Earnings Call Transcript - KRUS Q2 2020

Operator, Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Kura Sushi USA, Inc. Fiscal Second Quarter 2020 Earnings Conference Call. Please note that this conference is being recorded today, April 14, 2020. On the call today, we have Hajime “Jimmy” Uba, President and Chief Executive Officer; Koji Shinohara, Chief Financial Officer; and Benjamin Porten, Investor Relations Manager. And now, I would like to turn the conference over to Mr. Porten. Thank you. Please 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 second 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 thank you everyone for joining us today. Before we get started, I would like to say that I hope all of you on the call, your families, and your friends are healthy; and to those of you who have been impacted directly by COVID-19, I hope for a speedy recovery for you or your loved ones. Today’s call was scheduled for what would normally be a discussion of our fiscal second quarter financial results and ongoing operating initiatives, yet as you know these are not normal times, so I will touch only briefly on the second quarter before moving on to a review of our current operations. Our second quarter earnings release contains specific information about the quarter’s results and of course we will be happy to entertain any questions about earnings during today’s Q&A. We were pleased with our second quarter results, which included revenue growth of 28% driven by a 10.8% increase in comparable restaurant sales. Additionally, our loss per diluted earnings per share of $0.02 was in line with our expectations that we provided on our fiscal first quarter call. Exiting the second quarter, which ended on February 29, we felt very good about the momentum of our business and ongoing operating initiatives. However, as the news about COVID-19 began to spread, we started to see a slowdown in sales across the system, particularly in our West Coast restaurants. Our initial forecast was to manage store labor hours, but as an increasing number of state and local governments issued new guidelines for public activities, it quickly became apparent that business as usual was a thing of the past. As these guidelines featured mandatory shutdown of non-essential businesses, we made the difficult decision on March 18 to close all our restaurants system-wide. While many food service restaurants have moved to takeout and delivery services, we believe our technology-enabled concept and the distinctive multi-sensory dining experience will be impossible to replicate, and so it has not been an avenue we have pursued. Since then, our primary concerns have been the ongoing welfare of our team, our liquidity, and our ability to quickly and efficiently resume operations when the time is right. While we are currently unable to predict when that might be, I would like to provide some insight into our recent activities to give you an idea of how we are currently addressing the impact of COVID-19. Obviously, the closure of our restaurants has forced us to make some difficult decisions, but we were able to continue to pay our employees up until April 4 through the employee emergency relief fund that we established, and they are currently furloughed. Our kitchen staff is an exception, as they will remain on payroll. We made this decision because we believe the near-term extent of retention will be less than the cost of retraining staff and the loss of sales from delayed re-openings. To support our team during these difficult times, we are paying the full cost of health insurance for all of our furloughed employees. In addition, they will have the right of first refusal to occupy their previous positions when we reopen, and we also couldn’t offer retention bonuses to help ensure the continuity of our restaurant chains. With regards to our store level expenditures, we have also been in active discussions with all of our landlords. We hope to apply forgivable SBA loan funds towards our April and May debt obligations. Given the overall liquidity of the situation, we will continue to evaluate our occupancy obligations on a month-by-month basis with our landlord partners. On the corporate support side of our business, we have reduced our non-essential operating expenses, including the furlough of a modest group of supportive staff. With regard to our corporate operations, our thoughts in the near term are to be prepared to ramp our business up as quickly and efficiently as possible once we feel it is safe to do so. From a developmental standpoint, we had previously guided to six new restaurants in fiscal 2020, which represented the majority of our capital expenditures for the fiscal year. Two of those restaurants, Katy, Texas; and Glendale, California opened during fiscal Q2, prior to the temporary shutdown. Additionally, we had four new restaurants under construction in mid-March in Fort Lee, New Jersey, Koreatown in Los Angeles, Washington D.C., and Sherman Oaks in California, which are currently on hold, although Fort Lee is largely completed. While our new store development is generally on hold, I would note that some local governments are allowing construction work to continue with certain restrictions. So, we are currently reviewing our options. We are also looking at the possibility of pursuing some renovations during the downtime created by store closures, while adhering to local and federal regulations and the recommendations regarding safety and social distancing. Finally, I have two additional items to note. First, we have applied for a Payroll Protection Program under the CARES Act, which if successful will apply largely to payroll costs. Under the terms of the plan, we plan to spend the loan funds on expenditures that would maximize forgiveness. Secondly, last week, Kura Sushi Japan, our parent company agreed to make available to us a $20 million revolving line of credit over a four-year term. Please note that we have not borrowed any amount against the revolving credit agreement and we have no plans to do so in the immediate future. We very much appreciate the support of Kura Sushi Japan and their confidence in the long-term success of our business. Overall, we are very fortunate to have entered into this unique situation with a strong capital position. As of today, we have approximately $24 million in cash on hand and no debt. If all of our restaurants are closed, we estimate a near-term cash burn rate of approximately $1 million per week. Keep in mind that the above cash outlay includes capital expenditures and minimum rental relief. As you are well aware, the duration of a system-wide shutdown is difficult to predict at this time. However, we are confident that we have more levers to pull in the event that this crisis runs for an extended period of time. One final reminder, due to this uncertainty driven by COVID-19, we withdrew our previous financial guidance for the fiscal year 2020 and will not issue any update at this time. Thank you, again, for joining us this afternoon and for your interest in Kura Sushi USA. Despite the ongoing uncertainty, we believe we’re well-equipped to weather the storm. Even as our stores are closed, our store managers are undergoing retraining. We are working on implementing CrunchTime, our new back-of-the-house platform, and we are engaging with third parties in order to improve our store development and maintenance capabilities after reopening. Additionally, we are continuing with the development process for our previously mentioned technology initiatives. 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 of 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. Open it up. Please open the line for questions.

