Earnings Call Transcript - SG Q2 2023

Operator, Operator

Good day, everyone, and welcome to the Sweetgreen Second Quarter 2023 Earnings Call. Today's call is being recorded, and all lines have been muted to avoid background noise. Following the speakers' remarks, we will have a question-and-answer session. I would now like to turn the conference over to Rebecca Nounou, Head of Investor Relations. Please go ahead.

Rebecca Nounou, Head of Investor Relations

Thank you, and good afternoon, everyone. Here with me today are Jonathan Neman, Co-Founder and Chief Executive Officer; and Mitch Reback, Chief Financial Officer. Before we begin, we have a couple of reminders. Our earnings release is available on our website at investor.sweetgreen.com. During this call, we will be making comments of a forward-looking nature. Actual results may differ materially from those expressed or implied as a result of various risks and uncertainties. For more information about some of these risks, please review the company's SEC filings, including the section titled 'Risk Factors' in our latest Annual Report on Form 10-K filing and subsequently filed quarterly report on Form 10-Q. These forward-looking statements are based on information as of today, and we assume no obligation to publicly update or revise our forward-looking statements. Additionally, we will be discussing certain non-GAAP financial measures, which are in addition to and not a substitute for measures of financial performance prepared in accordance with GAAP. A reconciliation of these items to the nearest U.S. GAAP measure can be found in this afternoon's press release available on our IR website. With that, it's my pleasure to turn the call over to Jonathan to kick things off.

