ONE Group Hospitality, Inc. Q3 FY2021 Earnings Call

Greetings, and welcome to The ONE Group Third Quarter 2021 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to Tyler Loy. Please go ahead.

Thank you, operator, and good afternoon. Before we begin our formal remarks, let me remind you that part of our discussion today will include forward-looking statements. These forward-looking statements are not guarantees of future performance, and 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 reflect our opinion only as of the date of this call. We undertake no obligation to revise or publicly release any revisions of 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 conditions. During today's call, we will refer to certain non-GAAP financial measures, which we believe can be useful in evaluating our performance. However, 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. For reconciliations of these measures, such as adjusted EBITDA, adjusted net income, restaurant operating profit, comparable sales, and total food and beverage sales of owned, managed, and licensed units to GAAP measures, along with the discussion of why we consider these measures useful, please see our earnings release issued today. With that, I'd like to turn the call over to Manny Hilario. Manny?

Thank you, Tyler, and hello, everyone. Thank you for joining us today. We sincerely appreciate everyone's continued interest in The ONE Group. I would like to begin by thanking our team members who continue to work exceptionally hard in driving our world-class operation. It is because of their commitment to operating the best restaurants in the industry that we have been able to strengthen our leadership position in high-end and upscale casual dining and that we can move forward with great confidence in the long-term opportunity we see for The ONE Group. Today, I'd like to provide some detail on our recent results, strategic initiatives and then discuss our robust development plans. Then I'll turn the call over to Tyler, who will walk you through the quarterly financials in greater detail. Finally, I will provide closing remarks and open up the call for Q&A. We are thrilled to report that during the third quarter, we achieved record-setting revenue with almost $72 million in total GAAP revenue, reflecting $100 million in total food and beverage sales at owned and managed locations. We were able to leverage this sales growth to achieve restaurant margins in excess of 17% despite commodity headwinds and labor shortages across the industry. Also, we were able to reach over $10 million in adjusted EBITDA, which brings our year-to-date adjusted EBITDA to $29.4 million. Our third quarter U.S. average weekly sales were equally impressive at $285,000 for STK compared to $184,000 in the same period in 2019, and $99,000 for Kona Grill compared to $78,000 in the same period in 2019. Our recent comparable sales have been extremely strong, building on our long history of outperforming the industry. During the third quarter, consolidated comparable sales for The ONE Group increased 44.7% when compared to 2019. Comparable sales at STK increased 63.8% and Kona Grill comparable sales increased 26.9% compared to 2019. All, meaning each and every one of our domestic STK and Kona Grill restaurants were positive for the third quarter versus 2019 sales performance. The sales momentum continued through October as consolidated comparable sales increased 59.2% for the month, including a 73.7% increase at STK and a 42.9% increase at Kona Grill, all of these compared to 2019. This outstanding performance validates that guests are looking for the high-energy differentiated experience that our vibe-dining offering delivers. Of course, without our team's hard work, none of this would be possible, and we couldn't be prouder of the outstanding job that they are doing. To add more color to the results, we are seeing strength across all dayparts and days, but especially Thursday to Sunday. Sundays are becoming increasingly significant for both STK and Kona Grill since the addition of the brunch daypart. Several drivers continue to provide opportunities for us to differentiate and introduce guests to our STK and Kona Grill brands and create incredible content for our robust digital marketing capabilities. The first has always been happy hour, where we offer innovative food and drink specials. At STK, we have compelling culinary options from $2 to $8 in addition to drink specials such as half-off specialty cocktails. At Kona Grill, we have the $3, $6, and $9 menu in addition to our very successful Margarita Heaven program. Many of our happy hour guests transition to our main dining room and stay for dinner or get introduced to the brands via happy hour experience and return for celebratory occasions, an area which we truly excel. Second, we are using our takeout and delivery business to reach new and current guests and continue to be encouraged by this highly accretive revenue driver at both STK and Kona Grill. Even with the restaurants at full capacity, we haven't seen a slowdown in our off-premises business, and we continue to market and innovate the business for further growth. We have carefully crafted the takeout and delivery menu to be an extension of the in-dining room menu, and it provides a great introductory price point offering for both STK and Kona Grill. To quantify the delivery sales at some of our top-performing restaurants, we are generating an annualized rate of $1 million to $1.5 million in takeout and delivery revenues. Third, our brunch program continues to grow and provides a great introduction to the brands, where we offer differentiated and unique food and beverage options. We believe that we're still very early in the brunch daypart with a lot of opportunity ahead. Lastly, the fourth area of emphasis and an