the block with that site. We’re being very careful as to how we open that site. We’re making sure that we’re really building core business of what I call qualified STK diner. So, we are -- that’s probably something that we did different with San Diego is being very careful. But through the preopening activities that we are really driving people more serious about dining, and the vibe [indiscernible] for the bar component of the program. So, I think over time that bodes very well to build the super high quality consumer base in San Diego market. And actually one of the reasons why we were super excited when we were looking the Nashville market and we had an opportunity to bring in a company-owned store almost in like terms as license and management deal. So, our appetite based on that San Diego performances was actually -- it was a good starting point in terms of thinking that Nashville maybe is a great opportunity for us as well. So, we’re super excited about that. So, the answer is bottom-up. And from a top perspective, all of our top locations in New York and Vegas are performing extremely well in both sales and profitability.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Manny Hilario for closing remarks.

Well, thank you everyone for attending the call today. And we obviously appreciate your support for The ONE Group. And Linda and I look forward to running into you at our restaurants. So, see you at one of our STKs or one of our hotel properties. Thank you.