Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Kura Sushi USA, Inc. fiscal third quarter 2022 earnings conference call. At this time, all participants have been placed in a listen-only mode, and the lines will be open for your questions following the presentation. Please note that this call is being recorded. On the call today, we have Jimmy Uba, President and Chief Executive Officer, and Benjamin Porten, Vice President, Investor Relations and Business Development. Now I would like to turn the call over to Mr. Porten.
Thank you, operator. Good afternoon, everyone, and thank you all for joining. By now, everyone should have access to our fiscal third quarter 2022 earnings release. It can be found at www.kurasushi.com in the Investor Relations section. A copy of the earnings release has also been included in the 8-K we submitted to the SEC. Before we begin our formal remarks, I need to remind everyone that part of our discussion today will include forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance, and therefore you should not put undue reliance on them. These statements are also subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect.
We refer all of you to our SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. Also, during today's call, we will discuss certain non-GAAP financial measures which we believe to 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.
Thank you, Ben, and thank you everyone for joining us today. It has been a true pleasure to see how rapidly and completely our business has recovered since the most challenging days of the pandemic. This has been a year of restoration for Kura. In fact, we've gone past mere restoration, and we are performing better than ever. Each challenge that COVID presented ultimately proved to be an opportunity for us. Emerge as strong as we have was hard to imagine when we are in the thick of the pandemic, and I'm so proud and grateful for everything that our team members have done to make this possible. Now I would like to discuss our performance in our most recent quarter and why we think we are positioned for even greater things to come.
The strong sales momentum from the first half of our fiscal year has continued into our third quarter, which once again has proven to be a record sales quarter for the company. As compared to our pre-pandemic fiscal 2019 results, comparable sales growth in our third quarter was 28.3%. On a single year comparison against our fiscal 2021 third quarter, comparable sales grew by 65.3%. Whether we are looking at last year or back to pre-pandemic, our comparable sales growth has been spectacular. Sales recovery in our California markets has been especially pronounced with third quarter comp growth of 95.5% as compared to our 2021 results, reflecting the sales impact of dining room restrictions during the previous year.
During the same period, Texas delivered 33.6% comparable sales growth as compared to our 2021 results. Additionally, our off-premises revenue in the third quarter was $1.3 million or 3.5% of our sales mix. It's great to see such strong recovery across the board. In spite of ongoing inflationary pressures, consumer sentiment for Kura Sushi remains extremely strong as demonstrated by our recent results. As our typical customers have higher incomes and we offer an excellent value proposition, we are seeing continued strength in their spending and our check sizes continue to grow. Our sales performance as we enter the summer continued to be very strong, with June revenue of $12.7 million.
While much of the restaurant industry has been facing headwinds in terms of staffing and inflation, I'm extremely pleased to say that we have been largely spared and believe that we continue to occupy a uniquely privileged position to weather these macro pressures. Our costs as a percentage of sales for the first half of the fiscal year were at 30%, marking an all-time best in corporate history. While we haven't been entirely free from commodity pressures, taking price in conjunction with smart purchasing practices have allowed us to offset commodity inflation. In fact, costs as a percentage of sales decreased by a further 30 basis points in our third quarter. As a percentage of sales, labor is running at 31%, representing a sequential improvement of 210 basis points over the prior quarter, driven by superior sales leverage.
While we had previously faced staffing headwinds as a result of Omicron-related staff quarantining during the second quarter, we are pleased to say that we had no such issues during our third quarter, and we remain very close to achieving optimal staffing levels. These combined factors have resulted in restaurant level operating profit margins of 22.5%, representing 470 basis points of margin expansion relative to the prior quarter, and 210 basis points as compared to the same period in pre-pandemic fiscal year 2019. There remains ample opportunity for our full-year restaurant margins to exceed the 20% we historically achieved pre-pandemic. Turning to development, we opened one unit during the quarter in our new market of Watertown, Massachusetts. We are very encouraged by Watertown's early performance, as well as the continuing strength of our other fiscal 2022 openings.
In terms of upcoming openings, we expect our Novi restaurant to open in the coming weeks and to close out our fiscal year with a total of eight new restaurant openings. We expect the remaining stores under construction to open early in fiscal 2023. Now I would like to turn to an update on recent initiatives. In past earnings calls, I have mentioned that we planned to complete the system-wide rollout of our robot servers, tableside payment, and the touch panel drink order system by the end of the fiscal year. I'm proud to say that we are ahead of schedule and that we completed the rollout as of the end of May. As we previously mentioned, guest response and employee response have been phenomenal. The robot servers are a great addition to the Kura experience and were the focus of a recent marketing campaign.