opportunity to introduce guests to the brand is holidays. Our added emphasis on each holiday has really expanded our base. We have seen many people who will try us for a specific holiday meal and then come back for more regular dining. Looking to the fourth quarter, we are excited about our lineup at both STK and Kona Grill for Thanksgiving, Christmas, and New Year's Eve. Now turning to our events business, which will be an additive layer and high-margin business. This is the area of our model that still hasn't fully recovered from the COVID-19 pandemic, but we are seeing greater demand as we progress into the fourth quarter. We are focused on balancing this demand with our steady robust à la carte dining in order to maximize each of our restaurants. Overall, we believe that both brands have recovered extremely well and we feel optimistic about the opportunities for continued sales growth for the remainder of the year and beyond. Now turning our focus to development. We have an exciting pipeline of growth through both company-owned restaurants and managed unlicensed deals for the remainder of 2021 and into 2022. We still plan to open 13 new STK and F&B venues between 2021 and 2022. To date, in 2021, we have 7 new venues, all of which are off to an incredible start. These include a managed STK in Scottsdale, Arizona, which opened in January; a licensed STK at the Los Cabos Airport in Mexico, which opened in May and which we believe will be the first of many future airport locations globally. We opened a managed STK and 2 F&B venues in the Westminster area of London in May at the Westminster, Curio. On July 21, we opened a company-owned STK in Bellevue, Washington. This is the first STK to open in the Pacific Northwest. Weekly average sales volume there is surpassing $240,000 per week. And finally, in August, we entered into a management agreement to manage our operations in the Rivershore Barn & Grill in Oregon City, Oregon. As a reminder, for those restaurants that are managed or licensed, we generate management fee revenue based on top line revenues and incentive fee revenue based on a percentage of location revenues and profits. As of today, we have 3 additional STKs under construction. These include a company-owned STK in Dallas, Texas, a company-owned STK in San Francisco, California, and a managed STK in the Stratford area of London. We expect all of these locations to open in late 2021 or early 2022. Lastly, we have entered into an agreement with REEF kitchens to open pre-takeout and delivery-only venues featuring offerings from our STK, Kona Grill, and volume concepts. These will open either late 2021 or early 2022 in the Houston, Texas market. Turning to Kona Grill. We have set an initial target of 3 to 5 new Kona Grill locations per year beginning in 2022 with annual unit volumes exceeding $5 million and strong store level margins. Kona Grill produces highly attractive unit economics for us with potential 40% plus cash on cash returns on our investments. We continue to see high demand for new units from some of the most prestigious landlords in the country. We have identified The ONE Group's first new opening for Kona Grill, which will be a company-owned restaurant in Riverton, Utah, a high-profile suburb of South Lake City, Utah. This location is already leased, under construction, and we expect this restaurant to be open by May of 2022. Frankly, we are early in our growth strategy and lots of white space remains. Over the long term, we foresee a total addressable market of at least 200 STK restaurants globally and at least 200 Kona Grills domestically. Combined, that's over 400 restaurants. Much of this growth will be asset-light and our company-owned restaurants will be self-funded through internally generated cash. Before I turn the call to Tyler, I wanted to touch briefly on what you are seeing regarding labor shortages that our industry is facing. While we are not immune to these challenges, we have done a very good job of recruiting and retaining employees. We prioritized and invested in these areas during the quarter as we anticipate a very busy holiday season and believe that being fully staffed is a true differentiator and a competitive advantage in the industry today. Currently, we are over 100% staffed at both the manager and crew levels as we go into the busy fourth quarter, and our P&L reflects an investment in recruiting, training, and retention activities in the third quarter. In terms of what we're seeing from an inflation perspective, wages are up across the board, but we are managing these increases carefully. We are particularly seeing inflation for back-of-the-house employees as the demand is high in the marketplace. We have rolled out the TOG Perks program, an enhanced benefits program, and it has been beneficial in attracting people to us and maintaining employees. We have also rolled out TOG rapid deployment, an internal human resources initiative, whereby our human resource team works with our restaurant teams and consistently executing a 24-hour from application to interview to offer process for new employment applicants. In the toughest operating environment I can remember, we are focusing a lot of efforts on attracting and retaining talent. Our retention level, particularly for our general managers and executive chefs has been excellent, which is critical these days navigating through a complex and quickly changing environment. To conclude, our team has certainly proven their resiliency and they are doing a fantastic job welcoming guests into our restaurants for a great vibe dining experience. Ultimately, our focus on operations and day-to-day execution has proved effective in translating to a strong P&L, and we are very hopeful that our trajectory will continue to accelerate in the months ahead. Now I'll turn the call back to Tyler.

