Earnings Call Transcript - KRUS Q3 2023

Operator, Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Kura Sushi USA, Inc. Fiscal Third Quarter 2023 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode, and their lines will be open for your questions following the presentation. Please note that this call is being recorded. On this call today, we have Hajime Jimmy Uba, President and Chief Executive Officer; Jeff Uttz, Chief Financial Officer; and Benjamin Porten, Senior Vice President, Investor Relations and System Development. And now, I'd like to turn the call over to Mr. Porten.

Benjamin Porten, SVP, Investor Relations and System Development

Thank you, operator. Good afternoon, everyone, and thank you all for joining. By now, everyone should have access to our fiscal third quarter 2023 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.

Jimmy Uba, CEO

Thanks, Ben, and thank you to everyone for joining us today. I'm pleased to announce another excellent quarter for Kura Sushi, both in terms of restaurant-level performance and corporate initiatives. Year-over-year revenue has grown by approximately 30%, driven by our aggressive unit growth and industry-leading comparable sales trends. Our G&A leveraging efforts continue to bear fruit, with an improvement of 130 basis points over the prior year. I’m exceptionally proud to see Kura Sushi continue to mature as a company as it expands its footprint and takes strides towards greater profitability. Third quarter revenue was $49.2 million, with comparable sales of 10.3%, which breaks down to 3% traffic growth and 7.3% in price and mix. We continued to lead the casual dining industry with our third quarter traffic outperforming industry averages by 830 basis points. June performance has been even better with total sales of $17.6 million and the comps of 14.7%. As these results demonstrate, guest demand for Kura remains extremely strong. The inflationary pressures that we saw earlier in our fiscal year continued to ease with cost of goods sold as a percentage of sales coming in at 30%, which is in line with the all-time best we saw in fiscal 2022. Labor cost as a percentage of sales were 29.2%, representing an improvement of 180 basis points over the prior year. Our third quarter restaurant-level operating profit margin of 23.5% represents an improvement of 100 basis points over the prior year. I'm also very happy to note that between our growth in restaurant-level operating profit margin and the improvements in G&A, we were able to grow our adjusted EBITDA margin by 200 basis points over the prior year and our net income margin by 210 basis points. During Q3, we opened one new restaurant in Buford, Georgia, and one more new restaurant subsequent to the quarter end in Framingham, Massachusetts, for a total of seven new restaurants opened to date during the fiscal year. We have seven units under construction, as well as 11 more executed leases. We are in an excellent position to achieve our unit growth goals for fiscal ‘23 and couldn't be happier with the pipeline we have set up for fiscal ‘24. Our new Waitlist app has been successfully rolled out across our entire restaurant system. While it's too early for us to provide quantitative data on its impact, we are very encouraged by early results. Wait times are meaningfully more accurate and we believe this is part of why we continue to outperform our peers in terms of traffic, which is further underlined by the exceptional performance we've seen in June. Our revised membership continued to grow with approximately 120,000 new members over the course of the quarter. Our Demon Slayer campaign held during April and May again proved to be another great success and comp driver and our current collaboration with We Bare Bears, a television program on Cartoon Network, has far exceeded our initial expectations and has delivered some of the strongest guest responses we've seen from any collaboration, which sets our restaurants up for an amazing journey. As a final note, I would like to provide some updates on pricing. We lapped approximately 2% of pricing on March 1, bringing our effective repricing for our fiscal third quarter to 13%. Subsequent to the quarter, we lapped 6% of pricing on July 1, which was partially offset by 2% of pricing that we took concurrently. The relatively modest scale of this most recent pricing event reflects our confidence in the normalization of inflationary pressures seen earlier in the fiscal year. Lastly, I would like to share my deep appreciation for the amazing work by our employees, both at our restaurants and corporate support center. Thank you, everyone. And with that, I'll turn it over to Jeff to discuss our financial results and liquidity.

