Ruth’s Hospitality Group (RUTH) Q2 2018 Earnings Conference Call Transcript

Ruth's Hospitality Group (RUTH)
Q2 2018 Earnings Conference Call
Aug. 10, 2018 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to today's Ruth's Hospitality Group second-quarter 2018 earnings conference call. [Operator instructions] As a reminder, today's conference has been recorded. I would now like to turn the conference over to Mark Taylor, vice president of financial planning and analysis.

Please go ahead, sir.

Mark Taylor -- Vice President of Financial Planning and Analysis

Thank you, Tracy, and good morning, everyone. Joining me on the call today are Michael O'Donnell, our executive chairman; Cheryl Henry, our president and chief executive officer; and Arne Haak, executive vice president and chief financial officer. Before we begin, I'd like to remind you that part of our discussion today will include forward-looking statements. These statements are not guarantees of our future performance, and therefore, undue reliance should not be placed upon them.

We would like to refer you to the Investor Relations section of our website at rhgi.com as well as the SEC's website at sec.gov for copies of today's earnings press release and our recent filings with the SEC for a more detailed discussion of the risks that could impact our future operating and financial results. During this call, we will refer to adjusted earnings per share. This non-GAAP measurement was calculated by excluding certain items as well as losses from discontinued operations. We believe that this measure represents a useful internal measure of performance.

You can find a reconciliation of adjusted earnings per share in our press release for today's call. I would now like to turn the call over to our executive chairman, Mike O'Donnell.

Michael O'Donnell -- Executive Chairman

Thank you, Mark, and thank you all for joining us on this call this morning. We are pleased to announce second-quarter results, which demonstrated a continuation of our momentum from the start of the year. Highlights of the quarter include total revenue growth of 9.6%, net income growth of 22.6%, and non-GAAP diluted earnings-per-share growth of 26.6% to $0.32. All of our restaurants contributed to the revenue growth in the quarter, including our comp restaurants, noncomp restaurants as well as the six Hawaiian restaurants we acquired in December.

We continue to be very pleased with the performance of our Hawaiian restaurants and they delivered sales and profit growth at or above our expectations. We were in the final stages of integration, and I am proud to note that there has been no turnover in the management teams of these restaurants. We remain committed to being leaders in the fine dining steakhouse category, which we have achieved through our unrelenting focus on operational excellence. The Ruth's' Chris Steak House experience is the foundation of our brand and is responsible for the consistency of our results over the years.

This consistency allows us to execute our total return strategy, creating long-term value for all our stakeholders. As we've discussed before, successful execution of this strategy is accomplished by investing in our core business, growing in a disciplined fashion, and returning capital to our investors. Our first priority will always be our core business and protecting the brand that so many have worked hard over -- for over the last 30-plus years to create. To strengthen the brand and evolve today's consumer -- and evolve with today's consumer, we continued our Ruth's 2.0 restaurant remodel efforts during this quarter, which both enhances the guest experience and allows us to expand our operating capabilities.

We remain on track for seven to nine remodels in 2018. Furthermore, we are investing 20% to 30% of our 2018 tax savings into our core business in the form of brand, sales driving, and people initiatives. The second part of our strategy is growing brand in a disciplined fashion, and we continue to work diligently to build our development pipeline. We expect to open two new restaurants during the balance of 2018.

The first location will be in Jersey City, New Jersey, here in the third quarter and another in Paramus, New Jersey, in the fourth quarter. Additionally, we currently expect a management agreement restaurant in Reno, Nevada, to open early in the first quarter of 2019. This partnership with Eldorado Resorts will be our third casino location operating under a management agreement similar to our successful restaurants in Tulsa, Oklahoma, and Cherokee, North Carolina. We're also actively negotiating leases for additional sites to meet our investment criteria for development as we build our real estate pipeline for 2019 and beyond.