Thank you, Manny. Let me start by discussing our third quarter financials in greater detail and then provide an update on our cash and liquidity. For the third quarter, total GAAP revenues were a record $71.9 million, increasing 81.6% from $39.6 million for the same quarter last year. Included in our total revenues for the quarter is our owned restaurant net revenues of $68 million, which increased 79.7% from $37.8 million for the same quarter last year. The increase in revenue is primarily attributable to strong sales momentum resulting from our high-level execution of our sales initiatives along with the opening of new units. Domestic consolidated comparable sales increased 44.7% for the quarter compared to 2019. For STK, comparable sales increased 63.8% versus 2019, and Kona Grill comparable sales increased 26.9% versus 2019. Management license and incentive fee revenues were $3.9 million, increasing 123.7% from $1.7 million in the third quarter of 2020. This increase is primarily the result of sales recovery in the COVID-19 pandemic, coupled with the opening of STK Scottsdale in January, STK Los Cabos Airport in May and STK Westminster, including 2 F&B venues in May and another F&B venue in August. Owned restaurant cost of sales as a percentage of owned restaurant net revenue increased 210 basis points to 26.1% in the third quarter of 2021 compared to 24% in the prior year. As a reminder, our second quarter 2021 cost of sales were 25.3%, with our quarter-over-quarter increase of only 80 basis points reflecting effective cost management in this inflationary environment. The increase in cost of sales quarter-over-quarter was primarily driven by beef and shellfish costs. We continue to work with our vendors and supply chain in order to control costs and continue to manage and engineer our product mix towards higher-margin items. Owned restaurant operating expenses as a percentage of owned restaurant net revenue improved 250 basis points to 56.9% in the third quarter of 2021 from 59.4% in the third quarter of 2020. Increased sales volumes primarily drove the year-over-year decrease. Quarter-over-quarter operating expenses increased 480 basis points as we invested in fully staffing our restaurants, primarily hiring and training costs for new employees, and we also invested in stocking up operating lines in anticipation of high demand for those products as fourth quarter sales volumes increase. Restaurant operating profit increased 50 basis points to 17.1% for the quarter compared to 16.6% in the prior year third quarter. On a total reported basis, general and administrative expenses were $6 million compared to $3.4 million in the prior year. The increase is related to our restaurants generating strong sales and returning to more normal operations, including normal support staff and levels. When adjusting for stock-based compensation, adjusted general and administrative expenses were $5.3 million in the third quarter of 2021 and $2.9 million in the same quarter last year. As a percentage of revenues, adjusted general and administrative expenses were 7.4% of total revenue in the third quarter of 2021 and flat compared to the third quarter of 2020. Additionally, as a percentage of total sales at owned, managed, and licensed locations, adjusted general and administrative expenses were 5.3%, which is right in line with our 5% to 5.5% target. We incurred approximately $1.1 million of direct costs related to COVID-19 during the third quarter, composed primarily of costs for regular electrostatic cleaning of the venues, personal protective equipment and sanitation supplies to prevent the spread of COVID-19. This compares to $1.7 million of similar costs last year. Interest expense net of interest income was $0.8 million in the third quarter of 2021 and $1.3 million in the third quarter of 2020, reflecting lower average outstanding balance and lower interest rates. Income tax expense was $1.5 million for the third quarter of 2021 compared to an income tax benefit of $0.4 million in the third quarter of 2020. Net income attributable to The ONE Group Hospitality, Inc. was $11.7 million or $0.34 net income per share compared to a net loss of $0.9 million in the third quarter of 2020 or $0.03 net loss per share. Included in this quarter's net income is a $10 million gain related to the forgiveness of CARES Act loans. When adjusting for the gain related to the forgiveness of CARES Act loans and COVID-19-related expenses, adjusted net income was $3.7 million or $0.11 net income per share compared to an adjusted net income of $0.4 million in the third quarter of 2020 or $0.01 net income per share. Adjusted EBITDA for the third quarter attributable to The ONE Group Hospitality, Inc. was $10 million in the third quarter of 2021 compared to $4.7 million in the third quarter of 2020. Our adjusted EBITDA does not include any gains related to the CARES Act loan forgiveness. We have included a reconciliation of adjusted EBITDA and adjusted net income or loss to GAAP net income and loss in the tables in our third quarter earnings release. Finally, to touch on our liquidity, as of September 30, we had $19.1 million in cash and cash equivalents on our balance sheet, and we generated positive cash flow throughout the third quarter. As we discussed on our previous call, we amended our credit facility with Goldman Sachs and paid down $22.2 million in debt, resulting in a lower cash balance quarter-over-quarter. The amended agreement provides for a lower interest rate and extends the maturity date for both the term loan and revolving credit facility by 5 years. The amendment provides for a secured revolving credit facility of $12 million and a $25 million term loan. Other key modifications include the removal of many limiting restrictions, including the cash accumulation provision that restricted our revolving ability and the removal of all financial covenants at the maximum net leverage ratio of 2:1. Under the amendment and calculated retroactively, we would have been compliant with this covenant throughout 2020, including throughout the toughest times of COVID-19. Most importantly, as a result of this new amendment, we will save $2.5 million in cash interest expense annually and are nearly debt-free when taking into account our cash balance. And lastly, as previously discussed, on July 13, the company received notice from its bank that its remaining CARES Act loan of $9.8 million had been fully forgiven by the SBA. As a reminder, due to the uncertainty of COVID-19, other than development, we have suspended all financial guidance for this year, but we'll provide further business updates as warranted. I will now turn the call back to Manny.

