Kura Sushi USA, Inc. (NASDAQ:KRUS) Q3 2022 Earnings Conference Call July 7, 2022 5:00 PM ET
Company Participants
Benjamin Porten – Vice President of Investor Relations and Business Development
Hajime Uba – President and Chief Executive Officer
Conference Call Participants
Jeremy Hamblin – Craig-Hallum Capital Group
Sharon Zackfia – William Blair
George Kelly – ROTH Capital
Operator
Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Kura Sushi USA, Inc. Fiscal Third Quarter 2022 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode and the lines will be opened for your questions following the presentation. Please note that this call is being recorded.
On the call today, we have Jimmy Uba, President and Chief Executive Officer; and Benjamin Porten, Vice President of Investor Relations and Business Development.
And now, I would like to turn the call over to Mr. Porten.
Benjamin Porten
Thank you, operator. Good afternoon, everyone, and thank you all for joining. By now, everyone should have access to our fiscal third quarter 2022 earnings release. It can be found at www.kurasushi.com in the Investor Relations section. A copy of the earnings release has also been included in the 8-K we submitted to the SEC.
Before we begin our formal remarks, I need to remind everyone that part of our discussion today will include forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance, and therefore, you should not put undue reliance on them.
These statements are also subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. We refer all of you to our SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition.
Also during today’s call, we will discuss certain non-GAAP financial measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation nor as a substitute for results prepared in accordance with GAAP. And the reconciliations to comparable GAAP measures are available in our earnings release.
With that out of the way, I would like to turn the call over to Jimmy.
Hajime Uba
Thank you, Ben, and thank you, everyone, for joining us today. It has been a [indiscernible] how rapidly and completely our business has recovered since the most challenging days of the pandemic. This has been a year of exploration for Kura. In fact, we’ve gone past near expiration and we are performing better than ever. It’s a challenge that COVID presented ultimately true to be an opportunity for us. In March, we strong as we have, was hard to imaging when we are in the sick of the pandemic, and I’m so proud and grateful for everything that our team members have done to make this possible.
Now, I would like to discuss our performance in our most recent quarter and why we think we are positioned for even greater things to come. The strong sales momentum from the first half of our fiscal year has continued into our third quarter, which once again has proven to be a record of third quarter for the company. As compared to our pre-pamdemic fiscal 2019 results, comparable sales growth in our third quarter was 28.3%.
In a single year comparison against our fiscal 2021 third quarter, comparable sales grew by 65.3%. Whether we are looking at last year or about pre-pandemic, our comparable sales growth has been spectacular. Sales recovery in our California market has been especially pronounced with third quarter comp growth of 95.5%, as compared to our 2021 difference, reflecting the sales impact of dining room restrictions during the previous year.
During the same period Texas delivered 33.6% comparable sales growth, as compared to our 2021 results. Additionally, our operating expense revenue in the third quarter was $1.3 million or 3.5% of our sales mix. It’s greater to see such strong recovery across the board. In spite of ongoing inflationary pressure, consumer sentiment for Kura Sushi remains extremely strong as demonstrated by our recent results. As our typical customers of higher incomes, and we offer an excellent value proposition. We are seeing continued strength in their spending and our tech sizes continue to grow.
Our sales performance as we enter the summer continued to be very strong with June revenue of $12.7 million, while much of the restaurant industry has been facing headwinds in terms of staffing and inflation. I’m extremely pleased to say that, we have been largely fair and believe that we continue to occupy a uniquely privileged position to weather this macro pressures.
Our COGS as a percentage of sales for the first half of the fiscal year were, up 30% marking an all time best in corporate history. While we haven’t been entirely free from quality pressures, taking the price in conjunction with smart budgeting practices have allowed us to offset commodity inflation. In fact COGS as a percentage of sales decreased by a further 30 basis points in our third quarter.