Also supporting our growth efforts are our franchise partners, who continue to invest in new restaurants and expect to open two locations in 2018. The first of these franchise locations opened quite successfully in Fort Wayne, Indiana, during the second quarter, and we are currently expecting the second to open in Markham, Ontario, during the fourth quarter of this year. The final component of our total return strategy is returning capital to our shareholders. To that end, our board of directors recently approved the payment of a quarterly cash dividend of $0.11 to shareholders, which is a 22% increase over the quarterly dividend paid in August of '17.

Since the beginning of 2011, we've returned over $200 million to our shareholders in the form of dividend repayments -- dividend payments and share repurchases, and we continue to believe that our total return strategy is the best way to drive long-term shareholder value. Now before I turn the call over, I'd like to briefly comment on our executive management transition, which we announced in early June. Today, Cheryl Henry transitions from president and chief operating officer to president and chief executive officer, and I will assume the role of executive chairman. This transition is part of a multiyear planning process, and I couldn't be more pleased with Cheryl.

During the 11 years that she has spent here at Ruth, she has managed every commercial aspect of our business and is eminently qualified to lead this organization. A clear strategic direction has been set for the company. The company is in excellent shape and much of our success can be directly attributable to the initiatives led and implemented by Cheryl and her team. I look forward to supporting Cheryl in my new role as executive chairman.

With that, I will now turn the call over to Cheryl, who'll give some more color on our revenue performance before Arne provides detail on the second-quarter results. Madam CEO?

Cheryl Henry -- President and Chief Executive Officer

Thank you, Mike. Our restaurant operations team contributed a strong performance this quarter across all three of our key revenue segments. During the quarter, our special-occasion business again drove comparable restaurant sales growth. We saw solid year-over-year sales growth on both Mother's Day and Father's Day as guests continue to choose Ruth's Chris when celebrating these special moments.

We also experienced growth in our private dining and [Indiscernible] segments. This resulted in comparable-sales growth of 1.3% against a 0.1% decline in traffic. As a reminder, we experienced a 70-basis-point headwind in the second quarter due to the timing of the Easter holiday. I'm pleased to see that our traffic growth is significantly higher than the Black Box Fine Dining Index.

Our franchise partners, who remain the heart and soul of our business, also had a solid quarter, with total franchise comp sales up 1.3%. While sales trends in our international markets were not as strong as those in the U.S. our partners saw improving comparable sales trends throughout the quarter. As we look at the third quarter to date, our sales teams remain consistent with the trends we've seen so far this year.

Through this point in the third quarter, our comparable sales have been running flat to up low single digit year over year. With that, I'd like to turn the call over to Arne to go through our financial details.

Arne Haak -- Chief Financial Officer

Thank you, Cheryl.For the second quarter ended July 1, 2018, we reported net income of $9.6 million, or $0.32 per diluted share. This compares to net income of $7.8 million, or $0.25 per diluted share, during the second quarter of 2017. Net income in the second quarter of 2018 included $400,000 in deal-related expenses associated with the acquisition of our Hawaiian franchisee and the $300,000 income tax benefit related to the impact of discrete income tax items. Excluding these items, as well as the result from discontinued operations, our non-GAAP diluted earnings per common share were $0.32, up 26.6%, compared to $0.25 in the second quarter of last year.

Total company-owned restaurant sales for the second quarter were $103.5 million, an increase of 10% over last year. The increase was driven by the contribution from our new restaurants, including those acquired in Hawaii. Total operating weeks for all company-owned restaurants were 1,001, up 10% year over year from 910 in the second quarter of last year. This included an additional 78 operating weeks in the quarter from the acquisition of our Hawaii franchise restaurant.

Total franchise comparable sales increased 1.3% year over year. Comparable sales in our domestic franchise restaurants were up 3% during the quarter and comparable sales in our international franchise restaurants were down 7%, largely driven by softness in our Asian restaurants and certain Canadian locations. Franchise income in the second quarter was $4.5 million, up 4.7% versus the prior year. The increase in franchise income was driven by an increase in comparable sales, the reclassification of franchisee advertising contributions from marketing and advertising franchise income as well as the recognition of $1,000 in franchise development and site-specific fees.