Jeff Uttz, CFO

Thanks, Jimmy. For the third quarter, total sales were $49.2 million as compared to $38 million in the prior year period. Comparable restaurant sales performance as compared to the prior year period was positive 10.3% with regional comps of 15.5% in California and 4% in Texas. Turning to costs. Food and beverage costs as a percentage of sales were 30% as compared to 29.7% in the prior year quarter. We're very pleased to see that the flattening of the inflation curve that began during our second quarter has continued to hold and we continue to be encouraged in the trends that we are seeing. Labor and related costs as a percentage of sales decreased to 29.2% from 31% in the prior year quarter. This decrease is due to incremental efficiencies created by the implementation of technological initiatives and sales leveraging from increased traffic and pricing. This leveraging was partially offset by wage increases. Occupancy and related expenses as a percentage of sales were 7.2% compared to the prior year quarter's 7.1%. Other costs as a percentage of sales increased to 12.5% compared to 11.5% in the prior year quarter due to an increase in marketing costs as well as general cost inflation. General and administrative expenses as a percentage of sales decreased to 14.2% as compared to 15.5% in the prior year quarter. On a dollar basis, G&A expenses were $7 million as compared to $5.9 million in the prior year quarter. As we've mentioned in the last several calls, leveraging our G&A line has been a main focus of ours this year. The quarter-over-quarter increase of $1.1 million represents an increase of 18.8% against a revenue increase of approximately 30%. We're very pleased with this level of leverage and we will continue to keep this as a main focus going forward while making sure that we continue to make the key hires necessary to fuel our aggressive growth, such as in our construction and operations departments. Operating income was $1.3 million as compared to operating income of $0.5 million in the prior year quarter. As a percentage of sales, operating income was 2.7% as compared to 1.2% in the prior year quarter. Income tax expense was $41,000 compared to a benefit of $2,000 in the prior year quarter. Net income was $1.7 million, or $0.16 per share compared to net income of $0.5 million or $0.05 per share in the prior year quarter. Restaurant level operating profit as a percentage of sales was 23.5% compared to 22.5% in the prior year quarter. Adjusted EBITDA was $5.1 million compared to $3.2 million in the prior year quarter. Turning now to our cash and our liquidity. At the end of the fiscal third quarter, we had $70.5 million in cash and cash equivalents and no debt. This large increase in our cash balance is due to the follow-on offering, which we closed in April of this year. Lastly, I want to reiterate and update the following guidance for fiscal year 2023. We expect total sales to be between $187 million and $189 million. We expect to open between nine and 11 new units with average net capital expenditures per unit of approximately $2.5 million. And lastly, we expect general and administrative expenses as a percentage of sales to be between 15% and 15.5%. Please note also that our guidance assumes no material changes to consumer behavior or broader macroeconomic trends. In addition, as mentioned during our previous earnings calls, at the conclusion of the current fiscal year, beginning with our first quarter earnings call, we will no longer quantify quarter-to-date performance. And with that, I'd like to turn the call back over to Jimmy.

Jimmy Uba, CEO

Thanks, Jeff. This concludes our prepared remarks. We are now happy to answer any questions you might have. Operator, please open the line for questions. As a reminder, during the Q&A session, I may answer in Japanese before my response is translated into English. Thank you for your attention.

Operator, Operator

Thank you. We will now move into the question-and-answer session. Our first question comes from Jon Tower with Citigroup. Please go ahead with your question.

Jon Tower, Analyst

Thank you for taking the questions. I'm interested in the quarter-to-date results, specifically the 14.7% comparable sales. Do you mostly attribute that to the promotional activity? I apologize for not being up to date on the current promotion. How long do you expect that promotion to last?

Jimmy Uba, CEO

Thank you, Jon, for your first question. Please allow me to answer your question in Japanese. We're extremely pleased with the results from We Bare Bears; our marketing team did an amazing job with that collaboration. It has definitely played a significant role in the 14.7% comparative sales increase we've mentioned. All of our campaigns run over a two-month period, starting in June for We Bare Bears, and we will continue through the end of July. Historically, we have seen that the excitement for Demon Slayer campaigns is usually greater in the first month than in the second month. Therefore, our expectations for the impact of We Bare Bears in July are relatively tempered compared to Demon Slayer, but the enthusiasm in the first week of July has certainly helped. We're very pleased.