Now that we've completed the rollout of these three initiatives, I would like to discuss what we have coming up in our pipeline. We are in the process of upgrading our waitlist system through a partnership with Wisely, which we hope will improve the guest experience and reduce the attrition rate associated with our long lines. We are also in the process of moving loyalty platform to Punchh. Our rewards membership base is now approaching 500,000 members, and by moving to the more powerful Punchh platform, we believe we can truly begin to unlock the data-driven benefits that rewards program can offer. We expect to implement these initiatives during the first half of the upcoming fiscal year. As a final note, we took pricing of approximately 6% as of July 1st.
Although the minor pricing adjustment we took in March was enough to offset inflationary pressures through the third quarter, in light of month-over-month inflationary trends through the quarter, including the minimum wage increase in our California market, we believe this 6% is appropriate considering the excellent value we continue to provide relative to our competitors, especially those in the sushi space. We will also be lapping a pricing event as we reach September, at which point effective pricing will be 7.8%. Again, I would like to extend my thanks to all of our team members in our restaurants and support center. The hard work that they put in every day is the reason that Kura Sushi is such a special concept. With that, I'll turn it over to Ben to briefly discuss our financial results and liquidity. Ben?
Thank you, Jimmy. For the third quarter, total sales were $38 million as compared to $18.5 million in the prior year period. Comparable sales growth as compared to the prior year period was 65.3%, with regional comps of 95.5% in California and 33.6% for Texas. As compared to our pre-pandemic results of the fiscal 2019 third quarter, our comparable sales growth was 28.3%, with regional comps of 18.2% in California and 40.5% in Texas.
Turning to costs, food and beverage costs as a percentage of sales were 29.7% compared to 31.7% in the prior year quarter due to pricing taken at the start of the fiscal first and third quarters and higher food spoilage costs in the prior year, partially offset by food cost inflation. Labor and related costs as a percentage of sales increased to 31% from 28.9% in the prior year quarter due to the lapping of the employee retention credits recognized in the prior year. Excluding the impact of the ERC, retention and new hiring bonuses, labor and related costs as a percentage of sales in the prior year quarter would have been 36.6%.
The year-over-year improvement in labor and related costs as a percentage of sales, excluding the ERC, was due to higher sales leverage, partially offset by increases in minimum wage. Occupancy and related expenses as a percentage of sales improved to 7.1% from 10.2% in the prior year quarter, primarily due to higher sales leverage. Other costs as a percentage of sales decreased to 11.5% compared to 14.7% in the prior year quarter due to higher sales leverage as well. General and administrative expenses were $5.9 million compared to $4.3 million in the prior year quarter.
Excluding the impact of the ERC recognized in the prior year quarter, general and administrative expenses would have been $4.8 million. This increase was primarily due to compensation related expenses as we made investments in our team to support our accelerated growth plans, partially offset by a litigation accrual in the prior year quarter. As a percentage of sales, general and administrative expenses were 15.5% compared to 23.2% in the prior year quarter. Operating income was $473,000 compared to operating income of $866,000 in the prior year quarter. Excluding the impact of the ERC and litigation accrual in the prior year quarter, operating loss would have been -$4.4 million.
Income tax provision was a benefit of $2,000 compared to an income tax expense of $30,000 in the prior year quarter. Note that we expect to continue to incur nominal income tax expense irrespective of our pre-tax income or loss as a result of a full valuation allowance against our deferred income tax assets and incurrence of minor income taxes payable at state levels. Net income was $477,000, or $0.05 per diluted share, compared to net income of $770,000, or $0.09 per diluted share in the prior year quarter. When adjusting for the ERC benefit and litigation accrual in the prior year quarter, adjusted net loss would have been $4.5 million, or -$0.54 per diluted share.
Restaurant level operating profit as a percentage of sales was 22.5% compared to restaurant level operating profit as a percentage of sales of 5.8% in the prior year quarter. Adjusted EBITDA was $3.2 million compared to -$2.6 million in the prior year quarter. Turning to our cash and liquidity, at the end of the fiscal third quarter, we had $36 million in cash and cash equivalents and no debt. In light of our fiscal third quarter results, I would like to provide the following updated guidance. We expect total sales between $137 million and $142 million.