As a percentage of sales, labor is running at 31%, representing the sequential improvement of 215 basis points over the prior quarter, driven by superior sales leveraging. While we had previously faced starting headwinds, as a result of Omicron-related staff quarantining during the second quarter, we are pleased that we say that we had no such issues during our third quarter and we remain very close to achieving optimal staffing levels. These combined factors have deserted in [indiscernible] operating profit margin of 22.5%, representing 470 basis points of margin expansion relative to the prior year quarter and 210 basis points, as compared to the same period in pre-pandemic fiscal year 2019. There remains ample opportunity for our full-year restaurant margins to exceed to 20% we historically achieved pre-pandemic.
Turning to development. We opened one unit during the quarter in our new market of Watertown, Massachusetts. We are very encouraged by Watertown’s added performance, as well as the continued strength of our other fiscal ’22 openings. In terms of upcoming openings, we expect our Nova restaurant to open in the coming weeks and to close out our fiscal year with a total of eight new restaurant openings. We expect the remaining stores under construction to open early in fiscal 2023.
Now I would like to turn to an update on recent initiatives. In past earnings calls, I had mentioned that we planned to complete the systemwide rollout of our load servers, they will set the payment, and the touch panel is going to order system by the end of the fiscal year. I’m proud to say that we are ahead of schedule and that we completed the rollout as of the end of May. As we previously mentioned guest response and employee response have been phenomenal. The robot firewalls are a great addition to the Kura experience and was the focus for our recent marketing campaign.
Now that if completed the rollout of these three initiatives, I would like to discuss what we have coming up in our pipeline. We are in the process of upgrading our [Vitoria] (ph) system through a partnership with [Bribery] (ph), which we hope will improve the guest experience and reduce the attrition rate associated with our long runs. We are also in the process of moving loyalty platform to punch. Our [indiscernible] membership base is now approaching 0.5 million members. And by moving to more — moving to the more power upon platform, we believe we can truly begin to unlock a data driven benefit that you have the program can offer. We expect that to implement these initiatives during the first half of the upcoming fiscal year.
As a final note, basic pricing of approximately 6% as of July 1st. Although the minor pricing adjustment we took in March was enough to offset inflationary pressure through the third quarter. In light of month over month inflationary current through the quarter, including the minimum wage increase in our California market, we believe this 6% is appropriate considering the excellent value we continue to provide relative to our competitors especially those in the Sushi space. We would also be developing a pricing event as we reach September at which point, effective pricing will be 7.8%.
Again, I would like to extend my thanks to all of our team members in our restaurants and support center. The hard work that they put in every day is the reason that Kura Sushi is such a special concept.
And with that I will turn it over to Ben to briefly discuss our financial results and liquidity. Ben?
Benjamin Porten
Thank you, Jimmy. For the third quarter, total sales were $38 million, as compared to $18.5 million in the prior year period. Comparable sales growth as compared to the prior year period was 65.3% with regional comps of 95.5% in California and 33.6% for Texas. As compared to our pre-pandemic results of the fiscal 2019 third quarter, our comparable sales growth was 28.3% with regional comps of 18.2% in California and 40.5% in Texas.
Turning to costs, food and beverage costs as a percentage of sales were 29.7%, compared to 31.7% in the prior year quarter, due to pricing taken at the start of the fiscal first and third quarters and higher food spoilage costs in the prior year, partially offset by food cost inflation.
Labor and related costs as a percentage of sales increased to 31% from 8.95 in the prior year quarter, due to the lapping of the employee retention credits recognized in the prior year. Excluding the impact of the ERC and retention of new hiring bonuses, labor related costs as a percentage of sales in the prior year quarter would have been 36.6%. The year-over-year improvement in labor and related costs as a percentage of sales excluding ERC was due to higher sales leverage partially offset by increases in minimum wage.
Occupancy and related expenses as a percentage of sales improved to 7.1% from 10.2% in the prior year quarter, primarily due to higher sales leverage. Other costs as a percentage of sales decreased to 11.5%, compared to 14.7% in the prior year quarter, due to higher sales leverage as well.
General and administrative expense were $5.9 million, compared to $4.3 million in the prior year quarter. Excluding the impact of the ERC recognized in the prior year quarter, general and administrative expenses would have been $4.8 million. This increase was primarily due to compensation related as we made investments in our team to support our accelerated growth plans, partially offset by a litigation accrual in the prior year quarter. As a percentage of sales, general and administrative expenses were 15.5%, compared to 23.2% in the prior year quarter.
