Earnings Call Transcript - KRUS Q3 2020

Operator, Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Kura Sushi USA, Inc. Third Quarter 2020 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode, and the lines will be open for your questions following the presentation. Please note that this conference is being recorded today, July 14, 2020. On the call today we have Jimmy Uba, President and Chief Executive Officer; Koji Shinohara, Chief Financial Officer; and Benjamin Porten, Investor Relations Manager. I would like to turn the conference over to Mr. Porten. Thank you. You may begin.

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 third 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 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 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.

Jimmy Uba, President and CEO

Thank you, Ben, and thank you everyone for joining us today. As most of you know, our restaurants have been largely closed during our fiscal third quarter. As a result, we would like to spend today’s call providing you with an update on our business operations and initiatives. If you have specific questions about our third quarter financial results, we will be happy to answer your questions during Q&A. As we discussed on our last call, we entered 2020 with solid momentum across our restaurants that continued into January and February of this year. March was a challenging month across the restaurant industry as news about COVID-19 began to spread. On March 18th, local guidelines mandated the shutdown of indoor dining, so we made the difficult decision to close all our restaurants system-wide. From the start of the pandemic, our primary concerns have been the safety of our guests, the ongoing health and the welfare of our team, our liquidity, and our ability to quickly and efficiently resume operations when the time was right. To support our team during this difficult time, we maintained payroll for all employees through April 5th and expanded payroll for all kitchen employees through May 9th. We have also continued to pay the full cost of health insurance for all of our furloughed employees and stayed connected with our furloughed hourly team members throughout their absence. In addition to our store managers, critical kitchen staff members have remained on payroll as we believe that the near-term expense of retention will be less than the potential of reduced sales due to understaffing. Finally, all store employees that were furloughed in April were eligible for a return bonus in June to further incentivize their return to Kura. These actions have allowed us to bring back our people quickly and open our restaurants with minimal delays. Thanks to our team engagement efforts, fewer than 10% of our employees left the company between the end of March to early July, which has positioned us to ramp up swiftly as indoor dining restrictions are lifted and the seating capacity limitations are relaxed. As local restrictions have been lifted across the company, we have opened our restaurants promptly and successfully, however, at reduced capacity in accordance with local government requirements. We began the reopening process on May 22nd and by the end of May, we had reopened seven of our restaurants. Fourteen additional restaurants were opened throughout June, and as of today, all Kura Sushi restaurants are open for business. However, as you are likely aware, Governor Newsom of California announced the restriction on all indoor dining on July 1st for a minimum of three weeks. As a result, all of our California stores, most of which had reopened with limited indoor dining, are currently open for takeout service only. We are now actively working on building out our off-premises business and infrastructure for all of our customers. We have taken a number of steps to create a safer environment in our restaurants, such as providing personal protective equipment for our team members, enhancing cleaning processes, maintaining social distancing, and performing team members’ health checks before the start of each shift. The health and safety of our guests and the team members will always be our top priority. As part of our checkout process, we have a customer survey, and this is now focused on our COVID-19 safety procedures. I'm pleased that by the end of June, we have received more than 15,000 guest responses, and over 96% rated our efforts as a four or five on a five-point scale. Considering our restaurants were closed during most of the third quarter, I would like to discuss some results for the month of June. Overall, we've been pleased with the initial results of our openings. However, as you might imagine, the suddenness of the reopening and the closing policy changes in our various markets, as well as other COVID-19 related issues throughout the company have made recent sales trends more challenging to assess. Due to our staggered reopening schedule in May and June, only seven stores were open for the entire month of June. Of these seven stores, five stores were in our comp base and saw same-store sales decline of 48.6%, largely reflecting the 50% seating capacity restrictions for these stores. We are extremely encouraged by these comps, which we feel illustrate strong consumer demand for our unique dining experience. With this, our re-openings are moving in the right direction and reopening our services has allowed us to better manage our pandemic-related losses. Now, I would like to provide a brief update on our development efforts. As most of you know, we began the year with the expectation of opening six new restaurants in fiscal 2020. Two new restaurants, Katy, Texas, and Glendale, California, opened during the fiscal Q2 prior to the temporary shutdown. However, as we mentioned during last quarter's earnings call, our opening schedule has been slowed due to the pandemic. Four restaurants were under construction in mid-March: Fort Lee, New Jersey; Koreatown in Los Angeles; Washington DC; and Sherman Oaks, California. After brief interruption, all four have resumed construction and we have started to work on our Bellevue, Washington site as well. Fort Lee and Koreatown are both very nearly complete, although the actual opening date will depend on the coronavirus situation in their respective areas. During our temporary closure, we also completed renovations for seven of our restaurants. By completing these renovations during the pandemic, we are able to avoid the sales losses associated with closed renovations during non-pandemic periods. I would like to announce the latest addition to our executive team, Robert Kluger, our first Chief Development Officer. Most recently, Robert was Senior Vice President of Development for Blaze Pizza, where he oversaw the company's growth from 140 to 350 units. Prior to Blaze Pizza, he spent six years at Panera Bread, technically becoming their Senior Manager of Franchise Development, and 12 years at the Panda Restaurant Group, where he was Vice President of Real Estate and Strategy. Robert has been responsible for over 1,000 store openings with nationally successful brands, and we are incredibly excited about the impact we believe he can have on our long-term growth. Switching to our liquidity. Despite the ongoing uncertainty, we are very fortunate to have entered this unique situation with a strong capital position. As of today, we have approximately $14 million in cash on hand and no debt. Our $20 million revolving line of credit from Kura Sushi Japan remains secure. Although we have not borrowed any amount against it, we will likely begin utilizing our revolver to fund our capital expenditures during the upcoming fiscal year. We appreciate the support of Kura Japan, and have confidence in the long-term success of our business. Considering Governor Newsom’s announcement yesterday concerning additional COVID-19 prevention measures, which include more expansive dining prohibitions in California, it appears unlikely that we'll be able to reopen our California dining room prior to the end of our fiscal year. During our California dining room closure, we expect our weekly cash burn rate to be in the area of $800,000 to $850,000, which includes $400,000 of capital expenditures. Once we are able to reopen our California restaurants, we would expect this weekly burn rate to be reduced by approximately $50,000. Although we've been able to reduce our operating losses by reopening our restaurants, these gains have been offset by the additional capital expenditures associated with the construction of five new units previously mentioned. One final reminder, due to the uncertainty driven by COVID-19, we will not issue financial guidance for the remainder of fiscal year 2020 at this time. Thank you for joining us this afternoon and for your interest in Kura Sushi USA. We were extremely excited about the potential of our business before the threat of COVID-19, and we remain equally confident that when this crisis passes, we have a long runway for opportunity ahead of us. Before we open the line for questions, I would like to thank all of our team members for their hard work, flexibility, and support as we navigate this uncharted territory. This concludes our prepared remarks. We are now happy to answer any questions you have. As a reminder, during the Q&A session, I may answer in Japanese before my response is translated into English. Please bear with us. Operator, please open the line for questions.

