Earnings Call Transcript - CBRL Q2 2023

Operator, Operator

Good day and welcome to the Cracker Barrel Fiscal 2023 Second Quarter Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Kaleb Johannes, Vice President, Investor Relations and Business Transformation. Please go ahead.

Kaleb Johannes, Vice President, Investor Relations and Business Transformation

Thank you. Good morning, and welcome to Cracker Barrel's second quarter fiscal 2023 conference call and webcast. This morning, we issued a press release announcing our second quarter results. In this press release and on the call, we'll refer to non-GAAP financial measures for the second quarter ended January 27, 2023. The non-GAAP financial measures are adjusted to exclude the non-cash amortization of the assets recognized from the gain on our sales and leaseback transactions and the related tax impacts. The company believes that excluding these items from the financial results provides investors with an enhanced understanding of the company's financial performance. This information is not intended to be considered in isolation or as a substitute for net income or earnings per share information prepared in accordance with GAAP. The last page of the press release includes reconciliations from the non-GAAP information to the GAAP financials. On the call with me this morning are Cracker Barrel's President and CEO, Sandy Cochran; Senior Vice President and CFO, Craig Pommells and Senior Vice President and CMO, Jen Tate. Sandy and Craig will provide a review of the business, financials, and outlook. We will then open up the call for questions for Sandy, Craig, and Jen. On this call, statements may be made by management of their beliefs and expectations regarding the company's future operating results or expected future events. These are known as forward-looking statements, which involve risks and uncertainties that, in many cases, are beyond management's control or may cause actual results to differ materially from expectations. We caution our listeners and readers in considering forward-looking statements and information. Many of the factors that could affect results are summarized in the cautionary description of risks and uncertainties found at the end of the press release and are described in detail in our reports that we filed with or furnished to the SEC. Finally, the information shared on the call is valid as of today's date and the company undertakes no obligation to update it, except as may be required under applicable law. I'll now turn the call over to Cracker Barrel's President and CEO, Sandy Cochran. Sandy?

Sandy Cochran, President and CEO

Thank you, and good morning, everyone. This morning, we announced total sales growth of 8.3% and adjusted operating income margin rate of 4.5%. These results exceeded our expectations, and I was especially pleased with our continued strong retail and off-premise performance. I believe our results underscore the appeal of our brand, menu offerings, and merchandise as well as the traction from our initiatives. While we continue to face macroeconomic headwinds and heightened uncertainty, we are making great progress on key initiatives and I believe we're well positioned to sustain our momentum and deliver further margin improvements in the back half of the year, driven by Q4. I'd now like to speak to some highlights from our second quarter. As you know, our second quarter is of outsized importance to us due to the Thanksgiving and Christmas holidays. And our teams once again executed at a high level and bolstered our leadership for these occasions, particularly in our off-premise channels. We again saw significant demand for our bundled holiday offerings, meaningfully grew our catering business and offered seasonal culinary promotions, including Country Fried Turkey and Cinnamon Roll Pie that continue to resonate with guests as did the other menu items we introduced such as our new sampler offerings. We saw and are continuing to see our catering channel do well, driven by enhancements we've made to our offerings and our optimized marketing support and we're on track to achieve our target of growing this channel by 25% to $100 million this fiscal year. Our retail teams continued their streak of delivering strong results, which was especially impressive in light of the challenged retail backdrop and the performance we were lapping in the prior year. Guests responded enthusiastically to our holiday assortments, particularly our nostalgic blow molds, glitter globes, and holiday trim. Our retail margins, while below last year's historically high levels, were in line with our expectations. From an operations standpoint, we remain focused on hospitality and the guest experience. We believe our staffing levels are solid, and we've seen improvements in both hourly and manager turnover. We're encouraged by the test results of our labor system, and we recently implemented it in over 150 stores, bringing the total to approximately 300 and we are planning to complete the rollout to the substantial majority of the system by the end of the fiscal year. We believe this new system will enhance both the guest and employee experience while also delivering productivity improvements. From a guest visitation perspective, we again saw gains with the lower income guests as we believe our strong value proposition continues to appeal to this group who remain pressured by the macroeconomic environment. We saw a moderate improvement in year-over-year visitation from guests 65 and over, which was in part due to lapping Omicron and visitation among younger guests was relatively flat compared to the prior year. Lastly, Maple Street opened two locations during the quarter, both of which were in new markets, Columbus, Ohio and Houston, Texas, and we're encouraged by the performance of these new locations. The team continues to prepare for successfully scaling and we're looking forward to accelerating their growth in the back half of the fiscal year and beyond. Craig will now cover our second quarter results in greater detail and provide an update on our expectations for the fiscal year.