Operating income was $473,000, compared to operating income of $866,000 in the prior year quarter. Excluding the impact of the ERC and litigation accrual in the prior year quarter, operating loss would have been a negative $4.4 million. Income tax provision was a benefit of $2,000, compared to an income tax expense of $30,000 in the prior year quarter. Note that we expect to continue to incur nominal income tax expense irrespective of our pretax income or loss as a result of the full valuation allowance against our deferred income tax assets and incurrence of minor income taxes payable at state levels.
Net income was $477,000 or $0.05 per diluted share, compared to net income of $770,000 or $0.09 per diluted share in the prior year quarter. When adjusting for the ERC benefit and litigation accrual in the prior year quarter, adjusted net loss would have been $4.5 million or negative $0.54 per diluted share. Restaurant level operating profit as a percentage of sales was 22.5%, compared to restaurant level operating profit as a percentage of sales of 5.8% in the prior year quarter. Adjusted EBITDA was $3.2 million, compared to a negative $2.6 million in the prior year quarter.
Turning to our cash and liquidity, at the end of the fiscal third quarter, we had $36 million in cash and cash equivalents and no debt. In light of our fiscal third quarter results, I would like to provide the following updated guidance. We expect total sales between $137 million and $142 million. We expect general and administrative expenses as a percentage of sales of approximately 16.5% and we expect the opening of eight new units with net capital expenditures per unit of $2.2 million.
Now I’ll turn the call back to Jimmy.
Hajime Uba
Thank you, Ben. This concludes our prepared remarks. We are now happy to answer any questions you have. Operator, please open the line for questions. As a reminder during the Q&A session I may answer in Japanse, before my response is translated into English. Please bear with us.
Question-and-Answer Session
Operator
And at this time, we will be conducting a question-and-answer session. [Operator Instructions] And our first question comes from the line of Jeremy Hamblin with Craig-Hallum Capital Group. Please proceed with your question.
Jeremy Hamblin
Thank you and congratulations on the strong results. I wanted to focus first on your restaurant level margins 22.5%, I think is a record for the company, labor down to 31%. And obviously you are doing that in a fairly high food and labor inflation environment. So I wanted to get a sense of the sustainability of those margins? How much of the improvement in labor is a reflection of the price increases versus the use of Kura bots?
Benjamin Porten
Hi, Jeremy. This is Ben, it’s great to talk to you. In terms of pricing, we really use pricing to manage our prime costs of COGS and labor. That’s really why we’ve been able to keep it so consistent over the last three quarters. In terms of the improvement to our restaurant level operating profit margin, that would be a function of greater sales leverage, part of which would be the Kura bot.
Jeremy Hamblin
Got it. And then just in terms of, you know, you provided some color on — back in April on your March sales trends, I think you did about $12.5 million in the month of March. Looks like you had kind of sustained those trends in April and May. But in terms of looking forward here to this kind of implied guidance for Q4, it looks like you’ve seen some acceleration in productivity typically Q4 has your highest average unit volumes? Can you give us a sense of what you’ve seen quarter to-date thus far? And how much of the increased guidance is reflective of the price increase?
Benjamin Porten
Sure. In terms of June results, as Jimmy discussed in the opening remarks, we had $12.7 million in revenue that — if that were to be the run rate for the remainder of the quarter, that would be the sort of the lower end of the guidance. In terms of seasonality, Q4 is certainly the strongest quarter that we have. You can see that effect very meaningfully in pretty much every year. July and August are the — really when the summer begins to ramp up and so we do expect improvement over that $12.7 million that we saw in June, which is — what gets us to the higher end of that guidance.
Hajime Uba
Jeremy, please allow me to add some additional explanation, but please allow me to speak in Japanese. Ben will then translate. [Foreign Language]
Benjamin Porten
To give you some additional granular detail. Historically, the sales improvement in Q4 relative to Q3 has been 5.9% and then we took an additional 6% of price in July. And so that gets us higher up in that guidance range that we get. And then we have a number of other things that are in place, [indiscernible] collaboration campaign, which if it proves as successful as we hope it will be, then that will get us to the high end of that guidance.
