RED ROBIN GOURMET BURGERS

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RRGB: Recent Developments  and Conclusion  (As of Q3’17)

Per Q3’17 Corporate Release

http://investors.redrobin.com/phoenix.zhtml?c=131715&p=irol-newsArticle&ID=2314672

Per Q3’17 Conference Call

https://edge.media-server.com/m6/p/wjpoao8g

Operating results, though encouraging from a number of standpoints, were not impressive on the surface. The lower results were more a function of operating expenses than a shortfall in sales. Comps and traffic were basically flat, with a 1.6% decrease in menu mix offsetting a 1.5% price increase. Hurricanes Harvey and Irma affected sales by about 40 bp. For the fifth consecutive quarter RRGB gained market share within the casual dining industry, by 400 bp, but of course you can’t pay the rent with “market share” gains. (I’m “unfiltered”, don’t forget!) Restaurant operating “profit margin”, which I always point out is really restaurant EBITDA, was down 120 bp to 17.4%. Labor was up 50 bp, cost of sales was up 20 bp, “other” expenses were up 40 bp, and occupancy costs were up 10 bp. One of the positive aspects was the 41% YTY gain in off-premise sales, up to a still modest 7.6% but a help to be sure. Curbside delivery is available at 50% of the locations, expected to max out in the low 60s due to lease restrictions. Third party delivery was available in close to 50% of the locations, using up to three providers, and accounting for 110 bp of the 7.6% total. This area is still being refined, with self-delivery being evaluated in the hope of improving margins.

RRGB is coping with higher labor costs through their Maestro service model, now fully rolled out. This is expected to reduce labor hours by 5% in Q4 and beyond, though labor in ’17 as a whole will be up by 50 bp. Higher ground beef costs affected Q3, and it is expected that the higher cost of Steak Fries will affect Q4 as well, bringing cost of sales for ’17 as a whole slighter higher YTY. Selling expenses were up 50 bp to 3.4% in Q3, as a function of the timing of national media.

Guidance for Q4 was lowered materially. EPS should be in the range of $0.45-0.60, against a previous Street estimate of $1.01. Due to the Q3 shortfall of $.08 per share, the full ’17 year is expected to be $2.16 to $2.31, versus a Street estimate of $2.80. Comp sales are expected to be flat to up 0.5% for the full ’17 year, which would imply a flattish fourth quarter, perhaps up just slightly (against -4.3% LY). The Company pointed out, again, that EPS results are very substantially levered to comp sales (and margins). A one percent change in traffic can affect EPS by $0.40 annualized. Only 10 bp in operating margins can drive EPS up (or down) by $0.10 per share.

Overall, blocking and tackling, meal by meal, guest by guest, in an effort to gain market share in a difficult consumer environment, continues. In the supplemental material provided with the Q3 report, the company describes “our unique differentiating strengths” as: (1) Craveable, customizable burgers (2) Reputation for service and speed that meets the needs of Guests and (3) Best-in-class value perception with Bottomless promise, ‘affordable abundance’” Couldn’t have said it better. This management team is highly qualified, the balance sheet is strong enough to prevent financial jeopardy, and tangible progress is being made. The point at which the reported results turn for the better remains to be seen. As we have said many times over the last couple of years, sluggish sales combined with rising costs (labor, commodities, rents, etc.) are not a good combination. As somebody once said: “This too shall pass.” If I knew WHEN? I would tell you.

RRGB: Company Overview (Q3’17 -10Q) (2016 10-K) (ICR Slides 1.10.17) (Analyst Day Slides 5.23.17)

 Source of Revenues  Red Robin Gourmet Burgers, Inc. is a casual dining restaurant chain, s of  Q3’17 operating and franchising 565 restaurants (479 company, 86 franchised) with system-wide revenues of $1.5 billion in 39 US states and 2 Canadian provinces as of 17Q3.

Menu and Dayparts The Company lays claim to being “THE Burger Authority”, with a range of burgers from its core “Tavern” burger, priced at $6.99 which includes its signature “Bottomless Fries” to their “Finest” gourmet burgers, mostly offered as LTO’s at prices up to $14.99.  It also offers burgers made from chicken, fish, turkey, and vegetables. The menu features a variety of buns, toppings, sides (including some bottomless ones such as broccoli) and bottomless (non-alcohol) beverage refills.  Alcohol is served and features an extensive selection of beers, while a kids menu is a foundation of the company’s efforts to appeal to families.

Operational Model & Unit Level Economics  Of $1.36B T12M revenues to 17Q3, nearly all (98.8%) is generated by the company stores, while the balance consists of royalties and fees. Contrary to the current refranchising trend in the industry, RRGB is going the other way.  It has acquired 50 franchised units since 2014, including 13 in 2016., and for several years the company has not actively sought to expand franchising.  As discussed below in Strategy, the company is seeking to renew franchisee growth.