Thank you, Tyler, and thank you all for your time today. Let me conclude by saying I'm very encouraged with our results to date and our prospects for 2022 and beyond. Above all, I'm grateful to all our teammates who bring our mission to life every day to be the best restaurant in every market where we operate. They do this by delivering exceptional and unforgettable guest experiences to every guest every time. I also want to thank our customers that try and continue to return to our restaurants and enjoy the vibe dining experience that they have been craving. We appreciate everyone joining us on the call today. Tyler and I are happy to answer any questions that you may have. Operator?

And our first question is from Nicole Miller with Piper Sandler.

I appreciate the update. I was going to ask a numbers question and then a high-level question. Could you speak to the October STK comp you shared and the Kona comp? And could you talk about the equivalent average weekly sales for modeling purposes?

Go ahead, Tyler.

Yes. So in terms of the average weekly sales, Nicole, average weekly sales for all of North America for STK is $323,000, and then for Kona Grill, it's about $100,000. And then the same-store sales for October were 59.2% over 2019. Kona Grill was 43%, just shy of that, and STK was just shy of 74%.

Okay. So 74 and 43 on STK. I understand the comp of 43%. I'm just inquiring about the average weekly sales dollar amount associated with that.

Yes, that equates to about $100,000 a week.

Okay. I got that part. And then the comp up 74%. I'm sorry, was that the $323,000 then?

Yes, that's $323,000.

Okay. That helps out a lot. And then big picture, I mean, there's an October acceleration. I mean you had some commentary you bought it. There's some in the press release as well. But what is the acceleration primarily a function of because it's certainly more than just any mandates lifting that were remaining? And what does it really suggest for the holiday season ahead, maybe talking about how an October average weekly sales now that we can translate to that compares to what is the most likely higher November and December historical range of average weekly sales?