Operator, Operator

Thank you. At this time, we will be conducting a question-and-answer session. The first question comes from the line of Peter Saleh of BTIG. Please proceed with your questions.

Peter Saleh, Analyst

Great. Thank you. I just wanted to ask, I think if I heard you correctly, I think you said $1 million per week in cash burn at this point. Where do you think you can get that down to? Do you think that number can decline from the current levels if the sales environment persists, or is the $1 million per week kind of the best-case scenario in terms of cash burn?

Hajime Uba, CEO

Peter, thank you for your question. Please allow me to answer in Japanese. Ben is going to translate.

Benjamin Porten, Investor Relations Manager

Hi Peter, this is Ben. I want to clarify that the $1 million cash burn rate is a short-term figure. As Hajime mentioned, we believe there are several strategies we can implement to significantly reduce this burn rate, particularly regarding labor and payroll. We have applied for the Payment Protection Program, and we intend to use these funds responsibly to retain employees. Consequently, our labor costs are higher than they would be without the loan since we are keeping more staff on payroll. We have furloughed some employees, but those who remain are still receiving full pay. If we reach the end of the PPP loan coverage period and the store closures extend significantly, we might have to make difficult decisions and implement further furloughs. This $1 million cash burn rate assumes we will continue construction on four new units and renovations during the closures. If we opt to halt construction, we could reduce the CapEx portion by $300,000. Many may wonder why we are proceeding with construction while other companies are cutting back on CapEx. We felt the responsible approach was to prepare for various scenarios given the uncertainty of the pandemic's duration. We believe there are three potential outcomes: the pandemic could end sooner than anticipated, finish around our current expectations, or last longer than expected. Our decision to continue renovations and developing new units is based on the expectation that the pandemic will either conclude earlier or around our original expectations. Maintaining our restaurant-level contributions is crucial, as closing for renovations after reopening would adversely affect those contributions. We made this choice because we are in a strong financial position, with $24 million in cash and a new $20 million revolver from our parent company. We are proceeding with the assumption that one of the earlier scenarios will occur. However, if the pandemic continues beyond our expectations, we can halt construction and capital expenditures. I hope this clarifies things.

Operator, Operator

Our next questions come from the line of Andrew Strelzik of BMO. Please proceed with your questions.

Andrew Strelzik, Analyst

Hi, good afternoon, and thanks for taking the question. The first one from me, you talked about some of the flexibility on the burn rate. One thing you didn't quantify was the rent piece. So, I was wondering if you could talk about how the conversations with the landlords have been going so far. And how much would that – if you get some flexibility there, how much would that bring down the burn rates?

Hajime Uba, CEO

Hi, good afternoon, and thanks for taking the question. The first one from me is regarding the flexibility on the burn rate. I noticed you didn't quantify the rent aspect, so I was wondering if you could share how the discussions with the landlords have been progressing. Additionally, how much flexibility in that area would potentially reduce the burn rates?

Benjamin Porten, Investor Relations Manager

So as soon as we decided to close our stores on March 18, we began discussions with our landlords for both our existing stores and those in our new unit pipeline. We're currently negotiating, so it's a bit early to provide specific results, but we would like to discuss the general direction. Our main goal in these negotiations is to maximize the forgivable expenses under the PPP loan, which we believe will create a win-win situation with our landlords, with whom we need to maintain long-term relationships. We have been very focused on getting the PPP process finalized. Additionally, the $1 million cash burn rate assumes full occupancy costs.

Andrew Strelzik, Analyst

Okay, that’s helpful. And then I understand kind of the reticence to move towards the more takeout model, given the inability to kind of replicate the experience, which is a key piece of the brand. I'm just wondering, you've talked about takeout as or maybe delivery being more of a longer-term kind of opportunity. Have you kind of reshuffled at all your thinking around prioritizing that? Have you moved it up at all, just given kind of how things have unfolded? Did you consider this an opportunity to accelerate that at all, or you just kind of ruled it out immediately?

Hajime Uba, CEO

Sure.