Jonathan Neman, Co-Founder and Chief Executive Officer

Thank you, Rebecca, and good afternoon, everyone. I've shared before that I believe times like these create opportunities for companies with great brands, large addressable markets and loyal customers. Great businesses need to balance growth and profitability. In the second quarter, we put our words into action generating 22% year-over-year revenue growth, delivering a restaurant level profit margin of 20.4% and adjusted EBITDA of $3.3 million. This is our first quarter of positive adjusted EBITDA as a public company. This milestone demonstrates our commitment to disciplined capital-efficient growth. I want to extend my gratitude to every Sweetgreen team member for their hard work and dedication in delivering these results. We reported second quarter revenue of $152.5 million, representing 22% year-over-year growth and same-store sales growth of 3%. Our same-store sales growth was driven by an increase in price and traffic, with a partial offset from mix. Total digital sales represented 59% of our Q2 revenue, with approximately two-thirds of those sales coming from our own digital channels. We continue to work every day to improve our operations. The restaurant level margin of 20.4% in the second quarter was the result of strong operational execution and our cross-functional focus to identify a wide range of process optimizations. This includes better labor deployment as well as improvements in supply chain sourcing, which we see continuing into future quarters. We remain committed to identifying additional opportunities to enhance our restaurant margins. We balanced strong revenue growth and restaurant level profit performance with a focus on cost discipline that yielded a reduction in both absolute and relative G&A expenses when compared to the prior year. Our second quarter G&A expense of $40.4 million is down $11.4 million or 22% from the $51.8 million a year ago. We continue to gain operating leverage as we sharpen our allocation framework to increase the flow-through of each incremental dollar of revenue we generate. As we have discussed in the past, we operate with four strategic priorities, which are the basis for driving strong top-line growth, customer acquisition and loyalty, and profitability. Our strategic priorities are: one, expand and evolve our footprint in new and existing markets to connect more communities to real food; two, build our brand and digital experience as the industry leader allowing us to add new customer channels, drive frequency, and increase restaurant volume and margins; three, reinforce our commitment to craveability and inspire consumers to live healthier lives through reimagined fast food; four, run great restaurants with a people-first culture focused on developing talent for our future growth. Now let me provide an update on each of these priorities. In the second quarter, we opened 10 new restaurants, ending the quarter with a total of 205 restaurants. During the quarter, we opened our first restaurants in Cranston, Rhode Island and San Antonio, Texas. Since the quarter ended, we've opened an additional seven restaurants, including our first restaurants in Milwaukee and Orange County. While it's early, we are pleased with the class of 2023 openings. Sweetgreen has always been a significant innovator in the industry, and the launch of our first automated production line, we call the Sweetgreen Infinite Kitchen, is the latest example. Since launching on May 10, in Naperville, Illinois, we've been pleased with the performance of the restaurant and how it's enhanced the Sweetgreen experience. We've seen a more consistent customer experience and faster throughput, all while making our team members' jobs easier and more dynamic. June represented the first full month of operation. While early, the Infinite Kitchen has demonstrated several significant benefits to our operating model. First, we saw significantly faster throughput. Today, the Sweetgreen Infinite Kitchen has the capability to produce between 400 and 500 bowls, which is about 50% more than what a restaurant's front and digital make line can typically produce combined. Second, our customers tell us it's a better in-store experience. Customers know when they order their meal, they will get it in under five minutes with consistent portioning and accuracy. We believe that this speed of service and consistency is contributing to the Infinite Kitchen's overperformance on both the top and bottom line. Another benefit of faster throughput is noticeably less congestion in the restaurant, allowing team members to spend more time with customers. Third, it has been easier to hire and retain team members. We hired one-third fewer team members than a typical new restaurant with similar volume, and Naperville has experienced considerably less turnover. While we do not plan to disclose this metric quarterly, the restaurant level margin for Naperville in June was 26%, significantly higher than any new restaurant opening in its first month. As the restaurant continues to ramp, we see additional opportunities to significantly improve the margin. We expect our second Infinite Kitchen to be live at the end of this year in Huntington Beach, California. We are optimistic about the future of the Infinite Kitchen as we integrate this format into our pipeline. We continue to connect with our customers through our brand moments and digital experiences. Sweetpass, our loyalty program that launched at the end of April, is steadily growing in membership and driving incrementality. Over time, we believe that Sweetpass will have a significant impact on unit economics. We also continue to see strength in our developing channels, creating more brand moments for us. Our B2B channel, consisting of outposts and catering, more than doubled year-over-year in the second quarter. We continue to invest in these channels because they provide opportunities for significant incremental orders from new and existing customers. As always, we are committed to evolving our menu with fresh, healthy, delicious, and craveable food. Our menu strategy strives to attract new customers, engage our loyal guests, and drive additional day parts and occasions. On Tuesday, June 13, we released our early summer menu starring the fan-favorite Peach + Goat Cheese Salad backed by popular demand. The early summer menu also includes our barbecue chicken salad, as well as the chicken teriyaki bowl, a twist on teriyaki by adding a creamy nutty flavor with the addition of tahini. For the barbecue sauce in our barbecue chicken salad, we teamed up with two-time world barbecue champion Charlie McKenna. In true Sweetgreen style, our barbecue sauce contains no refined sugar or preservatives. Following the success of the Chicken + Chipotle Pepper Bowl, we continue to add heartier, flavorful options to our menu in order to broaden our offering. We are incredibly happy with customer reception to our drinks and desserts and have some additional new products launching later this year. As we continue to focus on evolving our day parts, we'll be launching some new warm menu items in time for the winter months. Running great restaurants is the foundational element for making our business thrive. The changes we have made over the past several months have resulted in more efficient restaurants, creating great experiences for both our customers and team members. This is evidenced by our margin improvement. At the beginning of the year, we introduced a new operating structure with our regional general manager model to create more empowerment at the restaurant level, get our teams closer to our customers, and reduce support center expenses related to field oversight. Subsequently, in the spring, we empowered our head coaches to spend more time on the floor coaching our teams and engaging with our customers. Our KPIs continue to show improvement across frontline throughput, lower turnover, and improved 90-day retention metrics. As a result, we've seen a 285 basis point improvement in labor from the first quarter. We continue to offer a great employee value proposition, which includes attractive wages and benefits, training and development to foster lifelong skills, and a clear path to advance their careers. In a few weeks, we'll be starting our digital and in-store trial of tipping across our Northern California restaurants. By the end of the year, we will launch tipping across the fleet, which we believe will improve team member turnover and in turn create a better overall customer experience. Sweetgreen is a category leader at the forefront of redefining fast food, and we are only at the beginning of our growth journey. When the world changed around us very quickly, we rose to the challenge. We remain relentlessly focused on continuous operational improvement, all while delivering exceptional service to our customers to drive ongoing strength. As we move forward, we aim to continue to build on the adjusted EBITDA profitability we delivered in what was a seminal quarter for Sweetgreen as we further our mission of building healthier communities by connecting people to real food. My co-founders and I collectively remain the largest shareholders of the company, and we treat every dollar as though it's our own. Our disciplined approach toward investments has been crucial to our strategy, and we see our approach paying off. These results today would not have been possible without the talented and dedicated team members in our restaurants and in our support center. I'm incredibly proud of this team and the results we delivered. Now, I'll turn it over to Mitch to walk through the quarter's financials in further detail.

