Earnings Call Transcript - KRUS Q1 2020

Operator, Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Kura Sushi USA, Inc. Fiscal First Quarter 2020 Earnings Conference Call. Please note that this conference is being recorded today, January 8, 2020.

Benjamin Porten, Investor Relations Manager

Thank you, operator. Good afternoon, everyone, and thank you all for joining. By now, everyone should have access to our fiscal first quarter 2020 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 an 8-K we submitted to the SEC. Before we begin our formal remarks, I need to remind everyone that part of our discussions 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 recent 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 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, CEO

Thank you, Ben, and good afternoon, everyone. Our fiscal first quarter results included strong momentum demonstrated by our comparable restaurant sales growth of 7.9% as guests continued to respond positively to our premium ingredients, affordable price points, and, most importantly, the distinctive Kura experience. Our net loss in the first quarter was generally in line with expectations, and the quarterly cadence that we laid out with our FY '20 guidance last quarter, adjusting for the delay in opening our Katy restaurant. Operationally, we are pleased to really affirm our guidance for the full year. We have a number of drivers in place that we believe will continue to improve our operating results. We continue to expand our rewards program, which offers guests a $5 coupon for every $50 they spend. We are very pleased with the results as rewards program members continue to have larger average checks as well as higher return rates. Furthermore, we have experienced an incredibly high response rate to direct advertising using the email addresses collected through the program. We expect to roll out the rewards program across our system during this fiscal year. In addition, we are pleased with the early results of our touch panel drink ordering test at our Little Tokyo restaurant and are monitoring its success in preparation for an anticipated expansion of the test. We expect the rewards program and the touch screen drink ordering, along with marketing initiatives and the new menu items to drive continued comp growth across our system. Before moving on to our store base, I would like to circle back on some initiatives mentioned in our previous earnings call. I'm happy to announce that we are making progress and are beginning to see the fruits of our efforts. More efficient staffing has reduced labor costs. Waste reduction has been a tailwind for our COGS, and current pricing that we took in Q1 did not negatively impact traffic. In fact, traffic has grown. We began to see these benefits midway through the quarter and look forward to enjoying the benefits throughout the entire remaining fiscal year. Turning now to our store base. We ended the quarter with 23 units across 5 states. As I mentioned earlier, our restaurant in Katy, Texas had been expected to open in Q1 but was delayed due to challenges scheduling the final inspection. It has since opened in late December. We remain on track to open 6 restaurants this year, with an upgraded cadence of 2 in Q2, 2 in Q3, and 2 in Q4. It's worth noting that given the small size of our restaurant base, delays, including those driven by external factors beyond our control, can have a material impact on our near-term model. We believe the recent addition of Kim Ellis to our Board of Directors, with her extensive background in development will be a significant help to our team. Kim was formerly the Executive Vice President of development at Panda Express, where she opened more than 600 restaurants in 5 years. Kim will chair our Strategy & Development Committee, and we are very excited to benefit from her expertise. We continue to believe that we have significant runway for growth in both existing and new markets with some estimated long-term total restaurant potential of nearly 300 restaurants. We expect to grow units up to a 20% CAGR over the 5-year period beginning in fiscal 2019. In terms of our existing restaurants, we currently have 4 units located in shopping centers that are not yet fully occupied. As such, these restaurants are experiencing lower-than-expected sales volumes. While we continue to believe these sites will be great locations once the centers are fully occupied and that the restaurants will reach their targets, we now know that we need to plan for a longer launch period in these underdeveloped sites. Lastly, based on the strength of our most recent restaurant openings which utilize our newest software design, we will be remodeling our existing restaurants. The remodel is very quick, requiring approximately only 10 days to complete for our smaller stores, and we expect to complete 2 to 3 remodels per year. We have completed 1 remodel year-to-date, our restaurant in Little Tokyo in Los Angeles. And while still very early, we are pleased with the results. With that, I would like to turn the call over to our CFO, Koji Shinohara.

