TEXAS ROADHOUSE

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 TXRH: COMPANY OVERVIEW  (2016 10K)

Company Background and Long-Term Strategy

Texas Roadhouse operates two restaurant brands – Texas Roadhouse and Bubba’s 33.  Texas Roadhouse restaurants are full service, casual restaurants that feature specially seasoned steaks that are hand-cut daily on premise.  The first Texas Roadhouse opened in Clarksville, Indiana in 1993; by the end of 2016, the Company operated 413 and franchised 86 Texas Roadhouse.  In addition, the Company operated 16 Bubba’s 33, a family-friendly sports-themed restaurant, the first of which opened in 2013.

The Company’s mission statement is “Legendary Food, Legendary Service” and its operating strategy is to position each restaurant to be the hometown favorite for a broad segment of consumers seeking high quality food served at fair prices and with friendly, attentive service.  Most restaurants are open only for dinner during the week, with lunch served in approximately half the locations on Fridays.  Management believes the focus on dinner attracts higher quality operating teams because it offers a better quality of life. This approach was “invented” thirty years ago by Outback Steakhouse, but they moved away from the “dinner only” approach years ago, no doubt feeling the continuous pressure from public investors to keep the same store sales moving upward.

The Company’s operating strategy is similar at each brand, based on the following components:

Serving high quality, freshly prepared food.  Many menu items are prepared using proprietary recipes.  At Texas Roadhouse, all but one cut of the steak offerings are hand-cut daily and sides are made from scratch.  At Bubba’s 33, sides are made and buns are baked from scratch.  A management level employee inspects every order to ensure quality and accuracy before it is delivered to a guest.

Performance-based management compensation.  Managing Partners (restaurant managers) and Market Partners (area supervisors) receive bonuses based on a percentage of the pretax income at their respective restaurants.

Focusing on dinner.  In addition to attracting higher quality employees, management believes that focusing on only one shift a day results in higher quality and more consistent food and service. We  will throw in our “two cents” here and suggest that few casual dining chains make much money at lunch, in any event, with one table turn, a lower average ticket, minimal alcohol sales, and higher labor costs. Add in the cost in terms of lifestyle and focus for the operating teams, and a pretty good case can be made that the lunch daypart is best left to traditional fast feeders and the new fast casual segment.

Offering attractive price points.  The average check per person (largely dinner only) at Texas Roadhouse was $16.68 in 2016.  Bubba’s 33 menu prices range from $8.99 for a Classic Cheeseburger to $19.99 for a 14-ounce ribeye.

Creating a fun and comfortable atmosphere with a focus on high quality service.  The Company maintains a low table-to-server ratio to provide more personal service to the guest.  A Texas Roadhouse features a rustic southwestern lodge décor and a Bubba’s 33 has numerous televisions playing sports and various sports memorabilia on the walls.

Management’s objective is to add approximately 30 total restaurants a year, the bulk of which will be Texas Roadhouse.  The Bubba’s 33 restaurant prototype is still under refinement; in 2017, four to six are expected to be opened.  Although there were 86 (13 international) franchised Texas Roadhouse locations open at the end of 2016, franchising is not a focus of the Company.

Sources of Revenue  Total revenues in 2016 were $2 billion, more than 99% of which were derived from sales of Company-operated restaurants, with the remainder from franchise fees and royalties.  The Company does not break out separately the contribution from Texas Roadhouse and Bubba’s 33.  Average unit volumes at Texas Roadhouse were $4,802,000, implying sales of Texas Roadhouse were $1.93 billion, or 98% of total Company sales in 2016.  Average unit sales of Bubba’s 33 are not disclosed.  Sales of alcoholic beverages accounted for 11% of sales in 2016.

Menu  The Texas Roadhouse menu (Texas Roadhouse Menu) features hand-cut steaks and other items including ribs, fish, seafood, chicken, pork chops, pulled pork, vegetable dishes, hamburgers, salads, and sandwiches; entrees come with two made-from-scratch sides.  The Bubba’s 33 menu (Bubba’s 33 Menu) features wings, sandwiches, pizza, and burgers, as well as an extensive selection of draft beers.