Mitch Reback, Chief Financial Officer

Thank you, Jonathan, and good afternoon, everyone. Total revenue for the second quarter was $152.5 million, up from $124.9 million in the second quarter of 2022, growing 22% year-over-year. Same-store sales grew 3%. This consisted of 4% of price, a 2% increase in traffic, offset by 3% in mix. The mix offset is largely attributable to the early investments made in Sweetpass as well as channel movement into the frontline and pickup from native delivery. Our average unit volume in the second quarter was $2.9 million. In the second quarter, we delivered $3.3 million profit on an adjusted EBITDA basis, an improvement of $11.1 million from the second quarter of 2022 loss of $7.8 million. Our second quarter revenue increase of $28 million year-over-year was a significant driver of the $11.1 million increase in adjusted EBITDA, a 40% flow-through to the bottom line. We opened 10 new restaurants this quarter for a total of 19 net new restaurants in the first half of 2023. We ended the quarter with 205 restaurants. We remain on track to achieve our guidance of at least 30 to 35 net new restaurants this year. The restaurant level profit margin in the second quarter was 20.4%, a 185 basis point improvement from the second quarter of 2022. We delivered a 20.4% margin with 40% of our fleet under two years old. The restaurant level profit for the second quarter was $31.1 million, up $7.9 million from a year ago. For a reconciliation of restaurant level margin to comparable GAAP figures, please refer to the earnings release. Food, beverage, and packaging costs are 27% of revenue for the quarter, consistent with the second quarter of 2022, and showing sequential improvement of approximately 160 basis points since Q1. Labor and related costs were 29% of revenue for the second quarter, down 100 basis points from the comparable period in 2022, and showing sequential improvement of 285 basis points since Q1. This improvement is primarily attributable to head coach schedule optimization we implemented in the spring. Our restaurants are fully staffed, and we remain pleased with the quality of talent we are able to attract. Additionally, we’ve seen an easing of wage pressures. Occupancy and related expenses were 9% of revenue, consistent with the second quarter of 2022. General and administrative expenses totaled $40.4 million or 26% of revenue for the second quarter of 2023, compared to $51.8 million or 41% of revenue in the prior year period. The decrease in general and administrative expense was primarily due to an $8.8 million decrease in stock-based compensation expense, as well as a reduction in spend across the support center. During the second quarter, our G&A expense excluding stock-based compensation was 9% lower than the second quarter of 2022. Our net loss for the quarter was $27.3 million, compared to a loss of $40.5 million in the prior year period. The $13.2 million improvement in net loss is primarily due to a $7.9 million increase in our restaurant level profit, a $2.7 million increase in interest income, as well as a decrease in G&A as previously discussed. These decreases in expense were partially offset by a non-cash restructuring charge associated with our former Sweetgreen Support Center and an increase in depreciation and amortization associated with additional restaurants. Adjusted EBITDA, which excludes stock-based compensation and certain other adjustments, was $3.3 million for the second quarter of 2023 as compared to a loss of $7.8 million in the prior year period. This $11.1 million improvement was primarily due to an increase in restaurant level profit and a decrease in general and administrative expenses as described previously. Last year, we made a commitment that we would be very close to a breakeven year in 2023 on an adjusted EBITDA basis, and in 2024 to be adjusted EBITDA profitable on a full-year basis. We remain relentless in pursuit to achieve these goals. Halfway through the year, our adjusted EBITDA is a loss of $3.4 million, compared to a loss last year at this time of $24.8 million, a $21.4 million improvement year-over-year. We ended the quarter with a cash balance of just over $280 million and generated positive operating cash flow during the second quarter. In light of our second quarter results, our fiscal 2023 guidance now reflects a higher restaurant level margin and a lower adjusted EBITDA loss: 30 to 35 net new restaurant openings, revenue ranging from $575 million to $595 million, same-store sales growth between 2% and 6%, restaurant level margins between 16% and 18%, and an adjusted EBITDA loss between $10 million and zero. We see pathways for further margin expansion and are unrelenting in our search to find efficiencies in G&A. We are keenly focused on continuing to be a high revenue growth company and becoming both profitable and cash flow positive. With that, I'll turn the call back to the operator to start Q&A.

Operator, Operator

Thank you. We'll take our first question from Sharon Zackfia with William Blair.

Sharon Zackfia, Analyst

Hi, good afternoon. I want to just touch based on the Infinite Kitchen because those restaurant level margins were pretty impressive. I also assume having been there, it costs more to build, so I'm curious on kind of how the ROI looks or how you expect it to look for Naperville, and then as you think about development and rolling out warrants in the kitchens, assuming they cost more how do you kind of adjust your development plans if you need to in order to kind of extend the runway of the cost that you have?