We expect general and administrative expenses as a percentage of sales of approximately 16.5%, and we expect the opening of eight new units with net capital expenditures per unit of $2.2 million. Now I'll turn the call back to Jimmy.
Thanks, Ben. This concludes our prepared remarks. We are now happy to answer any questions you have. Operator, please open the line for questions. As a reminder, during the Q&A session, I may answer in Japanese before my response is translated into English. Please bear with us.
At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Our first question comes from the line of Jeremy Hamblin with Craig-Hallum Capital Group. Please proceed with your question.
Thank you and congratulations on the strong results. I wanted to focus first on your restaurant level margins of 22.5%, I think is a record for the company. You know, labor down to 31%. Obviously you're doing that in a fairly high food and labor inflation environment. I wanted to get a sense of the sustainability of those margins. How much of the improvement in labor is a reflection of the price increases versus the use of Kura Bots?
Hi, Jeremy, this is Ben. It's great to talk to you. In terms of pricing, we really use pricing to manage our prime costs of COGS and labor. That's really why we've been able to keep it so consistent over the last three quarters. In terms of the improvement to our restaurant level operating profit margin, that would be a function of greater sales leverage, part of which would be the KuraBot.
Got it. Just in terms of, you know, you provided some color on, you know, back in April on your March sales trends. I think you did about $12.5 million in the month of March. Looks like you kind of sustained those trends in April and May. In terms of, you know, looking forward here to this kind of implied guidance for Q4, you know, it looks like you've seen some acceleration in productivity. Typically, Q4 has your highest average unit volumes. Can you give us a sense of what you've seen quarter- to- date thus far? You know, how much of the increased guidance is reflective of the price increase?
Sure. In terms of June results, as Jimmy discussed in the opening remarks, we had $12.7 million in revenue. If that were to be the run rate for the remainder of the quarter, that would be the sort of the lower end of the guidance. In terms of seasonality, Q4 is certainly the strongest quarter that we have. You can see that effect very meaningfully in pretty much every year. July and August are really when the summer begins to ramp up. We do expect improvement over that $12.7 that we saw in June, which is what gets us to the higher end of that guidance.
Jeremy, please allow me to add some additional explanation, but speak in Japanese, then it's gonna translate.
[Non-English content]
To give you some additional granular detail. Historically, the sales improvement in Q4 relative to Q3 has been 5.9%. We took an additional 6% of price in July. That gets us, you know, higher up in that guidance range that we get. We have a number of other things that are in play as well, such as our Demon Slayer collaboration campaign, which if it proves as successful as we hope it will be, then that will get us to the high end of that guidance.
Got it. That's great color. One last follow-up here. In terms of your average volumes versus kind of pre-pandemic levels, you know, I calculate it's up about 25% in the May quarter versus what you were generating three years ago. Can you give us a sense for the components of that? You know, how much of that is, you know, average check change versus transactions?
Sure. If we look at a three-year stack going back to fiscal 2019, which is, you know, our pre-pandemic comparison, the effect of pricing is a little over 22%. Our comps over that same period are 28.3%. We're still not 100% back to pre-pandemic traffic. That offsets a little bit. The rest of it will be in organic ticket growth just from people eating more plates than they used to.
Got it. Thanks so much for the color, guys, and best wishes.
Thanks, Jeremy.
Thank you, Jeremy.
Our next question comes from the line of Sharon Zackfia with William Blair. Please proceed with.
Hi, good afternoon. I guess I just wanted to follow up on the restaurant level margin because it was a very impressive metric. I understand the sales leverage component of it, but can you talk about structurally, you know, do you think there's a change in where your restaurant level margin can settle out now, over the next maybe three to five years? I'd also be curious to hear your thoughts, and I'm sorry if I missed this, on development for 2023, particularly as it sounds like maybe one or two locations might have slipped into 2023.
Sure. Let me answer that second question first. You're right, we did tighten our guidance from eight-10 units to eight units. Those remaining two units we expect to open early in fiscal 2023. We're excited to provide more granular guidance in terms of our unit growth expectations for fiscal 2023 at the Q4 earnings call or our next earnings call. What we can say at this point is that, you know, since going public, we've told the Street that we expect to maintain a 20% unit growth CAGR. We absolutely expect the same for 2023 with that 20% as a core.
In terms of the restaurant level operating profit margin expectations, I don't have a crystal ball for five years in the future but just looking at the trends from Q1 and Q3, I think you can certainly expect an elevated rate for restaurant level profit, operating profit margins. We don't think this is a fluke. This should continue into the next fiscal year.
