Red Robin Gourmet Burgers, Inc.

Good afternoon, everyone, and welcome to Red Robin Gourmet Burgers Incorporated Second Quarter 2021 Earnings Call. Please note that today's call is being recorded. During today's conference call, management will be making forward-looking statements about the company's business outlook and expectations. These forward-looking statements and all other statements that are not historical facts reflect management's beliefs and predictions as of today. and therefore are subject to risks and uncertainties as described in the safe harbor discussion found in the company's SEC filings. During today's conference call, management will also discuss non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles, but are intended to illustrate an alternative measure of the company's operating performance that may be useful. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in the earnings release. The company has posted its fiscal second quarter 2021 earnings release and supplemental financial information related to the results on its website at ir.redrobin.com. And now I would like to turn the call over to Red Robin's CEO, Paul Murphy.

Good afternoon, and thank you all for joining us today. Here with me is Lynn Schweinfurt, our Chief Financial Officer, who will review our second quarter results in detail after my prepared remarks. But first, let me briefly recap recent sales trends before updating you all on our strategic progress across the business initiatives that position Red Robin for long-term success. While we did not meet our own expectations in the second quarter, we generated sequential improvement in average weekly net sales each period during the second quarter. Despite operating under varying jurisdictional restrictions and reduced operating hours throughout the majority of the quarter, we believe these issues are timing related, not brand related, and are temporary in nature. Our largest West Coast markets, where we operate 105 of our 430 corporate-owned locations. We're subject to jurisdictional capacity restrictions and were not lifted until mid-June to early July during the last fiscal period of the second quarter. As a result of these capacity limitations, we utilized a more targeted marketing approach during the second quarter at reduced spending levels. To ensure a quality guest experience, and to build loyalty beyond the pandemic, we have been operating at reduced hours due to staffing shortages. This disciplined approach was taken to also support team member and restaurant management retention. Staffing is our number one priority, and our plan is to achieve staffing levels above 2019, supporting elevated demand compared to 2019. As we make progress and achieve those targets, the results are strong. By the end of the second fiscal quarter, restaurants that were able to operate at 100% indoor dining capacity and with full hours delivered a comparable restaurant revenue increase of 7% compared to 2019, and a restaurant margin of 19.5%, representing an increase of 1.8% compared to 2019. We have supported our staffing efforts through technology enhancements to the application and hiring process, held two national hiring days, and deployed internal and external resources to augment recruiting, hiring, and training efforts. These efforts enabled us to hire approximately 1,900 hourly team members. Additionally, supply chain and inflation are highly topical issues in the current environment. The challenges in hiring and retention have also affected our suppliers, resulting in some intermittent product and distribution shortages. Overall, we are mitigating supply chain disruptions by expanding the number of suppliers we purchase from and approving substitute products that meet our high-quality specifications. We also took proactive steps to ensure we had our equipment source to remain on track for the rollout of Donato's in 2021 and 2022. Now I'd like to provide a more detailed review of our transformation strategy, including the results that we are seeing from our key growth initiatives. Let's begin with Donato's Pizza. In Q2, we added Donato's to 41 locations and are on track to complete approximately 80 additional locations in the back half of 2021, bringing our total to approximately 200 company-owned restaurants. Recall that we believe Donato's will generate annual company pizza sales of more than $60 million and profitability of more than $25 million by 2023, when we expect to have completed our rollout to approximately 400 company-owned restaurants. We are pleased that restaurants that added Donato's to their menus are continuing to grow incremental sales beyond the first year, with average weekly pizza sales up 4.2% compared to 2019 in these original locations. Donato's Pizza generated sales of $2.9 million in a quarter, and our restaurants that offered Donato's outperformed the rest of the system by 550 basis points as compared to 2019, exceeding our original sales target by approximately 250 basis points. In March, we launched three virtual brands, which are now live system-wide across all delivery platforms. These brands incrementally bolster our off-premises business by featuring a mix of our