Saturday, August 9, 2014

Ruths Hospitality Groups CEO Presents at DbAccess Consumer

Ruths Hospitality Groups CEO Presents at DbAccess Consumer

Everyone, my name is Jason West, Im the restaurant analysts at Deutsche Bank, and were pleased to have Ruths Hospitality Group with us today. We have Michael ODonnell, Chairman and CEO; Arne Haak, the CFO. Just to give you a little background on the company, as you all know, Ruth Chris is a leader in the upscale dining space. Theyve got about 160 units, about 130 or so are on the Ruths side, sort of 50 50 franchise in company. And then 22 of the Mitchells brand, which is a little more of a seafood focus.

Ruth has had a really nice recovery last several years, entering fourth year positive comp this year, still running solid in the first quarter, which is not what most of the other restaurants are saying. Theyve seen a significant improvement in margins and the balance sheet since the recession in 08, 09. They are starting to dip their toe in the water a little bit on unit growth, again, so well touch on that a bit. And we did have Del Friscos also here as well, I just wanted to let you guys know they canceled the presentation because of the secondary.

But just kind of kick it off, Ill start with a couple of questions and then let the audience jump in if you guys have questions as well. But Mike and Arne, if you guys could talk a bit about just the overall consumer environment and I guess, from your perspective, its a little more on the upscale end. But 2 things, one, kind of where you think we are in the cycle now. I mean, weve had 4 year now were in the fourth year of a recovery, are things kind of back to normal or is there still a lot of your restaurants that are not at the levels that youd like to be or that you were, maybe, at the peak of the last cycle 05, 07? If you could talk about sort of that level and if you could also dive in a little bit more on the first quarter, why you think your business has kind of held up better than maybe what weve heard from some of the other chains out there?

Okay. I think a couple of things, Jason. One, we really look at our business from a segmentation standpoint, 3 sort of distinct customer bases and 1 is sort of business to business customer, basically, where somebody else is paying, sort of a traveling and entertainment kind of expense, thats roughly about 30% of our business. About 30% of our business is special occasion business, where we are really not selling steak as much as we are selling making memories on 500 degree sizzling plates, where we are celebrating birthdays and anniversaries and special occasions and then really, an aspirational sort of visit in many cases. And the third piece of the business, segmentation wise, is really the people that are just because they like what we do, its relatively expensive, but they can afford it and theyre at the higher end of the income chain. And what weve seen, really, across all of those segments had been really consistent growth and a consistent return to of that customer back to us on a frequency basis. The notion of, can we get back to where we were pre 2008, is really a question of the average unit volumes. Our average unit volumes at one point were up to $5.5 million. We reached a low watermark at $4 million, were back in the $4.9 million range. But that really has a different portfolio to it. So if you really adjusted that, Id say, and Arne and I were talking about this earlier, were probably 85% to 90% of the way back to what we think we can get to. Our strategy has really been one of being very price adverse; we have not been doing any discounting. Its all brand development over the last 4 years. We introduced our Ruths Classics in 08 and have continued to do that, and thats a prix fixe opportunity at either it started at $39.95 and $49.95, its now its moved up over the years to $42.95, $52.95, and were still seeing that represent about 20% of revenue. But all of those segments, our private dining business, our alcohol business, is improving. Were seeing a solid return in terms of spending habits that look like, and are starting to behave more like, it was back, say, in pre 08. But I dont Im not smart enough to know where the cycle is and then I say that because I keep thinking that we clearly have a correlation or trading effect between the consumer confidence in the stock market and our customers. And so you see something like the sequester come and you think thats going to be bad, the Dow hits an all time high, and our sales continue to be pretty good. And I keep waiting for something to say, Well, wait a minute, that shouldnt be. And fortunately, and you were kind enough to mention it, we worked hard in the last 4 years to put our economic position were in a great position, economically, our balance sheet is in great shape. Were in a position to return value to the shareholders as we have been for the share price, but equally, were in a position to weather whatever might come our way. And fortunately, so far, and I cant talk a whole lot about the first quarter other than what I said relative to when we announced our earnings, that we were still seeing things in the mid single digit range. And I dont I havent seen anything that would cause me to change that position. Now why others are not seeing that? If theyre in a segment thats at a lower price point than where we are, then I can kind of understand theres more sensitivity around payroll tax and things like that. But its the higher end, were not seeing as much of that as a challenge. Were still bullish.

And when you look at the business, you guys because youve got the biggest chain within the upscale space, youve got a more little geographic balance, but you also have more residential, probably, exposure than some of the other chains. Youve got the big California, Florida exposure on the company side, those were markets that were down, probably more severely, particularly, in some of the residential stores than the rest of your business. I mean, can you talk about are you even seeing those residential kind of up and coming places where you maybe got there at the wrong time, that have really come back and is that sort of leading the charge or still lagging?