Our franchise income was also reduced by $400,000 as a result of the acquisition of our Hawaii restaurant. Now turning to our costs. Food and beverage costs as a percentage of restaurant sales decreased 180 basis points year over year to 28.1%. This decrease was primarily driven by a 10% decrease in total beef costs as well as by 1.4% increase in average checks.

Last summer, beef prices were driven to record high levels due to increased retail demand for prime beef. This year, we have not experienced increased retail demand, and as a result, we now expect full-year beef deflation of 1% to 4%. We currently expect this deflation to be the highest in the third quarter before returning to more normal levels in the fourth quarter. For the quarter, our restaurant operating expenses as a percentage of restaurant sales increased 50 basis points year over year to 48.3%.

The increase was primarily driven by an increase in occupancy expenses as a result of the acquisition of our Hawaiian restaurants. Our G&A expenses as a percentage of total revenues were up 40 basis points year over year at 8.5%. The increase as a percentage of total revenue was also largely driven by additional costs related to the integration of the recently acquired Hawaiian restaurants. Marketing and advertising costs as a percentage of total revenues increased 80 basis points to 4.2%.

The increase was primarily attributable to the previously discussed accounting in revenue recognition changes of franchise marketing contributions as well as a planned increase in advertising spending. Preopening costs were $272,000, compared to $173,000 in the second quarter of 2017, driven by the timing of new restaurant openings. Income tax expense declined from $3.6 million in the second quarter of 2017 to $1.8 million, largely as a result of the enactment of the Tax Cuts and Jobs Act. As Mike mentioned during his remarks, we are reinvesting approximately 20% to 30% of these tax savings into our core business in the form of brand, sales driving, and people initiatives.

During the quarter, we repurchased just over 224,000 shares of common stock for $5.9 million, or $26.46 per share. At the end of the second quarter, we had $44.7 million outstanding under our previously announced $60 million share-repurchase authorization. We ended the quarter with $50 million in debt outstanding, up $7 million from the previous quarter, largely driven by increased capital expenditures as well as the timing of share repurchases. Now turning to our guidance.

I'd like to provide our revised outlook based on current information for the full year of 2018 for some of our key financial metrics. As Cheryl shared with you previously, we are pleased with the current cadence of our calendar comparable sales so far in the third quarter. As a reminder, the 53rd week in 2017 will have the minimal impact on our third-quarter sales. We expect the fourth quarter this year to once again be our strongest revenue quarter, but as a result of last year's 53rd week, the timing of the New Year's Eve holiday will provide a revenue headwind that we currently estimate will exceed $3 million in the fourth quarter.

Based on our current expectations of beef deflation in 2018 provided earlier in this call, we now expect our cost of goods sold to be in the range of 28% to 30% of restaurant sales. We continue to expect restaurant operating expenses to be between 47% and 49% of restaurant sales. We continue to expect marketing and advertising cost to be between 3.8% and 4%. We now expect G&A expenses to be between $33 million and $35 million, excluding Hawaii integration cost.

We now expect our annual effective tax rate to be between 17% and 19%, excluding the impact of discrete income tax items. We currently expect our capital expenditures to be between $30 million and $32 million and could grow depending on the timing of additional new unit openings. We continue to expect our fully diluted shares outstanding to be between 30.5 million and 31 million shares, exclusive of any share repurchases under the company's share repurchase program. With that, I'd now like to turn the call over to Tracy for any questions that we might have.

Questions and Answers:

Operator

Thank you, sir. [Operator instructions] We will now take the first question from Brian Vaccaro from Raymond James. Please go ahead.

Brian Vaccaro -- Raymond James -- Analyst

Good morning, and thanks for taking my questions. Wanted to start off with sales performance during the quarter, and it's encouraging to see your traffic share gains accelerate in the period. I was wondering first if you could quantify the outperformance versus the Black Box high-end segment that you called out? And then what do you think is driving that outperformance? It does seem that some competitors may be have pulled back on discounting. Do you think that's reinforcing your value positioning or any other dynamics worth highlighting?