high-quality menu items for which Red Robin is not typically known. as well as new menu items that are variations on core products. Given the low operational complexity and lack of additional SKUs, executing these virtual brands is seamless for our team members. While still early, we are excited about the performance to date. So far, the data indicates approximately 70% of our virtual brand guests have never ordered online from Red Robin before. demonstrating that we are reaching and activating an entirely new audience through this channel. During Q2, these brands contributed $5.1 million to our restaurant sales, or approximately six orders per restaurant per day on average. We look forward to sharing more on the progress of our virtual brands on subsequent calls. We sustained an off-premises sales mix of 32.8% during Q2, and continue to generate off-premises sales that are more than double 2019 levels, even as dining room restrictions have been removed. Note that we intend to maintain our off-premises stickiness by delivering an elevated experience. This is being accomplished through modifications to our processes, staffing, floor plans, and technology that will enable our team members to execute more effectively and accurately. As part of these efforts, we are increasing dedicated floor plan space to support our off premises and catering orders without impacting the dine in business. We are on track to complete these reconfiguration efforts in 2022. Our revamped Red Robin royalty program continues to positively impact our business with enhanced segmentation and personalized targeting in place since Q4 of last year. We continue to bring back lapsed guests and increase the visit frequency of our most loyal guests compared to 2019 levels. We have also expanded our loyalty program to 9.9 million current members, which is up from 9.7 million as of Q1. In addition to the benefits of loyalty related to amplifying guest engagement, we have moved away from broad discounting initiatives to targeted royalty offers. This shift better positions us to drive stronger profitability results over the long term. We're also setting the foundation for a loyalty integration with our upcoming app and enhanced website, creating a more user-friendly and efficient online ordering platform. In Q2, our pivot to digital marketing once again proved beneficial, as we were able to target our efforts to support fully staffed, and open restaurants. Our analysis indicates that our digital marketing campaign is driving increased traffic and a return on our investment, while continuing to exceed our impression and engagement goals. The Red Robin brand is better positioned today because we truly understand our primary demographic of Gen X, Millennials, and Centennials. We reach these digitally active guests where they consume media with highly relevant messaging, such as our Q2 bacon bash promotion, which exceeded our volume expectations. Building on our enhanced segmentation capabilities, our loyalty engagement hit a new high in the quarter. Over the remainder of this year, we will continue to be nimble and efficient with the bulk of our marketing investment in digital. We will also add broadcast TV to select local markets to support strategic initiatives like our Donato's rollout. On the last call, we discussed our enthusiasm for returning to menu innovation. Our featured Q3 limited time offer is the summer heat wave, and our new Scorpion Burger has outperformed our sales expectations by three times to date. This follows up two consecutive quarters of limited time offers outperforming our expectations, including our bacon bash lineup throughout Q2 and our plant-based limited time offer items in Q1, including cauliflower wings and cauliflower pizza crust in our Donatos locations. Before I turn the call over to Lynn, let me leave you with some additional thoughts on why we believe our future is so bright. First, we know that Red Robin can be a leading choice for guests by upholding our brand promise of creating memorable moments connecting family, friends, and fun. There is certainly a lot of pent-up demand for restaurant experiences during this recovery, and coupled with fewer restaurants in operation since last year, positions us to both expand our market share and build frequency. Second, the strategic initiatives we are executing are meaningfully impacting our brand by enabling us to earn and perpetuate our guest trust. And in doing so, foster loyalty and frequency for the benefit of our shareholders. These include, one, continued off-premises strength through operational and technology improvements. Two, enhancing our online ordering experience to create an improved and engaging digital presence for our brand. Three, consistent execution of our TGX hospitality standards so that our guests can capture memorable moments of connection. Four, menu innovation that supports sales growth concurrent with a higher dine-in mix. And five, expanding our Donato's footprint, building an ancillary sales channel with our three virtual brands and growing our nascent catering business as people return to office environments. Let me now turn the call over to Lynn to review our Q2 results.