Jonathan Neman, Co-Founder and Chief Executive Officer

Sharon, good to hear from you and I'm glad you're able to check out the Infinite Kitchen in person. What I'd say is, so far, we're really pleased with the results we're seeing. As I mentioned in the prepared remarks, I think first and foremost, we’re really excited about the experience we're delivering to customers. We're getting a lot of positive feedback on everything from the theater of the food to the hospitality, speed of service, and the portioning and accuracy. This addresses a lot of customer experience challenges that exist in the restaurant industry. And I think that was a huge proof point for it. Of course, we also expect it to have an economic financial gain in terms of margin expansion and overall improving our returns on capital. To your point, yes, of course, the machines do require an incremental investment, but we believe they will deliver an accretive return on capital wherever we put them. We're not guiding today around how much these actually cost, but we will only be deploying them where we will see an incremental accretive return on capital, which we expect to see given the early results. Just a reminder, what we saw in Naperville was just our first month, and as you'd expect in most restaurants, we anticipate a ramping period. Thus, we expect the stabilized margin to be north of where it was in its first month.

Operator, Operator

We'll take our next question from Katherine Griffin with Bank of America.

Katherine Griffin, Analyst

Hi, thanks for taking the question. I was hoping either Mitch or Jon, if you could just speak to the cadence monthly in the quarter, sort of what you saw in terms of traffic trends in the second quarter. That would be helpful. Thank you.

Mitch Reback, Chief Financial Officer

Hey Katherine, thank you for the question. What we saw were somewhat consistent traffic patterns during the quarter really across the fleet. As we came into the third quarter, I’ll make just an observation. We saw a slowdown during the July 4 weekend, and then it picked back up to be more consistent with the second quarter.

Operator, Operator

And we'll take our next question from John Ivankoe with JPMorgan.

John Ivankoe, Analyst

Hi, thank you. In your prepared remarks, you mentioned some of the second quarter margin improvement was due at least partially to, I think I wrote down, supply chain sourcing. I was hoping that if we could just elaborate on that topic broadly. I mean, what that specifically means is that just in terms of how you're consolidating some suppliers and how you're handling the physical distribution, or are you embarking on kind of considering how you're allocating some costs that you're currently duplicating within each store to potentially using or leaning a little bit more on your supply chain in terms of bringing in some value-added products into the store to make them in fact easier and more efficient to run?

Jonathan Neman, Co-Founder and Chief Executive Officer

John, you hit it pretty accurately. The margin leverage we saw was a combination of labor and COGS savings. On the COG side, it was due to a lot of supply chain sourcing around economies of scale and contract pricing that we were able to lock in. Additionally, as you mentioned, upstreaming doesn't help your COGS; it helps your labor. We actually spend a little bit more on bringing certain things in a different way to reduce the labor load inside of the restaurants. The balance is a higher margin restaurant that is easier to run. We do not compromise on the quality of any of the food in doing so. It was primarily about consolidating certain distribution logistics as well as contract pricing. A huge shoutout to our supply chain and procurement team for delivering an awesome quarter. We expect these savings to continue.

John Ivankoe, Analyst

And could you elaborate a little bit more on upstreaming, specifically on what you've already put into the stores and what you may see going forward, how big of an opportunity that might be?

Jonathan Neman, Co-Founder and Chief Executive Officer

Yes, absolutely. As you know, Sweetgreen prides itself on our sourcing as well as our scratch cooking model. However, we see opportunities to simplify the labor model inside restaurants by taking certain items that we think we can improve the quality and consistency and upstreaming them. You've seen us in past years implement items like Parmesan Crisps. This year, we've begun upstreaming several of our dressings. Not all of our dressings, but several that do not contain fresh herbs. We think that for those with herbs, we will keep making them in restaurants to capture that fresh flavor. For the others, we still use the same quality of ingredients, which is what took a long time to achieve — same-store, same quality, while broadening our offerings in the restaurants. We are cautious about what we change because we know that our customers love the quality we bring. We do expect to adopt more items, but we will proceed carefully over time.

Operator, Operator

We'll take our next question from Chris Carril with RBC Capital Markets.

Chris Carril, Analyst

Hi, thanks for taking the question. So can you expand a bit more on the updated restaurant level margin guidance and how we should think about margins here for the balance of the year? I know there's typically a good bit of seasonality with respect to the top line and margins. But could you just maybe walk us through some of the puts and takes around the restaurant margins here going forward, including your cost inflation outlook from here? Thanks.