Koji Shinohara, CFO

Thanks, Jimmy. I will now review results for our fiscal first quarter, which ended November 30, 2019. Comparisons are up to the same period last year. On a GAAP basis, net loss in the first quarter was $1.2 million or $0.15 per diluted share compared to a net loss of $400,000 or $0.08 per diluted share in the prior year quarter. As Jimmy noted previously, our results were generally in line with our overall cadence that we laid out during our recent fourth quarter call. Total sales increased 30% to $17.4 million from $13.4 million in the same period last year, primarily driven by incremental revenue from 6 new restaurants opened during and subsequent to the first quarter of fiscal 2019. Comparable restaurant sales during the first quarter increased 7.9%, including a 3.1% increase in average check and a 4.7% increase in traffic. As a reminder, we consider a restaurant to be comparable after it has been open for at least 18 months prior to the start of the accounting period represented, including those temporarily closed for renovation during the year. There are 14 restaurants included in the comparable store base during the first quarter of 2020. Turning to expenses. Food and beverage costs as a percent of sales decreased 100 basis points to 32.6%. The decrease was primarily driven by a decrease in avocado prices, cheaper sourcing associated with 4 FY '19 restaurant openings in California and, to a lesser degree, reduced whey. Labor and related costs as a percentage of sales increased 150 basis points to 32.3%. This increase was largely due to a higher wage rate in some of our newer restaurants, including 4 new units built in California since the first quarter of fiscal 2019 as well as planned wage increases in existing stores. Occupancy and related expenses as a percentage of sales increased 140 basis points to 8.3%. This increase was primarily driven by certain new stores opened in FY '19, with a higher occupancy rate as well as greater preopening costs as compared to the same period last year due to the timing of new unit openings. Overall, restaurant level contribution increased to $3 million from $2.5 million in the same period last year. General and administrative costs increased by $1.2 million to $3.3 million in the first quarter of 2020, or to 19.1% of sales. G&A in the first quarter included approximately $900,000 of new expenses related to being a public company. Excluding public company costs, G&A would have increased by $300,000, primarily driven by employee compensation. As we look at our fiscal 2020 G&A distribution, it's worth noting that due to the quarterly distribution of G&A costs, we incurred incremental costs in the first quarter that will not carry over into the remaining quarters of this fiscal year. Adjusted EBITDA for the first quarter was negative $143,000 compared to last year's $500,000. The decrease was primarily due to the front-end weighted distribution of incremental public company costs in G&A. Net interest income during this first quarter was $163,000 compared to net interest expense of $36,000 in the prior year period. We currently have 0 outstanding debt under our credit facility. Based on our current growth path, we continue to believe our cash flow from operations and our existing cash balance will be sufficient to fund our capital expenditure needs for the foreseeable future. Income tax benefit was approximately $4,000 compared to a benefit of $65,000 in last year's fiscal first quarter. Income taxes in the first quarter of fiscal 2020 were negatively impacted by approximately $140,000 due to certain discrete tax true-up adjustments related to stock-based compensation expense. And with that, I'll turn it back to Jimmy to discuss our outlook for our fiscal year 2020.

Hajime Uba, CEO

Thanks, Koji. Turning to our annual outlook, we are reaffirming the following guidance for fiscal year 2020, which ends on August 31, 2020. We expect total sales between $84 million and $87 million. We expect comparable restaurant sales growth between 2% and 4%. Restaurant level contribution margin is expected to be between 20.5% and 21.5%. We expect an adjusted EBITDA margin between 9% and 10%. And we expect the opening of 6 new restaurants with 2 openings in Q2, 2 in Q3, and 2 in Q4. Lastly, as we discussed on our fourth quarter call, we continue to expect our profitability to be materially varied through the second half of the fiscal year due to our historical seasonality, which will be more pronounced this year given the small size of our current store base, the timing of certain public company costs and our back-end loaded development schedule. In line with our historical cadence following the Q1 loss, we expect to be near breakeven in Q2 before steadily improving in the back half of the year. All in all, we are excited about the coming year. This concludes our prepared remarks. Thank you for your interest in Kura Sushi USA, and we are now happy to answer any questions. As a reminder, during the Q&A session, I may answer in Japanese before my response is translated into English, so bear with us.

Operator, Operator

Our first question comes from the line of Will Slabaugh with Stephens.

Will Slabaugh, Analyst

Congrats on another good quarter. I had a question about new unit performance. You mentioned the 4 stores in shopping centers that weren't fully occupied weighing a little bit on their sales. If you normalize for that, could you speak more broadly to how you believe the new stores are performing relative to your expectations?