Craig Pommells, Senior Vice President and CFO

Thank you, Sandy, and good morning, everyone. For the second quarter, we delivered top line results that surpassed our expectations for both restaurant and retail. Total revenue was $933.9 million, an increase of 8.3% over the prior year quarter. From a monthly cadence, our performance in November and December was generally in line with our expectations. And January outperformed as we benefited from a larger-than-anticipated benefit from lapping Omicron as well as favorable weather during the month. Restaurant revenue increased 9.4% to $718 million, and Retail revenue increased 4.7% to $215.9 million versus the prior year quarter. Comparable store total sales, including both restaurant and retail, grew by 7.4%. Comparable store restaurant sales grew by 8.4% over the prior year, driven primarily by approximately 9% traffic, roughly half of which was carried forward pricing from fiscal 2022 and half of which was new pricing. Traffic declined 1.7%, which was in line with industry trends. We continue to closely monitor the impact of our pricing on traffic and check, and we remain pleased that we have not seen any meaningful pushback from our guests in this regard. We also saw favorable menu mix of over 1%, driven by increased sales for our shareable Barrel Bites and beverages. Off-premise sales were approximately 23% of restaurant sales. As a reminder, off-premise mix is elevated during the second quarter due to the seasonally high sales for our bundled holiday offerings and catering business. Comparable store retail sales increased 4.1% compared to the second quarter of the prior year. Apparel, decor, and food delivered the largest increases by category. Moving on to our second quarter expenses. Total cost of goods sold in the quarter was 35% of total revenue versus 32.9% in the prior year quarter. Restaurant cost of goods sold in the second quarter was 29.3% of restaurant sales versus 27.4% in the prior year quarter. This 190 basis point increase was primarily driven by commodity inflation of 12.5% partially offset by pricing and, to a lesser extent, by a change in the mix of menu items as well as higher freight. We experienced inflation across most of our market basket where the primary drivers of the year-over-year increase in Q2 were poultry, dairy, and produce. Second quarter retail cost of goods sold was in line with our expectations at 54% of retail sales versus 50.4% in the prior quarter, which, as a reminder, was an atypically low COGS rate. This 360 basis point increase was primarily driven by a more normalized promotional activity, although our markdown rates remained favorable when compared to historical levels. Our inventories at quarter-end were $187 million compared to $154 million in the prior year. The increase was primarily due to carrying more retail product to support higher sales, and to a lesser extent, a normalization in the timing of deliveries. With regard to labor costs, our second quarter labor and related expenses were 33.6% of revenue versus 34.4% in the prior year quarter. This 80 basis point decrease was primarily driven by sales leverage, partially offset by hourly restaurant wage inflation of 7%. Adjusted other operating expenses were 22% of revenue versus 21.9% in the prior year quarter. This 10 basis point increase was primarily driven by higher maintenance, utilities, and supplies expense resulting from inflation, partially offset by lower depreciation and advertising expense resulting from sales leverage. Finally, our general and administrative expenses in the second quarter were 4.8% of revenue versus 5% in the prior year quarter. This 20 basis point decrease primarily resulted from sales leverage. All of this culminated in GAAP operating income of $39 million. Adjusted for the non-cash amortization of the asset recognized from the gains on the sale and leaseback transactions, operating income for the quarter was $42.2 million or 4.5% of revenue. Net interest expense for the quarter was $4.4 million compared to net interest expense of $2.2 million in the prior year quarter. This increase is the result of higher interest rates and a higher level of borrowing. Our GAAP effective tax rate for the second quarter was 11.8%. Second quarter GAAP earnings per diluted share were $1.37 and adjusted earnings per diluted share were $1.48. In the second quarter, EBITDA was $67.7 million or 7.3% of total revenue. Now turning to capital allocation and our balance sheet. We remain committed to a balanced approach to our capital allocation. Our first priority remains investment in the growth of Cracker Barrel and Maple Street. Beyond that, we plan to return capital to our shareholders while maintaining appropriate flexibility and a conservative balance sheet. In the second quarter, we invested $27 million in capital expenditures and we returned $34 million to shareholders in the second quarter through a combination of dividends and share repurchases. Lastly, we ended the quarter with $454 million in total debt. With respect to our 2023 outlook, I would like to provide some additional color on the guidance in this morning's release. We are pleased with our Q2 results, and we're confident we will sustain our momentum in the second half of the year. That said, I want to remind everyone, we continue to operate in an environment with heightened uncertainty that makes predicting the balance of the year even more challenging than normal. Turning to the guidance. We currently expect total fiscal 2023 revenue growth over the prior year of 7% to 9%. This is primarily driven by pricing, which we now anticipate will be approximately 8.5% for the full year. As previously mentioned, we remain prudent and thoughtful in our approach to pricing and continue to utilize multiple approaches to monitor guest reactions to price increases. We anticipate the opening of three to four new Cracker Barrel locations and approximately 15 new Maple Street locations. Our updated expectations from Maple Street reflect the possibility that some units that were planned to open late in fiscal '23 may slip into early fiscal '24, primarily as a result of construction delays. We now anticipate commodity inflation of approximately 8.5% to 9% for the fiscal year. This assumes mid-single-digit inflation in Q3 and low single-digit inflation in Q4. Our current outlook for commodity inflation reflects updated expectations for Q4. While we now expect lower inflation in some protein categories compared to our previous outlook, this favorability is being more than offset by higher anticipated inflation in eggs and produce. We now expect restaurant-only inflation of 6.5% for the fiscal year. The labor market for restaurants and hospitality remains relatively tight, which has resulted in a slower than anticipated moderation of wage inflation. We now expect to deliver approximately $25 million in cost savings during this fiscal year. In addition to the above assumptions for revenue growth, commodity and wage inflation and cost savings, our operating income margin expectation continues to contemplate the following assumptions: continued inflationary pressures in other areas of the P&L, most notably supplies, utilities, and maintenance, moderation in retail margin compared to the prior year near historic high and incentive compensation normalization, which will have a meaningful impact on G&A in Q3 and Q4. Taking all of this into account, we expect full year adjusted operating income margin in the high 4% range, including 4.3% to 4.7% in Q3 and 6.5% to 7% in Q4. We also believe there is upside in our operating income expectation if there were to be further moderation in the commodity environment and potential downside if there were to be a deterioration of the consumer environment or if inflation fails to moderate or further increases. Lastly, we expect a GAAP effective tax rate of 10% to 12% and an adjusted effective tax rate of 11% to 13%. And we anticipate that capital expenditures for the full year will be approximately $110 million to $120 million.

