Earnings Call Transcript - BROS Q1 2023

Operator, Operator

Thank you for standing by, and welcome to the Dutch Bros Incorporated First Quarter 2023 Conference Call and webcast. This conference call and webcast are being recorded today, Tuesday, May 09, 2023 at 5:00 PM Eastern and will be available for replay shortly after it has concluded. Following the company's presentation, we will open up line for questions and instructions to queue up will be provided at that time. I will now turn the call over to Paddy Warren, Dutch Bros, Director, Investor Relations and Corporate Development. Please go ahead.

Paddy Warren, Director, Investor Relations and Corporate Development

Thank you. Good afternoon, and welcome. I'm joined today by Joth Ricci, CEO; Christine Barone, President and Charley Jemley, CFO. We issued our earnings press release for the fourth quarter ended March 31, 2022, after the market closed today. The earnings press release along with the supplemental information deck have also now been uploaded on our Investor Relations website at investors.dutchbros.com. Please be aware that all statements in our prepared remarks and in response to your questions, other than those of historical fact are forward-looking statements and are subject to risks, uncertainty and assumptions that may cause actual results to differ materially. They are qualified by the cautionary statements in our earnings press release and the risk factors in our latest SEC filings, including our most recent Annual Report on Form 10-K and our Quarterly Report on Form 10-Q. We assume no obligation to update any forward-looking statements. We will also reference non-GAAP financial measures on today's call. As a reminder, non-GAAP financial measures are neither substitutes for nor superior to measures that are prepared under GAAP. Please review the reconciliations of non-GAAP measures to comparable GAAP results in our earnings press release. With that, I would now like to turn the call over to Joth.

Joth Ricci, CEO

Thank you, Paddy. Good afternoon, everyone. Q1 was a solid quarter for Dutch Bros, as we continue to deliver on our vision for long-term sustainable growth. We opened a record 45 new system-wide shops in the quarter of which 42 were company operated. We continued our expansion eastward, reaching Knoxville, Tennessee, and opened shops across nine states. We grew revenue by 29.6% and drove 590 basis points expansion in shop contribution margin year-over-year. We remain pleased with the underlying strength of the business. We responded decisively to the economic climate and focused on accelerating shop level profitability, particularly in labor productivity to deliver a strong company-operated shop margin. At the same time, we continue to invest in our shop footprint to grow business, delivering on yet another quarter of our new shop growth plan. Our people pipeline and systems are strong, demonstrated by our deep bench of qualified operator candidates and an already low and further improving employee turnover. We saw meaningful four-wall margin expansion and we continue to see SG&A as we built new shops and scale our platform. This continued underlying strength provides encouragement as we execute against our long-term goal of 4,000 shops in the next 10 to 15 years. For the quarter, system-wide, same shop sales were negative 2%. As a reminder, at this stage of our growth journey, just 70% of our shops sit within our comp base. Same shop sales decelerated into February before hitting an inflection point in March, exiting the quarter with momentum. Earlier in the quarter, we faced difficult comparisons, rolling over strong performance in 2022 as we remained open through the omicron wave. Later in the quarter, we began investing in a number of traffic-driving initiatives that leveraged our unique assets as we began to see the improvement. To expand more on what we're doing, I'd like to introduce our new president, Christine Barone. Christine joined Dutch Bros in February and is already leading the development and execution of both short and long-term strategies in this space.

Christine Barone, President

Thanks, Joth. It's been one of the great pleasures of my career to integrate into the Dutch Bros team and begin tackling our highest priorities. There is so much great opportunity ahead at Dutch Bros. We are focused for the remainder of the year on proactively responding to potential macroeconomic challenges and driving traffic. We're taking several steps to tackle our priorities. First, we're leaning into throwback promotions that have served to drive traffic and trial in the past. One example is our “Fill-a-Tray” promotion in March where we offered four medium drinks at a price that encouraged customers to bring friends. This promotion, which lasted six hours on a single Wednesday afternoon, resulted in the largest sales day in the company's recorded history, arriving at same shop sales upwards of 40% higher than a typical Wednesday. Most importantly, a trip to Dutch Bros became a group event, which is what the brand is all about. Second, we're driving innovation to ensure we're meeting the needs of our customer base. For St. Patrick's Day, we released our first-ever Flavored Soft Tops. The lucky clover and Irish cream flavors of our premium add-on allowed our customers to celebrate with a special drink, which was great for a couple of reasons. First, it increased overall check by 50 basis points and second, it drove approximately 35% higher soft top adoption during the limited time offer period. Finally, we're doubling down on targeted promotions within the Dutch Bros app to not only drive traffic, but to also encourage customers to load funds on the Dutch path. The refreshed rewards program announced in Q1 provides us the flexibility to invest more surgically whenever we intend to continue and moves us away from a one-size-fits-all approach. These results tell us our customers remain excited about the brand. Summer months are traditionally some of our best for sales, and we intend to build on the momentum we've built. We plan to continue to drive innovation and launch targeted marketing campaigns into Q2. For example, in April, we introduced our Mangonada Rebel and Double Point Tuesdays and we have been pleased with our customers' responses to these efforts. I look forward to continuing to work with the team to capitalize on these opportunities while also identifying operational efficiencies.