Operator, Operator

Thank you. At this time, we'll be conducting a question-and-answer session. Our first question comes from the line of Andrew Strelzik with BMO. Please proceed with your question.

Andrew Strelzik, Analyst

My first question is just on the recent sales trends. It's helpful that you gave us June numbers, but I believe they were just the June numbers. And I'm curious if you could maybe give an update on the stores that have remained open for dine-in that are in the comp base. How have the sales trended since, or even those outside the comp base kind of how the trajectory has been more recently.

Jimmy Uba, President and CEO

So looking at our performance over June and July for the restaurants where we've had, where we've been able to keep our dining rooms open with a 50% seating capacity limit, we've seen comps and sales levels be approximately half of pre-pandemic levels over the past year more or less mapping perfectly onto the capacity limits. That being said, California is now currently, all of our restaurants in California are currently open for takeout only. So unfortunately, we have seen a sales decline in California relative to pre-pandemic. If I could just add a little bit more color in terms of our takeout sales, one of the reasons that we decided to keep our takeout stores open this time as opposed to March is when we made our mid-March store closures, we kept a couple of our stores open for takeout only. But our June’s takeout sales, even for our stores that were open for indoor dining, were significantly outpacing those sales that we saw in March. And so, we are seeing an upward trend in that respect.

Andrew Strelzik, Analyst

So that brings me to my next question, I wanted to ask a little bit about the off-premises strategy generally. I mean, it seems like a little bit more of a push behind takeout. How are you communicating that to the guests? I think you made some comments about some investments behind infrastructure there. Can you just talk about what that entails? And have you changed your view or thinking at all around delivery? I know it has not been a priority. I'm just curious where that fits in the takeout and the off-premises picture for you at this point?