Sandy Cochran, President and CEO

As Craig outlined, while we continue to operate in an uncertain environment and face some headwinds, our outlook is optimistic. Despite this backdrop, we're confident that we'll deliver further margin improvements in the back half of the year, primarily driven by margin gains in Q4. I'd now like to speak to some Q3 highlights. I'm excited about several menu initiatives that we believe will further reinforce our value leadership, which we think is critical in the current environment while also introducing new craveable offerings. Our current menu promotion and advertising campaign is focused on value and variety, reminding guests that we have over 20 meals for under $12, including several hearty signature favorites. Additionally, we've recently introduced new $5 take home offerings. With the purchase of any entree, guests have the choice to add one of three additional entrees, which includes a protein inside for just $5. It's early, but we've been encouraged by what we've seen so far and believe this is yet another way we can provide value to and build affinity with our guests. We remain thoughtful and deliberate on how we're taking pricing, and we're being mindful to maintain the value sections of our menu and attractive entry price points. We continue to closely monitor the effects of our pricing actions and believe our strategy is appropriately balancing, protecting margins while also preserving our value strength. In addition to focusing on value, we continue to enhance our menu, currently featuring a new Cheesy Bacon Homestyle Chicken, which is part of the 20 under $12. And we're also seeing success with recent innovation in the Breakfast daypart with offerings such as our Homestyle Chicken and French Toast. Both of these offerings are examples of how we continue to leverage our signature fried chicken and innovate our menu. For off-premise, we're looking forward to the Easter occasion and expect we'll see strong demand for our Easter bundled offerings. We're continuing to enhance our catering menu as well. Regarding retail, we believe the strong value and uniqueness of our merchandise will continue to have cross-generational appeal. Our Easter assortments are off to a good start, and we're excited about other seasonal assortments that we believe will also resonate with guests. In closing, we had a solid quarter. We delivered quarterly results that exceeded our expectations. Our initiatives are gaining traction and we're making progress on our margin recovery. We remain confident in our strategies and believe we're well positioned to drive continued performance through our strategic initiatives and our focus on operational excellence, menu innovation, value, technology, and the guest experience. Finally, I want to thank our employees for their strong efforts and continued dedication. And with that, I'll turn the call over to the operator for your questions.