Yes. I think I do yes, were seeing improvement. I mean, were doing well in California, were doing well in Florida and basically so, were doing well across the country. I mean, some pockets are a little stronger than others, but as the housing challenge seems to be solving itself and people are feeling like their net worth is either gaining or not as far down as it once was, I think were seeing some favorability to that. I think thats very true in Florida, which was really challenged early on. But I, we dont were not really seeing any one pocket of the country as being an outlier either way up or down, its fairly stable.

Anybody out there have questions?

indiscernible Could you talk a little bit about indiscernible.

Right. So the question is, would we talk about a little bit about some of the restaurants that we have, theyre a little older that we can relocate. And thats a great question, and we have actually, were in the middle of when youre 47 years old, which is how old we are, you have the chance to change a few neighborhoods. We had great success in relocating our restaurant in Portland, almost 2 years ago now, and revenue and making it. We really view it as building a new store because its we go through all the challenges of opening a new store. And revenues are running north of 40% higher than they were in the old restaurant. Obviously, thats one of the reasons why we moved, but it is now that restaurant exceeds our average unit volume and the profitability is fabulous. So were excited about that. And we have a restaurant in Houston that had gone through a less than desirable neighborhood. We have concluded the sale of that property, were actually leasing it back for a period of time while we build a relocation and were moving closer into Post Oak. And again, we are reviewing any restaurant that is coming up for lease renewal. One of the processes we go through, is there a preferred location or is there some place we would rather go. And we have a number of those that well see over the next couple of years.

So you have any specific indiscernible?

Well, of the ones that could get relocated, I think thats probably more thats probably a very small number. I can probably I wont name them because I dont want to get into a public discussion with the landlord about renegotiations, but there are some restaurants that are still theyre in the right neighborhood on the wrong street, so to speak. But its not a substantial amount. And to follow on your question, were very proud of the fact that over the last 8 quarters weve generated $65 million worth of free cash. And whats important for us is that, not only have we managed to put the balance sheet back in a great place, we have continued to invest substantially into the restaurants. And so we have done significant major and minor remodels, we average 10 or 12 of those a year. So I mean, when you start to look at that and you say that our base of restaurants, 65 restaurants, lets say, were upgrading those, redoing those restaurants almost every 4.5 years, and we continue to do that. So I dont want anybody to get the impression that were not spending money on the business, because we are and we are happy. If youve been in our restaurant in Manhattan, we spent $1 million in that restaurant last year. It took us a little while to get that done because we needed the landlord to give us the lease extension to be able to pay for it, but were excited about being able to reinvest back in the business.

Just on the industry overall, there was a period in there, I have to relate, where that was growth kind of shut down in the high end steak chains and probably a lot of that on the private side as well. Were starting to see folks like you guys and Del Friscos picking up the pace again on unit growth. Does that worry you at all that were going to get back in the cycle of people sort of fighting for real estate and maybe having to get a little more competitive from a pricing standpoint or were really not anywhere close to where we were on that issue?

A good question, Jason. Weve built, in the last 4 years, weve built or relocated 16 the last 2 years, 16 restaurants between the company and franchise stores. So weve been active. Theres this notion that we havent been doing anything, and its really not true. Do I I think that good real estate is good real estate, and therefore its expensive. And I dont think anybody I think the days of people taking a flyer on real estate and hoping are gone, I hope. I know that theyre not in our discussion. We dont feel I feel pressured to get a return to the shareholders, and I can do that in a lot of ways, one of which is building restaurants. But I also can destroy value by building bad restaurants. So our diligence around the real estate and the way we go about it and what were thinking about is about as tough as it gets. I dont know what our competitors are going to do. We are not running into situations and deals that were looking at where somebody is saying, Well, if you dont do it, these guys are going to. I mean, we did pass on a deal that Del Frisco took. Maybe if fits better for a Del Frisco Grille than it fit for a steak house, we just didnt see the fit. But it wasnt like we ended up in a bidding war for a piece of property, I mean, its I dont think thats going to happen. I think, were getting out of bed everyday as the largest private or its the largest public company focused on the steak business, on the upscale steak business. And we got out of bed everyday trying to figure out how to sell more steaks, and thats our sort of singular focus. Most of the other companies are talking about now, Del Friscos has a similar situation, but most of our competitors are parts of bigger organizations and it may not be their primary focus. I think that some of our competitors have challenges around other parts of their brands and their real estate and focus probably is more appropriately placed there. So were not seeing it, but I were fortunate, I think, that we can look at because we know our opportunity to return value to shareholders, we can build restaurants, which wed love to do if we can find the right real estate. We can buyback franchisees, if that opportunity presents itself in the right way and the franchisee has additional developments, so that kind of an acquisition, were certainly buying a business we understand and to the extent it can be accretive and then build restaurants, so thats clearly an opportunity for us. And we said publicly and we did it, last year, we bought back shares. When we took out the preferred, thats an opportunity to return value to shareholders. And ultimately, at our current debt level and the amount of cash flow that were generating, we will, at some point, be at a very low, if not 0 debt position. And then the question is, are we do we do something like pay a dividend? And weve talked about that before, theres not been anything definitive there. But what it says is that I dont have to go build a bunch of restaurants lever up to do something. I have other options to create value for the shareholders. And weve been around for 47 years and the idea is how well make sure were around for the next 47.