Jon Tower, Analyst

Great. To continue that line of thinking, I believe you still have a planned promotion with DC Comics set for August, is that correct?

Jimmy Uba, CEO

Yeah, absolutely. We Bare Bears is one of our first sort of nationally known American brands. And DC being another one of those brands, we're very excited about August. If we had to put anybody up again, I'm glad that it's DC.

Jon Tower, Analyst

Okay. And then just on the labor cost per operating week, I was just looking at that in the model and I was surprised to see it actually go down on a year-over-year basis considering, I'm assuming some of the inflation you're seeing. So can you perhaps speak to what the drivers were behind that? Anything funky in last year's third quarter or are we just talking about a combination of sales leverage and technology rolling through the system and therefore, the sustainability of this trend moving forward? How should we think about that?

Jimmy Uba, CEO

Looking at labor cost performance year-over-year, there are a few key factors. One is sales leverage, and another is the effectiveness of our three initiatives that we rolled out at the end of Q3 last year. This year, we benefited fully from the server robots, unlike last year when we had only a partial benefit. Our operations team, along with our COO, has prioritized store operations and labor management, and they have executed that well. We're pleased with our performance for Q3. Moving forward, we want to provide more context regarding sustainability, especially as we face fiscal comparisons. Historically, we've seen leverage from Q3 to Q4, and we do expect some leveraging, but not as significant as 200 basis points. The three initiatives have been in place for a full year now, so their costs are already included. Additionally, we had a bonus adjustment in Q4 last year that we don't expect this year. While we anticipate some sales leverage, it's best to view Q4's labor as a percentage of sales for an accurate comparison to this year instead of trying to analyze the quarter-over-quarter changes from Q3 to Q4 last year.

Jon Tower, Analyst

All right. Thanks a lot. I’ll pass it along.

Benjamin Porten, SVP, Investor Relations and System Development

Thanks, Jon.

Jimmy Uba, CEO

Thank you, Jon.

Operator, Operator

Thank you. Our next question comes from Joshua Long with Stephens. Please proceed with your question.

Joshua Long, Analyst

Great. Thank you for taking my questions. I was curious if you could talk about some of the trends through the quarter. I know as we left off last quarter, started off in that sort of low double-digit, 11% range, very strong. Curious if there's any additional color you could share on just how things transformed through the quarter overall and then maybe by region with the California and Texas comp numbers that you called out as well?

Jimmy Uba, CEO

Yeah, looking at the regional performance, as Jeff mentioned earlier, California outperformed Texas in this quarter on a single year basis. However, when we look at a multiyear comparison, the difference narrows significantly due to the vastly different operating environments in California and Texas over the past two to three years. The year-over-year premium comparison can greatly influence the outcomes. Regarding our performance trend, we had a strong March, a slightly weaker April, which is consistent with what the restaurant industry experienced, but May picked up again and we were very satisfied with June, achieving a 14.7% increase in traffic. June has been quite positive for us. Additionally, it’s worth noting that our top three performing restaurants are located in Washington State, Texas, and New Jersey. While Texas may outperform California in certain quarters and vice versa, we’re excited to see our best restaurants spread out geographically and thriving in nearly every region across the country.

Joshua Long, Analyst

That's super helpful. I appreciate the two points. When you think about trends, I think in the past couple of quarters, we've talked about pretty consistent per plate consumption, also have been trying to think about this from a marketing perspective in terms of, you mentioned the We Bare Bears being the first American or most widely known here in America. And then going into thinking about the DC Comics. Are you pulling in a new guest, are you pulling in your kind of more frequent guests or your current guests more frequently? How do you think about that? And how has per plate consumption trended through 3Q?

Jimmy Uba, CEO

Looking at consumer sentiment, per plate consumption and check have remained stable. Check management has been minimal. Regarding the impact of We Bare Bears, we redeemed approximately 120,000 rewards members last quarter. For all of Q4, we've partnered with American properties, starting with We Bare Bears for the first two months and transitioning to DC Comics for August. Our ability to attract board members is significantly higher than in previous quarters, and this will definitely be part of our strategic approach. We observe a strong link between the effectiveness of brand collaborations and member sign-ups; to access better prices and giveaways like T-shirts and canisters, registration as a member is required. Effective collaborations can certainly drive membership growth, which is a key metric for assessing these partnerships.