Operator, Operator

The first question comes from Jeff Farmer with Gordon Haskett. Please go ahead.

Jeff Farmer, Analyst

Hi, thank you and good morning. You mentioned that you are aiming for $25 million in cost savings and improvements to your business model. I would like to know what contributed to the increase in your guidance regarding flow-through. How much of that increase do you anticipate will be realized versus what will be reinvested?

Craig Pommells, Senior Vice President and CFO

Good morning, Jeff, this is Craig. The increase in the guidance is due to our continued addition of projects to our cost-saving list. When addressing inflation, there is clearly a price component. We are always searching for ways to enhance business efficiency, and that is an ongoing effort. As more projects transition from idea to a high level of confidence in their successful implementation, we have raised our expected cost savings. The distribution of these savings is significantly skewed towards the second half of the year compared to the first half. That said, I want to emphasize that some of these cost savings are being utilized to help offset inflation in terms of commodities and wages. We have a total cost savings figure, with part of it being invested to support various technology initiatives, while another portion is aimed at alleviating cost increases in areas such as maintenance and commodities.

Jeff Farmer, Analyst

Okay. But it sounds like you're probably not going to be a little bit more specific than that. So if it's $25 million gross, is half of it being reinvested? Or is there some sort of market level you can provide for us?

Craig Pommells, Senior Vice President and CFO

Yes. The inflation numbers we've shared already account for the cost savings. If I were to quantify how much is actually being realized, there could be some double counting since we've included it in some of our other guidance figures.

Jeff Farmer, Analyst

Okay. And then just one more quick one. I apologize if I missed this, but just in terms of February trends, sort of moving through the Omicron favorability, anything you guys offered. Again, I apologize if I missed it on February trends, anything you can offer there?

Craig Pommells, Senior Vice President and CFO

So clearly, January on a year-over-year basis was a big positive in large part because of Omicron, but also weather was quite favorable. And February has been much more consistent with our overall expectations. So clearly, a moderation from January, but that was an unusual time period and February is in line with expectations.

Operator, Operator

Our next question comes from Todd Brooks with The Benchmark Company. Please go ahead.

Todd Brooks, Analyst

Hi, thanks for taking my questions. Appreciate it. First, if I can explore dine-in performance. Sandy, you talked about the buckets of strength at holiday being off-premise, being catering, but what are we seeing as far as dine-in performance either if you want to compare traffic levels to pre-pandemic or compare sequentially to what you were seeing in fiscal Q1? That would be helpful.

Craig Pommells, Senior Vice President and CFO

Hi. Good morning, Todd, this is Craig. I'll start us off. On a one-year basis, look, the consumer has shifted in a lot of ways. Okay? So on a one-year basis, we have continued to see some improvements in dine-in. Dine-in is clearly still down versus pre-COVID. Yes, so I think those are the highlights. Dine-in is growing certainly within sales and also traffic. Relative to pre-COVID, we're still down, but we've seen tremendous gains in off-premise or individual to-go third party and catering has been a particularly strong bright spot that we have made a focus area that's also driving our off-premise business.

Todd Brooks, Analyst

Okay. Craig, just a follow-up there. Can you share how much of that $25 million in growth in catering is already kind of in the bar now that we're through the important holiday season?