Mitch Reback, Chief Financial Officer

Hey Chris, thank you for the question. As you saw in the guidance, we increased our restaurant level margin from 15% to 17% to 16% to 18%. That change reflects the current actions we saw in the second quarter becoming permanent throughout the rest of the year. Jon talked a little about the changes made in labor and in the cost of goods in sourcing. What we saw in inflation during the second quarter was very little to no inflation in both commodities and labor. We expect these trends to continue through the back half of the year. These factors led to the improvement in margin, and we see that largely being sustained into the future.

Operator, Operator

We'll take our next question from Jon Tower with Citi.

Karen Holthouse, Analyst

Hey, it's actually Karen on for Jon this evening. So I think your comment about the dynamics of price mix in the quarter, it sounds like maybe we're at the point, or at least in the second quarter where Sweetpass was like net-net a bit of a net comp headwind in terms of giving the discount but not seeing the full benefit of potential frequency increases or even new people coming into the brand. So could you kind of comment on what those underlying dynamics are, when you think it becomes accretive, and if there's anything else to kind of help frame the scope of the program at this point in terms of membership, percent of sales or anything like that?

Jonathan Neman, Co-Founder and Chief Executive Officer

Yes, absolutely. We launched Sweetpass about three months ago, and you’ve captured it pretty accurately. The early phase of the launch was really about establishing the program, and there were significant costs associated with the discounting involved. We're really encouraged by the early success of the program, both the Sweetpass and Sweetpass Plus. We're seeing a healthy mix of low frequency users joining the program and observing strong incrementality from that group. When we initially launched, we indicated that Sweetpass would take time to build membership. The launch served as a pilot since it's currently a digital-only program. Our fastest-growing channel continues to be our in-store business, and Sweetpass, at the moment, does not work in-store. We are, however, excited to report that in the coming months, we will unlock the ability to earn and redeem Sweetpass benefits in our restaurants, which we believe will be tremendously beneficial for driving value, particularly since most of our new customers come via our retail outlets. Sweetpass will serve as a crucial channel for acquiring and retaining new customers while increasing frequency for our less frequent visitors. We look forward to sharing more once we fully launch the feature set and have some more experience.

Operator, Operator

We'll take our next question from Andrew Charles with TD Cowen.

Andrew Charles, Analyst

Great. Thank you. Two separate questions. Mitch, just following up on an earlier question, and I appreciate all the details around Infinite Kitchen, but what's the level of normal margin inefficiencies during a restaurant's first month of operation? I'm trying to better understand what could be a normalized level of margins from the Infinite Kitchen once you set aside new store inefficiencies. And then my second question was just on development guidance. Year-to-date you guys have opened 26, relative to guidance for 30 to 35. Just kind of curious, usually, it’s 4Q a year with the development, so what's changing that dynamic in 2023 unless it's just conservatism.

Mitch Reback, Chief Financial Officer

Thank you, Andrew, for the questions. We've never officially disclosed our first month margins for typical new stores, but it would be safe to assume they're below the company average. The Naperville location, however, has performed above par, offering significantly better margins than any previous first-month operations. Regarding our development guidance, we're sticking with the target of 30 to 35 net new restaurants. We're doing our best to accelerate openings and are quite pleased with the outcomes from our 2023 class of restaurants.

Operator, Operator

And we'll take our next question from Brian Mullan with Piper Sandler.

Brian Mullan, Analyst

Hey, thanks. Just to follow up on the Infinite Kitchen. I want to know if there's anything in that Naperville store that you'd like to see fixed or improved before you'd be willing to deploy it more broadly, whether that be around how it functions or just the cost of deploying it. I’m trying to get a sense of whether you think it could be a material part of the new unit pipeline as early as next year, or if it’s more likely to take a bit longer before it's deployed more broadly.

Jonathan Neman, Co-Founder and Chief Executive Officer

I'd say overall we're really pleased. As I mentioned in previous calls, we were confident in the technology itself, as we've been running it in a lab setting for a long time. A lot of what we were working to understand was the overall customer experience and what both the first and second order improvements we’d see within that experience. Today, we are mainly looking for more time. It's only been a couple of months since opening, so we’d like a bit more time to gauge customer and team member experiences, and how best we can continue to deploy it. However, we do expect it to be part of our development pipeline in 2024, and as we mentioned, we'll be opening a second unit at the end of this year.

Operator, Operator

And that does conclude today's presentation. Thank you for your participation and you may now disconnect.