Nicole, this is Manny. I believe there were three questions there, so I will address them in two parts. First, regarding the acceleration in October, I think we executed our promotional efforts very effectively that month. There was a strong emphasis on promotions. Additionally, we focused heavily on our takeout and delivery business in October, which I believe contributed to our positive numbers. We're seeing two benefits from our takeout and delivery marketing efforts. Even though we are promoting through platforms like Postmates and GrubHub, we're also noticing that this is translating into actual restaurant visits, as people are thinking of us when they use those delivery services, leading them to our restaurants and reservations. Therefore, our takeout and delivery promotions are beneficial for both our takeout and dine-in services. As for the fourth quarter, we have observed exceptional advance business demand for November and December, which is among the highest I've experienced during my time at the company. There is significant demand for parties and restaurant buyouts, with people willing to spend considerable amounts to secure our venues for large events. We are very optimistic and pleased with how bookings are shaping up for the fourth quarter. This is one of the highest demands I've seen, and as mentioned in our prepared comments, we have invested time in expanding our workforce because we believe we'll need every employee to manage the takeout, delivery, and event business effectively. Overall, we are confident that our fourth quarter will be remarkable in terms of sales, and we have adequately prepared during the third quarter to achieve this.

We have a question from Mark Smith with Lake Street Capital Markets.

I would like to explore the restaurant level margins further. Tyler, could you discuss the labor component? It seems like everyone is facing pressure, but did this affect Q3? Could it be considered a one-time issue as you invested in systems to retain labor?

So Mark, this is Manny. I'll start by addressing your question before handing it over to Tyler for more insights. In the third quarter, we increased our hourly employee count by approximately 300. We ended the second quarter with about 2,900 restaurant-level employees and raised it to 3,200, reflecting a net increase of over 300. This was necessary as we anticipated a strong fourth quarter, so we significantly enhanced our workforce. The average new employee we hired was working around 30 hours weekly while getting acclimated. This hiring occurred throughout the entire quarter. Given those figures, you can infer what we expect that workforce number to represent, and a substantial portion of this is dedicated to training. It typically takes around 50 to 60 days for our new employees to become proficient. Therefore, we invested a considerable amount in training and development to bring our new staff up to speed. Tyler, do you have anything else to add?

Yes, I would say that we are building up the staff in anticipation of a very busy fourth quarter. So I don't believe this is just a one-time situation; rather, it reflects an investment in what we expect to be a very busy holiday season.

Yes. I mean, last point on that is, I mean, our average volume for STK is 300,000-plus average week per restaurant. So that requires that we bring in more employees. So we did have to make sure that we really loaded up the employees in the restaurants to take care of that business, particularly when our objective is not just to take care of the business, but we believe in building repeat business and frequency. So we want to make sure that as we bulk up on sales that we continue to deliver an outstanding experience, making each one of our restaurants the best restaurant in the markets they're in.

Okay. And then looking at just other inflationary pressure, I think Tyler you called out beef and shellfish. What are you seeing today? And then if you can update us on anything that you've got kind of on contract or anything that's running out?

Seafood is particularly significant for us because our seafood platters are a key offering in our brand. Looking at our cost of goods sold, our third quarter COGS increased by only 80 basis points compared to the second quarter, which indicates that we managed the pressure quite well. We are using substitution strategies to offset some of the cost increases; for example, we switched from red king crab to Dungeness crab, which is also a high-quality product. We now have two engaged vendors for meat, allowing us to work with both on various cuts, enhancing our supply chain. Additionally, we've implemented promotions to positively impact our product mix. In October, we highlighted our Welcome Back Pumpkin promotion, which effectively drove sales and generated good costs for that featured product. We are emphasizing our beverage sales, particularly liquor, as a significant profit opportunity in our restaurants. Tyler, do you have anything to add?

No. I think Manny touched on it just in terms of our overall quarter-over-quarter COGS number really increasing only 80 basis points. Manny touched on all the different activities that we've employed to maintain that number and feel like we've managed that number very, very tightly for the quarter.

Okay. And the last one for me is just monthly cadence in sales. And thank you guys for giving us the October number, but I don't know if you have that readily available.

We reported that July was a very strong month for us. August was softer compared to the other two months in the quarter, but September rebounded strongly. The back-to-school timeframe was particularly beneficial for us, especially with many of our Kona Grill locations near major campuses. The promotional activities in October, including takeout and our Welcome Back Pumpkin features, have also been very successful.

We do have a question from David Kanen with KWM.

Congratulations. Excellent job. So the first question is in regards to the Events business. I know historically Q4 is a large chunk of your overall revenue. How does it look versus 2019 at this point, just the bookings? I'm sure it's off the charts versus 2020. But how would you characterize it versus 2019?