Benjamin Porten, Investor Relations Manager

We've always believed that our guests come for the complete dining experience. Our main focus has been on providing the best possible experience in our stores, which is why we haven't considered takeout or delivery in the past and are not currently planning to. However, considering the many uncertainties in this changing environment, we haven't dismissed the idea completely and want to keep our options open. For some context, we did keep certain stores open for takeout sales before deciding to close the entire system. However, with in-store dining largely restricted nationwide, off-premises sales are more competitive, and we could not generate enough sales to justify keeping those stores open solely for takeout. We lack established relationships with third-party services and don’t have the necessary infrastructure, so we decided it was better to focus our time and resources on other initiatives. Currently, while our stores are closed, we are actively pursuing various projects, including unit development, new store construction and renovations, as well as in-store technologies like drink ordering systems and tabletop touch panels. We are implementing our new back-of-house platform, CrunchTime, and we are using this time efficiently. Thus, we determined the best strategy was to invest in these efforts rather than trying to enter a highly competitive off-premises market. Our objective right now is to prepare ourselves to come out of this situation in the best possible position for recovery, which we believe will facilitate that.

Andrew Strelzik, Analyst

Okay. I appreciate all the color there. If I could just squeeze in one more, it sounds like a number of the decisions you're making are being made with an eye towards the restart. So, I guess, when you think about reopening the stores and getting running again, what's the biggest challenge in that process?

Hajime Uba, CEO

Our goal right now is to position ourselves to emerge in the best possible position for recovery. We believe this will make that easier. I appreciate all the information provided. If I could ask one more question, it seems that many of the decisions you’re making are focused on the restart. When considering reopening the stores and getting back to business, what do you see as the biggest challenge in that process?

Benjamin Porten, Investor Relations Manager

We expect that the choice to reopen our stores will be just as challenging and require significant consideration as the choice to close them. Our top priority, as it was when we closed our stores, is the health and safety of our employees and guests. We do not want to jeopardize the trust we've built with them. This will be our main focus. Once it is clear that it is safe for people to return to society and restaurants can reopen securely, we will assess whether reopening our stores would allow us to manage our losses more effectively than keeping them closed. If so, we would proceed with reopening. Even after federal or local restrictions are lifted, we will implement additional safety and health measures in our restaurants. We will need to consider the increased costs necessary to ensure these safety measures are properly executed as we plan for reopening.

Andrew Strelzik, Analyst

Great. Thank you very much.

Hajime Uba, CEO

Thank you, Andrew.

Benjamin Porten, Investor Relations Manager

Thanks, Andrew. Nice to hear from you.

Operator, Operator

Our next questions come from the line of James Rutherford of Stephens. Please proceed with your questions.

James Rutherford, Analyst

Hi, thank you for taking the questions here. I’ve got two. The first one is on the supply chain. I'm just curious if you anticipate any issues with your supply chain as you come out of COVID-19 and begin to reopen the stores?

Koji Shinohara, CFO

We have a local stance, but our main suppliers have confirmed to us that their financial health is extremely strong, and there is no impact on their operations as a result of these few months.

James Rutherford, Analyst

Okay. Thank you for that. As a follow-up to a couple of other questions we've had on the tenor of reopening, I understand the difficulty in estimating or forecasting that. My question is, what kind of authority you're going to watch as you look at this? And I ask the question because there is a variety of voices talking about when to reopen the state. I think Texas is trying to be pretty aggressive relative to other states, and you’ve got federal versus state kind of conflict as well. I'm just kind of curious what signs you will watch when you decide to reopen?

Hajime Uba, CEO

I understand that estimating or forecasting the timing of reopening is challenging. My question is about the indicators you will monitor as you consider this decision. There are various opinions regarding when to reopen the state. Texas appears to be adopting a more aggressive approach compared to other states, and there's also a conflict between federal and state perspectives. I'm interested to know what signals you will look for when deciding to reopen.

Benjamin Porten, Investor Relations Manager

We cannot provide a specific timeline for when we expect this to occur. Since we operate in five states, each with significantly different markets, the recovery conditions will vary widely across these areas. We will assess each unit individually based on local circumstances related to reopening. We do not anticipate that our sales will return to pre-pandemic levels immediately after reopening. Instead, we expect a slower sales rate and a gradual increase afterward.

James Rutherford, Analyst

Excellent. As a follow-up, what are some of the things that you can do to spur demand when those stores reopen? I know you have a nice large database of customer email addresses. Might you use that and perhaps some sort of specialized offers when the stores reopen? I know it may be a bit early to think about that, but what are your thoughts there?

Hajime Uba, CEO

James, please allow me to make sure we understand your question correctly.

Benjamin Porten, Investor Relations Manager

It's interesting you brought this up because we find ourselves in a unique situation. Normally, we would launch an advertising campaign similar to that of a new store opening. However, considering our obligation to the communities, it would be irresponsible to attract the usual crowds associated with store openings. Consequently, our initial move will likely involve reaching out to our current guests using our rewards database and tracking the traffic to determine next steps. We also need to factor in our employee retention and workforce levels when planning our reopening advertising.

James Rutherford, Analyst

Helpful color, thank you Jimmy, Koji, and Ben.

Hajime Uba, CEO

Thank you, James.

Benjamin Porten, Investor Relations Manager

Thanks, James.

Operator, Operator

We have reached the end of the question and answer session. I will now turn the call back over to management for any closing remarks.

Hajime Uba, CEO

Again, thank you for joining us today. Please stay safe, and we look forward to our next earnings call. Thank you for your time.

Operator, Operator

This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation and have a great evening.