ONE Group Hospitality, Inc. Q2 FY2022 Earnings Call

Greetings, and welcome to the ONE Group Second Quarter 2022 Earnings Conference Call. As a reminder, this conference call is being recorded. I'd now like to turn the conference over to your host today, Tyler Loy. Please go ahead.

Thank you, operator, and hello, everyone. 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 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 discuss 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 at owned, managed and licensed units to GAAP measures along with a 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. We sincerely appreciate you joining us today and for your interest in The ONE Group. Our focus on strong operational execution, innovative culinary offerings, and Vibe Dining continues to resonate with our guests, and I'm extremely pleased with our top line business performance during the second quarter despite the ongoing challenges facing our industry. I thank our entire team for these results and for providing our guests with exceptional and unforgettable value experiences each and every day. The strong sales momentum we experienced in the first quarter continued into the second quarter. Our total revenue grew nearly 15% to $81.1 million when compared to the prior year’s second quarter. Our comparable sales continue to be among the best in the restaurant industry. Consolidated comparable sales increased 12.8%, consisting of an increase of 19.8% at STK and a 3.7% increase at Kona Grill. Impressively, and also among the best in the industry, when compared to 2019, our pre-pandemic base year, consolidated comparable sales increased 53.5%, consisting of an increase of 81.9% at STK and a 27.6% increase at Kona Grill. Our second quarter U.S. average weekly sales were equally impressive at $331,000 for STK compared to $288,000 in the same period in 2021, and $107,000 at Kona Grill compared to $103,000 in the same period in 2021. We are also pleased with delivering over $4 million in net income and $10.4 million in adjusted EBITDA for the quarter. Since before the pandemic, we embarked on a mission to diversify our sales mix away from being heavily focused on corporate and event-driven business. Instead, we have been strategically capturing the special occasion business, which includes date nights, holidays, ladies' nights out, brunch, happy hours, and other social occasions. This strategy continues to pay dividends as reflected in our industry-leading results. However, after two years of limited corporate gatherings, we are now seeing group events and conventions return, and we have been able to capture that demand. In addition, we continue to build our catering capabilities and believe that private events and catering offer tremendous opportunities for the brands. We'll also focus our attention on creating incredible value offerings for both STK and Kona Grill. This allows us to expose our brands to new guests at approachable price points. Guests then remember us for their celebratory occasions and come back and join us in our dining rooms. It also allows us to capture demand during times when there is excess capacity. At both brands, we are currently running several value-driven programs such as our weekday Power Lunch, midweek date night promotions, pre-theater menus, and several take-out and delivery specials. Furthermore, we continue to leverage the important brunch daypart with bottomless mimosas and our new 369 happy hour menu. Throughout the second quarter, we captured demand for holidays without promoting around Easter, Mother's Day, and Father's Day at Kona Grill and STK. As a result of these efforts, we achieved some record-breaking sales during these holidays. Now turning our focus to development. We have an exciting pipeline of growth for both company-owned and managed and licensed deals this year, consisting of nine new STK, Kona Grill, and F&B venues. In July, we opened our first of three virtual locations through a license deal with REEF Kitchens in Austin, Texas. Guests in Austin can now enjoy delivery of select menu items from our award-winning dining concepts, Kona Grill and Bao Yum. This partnership enables us to further expand and capture a new consumer base with limited capital investments. For the remainder of the year, we plan to open two company-owned STK locations: one in Dallas and one in San Francisco, a managed STK in Stratford, London, U.K.; three company-owned Kona Grill, one in Riverton, one in Columbus, and last but not least, in Paradise Valley, Arizona. And finally, we planned to open two additional license units in partnership with these kitchens, which will provide takeout and delivery-only offerings from our Kona Grill and Bao Yum concepts. As we have long stated, we are early in our growth strategy with significant whitespace ahead. We are excited about our long-term opportunity as we believe our units deliver best-in-class returns. For new restaurants, we're targeting between 40% and 50% ROIs for new company-owned STKs and company-owned Kona Grill. We foresee a total addressable market for at least 400 restaurants, including 200 STK restaurants globally and at least 200 Kona Grill domestically. Moving on to the current cost environment. As you are aware, we are currently in a period of historically high inflation across our industry. That said, I'm pleased that we were able to deliver cost of goods sold at 25.8%, only slightly higher than the first quarter. We were able to accomplish this through product mix engineering, selling high-margin additive shack items such as toppings and sides, and committing to our beverage and bar programs. Turning to labor, we see noticeable increases in average wages year-over-year in both manager and hourly workforces. In addition, we have made investments to hire, train, and retain the best talent in the industry. And we believe these strategies have allowed us to keep the significant market share we've captured. We're committed to remain fully staffed in order to support our new unit growth and sales-driving initiatives. Lastly, we have taken modest price increases this year. With our strong traffic performance during the second quarter, along with our great value proposition for both brands, we believe we have significant pricing power and we'll strategically pick some price increases in the back half of the year. To conclude, our team is doing a fantastic job providing our guests exceptional and unforgettable dining experiences. Ultimately, our focus on operations and day-to-day execution has proven effective in translating to a strong P&L, and we plan to continue our current trajectory of industry-leading comparable sales, disciplined cost management, and new store development. Now I'll turn the call back to Tyler.

