Dutch Bros Inc. (NYSE:BROS) Q3 2023 Earnings Call Transcript November 7, 2023
Dutch Bros Inc. beats earnings expectations. Reported EPS is $0.14, expectations were $0.07.
Operator: Ladies and gentlemen, greetings, and welcome to the Dutch Bros, Inc. Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. It is now my pleasure to introduce your host, Paddy Warren, Director of IR at Corporate Development. Please go ahead.
Paddy Warren: Thank you. Good afternoon, and welcome. I’m joined by Joth Ricci, CEO; Christine Barone, President and Charley Jemley, CFO. We issued our earnings press release for the quarter ended September 30, 2023, after the market closed today. The earnings press release, along with the supplemental information deck have been posted to 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 facts are forward-looking statements and are subject to risks, uncertainties 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 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 measures are neither substitutes for nor superior to, measures that are prepared under GAAP. Please review the reconciliation 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.
Jonathan Ricci: Thank you, Paddy. Good afternoon, everyone. By all accounts, Q3 was a fantastic quarter, and we are extremely pleased with our unit openings, same shop sales, revenue and profitability results. We opened 39 new shops and system same-shop sales grew 4%. We delivered record performance since our IPO across both our top and bottom line with $265 million in revenue and $53 million in adjusted EBITDA, reflecting increases of 33% and 91%, respectively, year-over-year. It was also a strategically important quarter for the liquidity flexibility of the company. We upsized our credit facility by $150 million and executed a follow-on equity offering that we believe positions our balance sheet for a long runway of growth.
Dutch Bros will continue to confidently pursue high-quality investments in new shops in the path to 4,000. I’m very proud of the team for what they accomplished and I’m more encouraged than ever by the strength of the underlying business. This is the last time I’ll be on this call as CEO. When I joined our co-founder, Travis Boersma and the Dutch Bros team in 2018, it was clear to me that there was something special about this company and brand. In September of 2018, we laid out five key initiatives that would guide us through the next five years. With 317 shops, we set a goal to reach 800 shops by the end of 2023. We use data to inform better decision-making to execute a disciplined brand strategy to utilize and leverage technology to improve customer experience and to add new talent to our experienced team.
At the center of it all, we set the goal of continued connection with the communities we serve. Over the subsequent five years, we have accomplished each and every one of those goals while managing through a series of events that challenged our teams and made us better in the long run. The success of those initiatives is evident, and we’ve reached several important milestones. I’m pleased to announce that in October, we opened our 800th shop, a testament to the team’s discipline and the capacity we have created in the business. As of September 30, more than 22,000 people are employed at the shops across our system. Since 2019, we’ve also increased our AUVs by almost 20% and opened nine new states, demonstrating that the Dutch Bros brand resonates far beyond our home market.
In Q2 of 2022, we surpassed $1 billion in trailing 12-month system-wide sales, a milestone that few beverage-focused brands have ever achieved. Notably, we’ve generated this exceptional top line growth while further improving our margins. Our company-operated shop contribution margins have expanded considerably and were approximately 31% in Q3. We achieved another milestone in the quarter by opening our 500th company-operated shop, representing 38% more shops at the end of Q3 compared to the year earlier. To put this in perspective, we started 2018 with just 37 company-operated shops. This is really incredible. And we’ve been able to develop the systems and capacity to scale this segment quickly and profitably. Through all of the changes and progress we’ve made over these past five years, it is important to remember that we’re growing in order to share opportunities for our crews, brighten in our customers’ days and bring connection to our communities.
We do this while recognizing the responsibility to build long-term shareholder value. Finally, I’m pleased with the stability at the leadership level of this company. Travis? continued involvement, combined with decades of experience from internal leaders and franchisees, matched with fresh perspectives from new additions to the team, provides Dutch Bros an amazing foundation upon which to build. The list is long, but to everyone who has been involved in this journey over the last five-plus years. I want to say thank you. Our incoming CEO, Christine Barone, recognizes the power of this brand and has immersed herself in the business since coming on board in February. She is a fabulous leader and brings Dutch Bros the experience necessary to take us on the next phase of our journey.
I couldn’t be more excited for her and for the company. And now for the last time, I will turn it over to Christine for some remarks.
Christine Barone: Thank you, Joth. On behalf of all of us at Dutch Bros, I want to extend my heartfelt congratulations and thanks to you on a personal level for all you have done for me and for Dutch Bros. You prepared this company to compete on a national stage and have set us up for the growth that lies ahead. Thank you. I share Joth’s excitement for the exceptional performance we delivered in Q3 across our key metrics. We once again delivered on our new unit growth target as we have quarter after quarter. In Q3, we opened 39 new shops across 11 states in inter-Kentucky and Alabama. We now have Dutch Bros shops operating in 16 states. We also demonstrated continuing momentum, delivering 4% system same-shop sales growth, a 20 basis point improvement quarter-over-quarter.
Combined with sales contributions from new shops, we saw a 33% increase in revenue year-over-year. We are extremely pleased with the profitability we delivered in Q3, headlined by $53 million in adjusted EBITDA for the quarter. This is almost double the $28 million in adjusted EBITDA we reported in Q3 of 2022 and reflects our commitment to growth with profitability. I will now spend a few minutes discussing our key priorities and how they ladder up to these outcomes. We began any discussion of Dutch Bros with our fundamental differentiator, our people. The shop teams who greet and care for our customers and each other every day are the lifeblood of this organization, recruiting, developing and retaining outstanding people meets our primary focus and our greatest strength.