Jimmy Uba, President and CEO

So to answer your last question first, we'd like to reiterate that the core of our business remains our indoor dining experience, and we believe that it's still very popular with our guests as demonstrated by our sales and reopened dining room areas. So as we've mentioned in our previous earnings call, because of our focus being primarily on the indoor dining experience, the last three months we focused on developing the projects that we've mentioned before being the touch pedal drink order system and the table-side delivery, table-side payment system. Given that we've made significant progress on both of those, we've decided to shift our energies towards off-premises. And again, while we think of this as a long-term addition to our business, if there's going to be incremental sales or profitability from that, there is absolutely no reason not to capture that. So, in terms of infrastructure investments, our ultimate goal is to build out our own online ordering platform, which would ideally be hosted in an all-in-one package that would include our wait-list app, our rewards program, and our online ordering system. That being said, given sort of the suddenness of the announcement from Governor Newsom has pushed the timeline forward, and now our top priority is to roll out online ordering capabilities as soon as possible. So, we're thinking, just in the interest of time, that we're going to use this period, and we're going to use a third-party service to power our online ordering capabilities. Right now, it's going to be less profitable than having our own in-house ordering system, just because of service fees. But this is all, we're treating all of this as an investment. It's a learning process. Every day we're learning more things about how to operate off-premises. We're hoping that we can implement all these new learnings into the development of our online ordering system. So, in terms of your first question about advertising, right now, our orders are limited to in-store orders or phone orders. Online ordering is the top priority, because that would make things vastly more convenient, and it's easier to advertise as well.

Andrew Strelzik, Analyst

Can you just, you know, I guess the question is, where is takeout to-go mix in right now and what is kind of the breakeven level there? Can you just give us any sense for how we should think about the economics of that piece of the business? And I'll leave it there.

Jimmy Uba, President and CEO

So looking at June, and this includes our restaurants that were open for indoor dining as well, our off-premises mix is 6.5%, which is significantly higher than our historical mix, which is around 1%. Looking specifically at California, about half of our system had an off-premises mix of around 9% or more.

Operator, Operator

Our next question comes from the line of James Rutherford with Stephens Inc. Please proceed with your question.

James Rutherford, Analyst

My first one is just on the various kinds of ways you can reopen for indoor dining. My understanding is in certain cases, you can open with the express belts only. In certain cases, it has to be table service only. So, I'm just curious what impact those different statuses would have on your comps, average check, or really anything else that you care to speak to on that particular topic?

Jimmy Uba, President and CEO

So in terms of average ticket, we haven't changed pricing as a result of not having the conveyor belts, but we've actually seen ticket growth year-over-year, which was a pleasant surprise for us. The most onerous restrictions in terms of conveyor belts are in California. So in those markets, we're not operating express belts, and we did have incremental labor from the additional servers we needed to hire to run the food. But as everybody is aware, California is closed for indoor dining now anyway. So, it's kind of a moot point for us. One thing that was really interesting is that people were very understanding and forgiving of not having the conveyor belt live just because of the pandemic. However, given that this is one of the signature features of our restaurants, we plan on bringing this back as soon as we think the timing is right. We don't want to lose something that's so core to our identity. I spoke with the customer service department, and there was only one complaint, and that was because a family had driven 30-40 minutes to the excitement of the conveyor belt, and they were a little bit disappointed that we weren't able to provide that. So if this usage of the primary belt were to continue for a long time, we do think this would make us a little bit less attractive. However, on the flip side, we think that the experiential nature really positions us as a destination restaurant.

James Rutherford, Analyst

And then my second question is on development. Understanding there are a lot of moving pieces here. But I believe at one point you had said that the construction on a couple of the upcoming units are nearing completion. I’m just curious about your view on the possibility that Fort Lee or Koreatown would open this fiscal year, or if those would be more likely to open kind of next year and beyond?

Jimmy Uba, President and CEO

So in terms of the construction, both Fort Lee and Koreatown in Los Angeles are nearly complete. Fort Lee just has its final inspection to go through. Koreatown is actively going through the inspection process, and so, these stores are largely ready to open. Although, as everybody knows, both in Fort Lee, New Jersey generally and California, indoor dining is prohibited. Thus, the gating factor for opening those stores remains these external factors. That being said, we are hopeful that we'll be able to open at least one of these stores this fiscal year. Again, this will depend on the indoor dining restrictions being lifted. We wanted to give you some context behind the thinking around our store openings during the pandemic. Our calculations have indicated that as long as we're able to open with a 50% seating capacity limit, we will be able to secure restaurant-level operating profit from those stores. Therefore, that consideration is a major factor in terms of the opening timing for any given store.