Joth Ricci, CEO

Thanks, Christine. The work Christine and the team are doing supports our key business pillars: people, shop development, operating leverage, brand awareness, and technology. People remain our focus. On January 1, we made the proactive investment in our people and increased base wages in federal minimum wage markets. Our east has responded well. Shop level turnover in those markets improved by about 6%, system-wide shop level turnover fell by 3% to about 70%. Our people pipeline now includes more than 275 qualified operator candidates to support new shop growth. Average unit volumes for mature company-operated shops opened since 2019 were $2 million, approximately 20% higher than company-operated shops open prior to 2019. While 2022 new shop AUVs are down slightly from Q4 trends, it is still early in the maturity of many of these shops. Estimated sales transfer remains in line with our expectations, indicating limited if any unintentional drag from shop growth. The shop classes of 2019, 2020, and 2021 have each achieved our 30% contribution margin target, even as we've entered new trade zones across the country. Shops opened in 2022 are reaching a run rate, 30% contribution margin in just three to four quarters. Like many others, we have seen pressure on build costs and are working actively to value-engineer our shops in order to offset some portion of that escalation. We have a healthy list of actions that we can take and plan to incorporate into our pipeline. While we can't avoid all the escalation, we plan to make improvements going forward. Despite these market conditions, our shops continue to achieve strong cash-on-cash returns, which encourages us to keep investing in the long-term future. Continued expansion helps us to accrue the benefits of market scale over time as we introduce new customers to our brand. We are forming daily relationships and developing these routines takes time that often proves to be sticky. These considerations combined with other traffic-driving and operational initiatives Christine mentioned earlier support our continued steady pace of growth. We intend to drive margin expansion as we grow both through continued SG&A leverage and through operational improvements at the shop level. In Q1, adjusted SG&A was 18.6% of total revenue, a 220 basis point improvement from Q1 last year. We expect further leverage as our revenue growth continues outpacing the SG&A investments we need to support rapid development. We also realize significant contribution margin improvement in our company-operated shops, achieving 590 basis points of expansion year-over-year to 24.2% of company-operated shop revenue. Improvements in our labor processes were a major driver and we recognized 400 basis points of margin leverage year-over-year in labor to 28% of company-operated shop revenue. We believe this benefit was a product of steady improvements in scheduling standards and operating tactics that we began implementing in 2022. Included in this 400 basis points of improvement in Q1 is $3 million of the wage investments we discussed last quarter. Finally, we're in the process of ensuring we have the right technology in place to support our customers and shops. Used correctly, we believe technology can be a major traffic driver moving forward, helping us improve reliability, speed, and customer satisfaction. Currently, we're investing in our infrastructure and payment processing systems as well as the Dutch Bros app. The Dutch Rewards program is a major part of our business and continues to grow with approximately 65% of our transactions coming from Dutch rewards members. In March, we executed a change to our rewards program, the change right-sized the discount following last year's movement on price. As part of the refresh, we built in opportunities to reinvest in the program and our members. We now have the ability to provide a more one-on-one experience based on a customer's wants, needs, and habits. We believe our customers can now see how we are reinvesting in the program and to date we have not experienced any meaningful pushback. As we look ahead, we plan to continue our focus on execution, specifically driving traffic, optimizing operations, selecting strong sites, and building great shops. We believe we are beginning to see the benefits of these efforts in Q1 as we deliver $23.9 million in adjusted EBITDA, a nearly 150% increase year-over-year. I want to publicly thank our franchisees and operators who are executing every day. It is their operational focus that underpins this positive outcome, particularly as it relates to our strong labor and SG&A leverage and its corresponding impact on profitability. We aim to keep our eye on the ball as we navigate the larger business environment on our path to a long-term goal of 4,000 shops. Now I'd like to turn the call over to Charley to review our financials.

