BJ's beer and food improvements are driving positive results. Source: BJ's Restaurants.

The sit-down dining business has been under attack for several years, with increased competition from so-called "fast-casual" eateries such as Chipotle Mexican Grill and Panera Bread Co taking market share from both sit-down restaurants and fast food alike. 

And after a couple of years of struggles to find a recipe for success, it's looking like BJ's Restaurants, (NASDAQ:BJRI), a small chain with less than 200 locations, but big growth ambitions, has finally cooked up something that works. Here's a closer look at the company's third-quarter financial results, released on Oct. 22. 

The numbers 

 Q3 2015Q3 2014Change
Comps growth 2.3% 0.3% 200bps
Revenue $229.4MM $206.5MM 11%
Net income  $12.4MM $6.5MM 91%
EPS $0.48 $0.23 108.7%
Restaurant-level operating margins 19.7% 17.6%


What happened in the quarter 
BJ's restaurants continues its deliberate and slow-paced expansion, as well as its "Project Q" initiative to improve food quality and sales and to reduce cost and drive up efficiency in restaurant operations. A few highlights:

  • Project Q continues to drive improvements in margins and efficiency, with restaurant-level operating margins up 210 basis points to 19.7% in the quarter. However, it's worth noting that this was a sequential decline from the 20.9% margins reported in the second quarter. Nonetheless, the trend is decidedly up over the past year-plus, despite some quarterly fluctuation. 
  • BJ's opened six new locations in the quarter, putting it on track to open all 16 planned new restaurants for 2015 by November. This works out to just over 10% growth in 2015. 
  • The company spent roughly $18.8 million to repurchase 400,000 shares of stock. That works out to about $47 per share, or roughly what the stock was trading for the day after earnings were announced. 
  • $2.9 million of the company's $12.4 million in net income in the quarter was derived from an early lease termination payment to BJ's, due to a major remodeling at a property in California that forced the permanent closing of that location. This was a planned closing, but it's important to note that over 23% of the profits this quarter were this "one-time" benefit, and not a product of operating revenues. Factoring that gain out, operating income was still strong, increasing 70%. 
  • The company has repurchased nearly 10% of its stock since early 2014, but has used debt in part to do so. At the beginning of 2014 the company carried zero debt, but now has $67.5 million in long-term debt. 

What management said 
Better, more cost-effective restaurant operations has been a major area of focus for BJ's over the past two years, and the company has made some serious headway here. CFO Greg Levin said the following on the earnings call:

As a point of reference when we began this initiative, we had just finished fiscal 2013 averaging $22,400 per week and that again is excluding marketing cost. By comparison for the first nine months of this year, we have averaged about $20,400 per operating week. As such, our overall operating and occupancy costs excluding marketing spend, have gone from 22.4% of sales in fiscal 2013 to 20.9% for the first nine months of this year...

Levin also added some interesting color about comps, and how restaurants open for just over a year, actually tend to lag a bit, before picking up as they mature:

We mentioned at the Q2 time in July that our comp sales then would have been 50 basis points higher, taking out basically the "class of '13", which after 18 months are kind of dropping as well as some of that early "class of '14". And that 50 basis points to our overall comps is consistent even in this quarter, meaning we would have been closer to 3% comp this quarter, frankly, if we did a 24-month comp perspective. ... I think the last couple of years have been pretty consistent on this, that at 18 months as our restaurants go into the comp base they do go in negative. After about six months or so in the base -- so as you start to hit months 24 and greater -- they start to comp positive.

Looking ahead 
Over the past year-plus, BJ's management has done a solid job improving operations, lowering costs, and developing an appealing menu that's driving higher comps, while many casual eateries are still trying to just maintain traffic levels. 

However, investors need to remember that the company has several private equity investors holding major stakes, and they have significant influence on management because of this. It's these shareholders who influenced the company's decision to slow its pace of expansion, and to aggressively buy back shares. In other words, the company's strategy is at least partly driven by a small group of activist shareholders. 

The business has certainly improved as a result of the menu focus and operating improvements, but the balance sheet is more leveraged, and more debt could come as BJ's works through its remaining $35 million share buyback authorization. Yes -- fewer shares increase per-share returns, but management has to decide whether to allocate capital -- either from cash flows, or via debt -- to buy back shares, or to grow the store base. So far they've managed to balance it, but at the potential risk and expense of carrying debt. 

Looking long term, it boils down to how well management can continue to strike that balance, especially when dealing with activist shareholders at the same time.