Joshua Long, Analyst

Great. That's very helpful. One last quick one for me and then I'll hop back in the queue. When we think about kind of the marketing efforts. I think then in prior calls, you've talked about the opportunity to optimize your awareness to drive accessibility and it's been more about managing the current spend and again, optimizing versus adding dollars to the marketing pipeline. Can you square that off with some of the commentary you had in terms of the 3Q numbers that you just reported in terms of marketing kind of stepping up, it sounds like, is that kind of a one-time 3Q dynamic or how should we think about marketing and spend and then the overall kind of progress against our initiatives that are driving awareness and optimizing the brand visibility?

Jimmy Uba, CEO

So Josh, I believe you're referring to the note in the other cost line regarding marketing costs as one of the factors. However, the increase in marketing costs is likely to be minor, around 10 to 20 basis points, which isn't significant. As you've noted in previous earnings calls, our new marketing strategies, especially the targeted advertising across various channels, have primarily involved reallocating marketing funds. Given the traffic performance over the last two quarters, we've been very happy with the results. We believe our marketing investments are being utilized effectively. Therefore, we don't anticipate a substantial increase in marketing spending in the near future. We are satisfied with the current performance.

Joshua Long, Analyst

Understood. Thanks very much for the time.

Jimmy Uba, CEO

Thanks, Josh.

Operator, Operator

Thank you. Our next question comes from Sharon Zackfia with William Blair. Please proceed with your question.

Sharon Zackfia, Analyst

Hi. Good afternoon. I wanted to touch on development because it's still a pretty wide range implied for the fourth quarter, anywhere between three to five new openings. And I know you've opened one so far. I guess, are you more comfortable at the lower end or higher end? I mean, where is the status of that construction? I know everyone's been battling kind of permitting and delays and so on. So I'm just curious kind of where your comfort level is on hitting maybe the higher end of that?

Jimmy Uba, CEO

We are very comfortable with the range of nine to eleven units that we provided. Most of the seven units currently under construction are progressing well and are in the latter stages of construction. Therefore, reaching the higher end of our projection is certainly achievable. On the other hand, achieving the lower end seems less likely, as it would require significant unforeseen delays. Overall, we have strong confidence in the quality of our pipeline for the remainder of the quarter, and we are confident in the number of units we are targeting within that nine to eleven range.

Sharon Zackfia, Analyst

Thanks for that. And then I know, for June, you talked about kind of the changes to the Waitlist algorithm being a positive. I'm curious if there's any way to quantify that. And as you've had this in test with some locations longer, is that a benefit that kind of builds over time or is this something where you kind of manifest that improvement in the lunch and/or a late-night day parts pretty quickly?

Jimmy Uba, CEO

In terms of quantifying it, we just completed the rollout in Q3, and there's a six-week learning period for the algorithm to develop its traffic expectations. As a result, we are hesitant to provide specific numerical projections. Regarding your second question about whether the impact builds over time, it's an interesting point. We've been discussing with the marketing department the importance of effectively communicating the updates and improvements to the Waitlist app to our guests. While the accuracy has increased, I believe guest behavior won't change until we undertake a focused marketing effort to inform them about the significant enhancements in our Waitlist app that they can rely on to plan their schedules. Now that we've finished the Waitlist app rollout, we are also working on an update to our rewards program, which will have a completely new design. Our plan is to synchronize the communication of this new program with the launch of the updated apps. I can confidently say that the app has improved significantly.

Jeff Uttz, CFO

And also, Sharon, while we don't have the data yet to be able to quantify what it means in terms of sales or comps for the new Waitlist app. But we do know and the information we do have is that wait times are more accurate. And we do know that the over quoting or the underquoting of people by 0.5 hours or more has decreased substantially to where we – some restaurants could have been in the 20% to 25% range of people being misquoted by half an hour or more on their wait times. And we know now that in most of our restaurants, that’s down into the single digits.

Sharon Zackfia, Analyst

Great. Thank you.