Jennifer Tate, Senior Vice President and CMO

Can I take that?

Craig Pommells, Senior Vice President and CFO

Sure, Jen. I'll turn it over to Jennifer for that one.

Jennifer Tate, Senior Vice President and CMO

Yes. I think what we would say is that Q2 exceeded our expectations in terms of off-premise. We were up 40% year-over-year in terms of catering. So we felt really, really good about the progress we made in the second quarter in catering. And that's also true in terms of our third-party delivering. We had a solid quarter there as well. So we definitely feel like we are well on track to hit that goal that we set out for the year.

Sandy Cochran, President and CEO

And Q2 is our strongest. With respect to catering, Q2 is the biggest quarter.

Todd Brooks, Analyst

Great. I'll jump back in queue for the final question. Regarding the pricing strategy, I understand that coming out of last quarter, you were aiming for an 8% increase in menu prices. It seems that the full year target has now risen by an additional 50 basis points. Can we discuss the potential for further increases, especially in light of a moderating outlook for commodities? Additionally, how does the price roll-off play into this? I believe you mentioned that about half of the current increase took place during the quarter. Will we maintain a consistent increase of 8.5% for the rest of the year, or will it vary now that we have different roll-off timings?

Craig Pommells, Senior Vice President and CFO

It's Todd. The pricing has increased by 8.5% over the year. For the second quarter, approximately half of that is due to the rollover from the previous year, while the other half comes from the pricing actions we've implemented in this fiscal year. For the latter half of the year, we expect the cumulative pricing level, including the rollover from last year and this year's pricing, to stay in the high 8% range. Mathematically, as the year progresses, a smaller portion of this price increase will be due to actions taken in the prior year. However, we will still see benefits from pricing actions taken in the first quarter, leading us to anticipate an upper 8% range for the third and fourth quarters.

Operator, Operator

Our next question comes from Alton Stump with Loop Capital. Please go ahead.

Alton Stump, Analyst

Great. Thank you and good morning. Thanks for taking my questions as always. I just want to ask about the competitive environment. There's obviously been a lot of news flow. This time of the year certainly is typically more promotional anyway but even more so with consumers with the concern about a recession or et cetera. What do you see competitively? Is it worse than usually at this time of the year? Or do you think it's in par with what you had thought heading into the first half of the calendar year?

Sandy Cochran, President and CEO

Alton, I'll begin and then Jen can finish up. In Q3, we have focused on highlighting the value of our menu items, specifically our 20 options priced under $12 and our new $5 take-home offering. Our marketing efforts will primarily emphasize these values because we believe they are crucial. I think our competitors would concur, given their advertising strategies. We're noticing an increase in their promotions, suggesting they are also working to highlight value on their menus. This situation is similar to what we experienced in 2009 and 2010 when the industry was recovering from an economic downturn and consumers were facing challenges. Therefore, I expect this trend to persist, if not increase.

Jennifer Tate, Senior Vice President and CMO

Yes, I think Sandy said it really well. We're definitely seeing an increase in the number of price pointed, discounted promotional messaging, especially with some of our big competitors. But what we're really focused on is talking about the fact that we just have so many items on our menu that are price pointed well from $8.99, $9.99, and $10.99. We have over 20 things, 20 meals that are under $12. And so we start very soon promoting all of that across all channels of our media mix, just to drive home the point that whatever day part you come in, there are familiar favorites, but also new enticing innovations that are under $12. So we'll be focusing on that strong everyday value and promoting that for the balance of the year as well as that new platform of $5 take homes, which we think will really give people added value, an extra reason to make a visit to Cracker Barrel. We've seen really strong response so far on that. So I do think the competitive environment is heating up, but our intention is to continue to double down even more strongly on the great value we have on our menu.

Sandy Cochran, President and CEO

I'm going to add to that a little, Jen, just because while we're pleased with everything, Jen just said about value, we do continue to be pleased with the work we're doing on the check building initiatives that we have: our beverage attachments, our premium size, our Barrel Bites and those things. So we're watching all of that, especially with the price increases we're taking to be sure that for those guests who either are looking for something maybe more indulgent or can afford that those items are on the menu, and we're seeing that they are still choosing them. But for those guests that are looking for value, I think our investment over the last few years in ensuring the value is still there and now the marketing around it will be helpful.