Jeremy Hamblin
Got it. That’s great color. One last follow-up here. In terms of your average volumes versus kind of pre-pandemic levels, I calculate it’s up about 25% in the May quarter versus what you were generating three years ago. Can you give us a sense for the components of that? How much of that is average check change versus transactions?
Benjamin Porten
Sure. So if we look at a three year stack going back to fiscal ’19, which is our pre-pandemic comparison, the effective pricing is a little over 22%, our comps over that same period are 28.3%. We’re still not 100% back to pre-pandemic traffic and so that offsets a little bit, but the rest of it would be in organic ticket group just from people eating more plates than they used to.
Jeremy Hamblin
Got it. Thanks so much for the color guys and best wishes.
Benjamin Porten
Thanks, Jeremy.
Hajime Uba
Thank you, Jeremy.
Operator
Our next question comes from the line of Sharon Zackfia with William Blair. Please proceed with —
Sharon Zackfia
Hi, good afternoon. I guess I just wanted to follow-up on the restaurant level margin, because it was a very impressive metric. And I understand the sales leverage component of it. But can you talk about structurally, do you think there’s a change and where your restaurant level margin can settle out now over the next maybe three to five years? And I’d also be curious to hear your thoughts and I’m sorry if I missed this on development for 2023, particularly it sounds like maybe one or two locations might have slipped into ‘23?
Benjamin Porten
Sure. Let me answer that second question first. So you’re right we did tighten our guidance from eight to 10 units to eight units and so those remaining two units we expect to open early in fiscal ’23, we’re excited to provide more granular guidance in terms of our unit growth expectations for fiscal ’23 at the Q4 earnings call or next earnings call. But what we can say at this point is that since went public, we’ve told the Street that we expect to maintain a 20% unit growth CAGR and we absolutely expect the same for 2023 with that 20% as [indiscernible]. In terms of the restaurant level operating profit margin expectations, it’s — I don’t have a crystal ball for five years in the future. But just looking at the trends from Q1 and Q3, I think you could certainly expect an elevated rate for our restaurant level profit — operating profit margin, we don’t think this is a fluke — this should continue into the next fiscal year.
Sharon Zackfia
Okay. And then just a follow-up it sounds as if you feel very confident about the cadence of your business and clearly the fourth quarter guidance implies such. Are you seeing any signs of your customer weakening at all? Or anything on the margins that would suggest that the trends you’re seeing right now might not be sustainable?
Hajime Uba
[Foreign Language]
Benjamin Porten
So we’ve been extremely fortunate and that we really haven’t seen any sort of softening in terms of consumer sentiment. One of the things that we found most encouraging was that our March pricing of 1.8% was significantly outpaced by tech growth of 4.9% over that same period between Q2 to Q3. And so we know that our guests are not managing their tech sizes, but I think that’s a great indicator that we’ve yet to hit any sort of consumer elasticity point and that gave us a lot of comfort about that 6% that we decided to take at the beginning of July.
And looking at our traffic rates, we’re really — Q3 was pretty much in line with Q1, which was exceptionally strong and certainly better than Q2, which had those Omicron headwinds. And so, yes, in terms of customer sentiment, we feel that we’re in a very fortunate position.
Sharon Zackfia
Okay. Thank you very much.
Hajime Uba
Thank you, Sharon.
Benjamin Porten
Thanks, Sharon.
Operator
Our next question comes from the line of George Kelly with ROTH Capital. Please proceed with your question.
George Kelly
Hey, everyone. Thanks for taking my questions and congrats on a strong quarter. The first one is, did I hear you right that you’re contemplating taking pricing again in September as well?
Benjamin Porten
No. Just to clarify, that was referring to the September of 2021 pricing. But we’re just mentioning that we’d be lapping that price in two months.