Operator, Operator

Thank you. Our next question comes from Todd Brooks with Benchmark Company. Please proceed with your question.

Todd Brooks, Analyst

Thank you for taking my questions. Jeff, I wanted to ask about the general and administrative performance in the quarter. There has been a significant improvement, and you've provided guidance for the full year range. Where do you stand with this, considering it’s a priority for you? As we look toward future years, have you completed most of the efficiency initiatives you aimed for, or is there still room for improvement as we approach fiscal '24?

Jeff Uttz, CFO

There are additional opportunities for improvement in our efficiencies. Previously, I mentioned the potential to utilize more technology in our support center for our daily operations. Recently, we've launched new software in our financial planning and analysis department that will significantly enhance our forecasting, budgeting, and research tools for restaurant P&Ls. This software will empower our operators to analyze their financials independently, while still allowing our support center to assist them. This isn’t just an isolated technological upgrade; I’ve encouraged other departments to explore how IT can further support them. We've seen positive results in our leverage over the last two quarters, achieving 120 basis points in Q2 and 130 basis points this quarter, which has exceeded my expectations. I am very pleased with the collaborative efforts of our entire team to achieve this, as it requires a collective endeavor. Over the past nine months, we've somewhat slowed our hiring in the support center while still filling essential roles in construction, development, recruiting, and training to support our growth. We’ve encouraged everyone to focus on maintaining minimal hiring, which has contributed to the leverage we’ve experienced. I expect this trend of improved leverage to continue. While I haven’t provided specific guidance for the coming periods, I anticipate that we will eventually see single-digit percentage improvements, although this may not be within the next 12 to 24 months. Nonetheless, we are very satisfied with the leverage we've achieved in the last two quarters.

Todd Brooks, Analyst

That's great. And a follow-up question, if I may. Actually, a quick question on the pricing side. So I think the way that I heard you guys talking about the waterfall was 13% during the quarter. We lapped 6% at the start of July, but at the same time, we took another 3%. So kind of the back two months of the quarter, is it what we think about running maybe 10% effective price? Is my math right there?

Jeff Uttz, CFO

What you'll see is that there's a 6% and a 7% in place for June. In Q3, you'll see the 6% to 7%. As we mentioned, we rolled off 6% on July 1, but we introduced an additional 2%, so the pricing for July and August will be 8% for each of those months. Therefore, we have 13% for June, and 8% for both July and August.

Todd Brooks, Analyst

Perfect. Thanks. And my final one is.

Jeff Uttz, CFO

I'm sorry. I'm sorry, 13%, June; 9% July and August.

Todd Brooks, Analyst

Okay. Thanks. And then the final one, $70 million of cash on the balance sheet after the offering. I know the team has talked about, listen, we're building to grow. We'll make the hires that we need to grow. I guess, between the brand's performance, landlord appetite to get Kura in two projects and now the magnitude of cash on the balance sheet, do you see any uptick in the opportunities to open or accelerate the unit openings? I think you talked about 11 leases signed already for the coming year. But just would like to know if the incremental capital and the readiness for the organization as you're thinking of growing any faster into the opportunity that the brand has in the U.S.

Jimmy Uba, CEO

So this is very similar to what we mentioned in previous earnings calls. We consider our unit growth pace in terms of three key factors. The first is our liquidity. The second is the availability of high-quality sites. The third is our management pipeline. As noted, we are in the best cash position we have ever been in, and the sites are excellent. Over the last several years, we've focused on ensuring that the quality and breadth of our management pipeline align with our growth objectives. Historically, we aimed for 20% growth when we went public, and we often exceeded that, achieving 25% the year before and 28% the previous year. The midpoint of our guidance this year is also 25%. We are confident in that range and believe we can continue to deliver at that rate. Additionally, we've pointed out the increasing number of new markets we are entering, which brings challenges as we build up our regional management teams.

Jeff Uttz, CFO

And to keep that growth trajectory going, Todd, it kind of ties back to the G&A question you just asked. That's why we're going to be continuing to invest money into recruiting because it's all about eliminating potential bottlenecks. And as you mentioned, with the $70 million of cash on the balance sheet, we've eliminated a potential bottleneck for cash; we're set with cash for a while. But then as we continue to invest in the recruiting side, we want to make sure that we eliminate any potential bottleneck as it relates to hiring managers. So we're very well shored up in terms of development going forward to keep that pace.