Cheryl Henry -- President and Chief Executive Officer

Yes, Brian, thanks for the question. You asked about the index and the outperformance. As we look at it, we quantify just over 200 basis points from the traffic side. And I think to your question about this less discounting, more discounting, we've seen probably an increase in promotional activity from competitors, especially through June and July.

I'll tell you, and Mike mentioned it, I cannot stress the importance of executing the brand experience. And Mike also talked about the investments we're making around development and retention of our employees and ensuring that we're executing on that experience every time. And Arne mentioned the strength in all of the segments of the business. So I think some of the initiatives that we've been working on and talking about are kicking in the continued focus on execution from the ops teams.

And again, I can't say that I've seen lessening of promotions, if you will, from the competitive set, but that's something I think that, as we look through the year, we'll probably continue to see. Arne...

Brian Vaccaro -- Raymond James -- Analyst

OK, that's helpful. Thank you. And also, curious looking about the industry environment within the high-end space, is there any evidence that changes in the tax law around deductibility for certain entertainment expenses? Any evidence that that's having an impact on your business?

Cheryl Henry -- President and Chief Executive Officer

Yes. We're aware of it, but we haven't really seen any indication that that's having an impact.

Brian Vaccaro -- Raymond James -- Analyst

OK, OK. And if I can just shift gears, couple on the food cost line. Arne, thanks for the beef deflation comment in the second quarter. What was the overall deflation on the basket in the quarter?

Arne Haak -- Chief Financial Officer

In the quarter, we were running down around 3% for the quarter.

Brian Vaccaro -- Raymond James -- Analyst

OK, OK. And in terms of the updated annual COGS guidance, what does that assume in terms of deflation on the overall basket, you were specific about beef, which was helpful. But are there some other items we should be cognizant of? And could you help us with the overall basket deflation expectation?

Arne Haak -- Chief Financial Officer

Yes, sure. The overall basket, I think -- we're clear I think in the trough right now, the best deflation that we're going to see. For the full year, we've actually been experiencing some pressure on some seafood items, and obviously, the tariff situation can be dynamic there as well. So I don't know that we're prepared to give you like an overall COGS basket deflation.

But this is probably the strongest it's going to be in terms of the quarters, here in the second and third quarters.

Brian Vaccaro -- Raymond James -- Analyst

OK, OK. And last one just on the COGS ratio. Taking into account how high and different the comparisons are, if you will, third-quarter COGS ratio versus fourth quarter, are there any discrete items that we should keep in mind that might cause the COGS ratio third quarter versus fourth quarter to be materially different? Or is it reasonable to assume sort of a more stable COGS ratio sequentially moving forward? Thank you.

Arne Haak -- Chief Financial Officer

Brian, I don't -- I can't think of anything in terms of the COGS ratio that's unique to the third quarter other than the normal seasonality of sales. I guess -- here in Florida, we're always hopeful that the hurricane season stays benign. And we had a fairly active season. We had 20% of our restaurants in September of last year impacted by hurricanes.

And so we're hopeful that that would not repeat itself.

Brian Vaccaro -- Raymond James -- Analyst

All right. I'll pass it along. Thank you.

Operator

We will now take our next question from Joshua long from Piper Jaffray.

Joshua Long -- Piper Jaffray -- Analyst

Great. Thank you for taking my question. Congratulations for all of your transition. I imagine the answer is going to be a lot more of the same consistent execution and focus on the brand going forward.

But curious on, as you go through this transition, what your kind of first order of business? And how you're going to be focusing on the brands in your new role?

Cheryl Henry -- President and Chief Executive Officer

Sure, thanks for the question. I was thinking about it. And I was pretty sure someone would ask me what the next 90 to 100 days look like. And I'm fortunate that I have 11 years here.

So they do look kind of -- as we sat as a senior team for the past years and set the strategy out, they look very similar. I think Mike stated, we have our strategy, we have the team to implement it, and so my sole focus is making sure we do that, probably over the last year about the idea that we live in more of a constant state of evolution to meet the consumer demand. So there will be more to come and more to talk about as we start rolling things into the system. But again, the focus is on total return strategy and working with this great team to continue doing what we've been doing.

