Executives: Mark Taylor - VP, Financial Planning and Analysis Cheryl Henry - President & COO Arne Haak - CFO &

EVP
Analysts: Brett Levy - Deutsche Bank AG Andrew Barish - Jefferies LLC Nicole Regan - Piper Jaffray Companies Brandon Sonnemaker - Raymond

James
Operator: Good morning, ladies and gentlemen, and thank you for standing by. Welcome to today's Ruth's Hospitality Group Fourth Quarter 2017 Earnings Conference Call. [Operator Instructions]. As a reminder, today's conference is being recorded. I would now like to turn the conference over to Mark Taylor, Vice President of Financial Planning and Analysis.

Please go ahead, sir.

Mark Taylor: Thank you, Sergio, and good morning, everyone. Joining me on the call today are Cheryl Henry, President and Chief Operating Officer; and Arne Haak, Executive Vice President and Chief Financial Officer. You'll notice that Michael O'Donnell is absent from the call this morning. Mike had scheduled knee replacement surgery last week, and despite his sincere desire to be on the call this morning, he is still at home recovering per doctor's orders.

With that, Cheryl will lead off the call for us today. Before we begin, I'd like to remind you that part of our discussion today will include forward-looking statements. These statements are not guarantees of our future performance and therefore, undue reliance should not be placed upon them. We would like to refer you to the Investor Relations section of our website at rhgi.com as well as the SEC's website at sec.gov for copies of today's earnings press release and our recent filings with the SEC for a more detailed discussion of the risks that could impact our future operating and financial results. During this call, we will refer to adjusted earnings per share.

This non-GAAP measurement was calculated by excluding certain items as well as losses from discontinued operations. We believe that this measure represents a useful internal measure of performance. You can find a reconciliation of adjusted earnings per share in our press release for today's call. I would now like to turn the call over to Cheryl Henry.

Cheryl Henry: Thank you, Mark, and thank you all for joining us on the call this morning.

We are pleased to report fourth quarter results, which included a return to both positive traffic and comparable restaurant sales growth. We are proud of our restaurant team members, who did an outstanding job recovering from the challenges associated with the hurricanes in the third quarter to deliver these results. Comparable restaurant sales in the quarter increased 1.5% on a comparable 14-week basis, driven by a 0.8% increase in traffic and a 0.7% increase in average check. Our special occasion business continued to perform particularly well as Thanksgiving, Christmas and New Year holidays, all showed year-over-year growth. These results capped of yet another full year of comparable restaurant sales growth for Ruth's Hospitality Group.

The 1% increase we achieved in 2017 marks our eighth consecutive year of comparable restaurant sales growth. This consistency is a testament to the strength of our brand and a direct result of our restaurant team's unrelenting focus on operational excellence. It is this consistency of our results, along with our strong and flexible balance sheet that enables us to execute our total return strategy to create long-term shareholder value. This approach consists of investing in our core business, disciplined investments into growth and acquisitions and returning capital to our shareholders. All 3 components of this strategy were executed in the fourth quarter.

While we normally talk about the core business first, the acquisition of the Hawaii restaurants was the most significant event during our fourth quarter. In December, we closed on the previously announced acquisition of 6 Hawaiian locations from a longtime franchise partner. The newest members of our corporate family embody a strong culture of hospitality in each restaurant. It is evident in the fact that these restaurants produce above-average sales and strong restaurant level margins in a very competitive market. We are pleased that the acquisition closed quickly and are working for a deliberate integration of these exceptionally managed restaurants into our company-owned system over the next 6 to 8 months.

We also expanded our restaurant base organically during the fourth quarter, with the opening of one new company-owned restaurant in the Tech Center in suburban Denver, Colorado. The Tech Center location is our second in the Denver area and represents the fourth new company-operated restaurant to be opened in 2017. As previously announced, we have signed a lease for a new company-owned location in Jersey City, New Jersey, which we expect to open in the third quarter of 2018. While our lower priority for the first half of the year is ensuring the successful integration of our Hawaiian restaurants, we continue to aggressively work on additional sites for both late 2018 and into 2019. We look forward to announcing these once these leases have been signed.