Operator, Operator

Our next question comes from Katherine Griffin with Bank of America.

Katherine Griffin, Analyst

Hi, thank you. I wanted to ask about the fourth quarter commodities outlook. I think that went from expectations of deflationary to low single-digit inflation. So I was just wondering kind of how you could rank order what the main drivers of that were.

Craig Pommells, Senior Vice President and CFO

Yes. The main contributors will be eggs and produce. From a spot market perspective, egg prices increased significantly before moderating. Compared to our contracts and formula prices, we are in a better position with eggs. Despite the moderation in the spot market, we anticipate that egg prices will exceed our previous projections for Q4, and the same applies to produce. The positive aspect is that we are observing solid developments that align with our expectations in most other proteins.

Katherine Griffin, Analyst

Okay, understood. Regarding the outlook for the Maple Street unit, I was curious about the construction challenges you've mentioned. Can you provide more details on that? Are you referring to supply chain issues, labor shortages, or permitting delays? What exactly do you mean by construction challenges?

Sandy Cochran, President and CEO

There are various challenges in different areas. In some instances, the issue is related to permitting. Certain communities lack the workforce needed, which prolongs the process. Additionally, there are times when we cannot obtain the necessary equipment or labor for construction. Each of these areas likely faces at least one challenge.

Katherine Griffin, Analyst

And it's less so a problem for the Cracker Barrel stores?

Sandy Cochran, President and CEO

It's less of one because we have fewer stores. But on each of the ones we have, it is a problem. We actually are delayed on one of our new units because it couldn't pour the footings because of both weather and labor. So this is likely to be a problem for a little while longer, while the supply chain problems and the labor issues continue to work their way through the system.

Katherine Griffin, Analyst

Got it. Okay. Thank you. I'll hop back in the queue.

Operator, Operator

Our next question comes from Jake Bartlett with Truist Securities. Please go ahead.

Jake Bartlett, Analyst

Thanks for taking the question. My first inquiry is about the revenue guidance, which still shows a very wide range for the year, particularly for the second half. My calculations suggest that the revenue growth in the back half might be between just over 6% and just over 10%. Craig and Sandy have mentioned that the volatility in results contributes to the caution regarding this wide range. However, it seems that the volatility we’ve experienced so far has been positive, especially with the strong performance in January. What are the indicators that give you concern about demand, leading you to maintain such a broad range, even with the first half of the year already accounted for?

Craig Pommells, Senior Vice President and CFO

Good morning, Jake. You mentioned that the underlying environment is significantly more volatile than usual. This volatility suggests to us a broader range of outcomes. Our experience so far this fiscal year has aligned with our expectations, but the journey from point A to B has had more fluctuations than normal, as we noted in January. Looking ahead to the second half of the year, there are assumptions in place that, if they develop positively, could result in us reaching the high end of our range. Conversely, if they do not pan out, we could find ourselves at the low end of the range or facing additional risks. For instance, in the second half of the year, we will be comparing against the effects of the Ukraine war, which specifically affected gas prices and, subsequently, how people travel and their activities during trips. We also observed a significant decline in sentiment among our guests over 65, which has negatively influenced their perception of their financial future. Our guidance reflects an expectation to compare favorably against that situation, anticipating a positive impact. However, if other negative factors arise that counterbalance this, it would adversely affect us.

Jake Bartlett, Analyst

Got it. Got it. Okay. And then I wanted to dig in a little bit more on the commodity and the COGS new guidance. If you can tell us what you have contracted at this point? I think the last time you spoke, it was roughly 45%, but if you could just give us an idea of what's contracted. And then also what we should look out for. So of the exposure out there, what are you most sensitive to in the back that you don't have contracted for that we can really monitor and see whether you're kind of on track to hit that guidance?