Michael O'Donnell -- Executive Chairman

Actually, I've expectation you're going to do a better job than I do.

Cheryl Henry -- President and Chief Executive Officer

Thanks, Mike.

Joshua Long -- Piper Jaffray -- Analyst

That definitely makes sense. And shifting gears to the remodels. Nice to see that seven to nine are still on track. Curious what you've learned as you've gone through this? I know we've talked it over multiple conference calls, but there is always a variety of packages that you can put in place across the different systems, every unit might need something slightly different.

So curious on how you're seeing that progression roll out. And then, if you can remind us where we are in terms of touching all the different units in the system? Trying to get a sense of what the remodel opportunity might look like for 2019.

Cheryl Henry -- President and Chief Executive Officer

Sure. I'll take a bit of it, and I'll turn it to Arne. So I think when we started talking about this program remodel, we kind of had buckets or categories of different remodels from adding capacity to really bringing them up to the brand 2.0 to changing bars. And I think the early ones we've done -- so to your question about how many will you have done at this point, we're close to 28 or 29 and continue to look at between seven and 10 a year through the system.

I think the ones that we've identified as having opportunity around capacity, we've seen them pull through on that expectation. The other is around brand or doing what we expected them to do and it really is about maintaining the consistency of the sales and being relevant to our guests. Arne, if you want to weigh in a little bit on expected capital and how that looks going forward?

Arne Haak -- Chief Financial Officer

Josh, I think it's going to be a fairly consistent sized piece of our CapEx, as we go forward by a year, we kind of targeted that. The capacity -- as Cheryl mentioned, the capacity -- when there are opportunities to add capacity, those provide the best returns as it really provides the catalyst to grow sales. There's not a lot of those, and each one is a case-by-case situation. So I think we feel good about it.

We have a good understanding of what the money needs to do for us and it's been delivering it. And going way back to Brian's question, I think, continuing to consistently invest in the brand may be what's driving some of the traffic gains as well.

Joshua Long -- Piper Jaffray -- Analyst

Absolutely. Curious on the 20% to 30% of the tax savings that you've reinvested. If you could remind us kind of how we're using those? I know you mentioned brand, sales driving, and people retention, but anything more specific you could add or maybe looking at it differently, how many -- does that touch the entire system? Is that going to be used strategically in certain parts of the portfolio? Just trying to get a sense around how those dollars would be rolled out and spread across your portfolio?

Arne Haak -- Chief Financial Officer

I think it's a great question, like, where are they? And they're kind of sprinkled. Some of them are in the restaurant line. So there's some very targeted people initiatives, like we have key people that we think are important, and we're doing some things with them. We also have some broader initiatives at the restaurant level as well that -- because we think that's also very important.

Some of it is also in marketing and then some of it is also in the G&A line. So those are the three places where you're kind of seeing the money.

Joshua Long -- Piper Jaffray -- Analyst

Got it. Thank you. And then last one from me. In terms of just thinking about the disparity between the franchise same-store sales, the domestic has been pretty strong obviously than the international.

Seems like we've been talking about the Asian and Canadian softness here for a little while. If you could remind us kind of what's driving that? If it's just more macro concerns or there may be some pointed issues in some of those markets that would be worth noting? And then, anything that we might lap over as we go to the back half of 2018 or into 2019 that we should just keep on the radar to be aware of?

Michael O'Donnell -- Executive Chairman

Yes, this is Mike. This is some -- I think we've talked about it before, but sort of geopolitical issues in -- that have been affecting Asia, particularly Taiwan and Hong Kong. China has changed some of their tourism rules and regulations and it has not been as robust. And Canada has had some challenges around certain things.

They had to do the oil business for a while. And I think they're -- I think that they will recover a little bit faster than the Asian restaurants. Although I must say that our Asian franchisee Stanko is a fabulous franchisee integrated businessman and is doing a great job in weathering the softer sales and continuing to build restaurants and continuing to invest back into this business.