In addition to growing our footprint, we have continued to evolve. We have invested in our core business, and we focus on placing ourselves at the intersection of where the consumer is going and what our brand stands for. During the year, we completed 6 restaurant remodels, designed to enhance the guests experience and expand our operating capabilities. We expect to complete an additional 7 to 10 remodels in 2018. Our franchise partners who remain the heart and soul of our business are also continuing to invest in their restaurants.

During the quarter, a franchise partner relocated their restaurant in Mississauga, Canada. Additionally, partners are expected to open two restaurants in 2018, one in Fort Wayne, Indiana in the second quarter and one in Markham, Ontario in the fourth quarter. The third component of our total return strategy is returning capital to shareholders. In the fourth quarter, we demonstrated this through the return of $9.3 million in share repurchases and continued dividend payments. Subsequent to the end of the quarter, our Board of Directors approved the payment of a quarterly cash dividend of $0.11 per share to our shareholders, which represents a 22% increase year-over-year.

Reflecting back over the past five years, we've complemented our organic growth by returning over $148 million to shareholders through dividends and share repurchases, while growing our store count by 22%, our revenues by 29% and earnings by 54%. In summary, we are excited about the fourth quarter results. We saw return to sales growth, a rebound in restaurant level margins despite significant beef inflations and the acquisition of 6 restaurants in Hawaii. With an additional tailwind from tax reform, which Arne will discuss further, our total return strategy has us well positioned for 2018. I'll now turn the call over to Arne, who will provide more detail on our fourth quarter results.

Arne Haak: Thank you, Cheryl. For the 14-week fourth quarter ended December 31, 2017, we reported net income of $9.6 million or $0.31 per diluted share compared to net income of $9.2 million or $0.30 per diluted share during the 13-week fourth quarter of 2016. We estimate that the 53rd week in 2017 increased earnings in the fourth quarter by approximately $0.06 per share. Net income in the fourth quarter of 2017 included a $3.9 million noncash charge related to the impairment of assets at one restaurant location and a $600,000 in deal-related expenses associated with the acquisition of our Hawaiian franchisee. The Tax Cuts and Jobs Act also known as H.R.1 was signed into law on December 22, 2017.

While this act will significantly lower our tax rate, it also resulted in the revaluation of the company's net deferred tax assets. This reduction in rate reduced the value of our deferred tax assets by $1.1 million. Additionally, during the fourth quarter, the company recorded income tax expense of $100,000 related to other discrete state income tax items. Combined, these discrete income tax items reduced net income by $1.2 million or $0.04 per diluted share. Excluding these adjustments as well as the results from discontinued operations, our non-GAAP diluted earnings per common share were $0.44 in the 14-week fourth quarter of 2017 compared to $0.31 in the 13-week fourth quarter of 2016.

Total company-owned restaurant sales for the fourth quarter were $117.4 million, an increase of 16% from $101.2 million last year. Average weekly sales for company-owned restaurants were $117,4000 in the 14-week fourth quarter, up 2.5% from the $114,5000 in the 13-week fourth quarter of last year. Total operating weeks for company-owned restaurants were 1,000, up 13.1% year-over-year from 884 in the fourth quarter of 2016. The extra week accounted for 77 additional operating weeks during the fourth quarter of 2017. In addition, the acquisition of our Hawaii franchise restaurants added an additional 11 operating weeks and was modestly accretive to our earnings in the quarter.

Franchise income in the fourth quarter was $4.7 million, down 3.3% from $4.8 million in the year-ago period. The decrease was driven by the acquisition of the Hawaii franchise, which reduced royalty income from closing to the end of the year. This was partially offset by a 0.7% increase in total franchise comparable sales on a 14-week basis. Comparable sales in our domestic franchise restaurants were up 0.7% during the quarter and comparable sales in our international franchise restaurants were up 0.8%. Now turning to our costs.