Todd Brooks, Analyst

Perfect. Thank you all.

Jimmy Uba, CEO

Thanks, Todd.

Operator, Operator

Thank you. Our next question comes from Mark Smith with Lake Street Capital. Please proceed with your question.

Mark Smith, Analyst

Hi, guys. I want to follow up on the development question just a little bit. Any additional insights into what you're seeing on deals these days, any change in TI dollars and kind of availability of real estate deals that you're looking at?

Jimmy Uba, CEO

The biggest shift has been moving from smaller developers to larger, national developers. National developers, particularly if they manage sizable malls, tend to have more substantial tenant improvement budgets compared to smaller strip mall developers. While we've observed this change, it seems more structural rather than indicative of broader economic trends. It simply reflects a different position in our growth cycle.

Mark Smith, Analyst

Okay. And then just wanted to look kind of further out. You guys did a good job driving margins here. You've got some initiatives that you talked about a little bit, like some back-of-the-house dishwashing technology, things like that, that could maybe be margin drivers down the road? Any updates on that or any other initiatives that you have that maybe can help improve some restaurant margin as we look forward?

Benjamin Porten, SVP, Investor Relations and System Development

Yeah. There’s absolutely. That’s always the case. And so in terms of the dishwasher, that is the single most exciting thing that we have in our pipeline. I'm very pleased to say that I'm actually now in charge of these initiatives. And so, you've got only one neck to strangle. But yeah, no, I've been extremely hands-on. Right now, we're beginning the testing in a physical restaurant in Japan. Pending that, we're actually trying to get approval in the United States in parallel. And so unfortunately, it's impossible for me to give a timeline on a moment to roll this out. But the impact from the dishwasher alone would be greater than the three initiatives that we rolled out last year. And so the upside is tremendous. Keeping in mind that with such a material change, the impact would probably be limited more to new restaurants, but it is something that I'm extremely focused on. But the other part about margin is we’re a growth concept. And so as Jeff mentioned in his opening remarks, our G&A grew by 18% against revenue growing by 30%. And so I can get to do my best to deliver incremental restaurant margin improvements, but really the meat of the story is in leveraging.

Mark Smith, Analyst

Okay. Maybe I'll squeeze one more in. You've talked quite a bit about labor. Are you guys seeing any difference in retention rates here over the last couple of months?

Jimmy Uba, CEO

We take great pride in consistently outperforming the industry turnover averages in the United States. This success is likely due to our excellent work environment and competitive compensation, which is among the highest in the casual dining sector. It's challenging to make direct comparisons due to the potential for tips in our efficient operation. Being a relatively new concept in the U.S., many people still associate revolving sushi with emerging markets. For instance, when we recruit management candidates from outside their home state, we notice a higher attrition rate. However, this is just part of our growth process, and as we expand, we anticipate that this will become easier. We're already achieving retention rates that meet the industry average, which makes us very satisfied with our current performance.

Mark Smith, Analyst

Thanks a lot. Thank you, guys.

Benjamin Porten, SVP, Investor Relations and System Development

Thank you, Mark.

Operator, Operator

Thank you. Our next question comes from George Kelly with ROTH MKM. Please proceed with your question.

George Kelly, Analyst

Hi, everyone. I appreciate you taking my questions. To start, regarding the dishwasher, Ben, you expressed enthusiasm about it. I'm curious, you mentioned that this alone is expected to have a greater impact than the three initiatives from last year. Could you please recap those three initiatives and share how much savings they generated?

Benjamin Porten, SVP, Investor Relations and System Development

The three initiatives we are discussing include robot servers, table-side payments, and touch panel orders. We expect these to improve labor efficiency by about 50 to 60 basis points. We believe the impact of the dishwasher will be even more significant than that.

George Kelly, Analyst

Okay, that's great. Sorry for the interruption.