Red Robin units are generally leased and located on in malls (17.3%) or stand alone (74.3%) or in-line retail & other sites (8.4%).  Store size ranges from 4.5K to 5.8K square feet and in 2016 generated AUV’s of $2,969K and store level EBITDA margins of 20.4%. However, at the May 2017 Analyst Day, the company revealed it had stopped opening stores in malls in 2015 as performance deteriorated due to increasing occupancy costs, the drop in mall traffic and because the locations were not suitable for off-premise programs.  In 2016 mall and off-mall AUV’s were $2,827K and $2,998K, respectively and store-level EBITDA margins were 14.6% and 31.2%, respectively.  The company has been analyzing mall sites to develop an exit strategy or means to improve profitability of existing locations.

Not too many new stores are being built, but as of the end of 2016, a new store required a cash outlay of $2.2M-$2.6M (including pre-opening expense).  At the unit investment midpoint and at the historical off-mall performance levels, we estimate the cash-on-cash return would have been about 26.0%.  Obviously, the returns would be lower today, with lower sales and operating margins. Also in 2016, the company competed remodeling its fleet, an initiative begun in 2012.  The remodels feature new signage, technology, a greater separation of the bar and family areas.  The price tag for the remodels was about $400K, which reportedly generated a sales lift of 3%-5%. If the sales lift is a midpoint 4% of $2.9M, or $116,000, and 50% flows through to store level cash flow, $58,000 incremental cash flow returned 14.5% for a remodeled store.

Company Strategy In the nearly 5 years between a performance low in 10Q4 and 15Q3, growth in sales and earnings steadily improved. Revenues grew at a 7.9% annual pace driven by the 6.6% annual growth of new and acquired company units (including the net gain from store sales vs royalties) and consistently positive comps (average 2.7%).  Below the top line, EBITDA doubled with the recovery lifting RRGB’s operational metrics reaching near parity with the performance of its casual dining peers with less than 40% franchised:  Restaurant EBITDA margins expanded by 460bps to 21.6% (vs 18.2% peer average); Operating margins expanded by 340bps to 4.5% (vs 5.3% peer avg.), and ROIC expanded by 625bps to 7.6% (vs 10.9% peer avg.).  In 2015 the company embarked on its “Red Squared” initiative to build on the momentum of the prior 5 years, with a goal of doubling EBITDA again by 2020. Other goals of the program included completing the remodeling of its stores, mentioned above; plus improved customer service: increased seating turns & less unproductive seating; improvements in ordering & check wait times: expansion of the take-out, catering and delivery business (primarily through technology; and finally, a step up in new unit growth and stock buybacks.

Unfortunately, 15Q3 proved to be the high point of RRGB’s 5 years of progress, which was interrupted by the macro environment afflicting the entire industry, but also exposed operational missteps and oversights masked by the improving financials. Since then comps turned increasingly negative, hurt by declining traffic and average ticket.  These 2 components of comps had previously trended generally positive. Worse, until the last five quarters, the company’s traffic also underperformed its peers, which had been rare in the 5 years of the comeback.  Not surprisingly margins and profitability plunged, leading to turnover at the top.  In June 2016 the CFO resigned and 2 months later, coincident with the 16Q2 announcement, CEO Steven Carley resigned and of Denny Marie Post appointed as his successor.  Ms. Post had joined RRGB in 2011 as SVP and Chief Marketing Officer, was promoted to EVP Chief Concept Officer in 2015 and to President in February 2016. Guy Constant was recruited as CFO and Carin Stutz was promoted to COO.

 No one can accuse Ms. Post of glossing over the dismal state of casual dining.  At RRGB’s May 23rd Analyst day, she flatly predicted it will never return to its former glory when the  restaurants were a good place to eat when guests were doing something else, like shopping or seeing a movie.  Now, take-out, delivery or meals available at the grocery store are more suitable for today’s lifestyles.  Instead, customers are shopping less in the malls or less frequently heading out for a movie in favor of shopping online shopping or streaming entertainment at home.  Against this gloomy outlook she aims to pare Red Robin down to its core equities: Good value for gourmet burgers, bottomless fries and brews, which she feels will always be relevant. The program, as outlined in the 5/17 analyst update, includes:

  • The company will concentrate on core value burger line up rather than LTO’s centered on premium burgers.  It will concentrate on building out established and most productive markets to reap advertising and other efficiencies.  And it will expand off-premise, not only via its current on-line order and pick-up business but also through catering and delivery. In fact, off-premise sales have grown from 5.7% of sales to 7.6% of sales in Q3’17 vs. Q3’16.
  • It aims to increase speed of service and improve guest experience.  These initiatives together with menu simplification and operational streamlining, will drive store-level margin expansion, according to its plan.
  • Store Growth. Management will slow new unit growth to improve ROIC via better siting, lower unit investment costs and operational efficiencies (More detail in Unit-level Economics section).  This includes testing new prototypes (eg specialized production kitchens for infill, new territories and delivery-only).  The company also plans to accelerate the buildout of corporate markets and re-ignite franchisee activity by jointly develop the markets with franchisees.
  • Institute a stronger returns-based capital allocation discipline.