Okay. Just to follow up, it sounds as if you feel very confident about the cadence of your business, and clearly the fourth quarter guidance implies such. Are you seeing any signs of your customer weakening at all or anything on the margins that would suggest that the trends you're seeing right now might not be sustainable?
We've been extremely fortunate in that we really haven't seen any sort of softening in terms of consumer sentiment. One of the things that we found most encouraging was that our March pricing of 1.8% was significantly outpaced by check growth of 4.9% over that same period between Q2 to Q3. We know that our guests are not managing their check sizes. I think that's a great indicator that we've yet to hit any sort of consumer elasticity point, and that gave us a lot of comfort about that 6% that we decided to take at the beginning of July.
Looking at our traffic rates. We're really, Q3 is pretty much in line with Q1, which was exceptionally strong, and certainly better than Q2, which had those Omicron headwinds. In terms of customer sentiment, we feel that we're in a very, very fortunate position.
Okay. Thank you very much.
Thank you, Sharon Zackfia.
Thanks, Sharon.
Our next question comes from the line of George Kelly with ROTH MKM. Please proceed with your question.
Hey, everyone. Thanks for taking my questions. Congrats on a strong quarter. The first one is did I hear you right that you're contemplating taking pricing again in September as well?
No. Just to clarify, that was referring to the September 2021 pricing. We were just mentioning that we'd be lapping that price in two months.
Okay. Gotcha. Then still on pricing, I mean, I understand that it's a challenging environment as far as labor and food costs. You know, your inflation's hitting everywhere. But you just generated such a strong four wall margin in the quarter, and here you're taking another 6% pricing. And I understand that your consumer is showing no kind of signs of hesitation or, you know, it doesn't seem like you've hit a ceiling. But I guess the question is just a higher level one, which is, you know, why continue to kind of push margin through pricing? If you can just talk sort of, you know, directionally about, you know, should we expect more going forward or it just seems like maybe you've changed your thought process on the opportunity around pricing.
Sure. In terms of our decision for that 6% in July, this is really reflective of the month-over-month inflation that we saw through Q3 and then into June. If you look at, you know, our past quarters through fiscal 2022, you can see that our prime cost structures stayed very stable. Basically, that's to say that our FP&A team has done a tremendously good job in terms of forecasting inflation for the upcoming period, and that's what we've done for July as well. The goal isn't to drive margin by taking price. It's really just to keep our labor and COGS consistent. The growth in margin is more from, you know, just greater sales leveraging combined with that seasonal boost that we get.
Okay. Okay, great. Last one for me, I think. You mentioned a couple of initiatives you're working on and expect to implement in the first half of fiscal year 2023. I missed the first one. Could you just walk through what that longer term initiative is? That's all I had. Thank you.
[Foreign language]
Sure. I think you're talking about the waitlist improvement, George. Is that correct?
Yep. Yep. I think that was it.
Okay, great. Just to give you. We've been very happy with the wait list app. You know, it served us very well, but we know that we can get to a greater level of accuracy in terms of the wait times. The algorithm that we use is pretty straightforward and doesn't really take historical behavior into account. Just to give you an idea, let's say, you know, we're an hour before closing, but the wait time says there's a two-hour wait. Naturally, you're gonna have a lot of people drop off because they think they're not gonna be able to get a seat. But then, because those people have dropped off, the wait list is also, you know, or the wait time should also shrink.
Because those people have already left, that's traffic that we can't capture. Incorporating these attrition rates around, you know, especially shoulder periods and stuff like that, we think that we'll be able to seat a couple more people per day. Certainly, you know, just having a more accurate time is better for the consumer experience.
Okay. Understood. Thanks.
Thanks, George.
Thank you, George.
As a quick reminder, if anyone has any questions, you may press star one on your telephone keypad to join the question- and- answer queue. Our next question comes from the line of Andrew Strelzik with BMO Capital Markets. Please proceed with your question.
Hi, this is Daniel on for Andrew. I just had a question on off-premises. I was curious where that mix is standing now and, maybe also some information on the driver outlook.
Sure. Off-premises mix was 3.5% of sales in Q3 or about $1.3 million. That's on a dollar basis, very, very close to what we had in Q1. That lower mix is really just reflective of, you know, greater revenue total. In terms of our expectations for the future, we think this is in line. We think this is appropriate. Off-premises is, you know, gravy for us. We're basically hitting our kitchen capacity limits, and there's a point where trying to push additional off-premises is no longer incremental. In terms of our top line and bottom line growth, the opportunity is vastly greater than just unit growth.