Food and beverage costs as a percentage of restaurant sales increased 55 basis points year-over-year to 29.3%. This increase was driven by a 4% increase in total beef costs. For the quarter, our restaurant operating expenses as a percentage of restaurant sales decreased 80 basis points year-over-year to 44.6%. The decrease was primarily driven by leverage related to the 53rd week and a reduction in performance-based compensation. Our G&A expenses as a percentage of total revenues decreased by 115 basis points year-over-year to 7.6%, driven primarily by leverage on fixed costs related to the 53rd week and a reduction in performance-based compensation, which was partially offset by $600,000 of deal-related expenses for the Hawaii acquisition.

Marketing and advertising costs as a percentage of total revenues decreased to 100 basis points to 3%, primarily due to a planned shift of marketing spend across 2017. Preopening costs were $500,000 compared to $300,000 in the fourth quarter of 2016, driven by the timing of new restaurant openings. During the fourth quarter, the company also repurchased 450,000 shares of common stock for $9.3 million or $20.77 per share. At the end of the fourth quarter, we had $50 million in debt outstanding under our senior credit facility. During the quarter, we borrowed $35 million to finance the purchase of our Hawaiian franchise.

We used $12 million to repurchase shares and pay a quarterly dividend, and we also paid down $27 million in debt. Subsequent to the end of the fourth quarter, we had paid down an additional $6 million in debt, leaving our current debt balance at $44 million. Before I get to our 2018 outlook, I'd like to address a couple of accounting standard and policy changes that will impact us going forward as well as a few matters that impact comparability in 2018. In 2018, we'll be adopting ASU number 2014-09, which is generally referred to as the new revenue recognition standard. These standards will now require that advertising contributions received from franchise restaurants be recognized as franchise income.

In 2017, these contributions were credited against our marketing expenses. The impact of this standard change will increase franchise income in 2018 by approximately $1.5 million and increase marketing expense by a similar amount. Further, this standard requires us to recognize initial franchise fees ratably over the franchise agreement term compared to the previous practice of recognizing the fees upon completion of all material obligations, which generally occurred upon the opening of the restaurant. We are also evaluating whether certain discounts recognized on the sale of gift cards, which we've historically recognized as a marketing expense will be reclassified as a reduction of revenue on our income statement. The overall impact of these revenue recognition changes are expected to be immaterial to our net results.

Separate from the revenue recognition standards, we are moving certain administrative support costs that have been historically allocated to G&A and to the marketing line to better present the investments we make to support marketing and advertising. Finally, as part of our review of our revenue recognition standards, we are changing our policy on comparable restaurants from 15 months to 18 months, which will now be measured annually. This means that a restaurant will enter the comp group in the first quarter of the year, if it has been open for 18 months. We feel that this policy change more appropriately reflects the honeymoon periods in our new markets and also better aligns us with the balance of our peers. Now I'd like to provide our outlook based on current information for the full year of 2018 for some of our key cost metrics.

Because of the 53rd week in our 2017 fiscal year, our 2018 fiscal calendar is 1 week ahead of the same week in 2017. Since this will affect comparable restaurant sales reporting for 2018, we will be providing both fiscal and calendar quarter comparable restaurant sales measures for each quarter in 2018. We believe that the calendar base comparison will be a more reflective of the overall health of the business. As previously mentioned, the 53rd week of 2017 made a particularly strong contribution to our earnings as it contains both Christmas Day and New Year's Eve. Subsequently, our quarter-to-date fiscal comparison began the year approximately $3 million lower than 2017 and will lower fiscal comparable sales in the first quarter by approximately 300 basis points.

In addition, the Easter holiday will shift back into the first quarter in 2018 from the second quarter in 2017. We believe that the first quarter comparable sales last year decreased by approximately 70 basis points due to the shift of Easter. To this point in the first quarter, our calendar comparable sales are currently running flat. The Hawaiian franchise acquisition brought us a great group of restaurants, which produced sales of nearly $35 million in 2017 and generated $1.7 million in royalty revenues. Due to the higher cost of doing business in Hawaii, the average menu price is higher than our mainland restaurants.