Craig Pommells, Senior Vice President and CFO

In the latter half of the year, we are operating with approximately 10% less coverage compared to the same period last year. This is due to the fact that while spot market prices are decreasing, they are still significantly high compared to contracted prices. Consequently, we have found it unwise to secure contracts to the extent we typically would. This situation applies across various segments of our market basket. Although we have less coverage than usual, the reason is that while the spot market is declining, it remains elevated, and suppliers are hesitant to provide the usual level of coverage at traditional premiums. While this dynamic is evolving, it has not fully changed yet. We maintain a diverse market basket, and the exposure to market fluctuations is higher than it has been across most of those areas. We do have some coverage, but it is lower than normal, and we also have some formula prices that carry exposure, making the situation somewhat complex. There is more exposure than usual, but the overall conditions in the commodities market are beginning to look more promising.

Jake Bartlett, Analyst

Great. I appreciate it. Thank you.

Operator, Operator

Our next question comes from Andrew Wolf with CL King. Please go ahead.

Andrew Wolf, Analyst

Thank you. Good morning. I wanted to start by asking about the labor system you mentioned, which is now being rolled out to about half the chain. Can you provide an update on its performance in relation to the milestones achieved and the key performance indicators you've set? I understand that it involves aligning work with guest traffic. Is this ultimately a labor productivity metric that you can share or that we can deduce on our own?

Sandy Cochran, President and CEO

Yes. Good morning, Andrew, so let me start that. First of all, we've got our new, we call it here PCM labor. In about 300 stores now, just ruled about the last 150, and we are continued to be pleased with the results. As you said, the system does a variety of things, but it primarily helps matching the specific labor that a store needs with the sales they anticipate sort of by category. So catering sales have different labor demands than dine-in, which is different than individual off-premise, and it helps the stores match labor to the specific time of day and type of business that they're trying to do, gives them better visibility to their sales, it just allows them to better match. It also has a benefit for the employee experience. The system is cloud-based and comes with an app. So employees are able to access the system and do a variety of things that helps them. So it has this benefit to the employee experience. I think in general, we believe it will allow us to better manage our labor. I would imagine it will help us improve productivity, but I don't anticipate, Craig, giving specific guest per labor hour productivity metrics on that one component. There's a lot of other things in our labor line, management labor over a whole lot of other components that roll up to the guidance.

Craig Pommells, Senior Vice President and CFO

Yes, I think, Andrew, in the $25 million cost save, we've got, I think it's about 40% coming out of cost of sales, and I think we've got about 40% coming out of labor. And this is a component of that labor component.

Andrew Wolf, Analyst

Thank you for that information. The other question I wanted to ask is if I understood correctly, the younger demographic's visits or sales were approximately flat year-over-year, and I know that increasing their engagement is a strategic goal. Can you share if this is due to seasonality, such as an uptick in sales of catering-related items during Thanksgiving and Christmas? Or do you believe that some of the marketing or product initiatives are currently in a phase where they require adjustments, such as the loyalty program? Is this primarily a timing issue?

Jennifer Tate, Senior Vice President and CMO

Jen mentioned that in Q2, the younger cohorts remained stable. However, over the past several quarters, there has been a steady, modest improvement among these younger groups. This quarter did not show gains, but there was some modest improvement with older guests. It's unclear if this is due to seasonal factors or if the return of older guests is related to the conclusion of the Omicron wave. There is optimism about many older guests returning, although it's difficult to predict how many will continue coming back. The company has been actively working to diversify its guest base and is satisfied with the increased visitation frequency among younger guests, even though Q2 was not particularly impactful for them. Looking ahead, there are plans to attract more younger customers, including the launch of a new loyalty rewards program by year-end.

Andrew Wolf, Analyst

So you remain on track to launch the program in your fiscal fourth quarter, the loyalty program?

Jennifer Tate, Senior Vice President and CMO

We are working very hard to meet that timing, and we certainly do intend to launch in the fourth quarter.

Operator, Operator

Our next question comes from Jon Tower with Citibank. Please go ahead. Jon, your line might be on mute. We're going to get to the next questioner, Todd Brooks with the Benchmark Company. Please go ahead.

Todd Brooks, Analyst

Hi, thanks. Just a couple of quick follow-ups here. On an earlier question, you were talking about Maple Street and construction frictions. And I just want to start to look out to the forward year. If this is a 15 unit type of year and you're building a pipeline of sites, a pipeline of talent and then taking the frictions into account, which hopefully will ease going into fiscal '24 for you. What's a reasonable growth expectation? If you open 15 next year, you think you can open 20 in the out year? Or how should we start to frame that up?