Thank you, Manny. Let me start by discussing our second quarter financials in greater detail. Second quarter total GAAP revenues were $81.1 million, increasing 14.6% from $70.8 million for the same quarter last year. Included in our total revenue is our owned restaurant net revenue of $76.9 million, which increased 13.4% from $67.8 million for the same quarter last year. The increase in revenue is primarily attributable to strong sales momentum resulting from the execution of our sales initiatives along with the opening of new units. Domestic consolidated comparable sales increased 12.8% for the quarter compared to 2021. For STK, comparable sales increased 19.8% versus 2021, and Kona Grill comparable sales increased 3.7% versus 2021. Versus 2019, domestic consolidated comparable sales increased 53.5%, STK comparable sales increased 81.9%, and Kona Grill comparable sales increased 27.6%. Management license and incentive fee revenues were $4.2 million, increasing 44.1% from $2.9 million in the second quarter of 2021. This increase is primarily the result of the strong execution of our sales initiatives, capacity restrictions being lifted, and an increase in the number of venues. Owned restaurant cost of sales as a percentage of owned restaurant net revenue increased 50 basis points to 25.8% in the second quarter of 2022 compared to 25.3% in the prior year, primarily due to increased product costs, partially offset by operational and venue management initiatives. Owned restaurant operating expenses as a percentage of owned restaurant net revenue increased 550 basis points to 57.6% in the second quarter of 2022 from 52.1% in the second quarter of 2021, primarily due to consolidated average wage increases. We are particularly pleased this quarter with the restaurant operating profit of 21.9% at STK during this very challenging environment. On a total reported basis, general and administrative expenses were $7.3 million compared to $6.1 million in the prior year. The increase was attributable to increased professional fees and increased travel expenses due to rising hotel and airfare costs. When adjusting for stock-based compensation, adjusted general and administrative expenses were $6.4 million in the second quarter of 2022 and $5 million in the same quarter of last year. We incurred approximately $0.2 million of direct costs related to COVID-19 during the second quarter. COVID-19-related expenses are composed primarily of sanitation, supply, and safety precautions taken to prevent the spread of COVID-19. This compared to $1.1 million of similar costs last year. Interest expense was $0.4 million in the second quarter of 2022 compared to $1.2 million in the second quarter of 2021. The decrease was driven by lower average outstanding balances and lower interest rates driven by the refinancing of our credit facility in August of 2021. Income tax expense was $0.9 million in the second quarter of 2022 compared to $1 million for the second quarter of 2021. Our 2022 annualized effective tax rate is estimated at 19%. Net income attributable to The ONE Group Hospitality, Inc. was $4.3 million or $0.13 net income per share compared to a net income of $13.8 million in the second quarter of 2021 or $0.41 net income per share. When adjusting for COVID-19-related expenses and other nonrecurring expenses and gains, adjusted net income was $4.9 million or $0.15 adjusted net income per share compared to an adjusted net income of $6.5 million in the second quarter of 2021 or $0.19 adjusted net income per share. Adjusted EBITDA for the second quarter attributable to The ONE Group Hospitality, Inc. was $10.4 million compared to $12.9 million in the second quarter of 2021. We have included a reconciliation of adjusted EBITDA in the table in our second quarter 2022 earnings release. 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 that our business remains very solid despite the obvious headwinds. We are in the early stages of our long-term growth strategy as we continue to build a portfolio of high-volume, high-margin brands with compelling returns. Above all, I'm grateful to all of 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 would also like to thank our customers that visit and continue to return to our restaurants so that they can enjoy the highly differentiated Vibe Dining experiences that they have been craving. We appreciate everyone joining us on today's call. Tyler and I are happy to answer any questions that you may have.