This, combined with a tourist-driven economy, results in average checks that are roughly 25% higher than our current system average. Additionally, this acquisition will add an incremental $3 million in annual depreciation, driven by the purchase accounting for the assets and franchise territory rights. As you are aware, the recently passed tax reform will lower our effective tax rate. While certain aspects of the Tax Act are still subject to interpretation, it is safe to say that this impact in our business will enable us to enhance our total return strategy. We currently expect our effective tax rate to drop to a range of 19% to 21%.

We recognize the importance of investing in our restaurants, in our team members as well as the importance of returning capital to our shareholders. We plan to invest 20% to 30% of the benefit from the lower tax rate back into the business and the balance to drive incremental value to our shareholders. In regards to the cost of goods sold, we see an uncertain year in terms of beef prices. In 2017, we expected somewhat flattish beef prices and ultimately, saw full year inflation of 4.2%, which was driven by prime cuts which were up 9.8% year-over-year. This volatility was driven by increased retail demand for prime cuts, particularly in the summer months.

Although, the supply of prime beef continues to remain at historically high levels, retail demand is expected to continue, resulting in ongoing beef inflation. We currently expect total beef inflation of 3% to 5% for the full year, and we expect our cost of goods sold to be in the range of 29% to 31% of restaurant sales. We also currently expect restaurant operating expenses to be between 47% and 49% of restaurant sales. We currently expect marketing and advertising costs to be between 3.8% and 4% of total revenues, inclusive of the changes I previously discussed. We currently expect our G&A expenses to be between $32 million and $34 million.

We currently expect capital expenditures to be between $29 million and $31 million. We currently expect our fully diluted shares outstanding to be between 30.5 and 31 million shares, exclusive of any share repurchases under the company's share repurchase program. With that, I'd now like to turn the call back over to Sergio for any questions that we might have.

Operator: [Operator Instructions]. We will now take our first question from Brett Levy of Deutsche Bank.

Brett Levy: I guess, a couple of questions. First is, just a clarification on the comps. First, will you give us the restated numbers ahead of it, or as we get to each quarter? And just, is that -- you said it enters the period after first -- after the first full quarter after 18 months, can you just clarify that? And then I'll turn to the next few.

Arne Haak: Sure, Brett. The comp policy will be -- so at the start of the year, any restaurant that has been open for 18 months will be in the comp group.

So as of the first of the year -- and then we won't refresh that list until the first of the next year. So that will be the measuring point. We can follow-up with you off-line to make sure you have your counts right between comp and noncomp.

Brett Levy: Okay. Second, on CapEx, the number came in a little higher than I was thinking.

How much of that's going towards refreshing Hawaii? How much is going towards other areas? And then just one last question.

Arne Haak: Sure. So it kind of splits neatly into 3-like tiles that are about $10 million a piece. The first $10 million goes towards new units, and that assumes that we have a late 2018 or early 2019 site. And it also assumes that we have some restaurants coming in in 2019 as well.

The second $10 million is largely around the remodels. And that has some carryover in it from 2017, and then also our remodel class for 2018. And the last $10 million is what I will call maintenance CapEx, which includes both our standard restaurant maintenance, kind of our corporate and the IT investments as well as CapEx. There's some CapEx money in there as well for the Hawaii restaurants. We have a remodel and there's some other things that we would like to do to invest in that part of our business as well.

Brett Levy: And then, finally, on same-store sales. With the 15 for the quarter, you indicated that you had a much better holiday season. How much do you think that list of the comps, so in other words, what would the core comp had been for the fourth quarter had that shifted in? Can we just do the math as it simplistically is 300 basis points out of 1Q that came into 4Q?

Arne Haak: No. It's not quite that simple. But December was clearly, the best month of the quarter in terms of comps.

