In a recent look at the latest second-quarter results for O'Charley's (NASDAQ:CHUX), my Foolish colleague Jim Mueller highlighted the company's recent improvements in profit margins as an area worth monitoring. He noted that the recent hiring of a new supply-chain officer should help keep O'Charley's positive margin momentum going.
While margins appear to be in better shape, the same cannot be said for the company's top line; sales missed analysts' expectations for the quarter. In this latest edition of Folly Volley, I've asked Hank Schofield and Bodhi Zappa to join me once again in a roundtable discussion about the company's most recent quarterly earnings conference call. We'll be looking for clues to both the margins and revenue question.
A juicier steak equals juicier profits
Jeremy: Hank, get us started on the company's profit margins. Was there compelling evidence in the call to suggest that recent improvements can continue?
Hank: CEO Gregory Burns wasted no time getting to the reasons for the expanding margins: an increase in the average check, and better "control over food and labor costs." Declines in food costs like poultry, pork, and cheese also contributed.
Jeremy: Tell us more about the increase to O'Charley's average check.
Hank: At O'Charley's restaurants, the average check increased 3.4% for the quarter. A three-tiered menu-pricing structure was implemented, enabling the company "to selectively raise prices and reduce the availability of Kids Eat Free." Additionally, the introduction of limited-time menu items like butcher's-cut premium steak helped increase the average check.
Bodhi: Sounds like a tasty and winning strategy.
Hank: Sure, if we choose to overlook a little something called revenues. Sales lagged analyst estimates for the quarter, in part because the company witnessed a 3.9% decrease in its guest count for the period. Burns pointed to the reduction of its Kids Eat Free program, as well as general economic concerns, as reasons for the decline.
More time?
Bodhi: Give it more time. Its Project RevO'lution, which is being employed to improve the company's overall brand image through various initiatives, is still a work in progress. In addition, the company is cooking up some new menu items that should help drive customer traffic in the near future. Just last week, it launched its Wild Kitchen promotion, featuring Berry Cobbler Explosion, BBQ ribs, and orange-peel chicken, among other items. Additionally, in October, the company is set to launch a new menu.
Jeremy: Unfortunately, the new menu additions weren't enough to compel management to maintain its previous guidance. Instead, guidance for the year was revised downward. Management blamed challenging economic factors for the revision, but you have to wonder whether that's too simplistic.
Hank: Yes, perhaps the menu items aren't daring enough. Burns stated in the call, "I'm really excited about these new products. I've tried them all, and they taste great."
Sounds nice, right? But will the customer agree?
Jeremy: A valid point. When Papa John's (NASDAQ:PZZA) was looking to revamp sales, it embarked on an extensive, years-long market research and testing campaign. The result was Papa's Perfect Pan Pizza, which was a perfect hit for the company because it took the time to get it right.
Bodhi: I don't want to sound like a broken record, but again, give it time. During the Q&A portion of the call, Burns had this to say about the new menu: "We have a high degree of confidence, based on our experience so far this year, that these menu rollouts will be positive." He added that the company will get some benefit from this rollout in the third quarter, but even more so in the fourth quarter. Overall, Burns' sentiment is that he is "more bullish the second half of the year."
Check, please!
Jeremy: Bullishness is in the eyes of the investing beholder, I guess. For the year, management is expecting same-store sales growth of less than 1%. That sounds less like a stampede and more like a Texas tiptoe. (That one's for you, Hank.)
Should we heed Bodhi's advice and practice patience? I'm not convinced. If this is a true turnaround, like McDonald's (NYSE:MCD) remarkable rebound, investors will know it and still have time to buy in.
Shareholders can take comfort in management's methodical and analytical approach to the changes the company is making across the board, from its three-tiered menu pricing structure to the revamping of its supply chain. But I can't help but think that with a revitalization plan called Project RevO'lution, O'Charley's and its shareholders may be better served with greater emphasis on revolutionary-level changes.
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Fool contributor Jeremy MacNealy has no financial interest in any company mentioned.