I will discuss our bookings right now. We are seeing a significantly higher number of requests for events, particularly for premium events like restaurant buyouts. While there is a decline in demand for entry-level events, interest in premium options has surged. Our strategy for the fourth quarter is to prioritize high-end bookings because we also have a strong à la carte business. Our focus will be on balancing the strong demand for premium events with our à la carte offerings. This is the best demand I've witnessed for the fourth quarter since joining the company. We've also strengthened our event booking processes, so I expect that the combination of demand and improved processes will lead to a very successful quarter for events.

Okay. That's encouraging. So in other words, it's going to exceed 2019 despite the headwinds of COVID and so forth?

Yes. I mean, I would say that without creating a guidance number on it, I would say that the lead-in right now is that it will be a very robust and like I said, it's the best bookings I've seen in a while or actually since I've been with the company. So I think that will translate into an incredible events business. Again, I'm not mitigating it, but as we get into the quarter, we will make sure that we don't lose the à la carte business. So we always have to make sure that we keep a good balance of that. So that's really the only question is the capacity, right? How much capacity do we have relative to the demand both for events and à la carte dine-in? So that's going to be what our very seasoned operations team will be working on, making sure that we get the best of both.

Understood. Regarding labor, it seems that there was some increased hiring in preparation for Q4. You wanted to ensure that your staffing levels were adequate. Do you think that part of your labor expenses for Q3 included workers that you normally wouldn't have hired if you had known they wouldn't be necessary in the future? Could this be considered a one-time expense, or perhaps an increase in hiring to meet temporary demand? Is that the right perspective?

Yes. David, I would say that we are likely to invest between $1.5 million and $2.5 million while ramping up our hiring process. It typically takes our employees about 60 to 90 days to become fully proficient in executing both models effectively. We aimed to avoid heading into what we believe will be our busiest fourth quarter ever with a mix of rookies and seasoned staff. Therefore, we capitalized on the lower volume in the third quarter and increased hiring significantly, adding over 300 employees, which is substantial for us. We dedicated time to train them thoroughly, so as we enter the fourth quarter, we are set to operate with well-trained employees rather than trainees. When volumes exceed 300, it's crucial to ensure that the labor force is very well prepared. This was a key focus for us in the third quarter, as we wanted to position ourselves to excel in the fourth quarter, which informed our hiring strategy.

I understand your perspective, and I appreciate your proactive approach and leadership. On the topic of the airport business, I've heard from friends who have visited Cabo Airport, and they've shared photos showing long lines. Can you discuss the unit economics of that situation? You've mentioned an opportunity you believe will be the first of many. Looking ahead two to three years, can you provide some insight into that opportunity, specifically regarding potential STK airport locations?

Yes, great question. Our experience so far has been fantastic and aligned with our expectations. There has been a lot of excitement due to our strong bar business, which resonates well with airport travelers. We're thrilled about this. Our first deal was with Areas, an excellent airport operator with a significant global presence. We believe we have formed a great partnership that offers us access to future opportunities. We are actively engaging in discussions with them. Additionally, we are in talks with other reputable operators interested in entering the airport business with us, presenting a great opportunity for expansion. We estimate the potential to launch between 10 and 20 restaurants in airports. It's crucial for the airport business to be strategic. For instance, our location in Cabo is particularly strategic because it attracts visitors from Arizona, Nevada, and California for vacations. It's a prime spot for brand visibility, keeping our name fresh in travelers' minds. It's not only about the number of units but also about entering the right airports, terminals, and occasions. In Cabo, being located by the international gates is ideal. We are very excited about this, and the business has been performing at high volumes. Our partners are also enthusiastic about the profitability, particularly due to the bar aspect.

Sounds good. And then the last question. This is, I guess, looking out a year from now, it seems like you're going to be confronted with the high-class problem of having net cash pretty soon and generating significant free cash flow given the capital-light nature of the business. And it seems like CapEx next year based on development shouldn't be a whole lot higher than this year. Am I correct in saying that?

Yes. I mean, we're going to generate a lot of free cash flow is really the answer there, yes.

Okay. So this is the question is the high-class problem of generating so much free cash flow. How do you see you guys allocating that options being potential M&A, accretive M&A, dividends, stock buyback, all of the above? What are your thoughts thereof?