Unit Economics  In 2016, the average total investment in a Texas Roadhouse restaurant was $5.1 million including pre-opening expenses of $615,000 and a value assigned to real estate for leased locations equal to 10 times the base rent.  Management is focused on achieving an internal rate of return in the mid- to high teens, in excess of its normalized cost of capital of 10-11%.  Based on overall operating results in 2016, the average Texas Roadhouse appears to be generating approximately $1 million in store-level earnings before interest, depreciation, amortization and rent, or a little under 20% of the cost to develop a restaurant.

The Bubba’s 33 prototype is still under development so costs and returns are likely to change.  In 2016, the average cost to build a Bubba’s 33 was $6.5 million.  Management is focusing on reducing the investment cost as it develops new locations.  Bubba’s 33 has higher margins than a Texas Roadhouse primarily because of lower cost of sales so an internal rate of return in the mid- to high teens can be achieved with a higher investment cost and similar sales volumes.

Operating Metrics The Company’s debt level is relatively low, with 2016 year-end debt less than 7% of shareholders’ equity.   Even adjusting for leases, the Company’s leverage is low with lease-adjusted debt to EBITDAR of 1.26 in 2016.

Shareholder Returns  Texas Roadhouse has been one of the better performing casual dining restaurant stocks over the last five years, nearly tripling since the fall of 2012, as EPS has grown steadily from $1.11 in calendar 2013 to over $2.00 per share estimated for 2018. The current dividend represents a 1.7% yield.

Recent Developments – Per Q2’17 Release (below) and Conference Call

http://investor.texasroadhouse.com/releasedetail.cfm?ReleaseID=103514)

Texas Roadhouse continued its excellent performance, especially relative to its peers within the full service casual dining industry. Comp sales were up 4.0% and 3.6% at domestic company and franchise stores respectively. Equally impressive, traffic was up just over 3%. Restaurant EBITDA margin was up 9.8% to 18.9%,  down a modest 28 bp YTY due to wage inflation, partially offset by lower food cost. With a lower tax rate, diluted earnings per share was up 11.0%. There were 11 company owned Texas Roadhouse openings and 2 Bubba’s 33 new locations. Most encouraging to investors was that the first four weeks of the third quarter continued strong, with a 4.6% increase.

The details of the quarter included improving comps through the quarter, up 2.6%, 3.7% and 5.1% in April, May and June respectively. Wage rate inflation was 6%, driving labor expenses up 133 bp. Cost of sales deflation was about 1.9%, lowering CGS by 106 bp. Expectations for all of ’17 continue to be similar in terms of labor and CGS expense.

G&A, at 5%, improved by  27 bp. D&A was 10 bp lower at 4.1% of revenues. As indicated above, the lower tax rate, at 27.9% compared to 30.2% helped. Over the first half of ’17, $128 million of cash was generated from operations, capex was $74M, dividends were $28M and $17M was spent to acquire four franchised units. There were no share repurchased in the first half.

Also encouraging was that the newest restaurants, opened less than six months, averaged over $105,000/week, with sales at comp restaurants (over 18 months old) averaged $98,000. The current expectation was for 27-29 company restaurant openings for ’17, several units rolling into ’18 due to construction issues

A new menu was rolled out in Q2, which included 0.5% of price increase, the addition of calorie counts and two smaller portion entrees. Management indicated no problem with the price increase and a slight negative mix movement due to the new entrees. Analysts asked about “pricing power” and management reiterated their reluctance to raise prices unless absolutely necessary. While a delivery capability is a major emphasis for many operators, this team believes that, for the time being, the risks of product deterioration, unreliability by delivery agents, and excessive kitchen pressure during peak periods, outweigh the rewards. The mobile app, however, is in over 200 locations, allowing call ahead ordering, and payment, for food to be taken off premises.

Management discussed their ongoing effort to reduce crew labor turnover which is “average” within the restaurant industry at just under 120% annually, but unsatisfactory for this Company. Management turnover, however, is among the lowest in the industry, in the low teens, and an effort is being made to get that calculation under 10%. Overall, TXRH continues the day to day “blocking and tackling” that has produced the superior results over the long term.

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