The ONE Group Hospitality, Inc. (STKS) Q2 2019 Earnings Report, Transcript and Summary

Greetings, and welcome to The ONE Group Hospitality Second Quarter 2019 Earnings Conference Call. At this time, all participants are in listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Tyler Loy. Thank you. Please begin.

Thank you, operator, and good afternoon. Before we begin our formal remarks, we must remind you that part of our discussion 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 opinions 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 Hilario. Manny?

Thank you, Tyler, and we appreciate everyone's continued interest in The ONE Group. I'm pleased to report the strong sales momentum we experienced in the first quarter of 2019 continued into the second quarter as well. Specifically, we reported an increase in total revenue of 16.2%, including a 6.4% increase in domestic same-store sales as we lapped a challenging comp comparison of 7.5% from the prior year quarter. This resulted in a two-year comp of 13.9%, a level of performance that well exceeded our closest public company peers and demonstrates once again that we offer something that is truly unique, which we refer to as vibe dining and is a real differentiator, both in our eyes and in the eyes of our guests. Importantly, most of our comp growth was generated through increases in traffic and mix as we benefit from only a modest price increase in January. This sales momentum has cascaded into the third quarter. With respect to our key profitability metric, adjusted EBITDA, we knew that rolling over the significant growth that we experienced in the second quarter last year would be difficult, and this obviously proved to be correct. There were a number of factors that led to our year-over-year decline as I will now explain. First, we experienced operating inefficiencies at our new STK locations, which take time to scale up to normalized operating margins. That said, we are incredibly pleased by our sales volumes at our new stores, specifically our newest STK in Nashville, which opened in March. The restaurant is off to a great start with fantastic weekly sales, but it will take some time, typically 6 to 9 months, to reach economies of scale. Second, we have temporarily lost the patio at the STK Midtown, due to a surrounding construction. This was a profit center for dry rations because of its high-margin bar business and generated significant EBITDA for the company as a whole. We have since retooled our market for this location to focus on the lunch and pre-theater business and are beginning to build back overall sales. We have also worked on a rate concession with the landlord that will begin in the third quarter and save the company over $225,000 annually. Third, cost of sales were higher than we had anticipated due to a temporary spike in large premium shrimp costs that we use in our very popular seafood towers. We chose to keep this item in our menu and not take additional price. However, we have since contracted on shrimp on a six-month basis at a more favorable price, and we are evaluating other supply chain efficiencies. And finally, we were negatively impacted by the weaker British pound and euro relative to the dollar, which hurt our managed and licensed locations in the United Kingdom and Italy. Still, against this backdrop, we remain comfortable with our full year guidance as Tyler will reiterate shortly. And, of course, as we have discussed on previous conference calls, we will continue to execute against our four key strategic initiatives. Number one, driving same-store sales. As you know, sustainable same-store sales growth across all of our restaurants is critical to strengthening our business, managing inflation, and of course, increasing profitability. We know that to do so, we must ensure that the guest has an exceptional and differentiated vibe dine experience across all touch points. Amongst several strategies, we have emphasized the happy hour and predinner time frames as means to encourage trials and turning those experiences into full sit-down meals. We have also emphasized group dining by centralizing our event sales leadership and refining the event business model. Our unique dining experiences are perfectly suited for events or group dining, and we intend to continue capitalizing on this great opportunity going forward. Number two, improving operational efficiencies in our restaurants. Next, we continue to identify areas within our four walls where we can drive operational efficiencies without negatively impacting our vibe dine experience. These efforts were largely obscured by the mitigating factors that I mentioned earlier. But as we look ahead, we think we are still early in the process of our margin expansion program, and we'll benefit from growing economies of scale. Examples include menu optimization, more favorable service contracts and improved labor scheduling. Our turnover rates also remain considerably lower than the industry because of our focus on retaining employees, which reduces training costs and ensures a better and consistent guest experience. Our servers also benefit from our restaurant high volumes, which, in turn, creates fantastic income opportunities for them. Number three, reducing G&A at the corporate level. Reducing G&A at the corporate level represents another area of opportunity where we have and will continue to make headway through our focus on best practices and cost savings measures. G&A declined 140 basis points to 11.5% of total revenues in the second quarter, and adjusted for stock-based compensation, G&A decreased 170 basis points to 9.5% of total revenues. G&A leverage is due in part to increasing revenues, while reducing headcount, hiring better and changing to lower-cost outside vendors and service providers. We also expect G&A to further leverage as we continue to scale. The annual adjusted G&A, excluding stock-based compensation, is projected to run at less than 10% of total GAAP revenue, a significant decrease from our historical performance. Number four, focusing on asset-light growth. Finally, our development growth is focused primarily on high-margin, asset-light deals for managed and licensed STK restaurants as well as F&B venues. Earlier this year, as you know, we opened one international licensed STK in Doha at the newly renovated Ritz-Carlton Hotel and a company-owned STK in Nashville, Tennessee in the Gulch neighborhood between Music Row and Downtown. Both restaurants are off to great starts due to our success in creating unique guest dining and hospitality experiences that we intend to build upon. During the remainder of the year, we plan to open an additional 2 to 4 STK restaurants. This includes a licensed STK restaurant in Puerto Rico and a managed STK location in Scottsdale, Arizona. We'll also add 1 to 2 food and beverage venues, including a managed F&B location in Florence, Italy. Longer term, we have a robust pipeline for 2020 and 2021 to continue expanding our company and the STK brand as we are in the early stage of capturing our global opportunity. We view an addressable market for approximately 200 locations across over 75 major metropolitan areas, including company-owned STKs, licensed STKs and managed F&B and STK location. This represents an excess of $1 billion in system-wide food and beverage revenue opportunity. With that, I would now like to turn the call back to Tyler. Tyler?