Charley Jemley, CFO

Thanks, Joth. We just reported our seventh straight quarter of at least 30 shop openings. Our team's ability to embrace the challenges inherent with high growth and to operate an expanding portfolio of shops across multiple states with increasing profitability has been impressive. My comments around Q1 financial results center on our retail operations and how they drove excellent company shop profitability and then by extension our overall adjusted EBITDA was 150% higher than a year ago. In 2022, we absorbed significant margin impact from the effects of inflation. The teams were tasked with additional productivity objectives or asked to do so in a thoughtful way as to not risk our long-term sustainable growth. Even with some belt tightening, we continue to strategically invest in corporate capabilities and naval growth. As a reminder, we now have 438 company operated shops after having operated only 37 company shops at the beginning of 2018. Some quick highlights from the quarter; revenue of $197 million grew 30% compared to the same period in 2022. Adjusted EBITDA grew nearly 150% over Q1 last year to $23.9 million. Company shop sales grew 33% and company shop profit contribution grew 76%. Driving that profit lift was an increase in company operated shop contribution margin to 24.2%, or a 590 basis point improvement over the prior year. Recall that this contribution margin includes 190 basis points of pre-opening expenses. The key to this quarter and what bodes well as we move through our next phases of growth was our company operated shop margin expansion. Rather than walk down the P&L, let's start with the biggest driver; labor performance. Labor is an investment that is critical to delivering our goals around speed, quality, and service. Labor costs for 28% of company-operated shop revenue, improving 400 basis points from the same period last year. As a backdrop for this performance, recall that last quarter we announced an $8 million wage investment in states where the federal minimum wage is the standard. Further, we alerted you to an additional $11 million in incremental wage spending necessitated by legislative minimum wage increases. This aggregate $19 million in higher wages would be partially offset by the rollover from 2022's menu pricing actions. In Q1 2023, we enjoyed the full benefit of improved labor operating standards implemented in late 2022, when we began increasing productivity, optimizing schedules, and resetting standards. We believe this came together in Q1's P&L as retail operations delivered 400 basis points of labor improvement in spite of $3 million in incremental wage expense and what can be the negative effects of traffic deleverage. Cost of goods sold were 28.3% of company-operated shop revenue in Q1, up 90 basis points from the same period last year, as while inflation has slowed measurably, shop delivered costs remain elevated year over year. Pre-opening costs were 1.9% of company-operated shop revenue in Q1, down 270 basis points from the same period last year. Pre-opening costs are a function of the sequence of shops opening within a trade zone. The first shop within a trade zone requires our highest level of support, and as a result, we opened second and subsequent shops with lower levels of support. In Q1, we had a higher proportion of infill shops, which do not require as much support, driving down our pre-opening expense timing for the quarter. As the mix of first versus subsequent shops ebbs and flows each quarter, you'll see this expense be a function of that sequence. We managed to a full year number as we have to let the pipeline take on its natural sequence. In our franchising and another segment, gross profit improved to $16.9 million compared to $14.4 million in the same period last year. We executed a price increase on product sold to our franchisees in Q3 of 2022. This action was designed to shore our profitability in the segment, helping to offset input cost inflation and the goods we sell onward to our franchisees, including the high-quality coffee we proudly roast in our plant in Grants Pass, Oregon. Shifting now to SG&A for the quarter, SG&A was $46 million. This includes $9.2 million in stock-based compensation. Adjusted SG&A was $36.7 million and continues to decline as a percent of revenue to 18.6% for Q1 compared to 20.8% in Q1 last year. We are pleased with adjusted SG&A leverage in Q1 and we expect continued leverage going forward as an ongoing component of our investment thesis. Please make reference to the supplemental slides for a reconciliation between SG&A and adjusted SG&A. Now on to a few comments on the health of our balance sheet and liquidity. We finished Q1 with $235.9 million of net debt, that represents an increase of $45.2 million from Q4 directly tied to those record openings we reported. We have $247 million of undrawn liquidity on the present $500 million credit facility. We are committed to maintaining a well-capitalized balance sheet, remaining flexible, and being ready to take full advantage of the long growth runway ahead. Finally, we are affirming our full-year 2023 guidance. Total system shop openings are expected to be at least 150, of which at least 130 shops will be company operated; total revenue in the range of $950 million to $1 billion. Same shop sales growth is estimated to be in the low single digits. We are maintaining our adjusted EBITDA guidance of at least $125 million. Being just 90 days into our fiscal year, we believe it is too early to translate Q1's results towards any change in our view of the full year adjusted EBITDA. For example, despite the underlying improvements in company-operated shop margins, in the remainder of the year, we may see a moderation in the pre-opening favorability we experience in Q1. Furthermore, as noted, we will continue investing throughout the remainder of the year in initiatives designed to drive traffic. We look forward to updating you on our progress in early August when we'll share Q2 results. Capital expenditures are estimated to be in the range of $225 million to $250 million, which includes approximately $15 million to $20 million in spending in 2023 for a second roasting facility, which we project will open in 2024. Thank you. And now we will take your questions.