Benjamin Porten, Investor Relations Manager

So in terms of the occupancy, we haven't built into our model any expectations about full occupancy for those 4 stores. And while we're seeing a positive trend for some of our store occupancies, this is completely outside of our control given tenants come when tenants come. But otherwise, the stores are performing in line with our expectations.

Will Slabaugh, Analyst

Okay. Good to hear. Last quarter, you mentioned several stores in emerging shopping centers that were significant contributors to the comps. Did that trend continue in this first quarter?

Hajime Uba, CEO

Yes.

Benjamin Porten, Investor Relations Manager

So this is absolutely true. In fact, the number of stores has grown. Before, it was Austin and Doraville. This quarter, we've seen very strong comps from Austin, Doraville, and Frisco, which again, just illustrates how much of an impact full occupancy can have on our performance.

Operator, Operator

Our next question comes from the line of Peter Saleh with BTIG.

Peter Saleh, Analyst

Congrats on the great quarter as well. I just wanted to ask about the comp guidance for this year. I mean you put up a pretty solid number of over 7%, almost 8% this quarter. You're still guiding to 2% to 4% for the full year. That would suggest a pretty meaningful slowdown as we go through the year. Is that just conservatism? Or are you seeing some sort of slowdown in the business?

Hajime Uba, CEO

Thank you, Peter.

Benjamin Porten, Investor Relations Manager

So if we could go over the trends for Q1 comps. If you look at the comps that we posted in FY '19, in Q1, we had 4.4%; in Q2, we had 6.8%; in Q3, we had 7.6%; and in Q4, we had 9.4%. So as you can see, we face a progressively more difficult comparison. And then the other effect would be, working back to Will's question, the tailwinds that we're experiencing from full occupancy for Atlanta and for Austin and Frisco, we expect those to taper off eventually. And finally, to your point, we are trying to be very deliberate in the guidance that we provide.

Peter Saleh, Analyst

Understood. Okay, very helpful. Can you just remind us again, the traffic number for the quarter? And the check number for this quarter were what exactly again?

Benjamin Porten, Investor Relations Manager

Traffic was 4.7%, check was 3.1%. We're very proud of our traffic numbers. This would be our second consecutive quarter that our comps have been driven largely by traffic, which, I think, illustrates just how strongly we're resonating with our guests.

Peter Saleh, Analyst

Great. And then just last for me. The pricing benefit in the average check was about 3%, or was that more?

Benjamin Porten, Investor Relations Manager

That's about right.

Operator, Operator

Our next question comes from the line of Andrew Strelzik with BMO Capital Markets.

Andrew Strelzik, Analyst

I wanted to inquire about the expansion of the rewards program test. You mentioned some factors contributing to the strong comparable sales, but it didn't seem like you connected any of that to the rewards program, despite noting an increase in average check and repeat visits. Can you provide any data on how much of a boost it's delivering? Is it not yet a factor in the comparable sales, or do you expect it will be in the future? I’m seeking a bit more insight into its performance.

Hajime Uba, CEO

Thank you, Andrew. Please allow me to make sure with Ben, if I understand your questions quite clearly.

Koji Shinohara, CFO

So Andrew, this is an oversight. The rewards program has played a role in our strong comps.

Andrew Strelzik, Analyst

Okay. Is there an ability to quantify maybe what the check lift has been or anything like that? Maybe how many sign-ups you've got and just any data points. If not, that's okay. I was just wondering if there's any color you could provide.

Hajime Uba, CEO

So we’d like to avoid giving very specific numbers given that we're still in the pilot period. That being said, to your earlier point, we are seeing significantly higher checks and return rates for registered guests. One thing that's been very encouraging is that the engagement rates for people that have been issued coupons have been very high, and our registration rates have been steady week-to-week.

Andrew Strelzik, Analyst

Okay. That's great. And then my second question, in terms of the remodel that you're talking about, doesn't sound like it's overly significant, I guess, in terms of the downtime. So I guess I'm wondering what is going into that remodel? And can you provide some context to the cost around it?

Hajime Uba, CEO

So Andrew, I'm not sure if you've been to Sacramento or any of our stores opened after Sacramento, but we debuted a new design as of Sacramento, and it's been very well received by our guests. So we're going back and selectively renovating stores to fit the new design.