And the first question comes from Nicole Miller with Piper Sandler.

Super update. Just a couple of quick questions. The first one, very high level, how is Europe? How are you managing through? What are you seeing with consumer trends? How are things coming along?

This is Manny, by the way. So Nicole, I mean our London stores continue to do well. I mean, we have not seen a major slowdown, but there's clearly a lot more noise in Europe in general economy. So there's definitely lots of noise. We really haven't felt any significant impact out there, but that doesn't mean that it won't change anytime soon because there's a lot of noise in the market.

Looking at MLI, it has increased in dollars compared to last year. I don't have the quarter-over-quarter numbers in front of me. However, there are more units being operated in MLI, which is what I was trying to analyze for any patterns.

We haven't observed any notable changes. In fact, they performed quite well in the second quarter. However, there is a lot of uncertainty in the market right now, and we will analyze it closely.

And then this is just very curious about seasonality. So everybody knows how Q3 slows seasonally. Just any general comment outside of seasonal patterns you want us to consider that would mostly be on store level margin. But at the same time, Q4 becomes a big part of the year. And it's just so fascinating how you're holding on to all of these different types of customers at different occasions. So can you talk us through the scenario analysis or I should say, planning maybe you're doing for the fourth quarter, good holiday, neutral holiday, bad holiday. How are you kind of wrapping your minds around what may come?

Yes. That's a great question. For the fourth quarter, there are two key points to consider. First, we are starting to see a significant number of events scheduled for the fourth quarter, especially in December, which is a positive sign. Secondly, if we look back at December last year, we experienced the start of Omicron, so we believe that the fourth quarter will serve as a favorable comparison for us. Overall, we have a solid benchmark to measure against, and the outlook for events in the fourth quarter is promising. However, it's important to note that last year we only observed a slight rebound in events, so the current pipeline for events appears much stronger than it did last year.

And just one more question. Considering the promotions you're implementing and providing both affordable options and overall value, how are you analyzing your consumer data these days? What insights are you gaining from it, particularly regarding income levels, geography, and any underlying trends you are observing?

We are observing a very encouraging trend during happy hour since launching our $3.69 price point. This has led to significant customer activity in the earlier hours. Additionally, our high-end products are performing exceptionally well, prompting us to extend our Wagyu promotion throughout July. We recognize the importance of bringing customers in, so we are focusing our digital marketing on highlighting value. Notably, at STK, we’ve seen consumers eager to indulge in higher-end options, indicating strong demand in that segment. Meanwhile, Kona Grill caters to a slightly different demographic, with lower household income levels. There, we've introduced a $7.99 cheeseburger for lunch, which is performing very well. Interestingly, even with this low entry price, our $5 options for french fries and bacon are seeing high sales. Consumers entering for lower-priced items are willing to upgrade their orders once at the restaurant. We have always emphasized offering value, and our current marketing pushes entry price points while customers still choose regular menu prices when they visit. Overall, I haven't noticed any significant shift where customers are opting for fewer items or cheaper options.

So in conclusion, now that you have a more normalized comp because they've just been through the roof. Can you talk about what price is in there? And then I think you're counting on trades at least on the STK side, right, for comp? Can you talk to, however you're calculating transaction traffic entree essentially to understand that measure?

We actually use both checks and a measure of headcounts for our STK entree. In fact, we saw increases in both STK and Kona Grill, and the metrics performed well. From a trend perspective, we focus on the three-year stack against 2019, which is our baseline, to assess our performance. This has been our health metric, at least for a few more quarters until things stabilize. I'm uncertain if there is such a thing as a normalized comp anymore, but we reference that baseline to gauge how the business is performing. Regarding pricing, we have minimal price increases at STK and Kona Grill, which are almost negligible. We refrained from raising prices in the second quarter to observe consumer behavior and transaction patterns. Now, we feel more confident in utilizing our pricing power, and we plan to implement a price increase at Kona Grill this quarter, along with some minor adjustments at STK. We believe there is room for further pricing in the third quarter, which should significantly enhance our margins, especially at Kona Grill.