Yes. The question is about our marketing/advertising strategy for the second half of last year and what the impact was on the fourth quarter. That would have been our second year in a row of running what we ran with 70 we ran 7 weeks of television in advance of the holiday season. We can do that on a national our footprint is big enough, we can do it national, cable buy, and its efficient. Theres some inefficiencies to it because were advertising in Wichita, Kansas working out of the store, but the ability to do that, vis a vis network is highly efficient. We did it 2 years ago and it was very successful. The strategy was to do it in advance of our busiest time of the year so that we sort of have a buildup of 7 weeks and then we actually are off air through the end of November and Christmas when it would be most expensive anyway. And theres already people that are out using us, but we sort of prime the pump. And we did it again for the second year and realized the increase an incremental increase, a substantial incremental increase in sales over the first year, so were very pleased with the way that, that behaved. Advertising can be a dangerous drug. We recognize it, were an operating business not a marketing company. We think that we win the war because we operate better. We have fabulous people in the field that do great work for us, our franchisees do great work for us. And what we do is brand advertising. It is not discounting. Its not any sort of limited time offer called to action. It is brand positioning, talking about the quality of what we do. We clearly see that as an opportunity to look at and to continue to use that as a way to keep our brand top of mind. But the idea that we would do it again in the third year, I dont know that weve determined that we can use it in some other way. But its clearly an effective medium for us.

The question is how do we market to the people that we accumulate in terms of a database? So the e mail, social media, all of that. I mean, I think, its more than in todays world its much more than just whose name do we have on an e mail list. We have I would say that its a broad and comprehensive plan around a social media strategy that has to do with search, that has to do with search optimization, that has to do with identifying who we use, who our customers are, specifically, who are the tendency are for our customers to be, so that we have a very targeted approach from a social media standpoint, whether its e mail, whether its online or however that is, that actually is quite effective for us. And that, in combination with the television stuff that we do, the brand awareness stuff that weve done with Women In Business, things like that, that combination of things is very effective. Some of it is, frankly, proprietary to us, so we dont talk a whole lot about it. We like to think that its a bit of a competitive advantage. I can just tell you that we are deeply immersed in how all that works.

Im going to give Arne a chance to jump in here. Mike, you mentioned the balance sheet and sort of $45 million debt you have now, I think pretty low interest rate on that. Is the plan, because you guys are still generating a decent amount of free cash flow even with stepping up the growth a bit, is the plan to kind of take that $45 million down to 0, and then sort of go from there on the next step, whether its buybacks or dividends or franchise acquisitions. Or maybe thats not the right way to look at it, if you could talk about the thought on free cash flow?

Sure, Jason. We spent a fair amount of work in late 2011 and then 2012, first, renegotiating our bank credit facility, so thats our debt facility. Its a $100 million facility, its a LIBOR plus sort of around 3% money. And as Mike talked about all the accomplishments coming away from 2008 and kind of if I liken it to the bank group, we were put on a leverage diet and you go over here and time out and pay back your loan, get yourself in shape again. And weve kind of committed ourselves if you read through our SEC filings and look at it, weve kind of committed in our bank facilities that were 2.5x maximum levered. We have $100 million facility, we have $25 million accordion if we need more. Its priced very, I think, competitively. I still think it could go lower, but thats the ongoing sport of bank negotiations. But our first priority is really going to be, I think, organic growth is what we would like to do. But if you look at our facility and how weve approached it, weve created a lot of flexibility. We didnt have the ability to do buybacks before, we do today. We didnt have the ability to do dividends, we do today. We had very limited ability to do CapEx or we have limitations on what we can do with CapEx and acquisitions, those are much broader as well. And so if I had to summarize our strategy in whole, its to support Mike, give ourselves the flexibility that we need to grow the business organically and to return value to our shareholders in whatever form it may come at us. And I think, we are at a great point here today in terms of our flexibility of what we could do and thats how weve approached it.

I think, Jason, specifically, one of the questions you asked, and I think you asked this is, do we have to go to 0 to do something else? And the answer to that is no. If there were an attractive acquisition of a franchisee that would not preclude us from doing were going to for making our other investments. I mean, as you said and Arne has echoed, we generated a substantial amount of free cash and I dont see that changing. So we can be opportunistic in terms of that. But we really, were going to return value to shareholders. So what can we do that makes the most sense on a long term basis, thats really where our focus is.

Right. The question is, can we talk a little bit about Mitchells, and Ill be happy to. Mitchells was acquired in February 08, which precedes either Arne or myself in terms of that acquisition. I think the intent of the acquisition was a very good one. The notion was how much runway is there with Ruths Chris, and heres this concept that was in the Midwest that was showing very good volumes with really pretty good returns. Its a small number of restaurants. There was still a lot of development taking place at the t