Thank you, Paul. I share Paul's excitement for the future. Our improving dine-in sales trajectory, improved business model, incremental off-premises sales channels, and continuation of our transformation strategy together will drive meaningful long-term shareholder value. Turning to high-level second quarter results. The 66.3% increase in second quarter comparable restaurant revenues was primarily driven by operating our dining rooms at increasing capacities. Compared to the second quarter of 2019, comparable restaurant revenue was down 2.4%. Importantly, sequential average weekly sales continued to build each period through the second quarter and into the first fiscal period of the third quarter. We continue to deliver strong off-premises sales comprising 32.8% of total food and beverage sales compared to 63.8% and 12.5% in 2020 and 2019 respectively. Notably, total sales driven through digital channels represented 85.3% of off-premises sales. As a percentage of total off-premises sales, Third-party delivery represented 49.3%, to-go represented 42.7%, and catering and Red Robin delivery each represented 4%. Net cash provided by operating activities was $37.2 million, while cash used in investing activities was $10.8 million, and cash used in financing activities was $16.9 million. We ended the quarter with liquidity of approximately $117 million, including approximately $25.6 million of cash and cash equivalents and available borrowing capacity under our revolving line of credit. As Paul mentioned, at the end of the second fiscal quarter, Restaurants that were able to operate at 100% indoor dining capacity and with full hours delivered a comparable restaurant revenue increase of 7% compared to 2019 and a restaurant margin of 19.5% representing an increase of 1.8% compared to 2019. Additionally, we are confident in the future of Red Robin as we continue to execute on our transformation strategy and initiatives. Our plan prioritizes strategic initiatives that deliver strong financial returns while maintaining our diligence on cost management and liquidity as the restaurant industry continues to navigate the impacts of the pandemic. We intend to continue to effectively manage our bottom line and dedicate our free cash flow over the next several quarters to de-levering our balance sheet while maintaining flexibility to pursue strategic growth initiatives that will grow profitable sales going forward. Now, turning to some of the specifics related to the fiscal second quarter. Q2 2021, comparable restaurant revenues increased 66.3%, driven by a 47.7% increase in guest traffic and an 18.6% increase in average guest check. The increase in average guest check resulted from a 3% increase in pricing, a 14.9% increase in menu mix and a 0.7% increase from lower discounts. Second quarter total company revenues increased 71.9% to $277 million up $115.9 million from a year ago, driven by operating our restaurants at increasing capacities in Q2 and lapping prior year sales impacted by the COVID-19 pandemic. total company revenues decreased by 10.1% compared to the same period in 2019, primarily due to lower comparable restaurant revenue due to pandemic-related indoor dining capacity limitations and unprofitable closed restaurants. Dine-in sales were up 210.9% in the second quarter, further enhanced by off-premises sales representing 32.8% of total food and beverage sales. Our continued focus on our off-premises service model, technology, and incremental sales initiatives allowed us to capture meaningful growth in the channel. As I mentioned previously, this compares to off-premises sales mix of approximately 12.5% in the second quarter of 2019. Restaurant-level operating profit as a percentage of restaurant revenue was 15.7%, an improvement of 13.7 percentage points compared to 2020, primarily due to the following. Restaurant revenue increased by $112 million, primarily driven by increased guest traffic due to the continued lifting of jurisdictional restrictions. Cost of goods sold decreased by 140 basis points, primarily driven by pricing, favorable mix shifts, and discounts partially offset by commodity inflation. Labor costs decreased by 280 basis points, primarily driven by staffing shortages and sales leverage, partially offset by higher wage rates and staffing costs and increased restaurant management compensation costs. $1.6 million of incremental labor costs were incurred due to increased hiring ads, incremental hiring and training resources, and retention and sign-on bonuses to support our staffing initiatives. Other operating expenses decreased by 440 basis points, primarily driven by lower supplies, third-party delivery fees due to lower off-premises sales volumes and sales leverage. And occupancy costs decreased by 510 basis points, primarily driven by savings from permanently closed restaurants and restructuring of lease payments, rent concessions, and sales leverage. We plan to increase pricing to help offset inflationary commodity and wage pressures that we are experiencing or expect to experience in the foreseeable future, including increased hiring, training, and retention costs extending beyond the second fiscal quarter. We currently expect full-year commodity inflation in 2021 will be driven by increases in beef costs in the second half of 2021 That will more than offset decreases in year-over-year beef costs in the first half of the year. At the end of the second quarter, hourly wage increases were in the mid-single digits, partially offset by a favorable increase in front-of-house hours. Full pricing this year is currently expected to be between 3.5% and 4% to offset these headwinds. Restaurant level operating profit as a percentage of restaurant revenue was 18.2% in Q2 2019 and higher than 2021 by 250 basis points, driven by lower sales and higher third party delivery related costs, partially offset by lower occupancy costs. General and administrative costs were $17.7 million, an increase versus the prior year of $3.6 million. primarily driven by increased team member benefits and salaries lapping temporary salary reductions in 2020, partially offset by lower professional services spent. General and administrative costs were $21.8 million in 2019. Selling expenses were $10.6 million, an increase versus the prior year of $5.1 million. primarily driven by lapping the significant reduction in marketing spend in 2020 due to the COVID-19 pandemic. Selling expenses were $13.4 million in 2019. We recognized a tax benefit of $0.4 million in the second quarter, and our effective tax benefit for the quarter was 6.6%. The company has filed federal and state cash tax refund claims totaling approximately $16 million during 2021 from net operating loss carrybacks. While we expect to receive a portion of these refunds in 2021, due to government delays in processing these claims, we do not expect to receive the majority until 2022. As a result of these cash tax refund delays, we proactively sought and received a waiver from our banks for our FCCR covenant for the third and fourth quarters of 2021. During the quarter, we recognized other charges of $2.2 million, primarily triggered by the COVID-19 pandemic. These charges included $1.8 million related to restaurant closures, $0.2 million for COVID-19-related costs, including purchasing personal protective equipment for our restaurant team members and guests and providing emergency sick pay to our restaurant team members. 0.1 million dollars related to asset impairments and 0.1 million dollars related to litigation contingencies. Second quarter adjusted EBITDA was 19 million dollars as compared to an adjusted EBITDA loss of 15.3 million dollars in Q2 2020. Q2 adjusted loss per diluted share was $0.22 as compared to adjusted loss per diluted share of $3.31 in Q2 2020. Adjusted EBITDA was $25.5 million in the second quarter of 2019, and adjusted earnings per diluted share were $1.03. At quarter end, our outstanding debt balance was $154.8 million and letters of credit outstanding were $8.6 million. Guidance for 2021 is as follows. Capital expenditures of $45 million to $55 million, including continued investment in maintaining our restaurants and infrastructure with maintenance and systems capital, Donato's expansion to approximately 120 restaurants, including approximately 80 in our third and fourth fiscal quarters, digital guest and operational technology solutions, and off-premises execution enhancements, an effective tax benefit between 1% to 5%, selling general and administrative costs between $125 and $135 million. Before I conclude, I'd like to thank our entire Red Robin team for the results they are generating. We are confident in our ability to deliver long-term value for all of our stakeholders. With that, I will turn the call back over to Paul.