And the next question comes from Nick Setyan with Wedbush Securities.

So did you guys expect over 500 basis point uptick in operating expenses in Q2 versus last year? And if not, where was that difference? And then just give us if you can, just some more details around what exactly to aspire in the quarter for us to see that kind of an uptick in expenses?

Yes. So the uptick on expense, I think Tyler mentioned this on his prepared statement is mostly, if not all, associated with average wage for hourly and manager labor that has been the pressure point relative to that line item. And then, of course, we have chosen to keep our staffing at the restaurants at par. So we've kept all our restaurants fully staffed throughout the quarter. So the pressure point there is the fact that we're frankly just have head counts in our business model and the wage has gone up. So in hindsight, probably the thing that we could probably have taken on a little earlier was pricing because we did not take pricing in the quarter. But no, I mean, other than the labor, there is nothing really other significant on the P&L. Although, if you also think about it any kind of service that is labor-intensive like janitorial, DJs, and stuff like that, they also have exposure to labor rates, that's probably what I would say the pressure was on. In terms of other expenses, I think everything was pretty much in line with what we thought it would be.

And so going forward, like Q3, Q4, how should we think about margins in light of the incremental pricing you're taking?

So I mean, I think for Kona Grill, we're thinking about 4% to 5% on price. So that should have a substantial impact on the Kona Grill margins and then STK, we're thinking maybe one or two points, very select items. So I think those items will help the margin. Obviously, looking at the STK margin is still in the 21-plus range. So that 1% to 2% increase, we should put it back into the 22-plus range on the margin. And then the pricing at Kona Grill should bring it back up to the mid-double digits, right? So kind of 14%, 15% range.

Okay. And then just a final question. Can you talk about just sales trends as the quarter progressed and maybe into July? And whether you've seen any kind of slowdown in June or July?

I didn't notice it. In April and May, during the holidays, we experienced very strong trends. However, June was a different story. It wasn't necessarily a slowdown, but rather inconsistent, with some strong days and others that were weaker. June was a bit choppier and arguably softer than May. Out of the three months in the quarter, June was likely the slowest. July is interesting because it starts with the 4th of July holiday and is typically a slow month for urban downtown restaurants. Nonetheless, compared to the three-year trend, we felt July performed quite well. As I mentioned earlier with Nicole, the overall trend we observe from the three-year comparisons is very strong, and we believe this will continue into the third quarter. The challenge remains visibility due to all the noise from the news. However, as we've moved through the first couple of weeks of the quarter, things are looking okay in relation to the three-year trend.

And the next question comes from Mark Smith with Lake Street Capital Markets.

I want to dig in just a little bit deeper just as we look at the 4-wall margins. Can you just give us any insight, Kona Grill looked like had a tougher time on kind of restaurant level margins. Walk through any puts and takes that maybe impacted Kona more than your STK units?

So both were impacted on wage, hourly wage. And then the only meaningful differential between Kona Grill and STK is tuna prices in the quarter were much higher and tuna because of its sushi component, uses more tuna. So I would say that, that's the bigger difference between the margins on the two brands. And again, as I said in my previous answer, we didn't take pricing and we do plan to take pricing now. So I think that's going to help bring the Kona Grill margin back to the mid-teens.

Okay. And did I hear you right, as you look at the two different consumers, the STK customer versus the Kona Grill customer, did you see more change in behavior with inflationary pressure on that Kona consumer than you did on STK?

The answer is that the consumer interest in premium items at STK remains consistent. We observe a significant amount of upgrades in choice at STK, with no meaningful changes noted. Regarding Kona Grill, we haven't identified any clear trends in customer behavior, such as opting for less expensive items or fewer items per order. However, much of this might not be evident due to our extensive promotional efforts. We have a lot of marketing initiatives ongoing, especially with our bar promotions, which likely help counteract some broader market trends. The absence of noticeable changes may be more influenced by our promotions rather than actual shifts in consumer behavior at Kona Grill.

