Kona Grill Inc. (KONA) recently reported second quarter 2012 earnings of 22 cents per share, which comprehensively beat the Zacks Consensus Estimate of 15 cents and improved substantially from the year-ago earnings of 11 cents per share.

Total restaurant sales in the quarter were $25.0 million, up 2.0% year over year but in-line with the Zacks Consensus Estimate. The upside in sales can be traced back to a 2.3% increase in same-store sales, buoyed by growth in guest traffic, offset somewhat by lower average guest check which was affected by the Happy Hour initiatives.

Same-store sales growth of 2.3% in the quarter came on the top of 9.1% in the second quarter of 2011 and 8.7% in the previous quarter. This also represents the seventh consecutive quarter of positive same-store sales. However, a fire breakout in the Troy restaurant in Michigan in early May also hampered same-store sales in the quarter, resulting in a loss of around $200,000 in sales. Before the catastrophe, Troy's sales were up double digits.

Restaurant operating profit margins increased 100 basis points (bps) to 19.4% in the reported quarter attributable to cost containment efforts. The company’s expenditures were palpably less, with cost of sales remaining flat year over year, occupancy costs and restaurant operating expenses falling 90 bps to 6.2%, 30 bps to 14.2%, respectively, based on total revenue. However, only labor expenses provided a partial offset by increasing 20 bps to 32.9%.

Notably, cost of produce in the quarter was lower year over year, but the gain was offset by higher beer and wine costs related to Happy Hour promotions. The company’s operating margins saw a further increment of 390 bps to 7.5% owing to considerable decline in general and administrative costs as well as depreciation and amortization as portion of revenue.

Store Update

At quarter-end, Kona Grill currently owns and operates 23 restaurants in 16 states.

Liquidity

Kona Grill ended the quarter with current assets of $9.6 million and long-term obligations of $13.0 million.

Share Repurchase

During the second quarter, Kona Grill bought back 95,500 shares at an average cost of $7.93 per share as part of the company's $5 million stock repurchase program which commenced in May 2012.

Guidance

For the third quarter of 2012, the company expects total restaurant sales of $24.1 million. The guidance considers approximately 1% same-store sales increase as the company will overlap 10.3% comps from last year. Earnings per share is expected to be 12 cents per share.

Our Take

We remain impressed with the company’s profit momentum and continuous market share gain in a highly competitive bar and grill segment. The company enters the third quarter by exercising 1.1% pricing on new menus. The new pricing action came after 14 months. The company is also assessing untapped opportunities in new and existing markets.

Kona Grill, which competes with the likes of Jamba Inc. ( JMBA - Snapshot Report ) and Benihana Inc. ( ) also embarked upon several strategies like offloading unprofitable locations, restaurant remodeling and promotions in an attempt to create awareness and accelerate traffic.

However, management expects a tough comparison in same-store sales in the upcoming quarter. A back-to-school season will make the third quarter seasonally weak. However, we maintain our long-term Outperform recommendation on the stock.