Operator, Operator

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

Peter Saleh, Analyst

I just wanted to come back to the cash burn real quick. It looks like you guys burned about $10 million or so of cash over the course of the quarter. If I heard you correctly, I think you're burning another call it 800 to 850. I believe that was a weekly number that you guys provided. So, what is the thought process behind the cash burn? And if this continues longer than another, let's say three months, how do you guys plan to address that? And will we see a slowing of development while you put a halt on development to ease the cash burn, or will you tap revolvers to kind of move forward on development?

Jimmy Uba, President and CEO

So we just want to make it really clear that the weekly cash burn we gave during the prepared remarks are not to last for the next 12 months. There are a couple of pressures on our cash burn rate. The first one is that this burn rate reflects our 14 stores in California not being able to offer indoor dining. So, that is a downward pressure on our revenue. The other is that we resumed construction on five new units. So, we have a lot of capital expenditures because we've already executed these leases. These stores were in mid-construction before. The capital expenditures represent about $400,000 of that burn rate. That would be a significant lever for us to pull. In terms of the dining capacities, we think it's extremely unlikely that indoor dining will be prohibited for four months or four quarters. We're hopeful that it's going to be shorter than that. This pressure from the burn rate will be lifted when that happens. In terms of managing the burn rate, the capital expenditures are something that is completely within our control, and they represent the most substantial bucket. Therefore, we think there is a lot of room in terms of our burn rate going forward if the situation worsens or becomes clear that it will go on longer than initially expected.

Peter Saleh, Analyst

And I appreciate that you guys gave the takeout mix, I think in June the off-premise mix, if you will. But can you quantify that in dollars? I know there's a lot of moving parts here with pre-pandemic and post-pandemic AUV. So, can you quantify what the actual maybe dollar weekly sales were for restaurants in any way on off-premise?

Jimmy Uba, President and CEO

So, in terms of absolute numbers, for July we've only been operating for takeout for a couple of weeks. Thus, our advertising pushes haven't really begun in earnest, and this isn't necessarily reflective of where this can go. In terms of June, just the nature of our staggered reopening schedule means that every restaurant is operating different numbers of days. So, giving you an absolute number for June as well would not necessarily provide a meaningful look into what we can do in the future. That being said, in terms of your modeling purposes, we believe that we'll be able to capture 10% to 20% of our pre-pandemic sales through off-premises.

Peter Saleh, Analyst

Just last question, are you seeing or getting any sort of rent concessions or any opportunities to lower your rent expense from landlords? Are you seeing any of that yet?

Jimmy Uba, President and CEO

Our development team has been working very hard on this, and having our new CDO, Robert Kluger join us has been immensely helpful. We're happy that he's on our team. We've been in ongoing negotiations since April. We negotiated for April, May, and June, and we're currently negotiating for July. For both May and June, we received modest abatements and then deferrals representing approximately half of the cash rent expense. One thing we'd like to note is that because we book our rent on a straight-line basis, these deferrals will not be reflected on a P&L level.

Operator, Operator

Our final question comes from the line of Jeremy Hamblin with Craig-Hallum. Please proceed with your question.

Jeremy Hamblin, Analyst

Thanks for taking the questions and providing so much color. I wanted to start with thinking about your average location and the level of sales like on an average weekly sales level that you need to breakeven. I think you said that you'd open if you had 50% seating capacity. However, if you were to make that more granular and just look at the average weekly sales volume that you needed to do to breakeven at a restaurant level, could you give a range on where that would be?

Jimmy Uba, President and CEO

So our pre-pandemic average unit volumes are $3.5 million. We're able to secure half of pre-pandemic sales levels, which brings us to about a monthly revenue of $150,000, which would allow us to breakeven.

Jeremy Hamblin, Analyst

And then thinking about cash burn and moving forward, and the five restaurants under construction. I just wanted to confirm that excludes Fort Lee and Koreatown...

Jimmy Uba, President and CEO

That doesn’t include Koreatown and Fort Lee, sorry to interrupt...

Jeremy Hamblin, Analyst

As we think about, I know this is such a fluid situation and it's hard to forecast. But thinking ahead to fiscal 21 and the unit growth rate that you have maintained. Is there a threshold on cash that you need to think about? We're going to back off the CapEx for new unit construction, because this is just a prolonged recovery that we hit. Whether it's something that you're below $8 million, let's say, on your cash and you still haven't tapped your revolver. Is there a total level of liquidity where you say at this point, we want to make sure that we have ample liquidity, we don't want to get into a situation where this is carrying on longer and we're not going to develop new units? Is there kind of a level or a range that you have in mind before you make that difficult decision?