Thank you, Manny. For the second quarter ended June 30, 2019, total GAAP revenues were $23.6 million, representing a 16.2% increase from the comparable quarter last year. As Manny mentioned earlier, same-store sales at owned and managed STK restaurants rose 6.4%. Included in our total revenues for the second quarter of 2019 is our owned restaurant net revenues of $18.8 million, which increased approximately 21.2%, compared to $15.5 million in the second quarter of 2018. The increase was primarily due to an increase of 7.8% in same-store sales for domestic company-owned STK restaurants, coupled with the opening of STK San Diego in July 2018 and STK Nashville in March 2019. Management license and incentive fee revenues were flat to prior year at $2.7 million in the second quarter of 2019. These revenues were driven by the launch of the licensed STK Dubai Downtown in July 2018, STK Mexico in August 2018 and STK Doha in January 2019, coupled with an increase in performance at other locations. These increases were offset by the loss of management fee revenue from One 29 Park management agreement, which terminated on September 30, 2018, coupled with negative currency effects of a weaker British pound and euro related to our managed and licensed locations in the United Kingdom and Italy. Owned food, beverage and other net revenues were flat at $2.1 million in the second quarter of 2019 and the second quarter of 2018. Owned restaurant cost of sales as a percentage of owned restaurant net revenues increased 90 basis points to 26.9% in the second quarter of 2019, compared to 26% in the comparable quarter last year. The year-over-year increase was a result of the opening of STK San Diego and STK Nashville as our new restaurants faced operating inefficiencies in their first 6 to 9 months of operations. Additionally, we saw an increased food sales mix compared to beverage mix, which is related to the patio closure at our Midtown East location, which had previously done a significant and highly profitable bar business and experienced higher food inflation, particularly for large premium shrimp. We have since made a six-month purchase on this product that will yield savings relative to the short-term spike. This was partially offset by the cost savings initiatives put in place at the restaurant level across the company-owned units, coupled with selective price increases that we took at the beginning of the year. Owned restaurant operating expenses as a percentage of owned restaurant net revenues increased approximately 240 basis points to 63% in the second quarter of 2019, compared to 60.6% in the second quarter of 2018. The increase is due to the impact of minimum wage increases and the opening of STK San Diego and STK Nashville. This was partially offset by the cost savings initiatives put in place at the restaurant level, primarily in labor management, along with the leverage provided by our sales increase. On a total reported basis, general and administrative expenses, including stock-based compensation for the second quarter of 2019, was $2.7 million, compared to $2.6 million in the prior year. As a percentage of total revenues, general and administrative expenses decreased 140 basis points to 11.5% of total revenues. The decrease in G&A rate is a result of reductions in the overhead structure over the last year and additional leverage as a result of increase in revenues. On a go-forward basis, we would expect annual adjusted G&A to run less than 10% of GAAP revenue, excluding noncash stock-based compensation. This is a further improvement over our historical performance of 11.5% in 2018, 13.6% in 2017 and 14.2% in 2016. When adjusting for stock-based compensation, adjusted general and administrative costs decreased to $2.2 million in the second quarter. As a percentage of revenues, adjusted general and administrative expenses decreased 170 basis points to 9.5% of total revenue. Restaurant preopening costs for the second quarter of 2019 were $0.1 million, a decrease of $0.6 million from the $0.7 million incurred in the second quarter of 2018. This decrease was related to the timing of the STK Nashville and the STK San Diego opening. Interest expense, net of interest income, was approximately $0.2 million in the second quarter of 2019, compared to $0.3 million in the second quarter of the prior year. During the quarter, we entered into a new credit facility with Bank of America, which should save the company approximately $400,000 per year in interest expense on an annual basis. Note that costs associated with the refinance and the registration of shares issuable under the company's 2019 Equity Incentive Plan were nearly $600,000 for the quarter. Income tax benefit for the second quarter of 2019 was nominal, compared to an income tax expense of $169,000 for the second quarter of 2018. For the second quarter of 2019, net loss attributable to The ONE Group Hospitality was $322,000 or $0.01 loss per share, compared to net income of $181,000 in 2018 or $0.01 per share. Normalized for the costs associated with the new credit facility and the registration of shares issuable under the company's 2019 Equity Incentive Plan, net income for the quarter would have been $207,000 or $0.01 per share. Adjusted EBITDA attributable to The ONE Group for the second quarter was $2.1 million, compared to the prior year adjusted EBITDA of $2.5 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 table in the second quarter earnings release. Now, 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 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 the company's control, including weather conditions and factors under control of landlords, contractors, licensees and regulatory and licensing authorities. Based on the information available to us now and our expectations as of today, we are updating the following financial targets for 2019. Beginning with top line, we project our total GAAP revenues to be between $95 million and $97 million. We expect same-store sales for the year to grow at approximately 4% to 6%. And as a reminder, we're lapping very strong comparisons from 2018, both in the quarter just reported and for the balance of the year. Based on the information available to us now and our expectations as of today, we are reiterating the following financial targets for 2019. We estimate that total food and beverage sales at our owned and managed units will be between $190 million and $200 million; we estimate total food and beverage cost to be approximately 25% to 26%; approximately 50% of our beef is under contract, and the current estimate is based on negotiations with suppliers, coupled with current and expected marketing conditions concerning fresh and other commodity items that we are either unable or have currently elected not to contract for longer periods of time; total annual G&A, excluding stock-based compensation of approximately $8 million or less than 10% of revenues; we're expecting adjusted EBITDA of $13 million, which would represent an approximate 25% growth compared to 2018; total capital expenditures, net of allowances received from landlords, of approximately $3 million to $4 million; and finally, 3 to 5 licensed restaurant units, 1 company-owned STK and 1 to 2 food and beverage hospitality venue. With that, I'll now turn the call back to Manny for closing remarks.