It's a great time of the year for us. It's really strong. The special occasion business is very good. I think the only color I can really give you on the fourth quarter was, in fact, our November was probably a little softer than the rest of the quarter, but we were not surprised by it at all. It had a lot more to do with how we spread our marketing costs throughout the year, and we had a lot later marketing in November.

And we also had a pickup in the P&L line as well. So I think, overall, the business feels pretty good. It feels very similar to what we saw all of last year, every month. Last year was kind of between flat and up to, was kind of a general cadence. We had things like weather going on.

You have the movement of holidays in and out of quarters and stuff like that. But the business feels pretty good. The one place that we kind of saw some choppiness as we go into this year was really when the stock market went down. We definitely saw that slow our sales here in the first quarter. So if you're wondering why we're flat, it has a lot to do with Valentine's Day being on a Wednesday and also the stock market volatility.

There's a very strong correlation to what we saw in sales and to the market volatility that we saw as well.

Operator: I will now move to our next question from Andy Barish of Jefferies.

Andrew Barish: Do you have the rough number on what '17 comps would have look like with the change in the standard?

Arne Haak: Sure, Andy. It really doesn't change our comps much at all. It doesn't change how we -- this isn't going to improve or, I think, dramatically change our comp period.

So it's more -- we've always known, we were a little bit different. Most people are 18 months, we are at 15 months. So when the revenue recognition standard came through, we decided to go back and look at what our volatility looks like and -- but moving from 15 to 18 isn't really going to change our comp story sales story.

Andrew Barish: Okay. And then just on the first quarter.

You're digging out of kind of a 300 basis point hold, but you're flat quarter-to-date, so how do we think about the trends, I guess, on a normalized basis?

Arne Haak: So yes, you have two different comp comparisons there. And this is the joy of having a 53rd week in 2017 is the kind of messy comparisons. On a fiscal basis, which we would all use for modeling purposes, we started the year $3 million behind when you look at first week to first week because you had Christmas and New Year's Eve in the 53rd week of 2017. On a calendar basis, we're running about flat year-to-date. So I think, those are -- and we'll need to work on probably, being a little clear about that.

But those are the 2 comparisons. So if you're looking at it on a fiscal basis, you have this kind of 300 basis point headwind, which a lot of it is driven by the week. If you look at on a calendar basis, which should take that away, you're kind of looking at flattish trends right now.

Andrew Barish: Helpful. And then what are you assuming, I guess, in terms of restaurant operating expense, the underlying inflation that you're seeing and/or some investment backing people from some of the tax windfall?

Arne Haak: I guess, the question is kind of how do we see it affecting our margins.

In making the investments and inflation, I think, our biggest variable is probably beef and watching what happens there with retail. But overall, we're investing a little bit back in. But I think we have a price right now of a little bit over 2% in the menu, and that should keep our margins probably within plus or minus 30, 40 basis points of last year. So we think it's manageable. Obviously, the sales environment in the beef will affect where that goes.

But there's no big material changes in restaurant level margins because of investments we're making or because of inflation.

Operator: Our next question will go -- is going from Nicole Miller from Piper Jaffray.

Nicole Regan: How did the Hawaii stores impact comp for 2018 and what impact did they have in the fourth quarter?

Arne Haak: Sure, Nicole. Hawaii is not in our comp group. Historically, we brought them in like a new restaurant.

We haven't made the decision yet on when they will come into our comp group, but right now they are in our noncomp group. So they did not influence the comp sales base in the fourth quarter. And they had a -- we had them for 20 days roughly in the quarter. They were pretty good 20 days to have them, and we're happy to have them, but it wasn't a material change to our earnings for the fourth quarter. It was really the core mainland business that delivered the $0.44 in the fourth quarter.

Nicole Regan: So is there way that they have slowing than potentially or presumably in 2019 factor into why you went to an 18-month consumption?