George Kelly
Okay, got it. And then still on pricing, I mean, I understand that it’s a challenging environment as far as labor and food cost. You know your inflation is everywhere. But you just generated such a strong four-wall margin in the quarter. And here you’re taking another 6% pricing and I understand that your consumer is showing no kind of signs of hesitation or it doesn’t seem like you’ve hit a ceiling. But I guess the question is just a higher level one, which is why continue to kind of push margin through pricing? And if you can just talk, sort of, directionally about — should we expect more going forward? Or it just seems like maybe you’ve changed your thought process on the opportunity around pricing?
Benjamin Porten
Sure. In terms of — our decision for that 6% in July, this is really reflective over — reflective of the month-over-month inflation that we saw through Q3 and then into June. If you look at our past quarters through fiscal ’22, you can see that our prime cost structures stayed very, very stable. And so basically that’s to say that our FD&A team has done a tremendously good job in terms of forecasting inflation for the upcoming period and that’s what we’ve done for July as well. The goal isn’t to drive margin by taking price, it’s really just to keep our waiver and COGS consistent. The growth in margin is more from just greater sales leveraging combined with that seasonal boost that we get.
George Kelly
Okay, great. And then last one for me, I think. You mentioned a couple of pipeline of initiatives you’re working on and expect to implement in the first half of fiscal year ’23. I missed the first one, could you just walk through what that longer term initiative is, Ben? That’s all I had. Thank you.
Benjamin Porten
Sure. So —
Hajime Uba
[Foreign Language]
Benjamin Porten
So I think you’re talking about the Waitlist improvement? George, is that correct?
George Kelly
Yes, yes, I think that was it.
Benjamin Porten
Okay, great. So just to give you a — so we’ve been very happy with the Waitlist app, it served us very well, but we know that we can get to a greater level of accuracy in terms of the wait times. The algorithm that we use is pretty straightforward and doesn’t really take historical behavior into account. And so just to give you an idea, let’s say, we’re an hour before closing, but the wait time says if there’s a two hour wait, naturally you’re going to have a lot of people drop off, because they think they’re not going to be able to get a seat, but then because those people have dropped off, the Waitlist is also — the wait time should also shrink, but because those people have already left that traffic that we can’t capture. And so incorporating these attrition rates around, especially shoulder periods and stuff like that. We think that we’ll be able to seat a couple more people per day. And certainly, just having a more accurate time is better for consumer experience.
George Kelly
Okay, understood. Thanks.
Benjamin Porten
Thanks, George.
Hajime Uba
Thank you, George.
Operator
[Operator Instructions] Our next question comes from the line of Andrew Strelzik with Bank of Montreal. Please proceed with your question.
Unidentified Analyst
Hi. This is [Daniel] (ph) on for Andrew. I just had a question on off-premise, so I was curious where that mix is standing now? And maybe also some information on the driver outlook?
Benjamin Porten
Sure. Off-premises mix was 3.5% of sales in Q3 or about $1.3 million, that’s on a dollar basis, very, very close what we had in Q1. And so that lower mix is really just reflective of greater revenue total. In terms of our expectations for the future, we think this is in line. We think this is appropriate. Off-premises is gravy for us, we’re basically hitting our kitchen capacity limits. And so there’s a point we’re trying to push additional off-premises no longer incremental. In terms of our top line and bottom line growth, the opportunity is vastly, vastly greater in just unit growth. And so for the foreseeable future, we’re going to be putting our energies as a company into just growing our unit base as opposed to trying to deliver additional off-premises sales.
Unidentified Analyst
Got it. And would you also be able to provide any color on where your pipeline is right now?
Benjamin Porten
Sure. So we’ve got three units that we expect to open in July and August, and then two early in fiscal ‘23. But in terms of any further details on that, I think we’re going to wait till the next quarter to give a guidance update.
Unidentified Analyst
Got it. Thank you.
Operator
And our next question comes from the line of George Kelly with ROTH Capital. Please proceed with your question.
George Kelly
Hi, everyone. Just one more quick one for me. Can you remind me when you open a new restaurant like you’re doing three here in the last quarter. How much pre-open marketing expense and training and all this kind of stuff like what is it the expense around opening a restaurant.