Operator, Operator

Our first question comes from Andy Barish with Jefferies. Please proceed.

Andy Barish, Analyst

Hey guys. Christine, welcome aboard. I figured I'd asked the first question of you just in your impressions in the first few months, back up in the Pacific Northwest, kind of what you see as the opportunities and the key areas, some of which you touched on today that you're focusing on for the rest of '23 and beyond.

Christine Barone, President

Absolutely. Thanks Andy. Nice to hear your voice. Excited to be here today and to be part of this team. I think, going in I'd heard a lot about the culture and that special sauce that we have here at Dutch Bros. And, I would say kind of walking into the company, it's even better than I thought it would be. And, spending a lot of time in our shops, meeting some of our Bros, going to some of our new shop openings, it's really just been awesome to see the energy that comes to life in our shops and how much fun people are having as we're making drinks for our customers. The same energy really translates into the headquarters and so, excited to be here with the team. As I look forward for the year, the priority is certainly in driving traffic and continuing some of the momentum that I spoke about earlier in driving transactions. One of the things I wanted to highlight is with a move that we made on the rewards program, which really took some of that discount out of the base discount, it's going to allow us to really use that rewards program in a different way and to focus on areas where we can drive transactions as we see things soften here and there and so excited about that move and that'll be a big area of concentration. We also, you know, are very pleased with the margins that we're seeing, so we'll be continuing to focus on our operational efficiencies and delivering those to the shops. So thanks, Andy.

Andy Barish, Analyst

Thanks Christine. Hey, Charlie, one quick question diving into the cost of goods sold line a little bit. I think it's the first time at least that I can remember where cost of goods sold as a percentage of sales was higher than labor, even with dairy costs down significantly and rolling over your changes on the freeze product, you talked about a little bit of pressure on delivered costs. Is that some lag going on and how should we kind of think about that in the current commodity environment going forward?

Joth Ricci, CEO

Andy, thanks for that question. So a couple of things there on the cost side in cost of goods sold, dairy is still up year-over-year. As we mentioned, there's a lag from when the price comes down in that commodity when it flows through our system. And then for us, coffee costs are up year-over-year, low to mid-single digits. The sea price was elevated many, many months ago, and that flows into our system. And then that rebalancing of cost of goods being higher than labor is more of the product of the labor leverage and efficiency we got, and less about the escalation and the cost of goods percentage.

Operator, Operator

The next question comes from Chris O'Cull with Stifel. Please proceed.

Chris O'Cull, Analyst

Yeah, good afternoon guys. Joth, you mentioned you exited the quarter with some comp sales momentum. So I'm just curious if it looks like transactions may have been down kind of in that high single-digit range in the first quarter, but what level of sequential improvement in transactions have you seen so far in the current quarter?

Joth Ricci, CEO

Well, we talk about momentum coming out of March. The Fill-a-Tray promotion happened on March 29. And we had days of sequential improvement coming out of that. We are not talking about April today. We're not going to get into Q2 and just kind of focus on Q1. We feel like overall, listen, we were lapping a tough Q1 of omicron from 2022. And I think what Christine did when she first came in was really look at traffic-driving opportunities through the balance of the quarter and we really weren't able to execute those until kind of mid to late March and really start to put good plans in place as we go forward. So, we're about flat on underlying traffic for Q1 versus Q4. So there was a steady rate there, and we'll kind of see how the balance of the year plays itself out here as we're building our new programs and using some of that investment that Christine discussed coming out of the rewards program and our ability to really dissect and go after market opportunities.