My response to that is that we have a favorable situation, as you mentioned, a high-class problem. We expect this to happen very soon. Our priority will always be to do what’s best for our shareholders and maximize shareholder returns. If we find a suitable acquisition opportunity, similar to what we did with Kona Grill, we will pursue it. This means achieving a great return and significantly enhancing our assets will always be on the table. Additionally, we can choose to accelerate growth, and we’ve already done that by incorporating 3 to 5 Kona Grill locations into our growth model. This gives us another option and flexibility. Beyond those, we also have the possibility of implementing dividends and stock buybacks. All these strategies are available to us, and as we approach decision-making points, we will choose the option that best drives shareholder value.

We also have a follow-up question from Nicole Miller with Piper Sandler.

I wanted to come back, digging into the back of the release here, there's the operating profit by brand. It just has to be store level. That's what that is, right, Tyler, the $8.3 million and the $3.4 million?

Yes, you're talking about the 17% and the 11%...

Yes, exactly. Okay. So on STK, the 22.6%, how much of that was this labor you're talking about getting fully staffed and getting ahead of what's going to be a great holiday? And how does that kind of taper? Does it not entirely taper in a quarter, but does it stick with you for just a couple of quarters or does it get to annualize it?

I believe that about 75% of the labor investment was for Kona Grill and the remaining 25% was for other areas.

I was going to ask the same question about Kona. So, did Kona have an impact on lowering the overall store level margin?

Yes. Overall, I would say Kona was the main contributor to that. Of the 300 employees we added, around 200 were from Kona Grill and about 100 were from STK. We invested more in labor for Kona Grill. As I mentioned in response to David's question about the range of value, I estimate the onboarding and initial training costs to be around $1.5 million to $2 million. Regarding the duration of these costs, I don't expect them to last more than 60 to 90 days, making it a short-term one-time investment in labor.

And then is the whole idea, big picture long term, no timeline attached that Kona is still like a 17% store level margin and STK with all of its modifications and certainly higher volume enhancement is like a 27% store-level margin?

Yes. I mean, if I adjust for the labor just this quarter alone for Kona Grill, we'd probably would have been in the 14% to 15% range once you adjust for everything associated with bringing the individuals and so forth. And but then also remember that the third quarter is an average quarter in volume for Kona Grill. So seasonally, that is not the best quarter for Kona Grill. I think the second quarter is actually the best quarter for Kona Grill. So I would look at the quarter dip mostly as a factor of seasonality as well as the investment in labor.

All right. Thanks for clearing that up for me. And sorry I had to repeat some of it. I appreciate it.

No worries. Thank you, Nicole.

We have a question from Greg Cohen with Rambleside.

Congrats on the amazing performance. Question on the REEF ghost kitchen deal. Can you just kind of walk through the economics of that agreement in Houston just so we can understand the potential EBITDA contribution? And then is that just a trial market, and this is something we could expand across the country in kind of the secondary and tertiary markets where we don't want to have a store? Or how should we think about how meaningful that deal could be?

Our initial agreement with REEF is focused on Texas, specifically in Houston, as we currently lack a restaurant in that market. Our development plan indicates that we will eventually reach Houston with the street store, but that will take some time, so there will be a delay before we get there. We are aware that Kona Grill previously had a strong presence in Houston and was well-received. We see REEF as a way to introduce our brands to a market without a street store, viewing this as a complementary opportunity. We believe the REEF partnership has significant potential, estimating about 300 to 500 locations just in the U.S., which could be a substantial business for us. However, we want to be cautious and not make any overpromises. While REEF expressed interest in a nationwide agreement, we prefer to test the waters first to gauge brand acceptance when introducing STK and Kona Grill in a market where we don't have a street presence. There's enthusiasm about this opportunity, but we remain careful, as we are focused on growth without overcommitting. There are many locations we can explore together and others where establishing street stores may not be cost-effective. This partnership could serve as an interesting strategy alongside our existing street store approach. Financially, this agreement is structured as a top-line deal, and we receive a royalty based on revenues, which aligns with our typical 5% to 7% arrangement, posing no risk to our bottom line.