Hajime Uba
[Foreign Language]
Benjamin Porten
Looking at our pre-opening marketing fees, it’s pretty insignificant, we don’t do anything like big ad buys, no television campaigns, TV commercials. We focus mostly on digital and then leveraging local media. So the spend could be — it’s pretty insignificant. In terms of — and we think that — sorry, Jimmy did I hear you right when you said it was $2,000 to $3,000 per store or $20,000 to $30,000.
Hajime Uba
Yes, $20,000, $30,000.
Benjamin Porten
Yes, so $20,000 to $30,000, which obviously is not a very big spend, but just given how strong our openings continue to be in spite of inflation, we think that’s spend rate is appropriate. In terms of pre-opening labor costs, our operations are very simple and automated as you know. And so the training period is very truncated, we’re able to open pretty rapidly following our final inspections and approvals. And so because that trading period is short, the pre-opening leaders is — I imagine substantially less than a comparable casual dining restaurant.
George Kelly
Okay. That’s helpful. Thanks.
Hajime Uba
Thank you.
Benjamin Porten
Thanks, George.
Operator
Our next question comes from the line of Jeremy Hamblin with Craig-Hallum Capital Group. Please proceed with your question.
Jeremy Hamblin
Thanks for taking the follow-up. So I wanted to get an understanding rather than asking about the number of units on a go forward basis. I wanted to get a better understanding of the type of unit and potential size that you’re looking at. I know the Watertown, Massachusetts has been great, I think the San Antonio location has been off the charts and may be challenging for the best unit you have in the system. But in terms of thinking about the square footage and wait times and so forth, are you thinking about having a slightly bigger footprint on a go forward basis given where demand is? Any color you can share on that would be great.
Hajime Uba
[Foreign Language]
Benjamin Porten
So thank you for commenting on Watertown and San Antonio we couldn’t be prouder of those locations. We’ve mentioned this in past calls, but the vintages since fiscal ’21 and ’22 have been the best vintages we’ve ever put out. And so we’ve been very pleased by their strong performance. If — there’s very strong demand within one of those — within a given market and there happens to be a larger box that’s available in a grant site location within that market. That’s something that we would consider taking, but we’ve always thought of our box flexibility as a huge competitive strength. We don’t have a set prototype. We don’t have a set square footage. We’re able to look at the entire country and just identify sites that mirror our best successes and then fit our concept into those spaces. And that’s one of the reasons that we’ve had such strong unit economics.
One other thing is that regardless of the size, our units can be highly successful. We can have a smaller unit that maybe has a lower AUV than the system average. But the cash on cash returns for that unit are going to be just as strong as the system average or even stronger. And square footage doesn’t necessarily correlate one to one with higher sales. For example, our port relocation is actually lower than the system average, but it’s in our top three performers. And so the bigger factor really here is just the quality of the site selection more than the square footage.
Jeremy Hamblin
Got it. Then I can target the question in a slightly different way. In terms of thinking about your occupancy costs, which pre-pandemic were right around 7% I think before you were public, they were closer to 6%. Do you have kind of a target range? Are you looking to be back in that 6% to 7% on a longer term basis? Or how you think about that?
Benjamin Porten
So that 6% goes —
Hajime Uba
Okay. [Foreign Language]
Benjamin Porten
So when you think about our units hoslistically, whenever we do a go/no-go decision with the real estate committee in terms of opening any new site, we evaluate a pro form of the expected financials for that unit. And really the single most important metric that we focus on is on cash on cash return. And so there might be a location that has higher rent, but it’s in a lower labor market with high earnings or whatever. We look for a unit that can deliver the cash on cash returns that we’re accustomed to. And so, rent is just a part of that, so we don’t necessarily have a target for rent, it’s really more our expectations for all the cost items.
Jeremy Hamblin
Great. Thanks so much for taking the additional questions.
Benjamin Porten
Thanks, Jeremy.
Operator
And we have reached the end of the question-and-answer session, and this also concludes today’s conference. And you may disconnect your lines at this time. Thank you for your participation.
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