Executives hope a new partnership will propel the brand's expansion.

Kona Grill’s sales and traffic remain in the red. But can a summer of changes—both customer facing and internally—engineer a turnaround for the 46-unit brand?

Perhaps the biggest move in recent months was Kona’s strategic investment with Nanyan Zheng, the magnate who grew Plateno Group into one of the world’s top five hotel companies with more than 4,400 locations. He’s also the co-founder of Ocean Link, a private-equity firm focused on China’s travel and leisure sector.

On that latter note, Kona, known for its sushi selection, has designs to tap into China’s vast market. Berke Bakay, Kona’s president and chief executive officer, said China is now a target for international development of the Kona Grill brand “to a massive franchise agreement.” Zheng is vice chairman of the Board of Directors at Kona. Through the investment, the chain raised $5.6 million for working capital and to pay down debt.

Additionally, Kona also filed franchise registration statements in certain states so it can expand domestically through franchising.

“Similar to many other restaurant companies, we intend to utilize a dual strategy of both company-owned and franchised restaurants, which allows for the expansion of the brand in more markets throughout the United States,” Bakay said in a conference call.

This would mark a significant shift for Kona, which has just three international units open by franchise partners (Monterrey, Mexico; Dubai; and Vaughan, Ontario). Bakay did not provide further details but said, “we believe that the footprint of this brand can grow significantly over the next several years.”

Bakay pointed to Zheng’s track record, where he was involved in “multiple hundreds of restaurants in China through ownership” as a vehicle for Kona’s potential.

“We feel like we have an excellent partner … I would imagine you would consider that to be a significant opportunity given the size of the market and who are partner is,” he added.

Kona said its operating margins and EBITDA improved during the first quarter, but the top- and bottom-line picture is currently not a rosy one. Kona’s same-store sales declined 8.3 percent in Q1 after a 4.3 percent fall in the same quarter a year ago, giving it a plus-10-percent decline on a two-year basis. Kona said restaurant-level operating profit improved to 11.9 percent of sales, despite the lower sales volume. Revenues were $42 million compared to $45.2 million in the prior-year period.

Several factors contributed to the figures, Christi Hing, the brand’s chief financial officer, said.

Promotional activity, such as beer and happy hour promotion in Q1 2017, increased traffic but hurt margins, Hing said. Kona reduced the amount of discounted items, and took a sales hit. However, profitability improved. Also, 40 of Kona’s 46 restaurants are now in its comp base, or 87 percent. Underperforming units joining the weighed down sales as well.

“We believe that by executing the Kona Grill brand, through great service and food and a cleaner and filling ambience, we will ultimately be able to build sales for the long term. As noted above, we have reduced the amount of discounts and promotions in our restaurants and are seeing the results in improved EBITDA performance during the quarter,” Hing said, adding that cost of goods sold was the biggest drive of margin improvement thanks to a a decrease of 210 basis points to 25.7 percent compared to 27.8 percent. Traffic was down double-digits as Kona lapped the honeymoon periods for restaurants that opened in the second half of 2016.

Kona’s stock is down more than 60 percent in the past year. 

Bakay said Kona reported positive results from several initiatives it unveiled at the end of fiscal 2017. This includes “elevating all aspects of restaurant operations to a great service and hospitality, and atmosphere that has the right music, lightening ambiance to appeal to all audiences.”

“We have reviewed every recipe and made enhancements to improve the flavor profile and consistency of our menu items,” Bakay said. A new menu is coming in June, with several new features and an updated layout that will simplify the process for guests. This includes a classic drink book that features Kona’s beer, wine, and cocktail offerings. In early April, Kona implemented changes to its happy hour times and offerings, “designed to ultimately benefit the long-term success of the brand, including improved profitability and better brand positioning,” Bakay said. Less discounting was a key factor. There are also guest server features on receipts to solicit feedback, and Kona is working on upgrading its loyalty program to enable guests to earn rewards based on spending levels.

Kona is working on a smaller prototype of about 5,000–5,300 square feet to shrink the current 7,000 square-foot box. This will open the real estate map, while also reducing build-out costs. Kona hired Jim Kuhn as chief operating officer last December and the chain continues to closely monitor what it deems underperforming locations.

“We continue to evaluate our underperforming restaurants and our focus on either improving their operating performance and/or strategic alternatives,” Bakay said. “We have negotiated rent abatements for five of these restaurants to help reduce the cash burn while we seek to turn them around.”

Casual Dining, Chain Restaurants, Feature, Finance, Kona Grill