For the foreseeable future, we're gonna be putting our energies as a company into just growing our unit base as opposed to trying to deliver additional off-premises sales.
Got it. Would you also be able to provide any color on where your pipeline is right now?
Sure. We've got three units that we expect to open in July and August, and then two early in fiscal 2023. In terms of any further details than that, I think we're gonna wait till the next quarter to give a guidance update.
Got it. Thank you.
Our next question comes from the line of George Kelly with Roth Capital. Please proceed with your question.
Hi, everyone. Just one more quick one for me. Can you remind me when you open a new restaurant, like you're doing three here in the last quarter, how much pre-opening marketing expense and training and all this kind of stuff, like what is the expense around opening a restaurant?
[Foreign language]
Hi. Looking at our pre-opening marketing fees, it's pretty insignificant. We don't do anything like big ad buys. No television campaigns or TV commercials. We focus mostly on digital and then leveraging local media. You know, the spend could be, you know. It's pretty insignificant. In terms of. We think that, you know.
Sorry, Jimmy, did I hear you right when you said it was $2,000-$3,000 per store or $20,000-$30,000?
Yeah. Yeah, 20, 30.
Yeah. Twenty to thirty thousand, which, obviously is not a very big spend, but just given how strong our openings continue to be in spite of inflation, we think that spend rate is appropriate. In terms of pre-opening labor costs, our operations are very simple and automated as you know, and the training periods very truncated. We're able to open pretty rapidly following our final inspections and approvals. Because that training period is short, pre-opening labor is, I imagine, substantially less than a comparable dining casual dining restaurant.
Okay, that's helpful. Thanks.
Thank you.
Thanks, George. Our next question comes from the line of Jeremy Hamblin with Craig-Hallum Capital Group. Please proceed with your question.
Thanks for taking the follow-up. I wanted to get an understanding rather than asking about the number of units on a go-forward basis. I wanted to get a better understanding of the type of unit and potential size that you're looking at. I know you know the Watertown; Massachusetts has been great. I think the San Antonio location has been off the charts and maybe challenging for the best unit you have in the system. In terms of thinking about the square footage, you know, and wait times and so forth, are you thinking about having a slightly bigger footprint on a go-forward basis given where demand is? Any color you can share on that would be great.
[Foreign language]
Great. Thank you for commenting on Watertown and San Antonio. We couldn't be prouder of those locations. We've mentioned this in past calls, but the vintages from fiscal 2021 and 2022 have been, you know, the best vintages we've ever put out, and so we've been very pleased by their strong performance. If, you know, there's very strong demand within a given market, and there happens to be a larger box that's available in a great site location within that market, that's something that we would consider taking. We've always thought of our box flexibility as a huge competitive strength. We don't have a set prototype. We don't have a set square footage.
We're able to look at the entire, you know, country and just identify sites that mirror our best successes and then fit our concept into those spaces. That's one of the reasons that we've had such strong unit economics. One other thing is that regardless of the size, our units can be highly successful. We could have a smaller unit that maybe has a lower AUV than the system average, but the cash-on-cash returns for that unit are gonna be just, you know, as strong as the system average or even stronger. Square footage doesn't necessarily correlate one-to-one with higher sales. For example, our Fort Lee location is actually lower than the system average, but it's in our top three performers.
The bigger factor really here is just the quality of the site selection more than the square footage.
Got it. I can target the question in a slightly different way. In terms of thinking about your occupancy costs, which, you know, pre-pandemic were, you know, right around 7%. I think before you were public, they were closer to 6%. Do you have kind of a target, you know, range? Are you looking to be back in that 6%-7% on a longer-term basis? Or how do you think about that?
So that, that 6% t goes.
[Foreign language]
Right. We think about our units holistically. Whenever we do a go, no-go decision, you know, with the real estate committee in terms of opening any new site, we evaluate a pro forma of the expected financials for that unit. Really, the single most important metric that we focus on is on cash-on-cash return. You know, there might be a location that has higher rent, but it's in a lower labor market with high earnings or whatever. We look for a unit that can deliver the cash-on-cash return that we're accustomed to. You know, rent is just a part of that. We don't necessarily have a target for rent. It's really more our expectations for all, you know, all the cost items.
Great. Thanks so much for taking the additional questions.
Thanks, Jeremy.
Yes.
We have reached the end of the question- and- answer session, and this also concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.