Thank you, Tyler. As you can see, we are taking our second quarter results in stride and remain confident that we can deliver on our full year expectations. I should add that even though we are only in August, our holiday party bookings are already looking great, and we think we can build on this early momentum through our great marketing and event promotion efforts. As always, let me end my remarks by thanking our ONE Group team for making everything that we do possible on behalf of our guests and shareholders. We have a plan in place that we are executing and envision a tremendous opportunity for expansion of the STK brand around the world. Thank you, team, and thank you all for joining us on the call today. Tyler and myself are happy to answer any questions that you may have. Operator?

Thank you. [Operator Instructions] Our first question comes from Mark Smith of Lake Street.

Hi, guys. Just a couple of quick ones for you. First, if we look at Nashville, is it following fairly historical trends of inefficiencies? Or is there anything else going on there or in San Diego?

No. I think they're following the typical path for us in terms of, I would say, inefficiencies in the P&L, on the middle of the P&L. But from a top line perspective, Nashville has been very strong for us. So, I would say the answer is typical early inefficiencies and great top line. And I think we're really starting to get that operations out then. So, I feel very strong about that one. And then San Diego it's just a seasonal market. The second quarter relative to the other quarters is a lower seasonal from a sales perspective. And as you think as we go out to third, fourth quarter, we'll pick up pace there as well. So, typical operating inefficiencies.

Okay. And then, Tyler, I don't know if you quantified this or if I missed it. Can you quantify or talk at all about kind of the total impact of exchange rates and the impact that, that had?

Yes. So, the impact on exchange rates for the management license channel was probably between, I'd say, it's around 100,000 for the quarter.

Okay. Perfect. And then anything else as we look at commodities? I know you guys talked about shrimp going on contract and a lot of your beef there. Anything else that's going on? Or what do you look at when you guys see kind of the commodity market today?

Generally – this is Manny. Generally, we've been pretty – it's been very efficient as we contract the majority of our beef or over 50% of it. And only in this quarter, we did get a bit of a surprise on shrimp. I don't know for – if you follow the shrimp market or not, but the super high-end shrimp, which is what we have in our platters and it's a very high utilization product for us, the U8 sort of really big shrimp market gets supply shortage there. So, we have to play an incremental cost per pound on it. But our choice was we didn't want to dummy down the product, so we kept them on the menu as long as we had to and then we contracted. And as I think we mentioned on our prepared comments, we've locked in into a very strong contract for, I think, 30,000 pounds of shrimp. So, we should be okay with shrimp. In terms of all the other commodities, nothing really that interesting going on in our basket of products right now.

Okay. And then just the last one for me. Any additional guidance or insight into timing of new openings? Or even if you can speak generally about how the new units are kind of moving along at this point?

Yes. I mean so Florence, Italy, which is an F&B deal, is very [technical difficulty] probably be the next one that we'll do an announcement on. Puerto Rico is built. We're actually in the process of training the team right now. So, that will come thereafter. And then Scottsdale will come late in the fourth quarter as an opening.

Perfect. Thank you.

This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Hilario for any closing remarks.

Thank you. And as always, we thank you for your continued interest in The ONE Group, and we look forward to seeing you in our restaurants. Thank you, operator.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.