Jimmy Uba, CEO

Keeping in mind the impact on the dishwasher, the robotic dishwashers will gradually be implemented in our existing restaurants. You will not see an immediate improvement; instead, it will be a steady one. As mentioned earlier, dishwashers are among the highest-paid positions in the back of the house since they do not receive tips. The only position where we have not received approval is for dishwashers, as our other employees are eligible for tips while serving guests through conveyor belts, and their job is physically demanding. This creates an expensive position with high turnover. Automating this will significantly reduce the workload for the remaining staff. The benefits will extend beyond the restaurant level to general and administrative areas, allowing us to focus less on recruiting and replacing staff. I'm truly excited about this.

George Kelly, Analyst

Okay. That's great. And then last question for me. If I look historically at your restaurant-level margin, just the seasonality of that line, there's been a really nice step-up between 3Q and 4Q historically. And you just reported such a strong number. I'm just curious if there's anything I should be aware of that would make it hard for you to achieve that kind of step up again this year?

Jeff Uttz, CFO

Well, I think the biggest thing, George, when you look at last year from Q3 to Q4, Jimmy already touched on this was we got such a big jump in labor for last year because of the initiatives that we put in place. It was the first quarter where everything was fully in place last year between Q3 and Q4. So we got a lot of benefit between those two quarters. In addition, we took an incentive compensation adjustment last year in Q4 both of which we're not going to have those benefits in this year. So if you look specifically at last year, be very careful to assume that kind of a jump from Q3 to Q4 in terms of the labor line. What you've seen historically in the other lines, I think it's probably pretty consistent with where I would keep your eye on.

George Kelly, Analyst

Okay. That’s helpful. Great. And then last question for me. I don't believe you've talked about this recently, but I remember as part of the IPO process, there was a TAM study that you guys did just about the number of units that you thought was a realistic goal? And then there was discussion about maybe updating that. Is that something you're still working on?

Jeff Uttz, CFO

We don't have a new update at this time. Currently, we have about 50 units compared to our initial estimate of 300, so there isn't an urgent need to revise it. One of the challenges we've encountered is that the biggest opportunity we've identified since going public has been the significant closures of Japanese restaurants. Our white space studies usually focus more on demographics rather than competitive dynamics. The challenge lies in integrating how dramatically the competitive landscape has shifted, even though demographics remain relatively stable. We know from our total addressable market study during the IPO that the assumptions we made were quite conservative, and we've been profitable at sales levels below those used in the previous white space analysis. When we update that study, if we adjust some of the parameters, I believe everyone here agrees that the estimate will likely exceed 300, and we plan to refresh that study approximately five years post-IPO, which will be next summer for us. Fortunately, analysts have been providing their own white space estimates, so we haven't needed to produce a new one ourselves.

George Kelly, Analyst

Thank you. I’ll keep guessing.

Jeff Uttz, CFO

Thanks, George.

Operator, Operator

Thank you. Our next question comes from Jeremy Halan with Craig Hallum Capital Group. Please proceed with your question.

Jack Cole, Analyst

Thanks, guys. This is Jack Cole on for Jeremy. Congrats on the great quarter. So you mentioned that wages are still up year-over-year. Could you just clarify the magnitude of wage pressure in Q3? Is that still up high-single digits? And then just how do we think about wage pressure heading into FY '24?

Jimmy Uba, CEO

In the last quarter, we noted that year-over-year labor inflation was around 10%, and that has largely remained the case for Q3. We have seen a slight easing, which is reflected in our pricing being significantly lower than what we have historically set. Currently, it is much more aligned with our past pricing over the last year and a half. This indicates our confidence in where we anticipate our labor costs and cost of goods sold will be, and our pricing strategy will adequately support this. We're looking at low to mid-single digits in labor increases, and we're very pleased with our progress.

Jack Cole, Analyst

Got it. That's helpful. And then related to the unit development again, what does the pipeline look like in terms of executed leases versus active units under construction? I think you mentioned seven under construction. So could you just clarify that? And then provide us the number of executed leases.

Jimmy Uba, CEO

We have seven units currently under construction, most of which are in the later stages of that process. We have executed 11 leases and anticipate that more will be finalized shortly, along with a significantly increased number of letters of intent. Overall, the pipeline looks promising, and we are very pleased with it.