Joshua Long -- Piper Jaffray -- Analyst

Great. Thank you for that. I'll pass it along.

Operator

[Operator instructions] We will now take our next question from Andy Barish from Jefferies. Please go ahead.

Andy Barish -- Jefferies -- Analyst

Good morning. Hey, Arne, is there a difference in the calendar and fiscal, I'm not sure if I may have missed that, same-store sales number this quarter?

Arne Haak -- Chief Financial Officer

Nothing. Nothing really from the 53rd week other than the Easter shift, which we called out, which was 70 bps on the quarter.

Andy Barish -- Jefferies -- Analyst

OK. And then on the domestic franchise sales running higher than the company-owned, is there sort of more remodel effort going on in the franchise system as well? And maybe Cheryl can give a sense of where the franchisees stand in terms of kind of modernization of their restaurants?

Cheryl Henry -- President and Chief Executive Officer

Sure. Let me -- and I'll turn it to Arne in just a second, but -- we looked at the quarter for the franchisees, I think it's a couple of things. There is some additional price. The traffic is somewhat in line.

There is some price in there. And then there are four, five restaurants. And to your point, a couple of remodels that are performing well for our franchisees, they are, I would say, more aligned as they go forward in through their remodels. I know Mike can speak to just up in Savannah and saw a fantastic remodel.

They're really investing back more and brought into 2.0. So we're really glad to see that. Arne, [indiscernible] if you have anything you want to add.

Arne Haak -- Chief Financial Officer

Yes. The only other thing, chiming on that, Puerto Rico is rebounding very nicely after a very disappointing last year. And the second thing is that, as Cheryl said, the remodels, the restaurants. When we look at domestic franchisees that have the biggest growth in sales and traffic, they are ones that have invested in remodels or in -- in particularly the ones that have -- there's a couple of them that had some capacity opportunities and those are -- as we said, they are paying off as well.

I think they are a little earlier in the innings of remodel. So there is some good runway there as well.

Andy Barish -- Jefferies -- Analyst

Great. And then, just finally on the price mix in the 2Q?

Arne Haak -- Chief Financial Officer

Sure. In terms of the mix, I think we're really pleased with all three. As Cheryl mentioned in her comments, all three of our segments, as we look at, had positive sales. The bar, private dining, and business are kind of growing a little bit faster.

In the restaurant revenues, I know we've got a little bit of mix shift, and I don't think is anything particularly concerning, it's -- we're seeing a little bit higher preference on the Ruth's Classics, but still -- but it's still in line kind of with historical norm, just moving a little bit. We have just a little bit over 2% in price across the whole restaurant.

Andy Barish -- Jefferies -- Analyst

Thank you.

Operator

There are no further questions. I would now like to turn it back to the host for any additional or closing remarks.

Michael O'Donnell -- Executive Chairman

OK. Thank you. Thank you all very much for joining us this morning on the call. This is my last time hosting this call as Cheryl will assume this responsibility going forward.

I want to take a moment to thank all of you for your interest, your dialogue and your thoughtful approach over the past 10 years and for getting up on Friday mornings each quarter to talk to us. But it's been a great 10 years, and I thank you all for your engagement. And for the last time, signing off these calls, I will leave you with, it's a great day to go out and eat steak at Ruth's Chris. And as the great Captain Kirk of Star Trek fame would've said, "Cheryl, you have the gun."

Cheryl Henry -- President and Chief Executive Officer

Thanks, Mike.

Operator

[Operator signoff]

Duration: 30 minutes

Call Participants:

Mark Taylor -- Vice President of Financial Planning and Analysis

Michael O'Donnell -- Executive Chairman

Cheryl Henry -- President and Chief Executive Officer

Arne Haak -- Chief Financial Officer

Brian Vaccaro -- Raymond James -- Analyst

Joshua Long -- Piper Jaffray -- Analyst

Andy Barish -- Jefferies -- Analyst

More RUTH analysis

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