Jimmy Uba, President and CEO

Certainly, that's really been top of mind. I imagine it's top of mind for pretty much any other player in the restaurant industry. It's certainly guiding our thinking and our development strategy going forward. One thing that we can say is that we're very confident that we'll be able to meet or beat the 20% unit growth CAGR that we've been discussing in the past. Our development strategy is more aggressive compared to the rest of the restaurant space right now. We have two main things that are working in our favor and are driving us forward. One is the ongoing financial support from the parent, as they have very strong financial positions. The other is that our calculations indicate that we're able to capture restaurant-level operating profit as long as we're able to open at 50% or more. If one of these factors were to no longer be true, then we would certainly reevaluate.

Jeremy Hamblin, Analyst

Last question is you've been I think very generous relative to your public company restaurant peers in how you've managed your staff, providing full healthcare benefits and really have weighted to furlough really any employees for an extended period. Is that another situation that you would reevaluate at some point? How much of your staff is furloughed at this point? But how do you make that decision moving forward as well?

Jimmy Uba, President and CEO

Just to give you some context on why we were more generous than some of our peers, this was a financially strategic move by us. We believe that being able to maintain high retention rates and being able to reopen immediately when it was the right time allowed us to capture those profits without worrying about understaffing. The profits we’d be able to capture were more meaningful than the near-term costs. Our lack of furloughing anybody until early April was predicated on the assumption that we would be receiving the PPP loan. The situation has obviously changed. In May, we did another significant furlough of kitchen employees, and we brought them back in June. However, in July the number of shifts we need has been significantly cut in California. So, not every employee is working right now, but the cash support is largely done.

Operator, Operator

Our final question comes from line of George Kelly with ROTH Capital. Please submit your question.

George Kelly, Analyst

So just two for you. First, I understand there's all sorts of barriers and kind of issues with getting your guests into a seat. But my question, you mentioned in response to another question that average ticket is growing. I was just wondering if you could expand on that. What's kind of changed versus February within average customer? How does the average guest look? Are they cautious in general or just what have you seen?

Jimmy Uba, President and CEO

In terms of the average ticket, while we have seen an increase, we haven't been able to draw a direct conclusion about what's driving it. In terms of what our guests look like, we’ve seen a modest shrinking of our average party size. We're no longer seeing large parties of five or six which has been a driver. It’s possible that fewer kids are coming because there are fewer large parties, and children bring down average tickets. Not having as many children could be one of the reasons.

George Kelly, Analyst

And then second question from me is just about your development pipeline. So, you mentioned the 20% CAGR. But I was just wondering if you could be more specific for fiscal year '21. Can you talk about any of the sites that you're continuing to, you mentioned Washington DC and Sherman Oaks. But what else is on the table? Are you continuing to invest with plans to open in 2021?

Jimmy Uba, President and CEO

As a context for everything, right now, we have 10 leases that are executed. We expect to open one of those 10 for us this fiscal year and then for the remainder to be distributed over fiscal '21 and fiscal '22. The pacing in the distribution will depend on what our burn rate looks like as a result of our sales recovery. Looking directly at fiscal '21, beyond the five stores that are actively under construction now, we think these three stores will be the likely candidates for fiscal '21 opening, which would be Aventura in Florida, Troy in Michigan, and then the Stonestown Galleria mall in San Francisco.

George Kelly, Analyst

And I guess I do have one follow-up to that. Any significant changes as you think of your average store and the construction? Does all this COVID-related stuff cause you to rethink any of that, what the box looks like?

Jimmy Uba, President and CEO

Every construction we do is a 20-year investment given the 20-year leases. The pandemic is not going to last 20 years. So, we're a little bit reluctant to make construction-related changes related to the pandemic. That being said, and this was already part of our planned pipeline, we are testing new models that are designed more towards off-premises, whether that means a dedicated make line in the kitchen or pickup racks in the front of the house. That would be the main change we are considering. On a cost level, there is not going to be a material difference between a traditional store and a store that’s geared more towards takeout.

Operator, Operator

This concludes today's question-and-answer session. I would like to turn the floor back over to Mr. Jimmy Uba for any closing remarks.

Jimmy Uba, President and CEO

Thank you everybody for joining us today. Please take care and stay safe. Thank you very much.

Operator, Operator

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.