Thank you, Lynn. Let me wrap up things with a few thoughts before we take your questions. The growth and profitability drivers that we have articulated over our past several calls are firmly in place and are the foundation upon which we can create and grow long-term value for our shareholders. Despite increased staffing and retention costs and other inflationary pressures, we remain confident that the business recovery will continue and that our diligent focus on our robust business model will deliver more than 100 basis points of enterprise margin improvement as sales reach 2019 levels. Of course, our expectation of greater normalcy over the next few months as more adults return to their workplaces and children return to school in person assumes that the Delta variant does not dramatically affect or force a return to mandated restrictions, and thereby impede our current trajectory. Brett Robbins' positioning as a playful, family-friendly atmosphere, enabling people to connect while enjoying gourmet burgers and other mainstream favorites, or enjoying our great food outside of our restaurants, resonates so well today. This is because the need to be with others and spend quality time with them will endure as people reflect on what they have been through over the last 18 months. Importantly, our understanding of our guests and what they expect from a Red Robin experience has also never been greater. And while we have already made great progress in elevating our level of engagement, there is still greater opportunity for us to do so, particularly through digital channels as we augment our online presence. Let me wrap up by expressing my appreciation for our great team and all of their accomplishments. Their passion for the brand and know-how are why I am so bullish on Red Robin's future, and I thank them profusely for all that they do on our behalf. Let us now open the call for questions.

At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad, and a confirmation tone will indicate that your line is in the queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question is from Alex Slagle with Jefferies. Please proceed.

Thanks. Hey, Paul, Lynn, good afternoon.

Hi, Alex.

How are you today, Alex? I'm good. A little tired.

Good.

I might have missed this. Did you provide any July or August in-store sales trends for the whole system versus 2019? I know some of the industry data we've been looking at and some peers are noting some choppiness into August.

Yeah, what we did provide is an indication that our fiscal eighth period did see sequential improvement off of our Q2 trend.

Okay, and that was average weekly sales?

That's correct.

Okay. And then the strong metrics that you mentioned recorded at the end of the quarter, specifically what period was that, the one where the full indoor capacity, we're generating seven percent comps versus 19.