Chris O'Cull, Analyst

That's helpful. It doesn't sound like you're planning to take any additional pricing this year. So I guess, as pricing starts to roll off, presumably you're going to need to rely on that better traffic performance to hit that comp guidance. Are you seeing success with these programs that gives you confidence that you can see that type of improvement in the comp over the course of the rest of the year, especially in the back half?

Joth Ricci, CEO

No, I think everything Chris is currently in evaluation mode. We're testing some new programs and have run some new initiatives related to our rewards program. We've also assessed some local area marketing programs. We're continuing to evaluate what the latter half of the year might look like, and discussions about pricing are ongoing. Overall, we're happy with the momentum coming out of Q1, and we believe that the plans Christine and the team have implemented will be beneficial for the business, but only time will tell.

Operator, Operator

The next question comes from John Ivankoe with JPMorgan. Please proceed.

John Ivankoe, Analyst

Hi, the question is on new unit volumes, and I think I picked up in your remarks, Joth, that maybe some of the units started slower as they kind of ramp on their maturity curve and certainly, we picked up that in our numbers that the new unit volumes, at least on a system-wide basis, year over year, not a perfect calculation by any means, but looked a little bit lower. So, can you, I guess expand on that topic what you're seeing different types of markets? If you see anything that's really below your expectations or it's just like a series of units, know that are just going to take a couple of months or a couple of quarters to get up to their averages given you open so many in the quarter?

Joth Ricci, CEO

I believe the last part of your comment is very insightful. We've had some incredible openings, especially in Southern California, where we've seen some of the largest openings in our history. In the past 27 months, we've opened 112 new locations in Texas. Some of these were opportunistic opportunities, like 16 locations in just over a year in San Antonio, along with new shops in Houston and Dallas. There's a lot of infill happening that takes time to develop. The advantage we have at Dutch Bros is our 30 years of experience; we’ve seen markets like Las Vegas, Tucson, and Colorado Springs start off lower than average and build up over time. We're confident that having great margins allows us to invest for the long term, rather than just focusing on acquiring customers. We're dedicated to creating a great service experience for our customers. Each market will be unique, and we’re very pleased with the reception across all our markets, including our recent opening in Knoxville, Tennessee. The customer response has been fantastic, and we're excited to continue our growth.

John Ivankoe, Analyst

Okay, thank you for that. And secondly, if I may operationally, I have in our notes you were expected to move to a tap system at around 10 shops a month from March and every new store from July 1, correct me if those numbers aren't correct. What are you seeing in terms of the taps? Are you getting operational efficiency? You've seen a talk about the crew customer margin responses that system is still very, very new in your system?

Joth Ricci, CEO

Yeah, it's still very new. We launched the five taps in Texas since we had our last call, which was our March program, was to get those five tap systems in place. Our plan remains intact to launch, by the end of the second quarter, we'll have 30 locations executed and then we'll start to implement in new shops starting in the back end really in July. So it's too early for us to be counting on or touting any specific operational efficiencies, but we like the way the tests are going. Obviously, we like the plan that we have to execute the build-out, and I think hopefully on the next call we'll be in a position to really give some early indicators as far as what that looks like.

Operator, Operator

The next question comes from Andrew Charles with TD Cowen. Please proceed.

Andrew Charles, Analyst

Great, thanks. Joth, I have two questions. I'm just going to reiterate the sales guidance. Can you walk us through your thoughts on how this will progress through 2023, just given the different dynamics of lapsing amount of price with a rebound amount of traffic, and how you expect that to broadly manifest, within kind of the same-store sales cadence? And then just separately, just given that Q1 was a bit below our expectations, thinking that you guys were really positive for the quarter, when can we expect the shortfall to be made up from Q1?

Charley Jemley, CFO

So in terms of the progress through the quarter, first start with the pricing rollover. So in round terms, Q1 is eight, Q2 is six, Q3 is three, and then Q4 is flat for a full year of four, and then the traffic rollover gets a little bit easier as we move through the year. So that's how we would expect things to progress through the balance of the year. In terms of your question about Q1 being below on a comparable sales basis, that's for the most part anchored in the afternoon day part. It's not a product or a geography per se. It is that afternoon day part, which does have a tendency to be a bit more discretionary.

Operator, Operator

Thank you. That concludes today's teleconference and webcast. You may disconnect your line at this time and thank you for your participation.