Benjamin Porten, Investor Relations Manager

The aesthetic change involves updating our touch panels. Guests at the Little Tokyo store can now order drinks from their tables using the side panels. In the last earnings call, we expressed our excitement about the potential to increase our drink mix. Although it's still early, since the renovation was completed about a month ago, we are already seeing growth in both soft drink and alcohol sales. The initial results have been very promising.

Andrew Strelzik, Analyst

That's fantastic. And my last one is just on the margin side. I just wanted to gauge your confidence in the margin guidance. It does suggest year-over-year improvement in margins. So I guess, the 2 questions are when do you expect to see that inflection? And what is kind of the key to achieving that?

Hajime Uba, CEO

So the first thing that we'd like to point out is that the numbers that we posted in Q1 for FY '19 were an outlier. They were exceptionally good. And if you look at our financials a year back, you'll see that in Q1 '18, we had restaurant level contribution margins of 17.8%. And so this variance isn't really driven by our changes in core operations. This is really just the store opening cadence.

Benjamin Porten, Investor Relations Manager

So looking at Q1 '18 restaurant level contribution margin, the stores that we opened in fiscal '17, we had 2 new stores opened, 1 was in July, and 1 was opened like a week before the end of the quarter, and both of them were in new markets. And so these were relatively immature stores in new markets, and so they weren't able to immediately contribute to the entire system.

Hajime Uba, CEO

And what's really important here is that given the relatively small size of our system, a couple of units can have a material impact on our labor costs and our restaurant level contribution margin. Naturally, this will just become noise once we reach a sufficiently large unit size.

Andrew Strelzik, Analyst

Really helpful color. I appreciate it and congrats from me as well on really nice momentum in the comps this quarter.

Hajime Uba, CEO

So yes. Thank you, Andrew.

Operator, Operator

Our next question comes from the line of Stephen Anderson with Maxim Group.

Stephen Anderson, Analyst

I want to move quickly to the back of the house. I wanted to discuss some of what you've been doing there regarding the manager app that enables managers to utilize more automation for reordering supplies. I also wanted to talk about the efforts made to shift the scheduling to the headquarters level.

Hajime Uba, CEO

So to answer your first question — well, just to confirm, are you asking about the more efficient staffing that we've mentioned in the previous earnings call?

Benjamin Porten, Investor Relations Manager

Yes. So looking at the staffing first, we focused primarily on reducing the number of man-hours spent during the prep period, and we've begun seeing very positive results starting in November. Given that this isn't changing staffing during, say, peak hours, the prep hours are going to be the same. It's going to be stable. And so we expect the same results to continue for the rest of the year. But even then it's like just the morning prep is not a huge number or anything like that.

Hajime Uba, CEO

And so I don't think we discussed the new manager app in the last earnings call. In terms of COGS improvement, we think the bigger factors here were reducing waste during idle times and end of day. The system that you're referring to has automated our purchase order system, so that the managers don't need to figure out how much to order. It's basically the orders are automatically done relative to inventory. But in terms of this quarter, the bigger contributor to COGS was waste reduction.

Operator, Operator

Our next question is a follow-up from the line of Peter Saleh with BTIG.

Peter Saleh, Analyst

Yes. I just wanted to follow up on the development for the rest of this year. I mean I think you just opened 1, you've got 5 more to open for the balance of this year. Do you anticipate any of those units being in shopping centers that are not fully occupied similar to the 4 that you discussed earlier in the call?

Hajime Uba, CEO

So Bellevue would be the potential candidate for being in the not fully occupied shopping center.

Benjamin Porten, Investor Relations Manager

I believe we mentioned this in the last earnings call, but in the fourth quarter, we'll be working on Bellevue, Washington, Washington, D.C., and Sherman Oaks simultaneously. We expect to open at least two of the three. Therefore, it's possible that Bellevue might be delayed until 2021. In terms of development, we currently have three stores under construction and have executed leases for all the remaining stores in our pipeline. We believe we're in a strong position. The delay in Katy was unprecedented; we had a fully built store that we had to hold for about two months because we couldn't schedule the final inspection. We do not expect that kind of delay to happen again; it's never occurred before.

Operator, Operator

Thank you. We have reached the end of our Q&A session and our conference for today. You may disconnect your lines at this time, and I thank you for your participation.