Arne Haak: It's certainly, I think, it's obviously, a big group that is going to come into our comp base when we bring it in. It did not drive our decision. I think our decision was more around what is the volatility that we're seeing on our restaurants and what's the appropriate period. I think we'll make the decision on went to bring the Hawaii restaurants into our comp group as we complete the integration and to knock on our systems and sales. But, no, it didn't influence.

It wasn't the key driver of how we made our comp base decision.

Nicole Regan: And if I chew up the third quarter comp for the hurricane impact, I believe, it would have been up low single digit and then comparisons eased by 200 basis points. I know this is only simple math and not the way the world works. Comp was expected to be higher by 2% to 3%. What did we miss model or how did the comp compare may be versus your expectations? And what are the things that were potentially drag in the fourth quarter?

Arne Haak: Sure.

So in regards to the hurricane for the full year, it's somewhere around 35 basis points of affect. So it was a little bit over 100. It wasn't quite 200 basis points in the third quarter. So you are absolutely right. Third quarter comps, we will have a bit of a tailwind because we'll be going up against the hurricane period last year.

In regards to the fourth quarter comp, I think, the biggest change on what I can see versus kind of expectations was with November. And we -- and that had a lot to do with how we split our marketing through the year. We had a much heavier marketing spend last year in November. And we did a lot to communicate that this year, that we were spreading it out more throughout the year. We're very pleased with the outcome.

We look at the full year positive sales, flat traffic despite hurricanes, despite -- and the earnings results we produced, despite 10% inflation in the summer. We think that's all pretty good. So I think the business feels very much the same as we had the great holiday, we had the great special occasions, all the special occasion days. We just had a great Valentine's Day. I still wish it was a Saturday night.

But Wednesday over a Tuesday was still a very good night for us this year as well.

Nicole Regan: And then just my last question, specifically, as you comment on November suffering from a marketing change. What's the cadence as marketing by quarter for 2018?

Arne Haak: Sure. I'm not quite sure. Well, the best way to go at it in terms of percentage of sales, it's pretty consistent throughout the year with the exception, I think, the second quarter is going to be a little bit higher year-over-year.

But as...

Nicole Regan: So consistent with the prior year or split equally amongst the 4 quarters of this year?

Arne Haak: Both, both year-over-year and versus sequentially.

Operator: [Operator Instructions]. Our next question comes from Brian Vaccaro of Raymond James.

Brandon Sonnemaker: This is Brandon on for Brian.

On the 2018 cost guidance, what level of menu pricing does that assume in '18? And could you talk about commodity inflation expectations? I see beef 3 to 5, could you walk through some of the other components of the basket?

Arne Haak: Sure, Brandon. We have roughly, just a little bit over 2% in price on our menu and a little bit lower than that in the back half of the year right now. Beef is -- you heard the beef guidance. I think overall, we're expecting kind of flat to up 1%. Beef is driving the inflation.

Seafood looks pretty good. The other areas that are having the biggest percentage is kind of this producers kind of a wildcard right now for us. But overall, up around 1% is what we think about the overall basket.

Brandon Sonnemaker: Okay. That's helpful.

And then just real quick on the 4Q comp. Could you break down the price versus mix with the check?

Arne Haak: Sure. So in the fourth quarter, we had right around 2%, again, on price. So we had some negative mix. Some of that is what we're seeing in -- that negative mix is coming from, we've had really robust bar sales growth, and we're really pleased with what's happening there.

And we look at overall sales and what's happening in the bar and the total restaurants, I think, we're happy with it. But that's the biggest driver of the negative mix.

Operator: [Operator Instructions]. As there are no further questions in the queue, that will conclude today's question-and-answer session. And I would like to turn the call back to our speakers for any additional or closing remarks.

Cheryl Henry: Thank you all very much for joining our call this morning. And as Mike would like for me to say, it's always a great day to go out and eat steak. Have a great day, everyone.

Operator: Thank you. That will conclude today's conference call.

Thank you for your participation. Ladies and gentlemen, you may now disconnect.