Yes, we saw sequential improvement throughout the quarter, and during the seventh fiscal period, we were opening several western jurisdictions in terms of indoor dining, so we definitely saw momentum through the entire corridor, certainly with the strongest performance in the last period.

Okay, and then on labor, maybe you can kind of help me out, kind of walk through some pieces here. It's a little higher than we expected, but realize there's just a lot going on there with additional hiring and training and overtime and then the limited operating hours. Maybe you could just kind of walk through those various dynamics a bit more. I'm kind of curious what labor as a percentage of sales would have looked like if you had full staffing and operating hours there.

Yeah, so what we did provide is we did isolate the incremental hiring and training costs that were non-recurring in nature during the quarter of $1.6 million. Our wage rates had a couple things going on. By the end of the quarter, we were generating mid-single-digit wage rate inflation, but that inflation was partially offset by the increased mix of front-of-house hours. And yes, we did see benefits associated with some staffing vacancies during the quarter.

Okay. Then just finally on Donato's, the outperformance of those stores was very nice in the second quarter, good reacceleration. As you dissect that improved performance just relative to the first quarter, is all that sort of marketing support or do you see some other factors behind that driving the performance?

Well, I think it's a combination, Alex. I do think it's, you know, we did elevate some marketing support, especially in the back half. I think what I'm especially pleased with is, as we look at the Donato's restaurants that are in their second year performance, that we've seen the growth year over year, that incrementality of, I think it was roughly 4.2%. You know, I think that's something that really speaks to our commitment to the growth of that. Also, quite honestly, one of the drivers of mix, you know, I mean, our PPA was an increase in appetizer sales, and the Donato's Pizza plays well from a dine-in perspective in terms of appetizers. So very pleased with the performance of the restaurants that have it, pleased to see that year over year, that we're seeing growth and that versus our initial modeling is performing at about 250 basis points better than we originally thought the pizza would.

Great. Thanks.

Our next question is from Brian Vaccaro with Raymond James. Please proceed.

Thanks, and good evening. I was hoping to circle back on the sales cadence. And would you be willing to provide sort of a sense of monthly comps versus 19 that you saw through the period? Just given how significant the West Coast is to your system and the capacity restrictions that ease very late in the period, I'm just trying to get a sense of the magnitude of improvement that you saw kind of moving through the period.

Sure, Brian. Our comps compared to 2019... started at down 3.7% in the first period of the quarter and ended the quarter at a positive 2.2%. Okay, great.

And that positive 2.2 would be the P7?

Correct.

Okay, great, great. Thank you for that. And the units that you highlighted at full capacity and hours, those up 7% and nearly 20% margin units, How many units are in that bucket?

How many units are we talking about there? About over 150.

Over 150. Okay. Okay, great. And then just thinking about the commodity inflation outlook, Lynn, and sorry if I missed it in your prepared remarks, but where do you expect – what was commodity inflation in the second quarter, and what are your expectations for the second half of the year?

Yeah, so commodity inflation, we've actually, maybe I'll point to a percent of restaurant sales in terms of food and beverage costs. And we did see improvements compared to the prior year, certainly in the first quarter, which carried forward in the second quarter. However, we do believe that increasing beef costs through the second half of the year will greatly offset the benefits we saw in the first half of the year. and we're currently expecting approximately 50 basis points or better compared to 2019 for the full year.

Okay, 50 basis points or better versus the low 23% range in 2020?

Correct.

Okay, great, great. And then on the labor line, I appreciate the 1.6 million that you called out. I'm curious. Just give us a sense of where average staffing levels are versus pre-COVID levels, or perhaps how many additional employees you need to hire to hit your targeted levels. And then, sorry if I missed it, but how much was overtime up versus normal in the second quarter?

Well, a lot of questions inside that one question. But, you know, given the strength that we have, are seeing in the stickiness of the off premise at the about the 30, 32% level versus 12% in the same quarter last year. Our goal is not to only get to 2019, but to get above 2019 in the staffing levels. We will be continuing to hire and train and have some costs against that continuing into the third quarter. But on average, I'd say probably I think it's five more per restaurant, so roughly about another 2,000 people that we would need to bring on board to get to elevated above 2019, which is the goal.

Okay, that's very helpful. I'll pass it along. Thank you.

Great. Thank you. Ladies and gentlemen, we have reached the end of the question and answer session, and this will conclude today's conference. You may disconnect your lines at this time. Thank you very much for your participation, and have a great day.