Craig Pommells, Senior Vice President and CFO

Todd, it's Craig. At this time, it's still early enough in the planning process that we're not prepared to share any of our fiscal '24 openings as yet.

Todd Brooks, Analyst

Okay. Fair enough. And then my second follow-up is on the retail gross margins. I know we talked in the quarter that just ended about a normalization in kind of markdown rates, and we saw that in the gross margin. When I look at Q3, because we've been so clean the past couple of years from an inventory standpoint, we've seen kind of retail gross margins in that 47% range. But I think historically, in a normalized environment, even more in the mid-48% to 49% range. So just wondering how clean are the inventories? Do the markdowns carry over into this quarter? And should we think about that old historical kind of 48% to 49% range? Or is there a shot to do the 47% again? Thanks.

Sandy Cochran, President and CEO

I will begin by discussing the inventory and then hand it over to Craig for details on retail guidance. The inventories are in excellent shape. Our retail teams effectively managed our seasonal inventories, which the consumers really appreciated. We entered the season with strong sales, and as we progressed, they successfully handled the markdowns, allowing us to clear much of our inventory at higher prices than expected, especially considering the significant storm over the Christmas weekend. I'm optimistic about our current inventory levels. Regarding margin expectations for the quarter, we anticipate returning to a more normalized level moving forward, which will not reach last year's performance but will be better than 2019.

Craig Pommells, Senior Vice President and CFO

Exactly. That's absolutely correct. The retail business is performing exceptionally well and is on track. We are very satisfied, and the margin approach is returning to normal. During last year's third quarter, our margins were still below normal levels, but by the fourth quarter, we were much closer to where we aim to be. Looking ahead, I would say we're approaching our traditional margins from before the pandemic.

Operator, Operator

Our next question comes from Katherine Griffin with Bank of America.

Katherine Griffin, Analyst

Hi, thank you. I wanted to ask about a little bit more on off-premise. So I think with that coming in a little stronger than expected, maybe reflecting some sort of structurally stronger demand. I'm just wondering if you could talk more about any of the changes you made in the restaurants either with respect to technology or adopting the physical layout in order to fulfill that demand?

Sandy Cochran, President and CEO

I'll turn it over to Jen for more specifics. The second quarter is typically a strong off-premise quarter for us, with opportunities in celebration meals, catering, and individual to-go orders. Our teams excelled in each area. Our operations teams focused on enhancing the guest experience with off-premise and improving accuracy, especially during Thanksgiving and Christmas. A significant portion of this business is managed at our back door, and it was handled effectively. We invested more in marketing our catering services, and our catering sales managers did an excellent job promoting our offerings to various businesses as the holidays approached. Overall, a lot of hard work from many teams contributed to these results. Jen, do you want to add anything?

Jennifer Tate, Senior Vice President and CMO

Well, that was pretty good. Yes, I would just say our off-premise business is composed of 40% individual to go pick up, 40% third-party delivery, and then 20% like catering and Heat n' Serve. During this quarter, the two strongest parts of the off-premise business were indeed the third-party delivery and then our catering and Heat n' Serve. And I would say that big drivers of that were marketing efforts in terms of third-party and catering and improving accuracy, which has really helped delivery and getting fully staffed with those catering sales managers because we saw strong growth in the B2B sales there, expanding that delivery network for catering so that all of our stores in our whole system can deliver catering. That was really important. And we are doubling down on marketing because we do have such a strong platform with catering and third party. So we plan to continue that the balance of the year.

Sandy Cochran, President and CEO

We also did launch and improve our digital app.

Jennifer Tate, Senior Vice President and CMO

Yes, we have a native app that has performed very well, and our app ratings are impressive. The latest rating I saw in the Apple Store was 4.8, which marks a significant improvement. We're witnessing considerable customer adoption and increased usage for placing orders.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference over to Sandra Cochran for any closing remarks.

Sandy Cochran, President and CEO

Well, thank you for joining us today. We appreciate the interest. I'm pleased with our Q2 results. Believe our strategy and execution will sustain our momentum and drive continued performance improvements in the second half of the fiscal year.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.