Great. It’s interesting to consider that if we can’t grow this, it could serve as a second franchise pillar, especially since it requires no capital from us. It’s not hard to imagine this could quickly generate tens of millions in EBITDA. That’s a good clarification. My second question is about street stores. Historically, we’ve discussed opening stores in major markets like Boston, D.C., and Minneapolis, and then expanding into secondary markets and additional locations within primary markets. Could you updated us on where we stand with this, particularly with STK, as we look at the pipeline for next year and possibly the following year?

Yes. I mean, so great question in terms of talking about the strategic development of the footprint. I guess if you're in New York, everything else is kind of the secondary market; that's kind of like our old definition of secondary markets. But I think actually, what we've seen the last couple of years actually are mid-sized markets like Denver, markets like San Diego, markets like Nashville, they're just killing it. I mean, actually, in those markets, our volumes have become frankly, incredibly attractive in the $250,000 range. And we also saw that when we opened in Bellevue, we're also around that $250 level. So we're seeing now that frankly, this idea of secondary market is really non-existent for us because I don't think there are other brands in America that opened to a $250,000 pace and kept it there. So right now, I'm looking from an STK perspective, the white space for us is actually wide open right now because once we can be successful in this type of markets, it just gives us a lot of comfort that markets like Houston, Boston, Washington, D.C., Minneapolis, Charlotte, Philadelphia, all those markets now really in play for us. And what we're also doing now is we're looking at markets like Denver and Chicago, which we're just destroying in those markets. We're looking at those markets as a second and third store opportunity. So we're really seeing, frankly, right now, a very white space for STK. And I really don't see anything as a secondary market anymore. It's really about trying to get to market as fast as you can in these markets to have the opportunities. Then on Kona Grill, the opportunity is there's a lot of great markets in America that don't have a clear player in the sushi category or that in great college campuses type of towns. I think there's a tremendous opportunity for us to go hit. Now that our definition of secondary markets is more the high-profile suburbs and really cities in the 500,000 population range, where we think that Kona Grill can do really well, particularly with its broad grill offering complemented with a unique sushi program. So I think that right now, pretty much the map is wide open in the U.S. And I think we have a tremendous amount of white space ahead of us. As a matter of fact, I think we stated that we're excited about the fact that our white space is now 400-plus restaurants. So we're super excited and frankly, really busy right now just getting through managing our real estate pipeline.

Okay, that makes a lot of sense and is very helpful. I have one final question. Considering what you mentioned about our industry-leading sales, growth, margins, brands, food quality, and three separate high-growth business lines, including a growing franchise component with ghost kitchens, cloud kitchens, and traditional franchise and management, what do you think the market is overlooking or what could the company improve to better communicate its story? Based on my calculations, and I hope Nicole updates her model accordingly, we should be generating $70 million in EBITDA next year, taking into account the EBITDA from the franchise channel, new store growth, and contributions from Kona. Looking at the recent IPOs of various fast casual restaurant chains, where premium high-growth, low CapEx businesses, despite having worse unit economics, margins, products, and growth, are trading at 15 to 20 times EBITDA from the start, it seems our business should be valued between $1 billion and $1.5 billion in enterprise value, potentially leading to a stock price of $30 to $40. So the short answer to my long question is, why are we trading at $15, $14, or $13 a share when we should be trading at least two to three times that value? What are we going to do about it?

Let me respond to your question this way. As a business, we concentrate on our strategy, execution, and achieving strong results. We then communicate our activities and plans, which is what we're doing today. We focus on our business and share our progress. Regarding the market, we will continue to address that as we move forward. Additionally, remember that our total shareholder return has exceeded 400% over the past year, highlighting the positive aspects of a business that is achieving such impressive returns. As CEO, my priority is to maintain the business’s trajectory, continue executing, delivering excellent results, and allow the market to assess our performance.

And there's no further questions at this time.

All right. Well, I want to thank everyone for taking the time and interest on The ONE Group. As I always do, I want to thank the fantastic contributions of our teammates, frankly, in my opinion, the best team in the industry. They have frankly done some extraordinary things, and I look forward to the fourth quarter and beyond. I look forward to running into you in our restaurants. So everyone, have a great day, and I'll turn it back over to the operator.

Thank you. That concludes the call for today. We thank you for your participation and ask that you please disconnect your lines.