Jack Cole, Analyst

Got it. Thank you. That’s all from me.

Jimmy Uba, CEO

Thanks, Jack.

Operator, Operator

Thank you. Our next question comes from Joshua Long with Stephens. Please proceed with your question.

Joshua Long, Analyst

Great. Thanks for taking the follow-up. Wanted to see if we could dig into the inflationary environment, specifically in the food basket. You talked about how that is coming back in line like we had hoped and sort of expected here in the back half of the year. But I think in prior quarters, we had talked about an opportunity. You all had talked about an opportunity in terms of sourcing, maybe with some contracting around shrimp and salmon or some of the other key proteins. Curious if you could give us an update there. And then, Jeff, I know one of the other initiatives that was on the plate for, at some point, maybe a longer term was the ability to ship to a broadline distribution partner. And so just curious if you have any sort of update there, if any, in terms of just how you're thinking about that or maybe the timing and potential?

Jeff Uttz, CFO

I have an update regarding the broadline distribution project, which aligns with our discussions about semi contracts for the next six months to a year. We will be in a significantly improved position for that once our consolidation is initiated. Previously, we considered moving to a U.S. broadliner like Cisco or U.S. Foods, but we have decided instead to consolidate some of our existing Japanese broadline distributors. We found it challenging for a U.S. broadliner to source some specialized Japanese ingredients that our products require. Since our Japanese suppliers already have access to these items, it makes more sense to work with them for those specialty products, along with mainstream items. We are consolidating down to two Japanese suppliers that have U.S. operations, ensuring we cover the entire country while securing hard-to-find specialty items used in Asian cooking. This consolidation process is underway, and many of our SKUs have already been integrated. I expect that this will be completed in the coming months. Regarding the inflationary environment, we have noticed a continuing decline, with about a 2% drop in our cost of goods sold inflation from Q2 to Q3. The situation is improving, aided by our efforts in supply chain management and distributor consolidation, as well as the general economy showing signs of stabilization. All of these factors are playing to our advantage, and we are pleased with the progress we’re making on the cost of goods sold front.

Joshua Long, Analyst

That's very helpful commentary. Regarding the inflation in the third quarter, I understand that there was a 2% decline from the previous quarter. How can we assess that on a year-over-year basis?

Jeff Uttz, CFO

What we talked about last quarter, it’s in about the same range as we talked about last quarter, but what was most important to us is its easing.

Joshua Long, Analyst

Understood. That's super helpful. And then one of the key pieces in one of your questions earlier that came through is that it's not really about you're not capital constrained. You've got a great concept, lots of growth opportunities. You mentioned the importance of the human capital side. And so just curious if you could quantify or talk about that manager pipeline? And where are the biggest opportunities are to either develop talent, funnel talent into that or just how you're approaching that? Because that seems like that is the bigger piece of the overall growth rate going over time?

Jimmy Uba, CEO

So this goes back to what we mentioned earlier. We have a unique concept and are experiencing a distinct phase of growth where most of our units operate in single unit markets. This naturally leads to challenges related to recruiting, training, and human resources. That's been a recurring theme in our earnings calls for the last two years, as we recognize it is the most critical factor for our growth, and we don't want to compromise that. Our efforts have been focused on this priority. We want to be transparent about our priorities. We don't want you to think that this concern will hinder our growth; that's not the case at all. We're emphasizing that this is simply our primary focus at the moment. Additionally, with our American operations performing well, there are significant growth opportunities that many Japanese expats want to tap into by joining the American route. We have a dual pipeline for talent, including promotions from American store employees and interest from Japanese employees eager to advance. To summarize, while our position is not easy, I wouldn't describe it as concerning either.

Joshua Long, Analyst

Totally understand. And to be clear, there's no concern on my part from that side, just knowing its restaurants there, an easy business, easy and hard to do, especially when you're trying to scale your procure. So I appreciate that perspective and the information there on the dual and triple pipeline, it's certainly encouraging. Appreciate the color.

Jimmy Uba, CEO

Of course.

Operator, Operator

Thank you. There are no further questions at this time. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.