Okay. And then the last question for me. Can you just talk about your non-comp restaurants and how those units are performing?

Non-comp restaurants would be Bellevue. Bellevue is performing very well, averaging $200,000 in weekly volume. I'm not sure what other non-comps we have there, but everything else is generally in line with the comps.

Yes, so no changes. As you consider new restaurants, does this give you some of the confidence in your target of 40% to 50% ROI on new units?

The new restaurants we are opening depend heavily on the quality of the real estate. The locations we have chosen are excellent, which adds significant value. For instance, we're about to open in San Francisco at 30 Mission, a great area. Dallas also offers high-quality real estate, along with Riverton and Columbus. I am confident in the quality of these locations, which show promising indicators for the future. In San Francisco, there is an increase in office workers and overall population, which is better than the previous historical data. We've also noticed more foot traffic in the city, especially on busy nights like Thursdays and Fridays, with restaurant seats getting filled. This is a positive sign. In Dallas, the response to our recruitment ads for employees has been overwhelmingly high, indicating strong demand for that property. I am optimistic that the real estate we are focusing on will perform well with our upcoming restaurant openings.

And the next question comes from JP Wilhelm with ROTH Capital Partners.

If we could start briefly on brunch. I was just curious kind of what the dispersion looks like. Is most of brunch concentrated in a couple of locations? Are you seeing activity across all the STK locations? And then kind of as a follow-up to that, how are you guys thinking about driving further growth in that brunch segment?

Our brunch performance is generally consistent across all locations, though some, like our Vegas spots, outperform others due to their specific market. Overall, the brunch segment is quite balanced on a per-restaurant basis. We see considerable growth potential in this area, which we aim to harness through continued promotion and increased guest frequency. We are pleased with its current growth, but we recognize we are just beginning to tap into what we can achieve with our brunch program. We plan to enhance our drink offerings and introduce new product features to create more interest in this segment. Quality alcohol offerings at brunch are currently resonating well with consumers, especially on Sundays, which is a popular time for dining out. We believe there is still significant opportunity for growth in brunch through focused promotion and product enhancements.

Great. And just sort of as we start thinking about 2023 and without asking you to guide to anything. When we think about revenue growth, I guess, would you guys be disappointed seeing same-store sales flat or kind of unit growth on par with this year. Is there any way we should be thinking about that out next year?

At this point, navigating through the third quarter and looking ahead is challenging due to the current noise in the news and other factors. Anytime we don't achieve positive comparisons, which has been rare for our company, we strive to avoid that situation. However, the reality is that, similar to our approach during COVID, we will do our best with the circumstances we face. I have great confidence in our team's ability to adapt and focus on areas that continue to succeed despite changing economic conditions. It’s important to recognize that not every aspect of different economic cycles is negative, as there are opportunities for growth, particularly among higher-end consumers and diverse strategies. Ultimately, it’s about being adaptable, pivoting as needed, and ensuring the team remains committed to our culture of exceeding expectations and outperforming the industry.

Perfect. And then just one quick last one for you guys. Just on about development time lines. I know we've talked in the past inspections, municipalities kind of seeing a little bit of delays there. Are any restaurant openings kind of slipping later than expected?

Yes, the jurisdictions pose a challenge. One issue we've encountered recently in construction is mobilizing labor. Securing adequate labor for construction is proving to be more difficult than it has been in the past. However, we don’t see any insurmountable obstacles. We will need to be more flexible with the timelines for opening and building these restaurants. Given that STKs are large establishments with many components, it’s essential to allow ample time to ensure quality while managing costs. Balancing cost and construction timelines is critical. As I mentioned earlier, San Francisco is currently on track for its opening, with all our employees training there this week, which is encouraging. Dallas will follow shortly after, and that looks promising as well. We're excited to continue opening these locations.

And this concludes the question-and-answer session. And now I'd like to return the call to Manny Hilario for any closing comments.

As always, I appreciate everyone's interest and support of The ONE Group. And as always, conclude our call here, none of our success and what we do is possible without the incredible work of our team. I'm very honored to be part of one of the best teams in the industry, and I appreciate that, and I look forward to seeing all of you out in our restaurants.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.