Similar to its competitors, much of the strategy boils down to basic blocking and tackling for which management has set itself measurable objectives and milestones.   As such the company has planned slowed company unit growth (16 new unit in 2017, with 2 units sold through Q3) or about 1% annual growth, which combined with 1%to 2% comps, would drive 2% to 4% top lie growth through 2021, Below the top line the company, earlier this year, was planning on 200-300bps of cumulative margin expansion by 2021.  Of this, labor would contribute 75-100bps (despite inflation), Occupancy & other store level expense savings and leverage would contribute 75-150bps, and G&A savings and leverage 50-75 bps.   As such the company expected EBITDA to reach $200M by 2021. Obviously, these expectations have been scaled back. Free cash flow has continued to be part of the equation here, but, for the moment, will reduce debt, rather than repurchase shares or build new stores. While, the combined effect of the company’s previously stated strategy was to double EPS by 2021, with a 10%-15% CAGR (2-4% revenue, 3-5% margin, 4-6% share repurchases).  New guidance has not been provided, since the general industry and macro-economic trends are so uncertain.

Shareholder Returns   In the last 3 years the return on RRGB has been negligible, having made a round trip, from the mid 40s to over 90 and back again. Longer term, the original IPO was in 2002, at $12.00 per share. The stock had a run to over $60 by late, 2005, declined to about $10 at the market low in 2009, had a great run to over $80 by early 2014, which has been the high point a couple of times in the last three years. I would say that long term shareholders have had more than their share of excitement. There is no dividend.

RRGB: Recent Developments  (As of Q3’17)

Per Q3’17 Corporate Release

http://investors.redrobin.com/phoenix.zhtml?c=131715&p=irol-newsArticle&ID=2314672

Per Q3’17 Conference Call

https://edge.media-server.com/m6/p/wjpoao8g

Operating results, though encouraging from a number of standpoints, were not impressive on the surface. The lower results were more a function of operating expenses than a shortfall in sales. Comps and traffic were basically flat, with a 1.6% decrease in menu mix offsetting a 1.5% price increase. Hurricanes Harvey and Irma affected sales by about 40 bp. For the fifth consecutive quarter RRGB gained market share within the casual dining industry, by 400 bp, but of course you can’t pay the rent with “market share” gains. (I’m “unfiltered”, don’t forget!) Restaurant operating “profit margin”, which I always point out is really restaurant EBITDA, was down 120 bp to 17.4%. Labor was up 50 bp, cost of sales was up 20 bp, “other” expenses were up 40 bp, and occupancy costs were up 10 bp. One of the positive aspects was the 41% YTY gain in off-premise sales, up to a still modest 7.6% but a help to be sure. Curbside delivery is available at 50% of the locations, expected to max out in the low 60s due to lease restrictions. Third party delivery was available in close to 50% of the locations, using up to three providers, and accounting for 110 bp of the 7.6% total. This area is still being refined, with self-delivery being evaluated in the hope of improving margins.

RRGB is coping with higher labor costs through their Maestro service model, now fully rolled out. This is expected to reduce labor hours by 5% in Q4 and beyond, though labor in ’17 as a whole will be up by 50 bp. Higher ground beef costs affected Q3, and it is expected that the higher cost of Steak Fries will affect Q4 as well, bringing cost of sales for ’17 as a whole slighter higher YTY. Selling expenses were up 50 bp to 3.4% in Q3, as a function of the timing of national media.

Guidance for Q4 was lowered materially. EPS should be in the range of $0.45-0.60, against a previous Street estimate of $1.01. Due to the Q3 shortfall of $.08 per share, the full ’17 year is expected to be $2.16 to $2.31, versus a Street estimate of $2.80. Comp sales are expected to be flat to up 0.5% for the full ’17 year, which would imply a flattish fourth quarter, perhaps up just slightly (against -4.3% LY). The Company pointed out, again, that EPS results are very substantially levered to comp sales (and margins). A one percent change in traffic can affect EPS by $0.40 annualized. Only 10 bp in operating margins can drive EPS up (or down) by $0.10 per share.

Overall, blocking and tackling, meal by meal, guest by guest, in an effort to gain market share in a difficult consumer environment, continues. In the supplemental material provided with the Q3 report, the company describes “our unique differentiating strengths” as: (1) Craveable, customizable burgers (2) Reputation for service and speed that meets the needs of Guests and (3) Best-in-class value perception with Bottomless promise, ‘affordable abundance’” Couldn’t have said it better. This management team is highly qualified, the balance sheet is strong enough to prevent financial jeopardy, and tangible progress is being made. The point at which the reported results turn for the better remains to be seen. As we have said many times over the last couple of years, sluggish sales combined with rising costs (labor, commodities, rents, etc.) are not a good combination. As somebody once said: “This too shall pass.” If I knew WHEN? I would tell you.

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