Our people pipeline is robust. We have more than 325 qualified operator candidates in the pipeline with an average tenure of seven years. At scale, we anticipate that each operator will be capable of leading three to seven shops on average. Over the past two years, we’ve yielded nearly 50 people to the position of operator. These new operators started out as broistas for Dutch Bros working their way up to the ranks and embodying our brand value of speed, quality and service. We love this model because it allows us to reward our highest performing and most committed employees with an opportunity to continue to advance within the organization while cementing our culture and values as we grow. Our shop expansion strategy is motivated by our commitment to create opportunities for our people.
We intend to continue to look for opportunities to open profitable shops led by strong homegrown leaders at what we believe are top-tier return outcome. Furthermore, our expanding margins allow the flexibility to continue to make proactive investments in crew wages and benefits. As discussed last quarter, we are committed to making further investments in our people. On November 1, we made changes to our shop manager pay structure to recognition of the critical role these leaders play in growing our business. We also reimagined our incentive structure more closely aligned with both sales growth and great customer service. We believe these changes will more closely align manager pay with our internal sales growth and customer service objectives.
Like many of our peers in the industry, we have managed through a difficult development environment, characterized by elevated build costs, supply chain shock, permitting delays and rising interest rates. We continue to work diligently to manage these headwinds, and we remain confident in our 2023 development target. We have also engaged in a purposeful strategy to rapidly gain share in new markets and achieve efficiencies. As we have discussed in the past, we believe this approach to market entry and its associated higher levels of infill have been a key driver in the moderation of new shop AUV. Last quarter, we outlined a shift in our real estate strategy, which we believe will position us for long-term success. This new approach is underpinned by three key elements: first, widening our initial reach as we enter new markets and allowing our brand awareness to build.
A cup of the company’s signature coffee being brewed in a state-of-the-art espresso machine.
We expect to achieve the same ultimate density though our TAM remains unchanged at 4,000 shops. Second, shifting back towards more build-to-suit leases, which require a lower upfront cash commitment. Third, developing new prototypes to efficiently and effectively penetrate markets and generate strong unit . We anticipate beginning to feel the effects of the changes in 2025 as the impacts work through our robust pipeline. As we grow, we believe maintaining financial discipline on strict underwriting standards allows us to balance creating opportunities for our people while supporting long-term unit development goals. In Q3, we continued to see margins expand, driven primarily by a combination of pricing, shop level operational improvements and moderating SG&A growth.
Not only do total company-operated shop contribution almost doubled from Q3 2022, approximately $72 million this quarter, eShop delivered 540 basis points of margin expansion year-over-year to 31% of company-operated shop revenue. Strong margins propel our new shop growth, delivering quick payback periods and enabling us to reinvest into further development opportunities. We believe our four-wall model also provides us a certain level of flexibility to adjust and adapt as we expand. Moderating growth in SG&A spending is an opportunity for leverage. While we intend to make smart investments that support critical capabilities as we scale, we expect to see leverage as revenue growth outpaces SG&A spending growth. We also remain committed to introducing more customers to the Dutch Bros brand.
In Q3, we saw system-wide same-shop sales growth expand to 4%, an improvement of 20 basis points from Q2. We successfully executed through a variety of tactics. First, innovation keeps the brand fresh and Fund. We launched three seasonal LTOs in the quarter beginning with the Chocolate Crunch Cold Brew Freeze and Frost, topped with soft top and Oreo crumbles and rounding out the quarter with the Carmel Pumpkin Brulee and Sweater Weather Chi. We intend to use innovation to drive excitement and trial and leverage our in customization advantages. Second, we are continuing to enhance our rewards program and find new ways to delight our customers, rewarding and recognizing customers as part of legacy at Dutch Bros. In Phase I, we digitized our existing program and rapidly scaled it by converting to a spend-based approach.
Introduced in early 2021, the Board members accounted for 60% of transactions in less than 12 months. Impressively, this metric has continued to grow even as we are entering into new geographies. We began laying the groundwork of the second phase of our rewards journey. In March, we moved from a broad-based giveback program through a more targeted approach where we are using consumer insights to drive behaviors that we expect will create more lasting value. We are beginning to activate specific campaigns and target dayparts. For example, in Q3, we ran double point Tuesdays and a visit frequency challenge. We believe that customers are responding to our efforts and that we are beginning to see [indiscernible]. As we look forward, we plan to continue to use our increasing capabilities to specific behavior.
We are still at the beginning of our journey, and we believe we have significant runway to continue refining personalized offers. Third, selective promotion helps open new experiences. We’re enjoying success with our Fill-A-Tray program, which we have now run quarterly since March. We continue to experiment with offer design and timing and remain pleased with both the execution and results. In our most recent iteration, we once again drove substantial sales. Outside of Fill-A-Tray, we will continue to execute on multiple base promotional activities to encourage trial and group . Then fourth, paid media brings awareness. While approximately 63% of our transactions were attributable to our Rewards members this quarter, we recognize an opportunity to connect with a wider range of customers in various stages of their journey at Dutch Bros.
We have increased paid media spend in an effort to bring new customers to Dutch Bros, more brand awareness in new markets and keep the brand top-of-mind for our existing customers. We look forward to continuing to scale this spend over time and are optimistic about the long-term impact of these sustained efforts. We have high expectations for ourselves and our business. We are proud of both our third quarter results and the steps we’re taking to build on our strong foundation for the long term. We have terrific customer engagement with rewards members driving 63% of our transactions, we are excited about opportunities in front of us to further accelerate this platform. We have top-tier growth. We delivered record revenue in Q3 and a 33% year-over-year increase.
This growth has been consistent, demonstrated by nine consecutive quarters of opening shops on our rate of 4,000 plus. We have excellent shop margins. We have demonstrated that we can drive this exceptional growth with profitability, culminating in this quarter, delivering record adjusted EBITDA since our IPO. We are well capitalized. We believe our recent primary offering and credit upsizing provides a long runway and plenty of flexibility upon which to execute our growth plan and capitalize on our considerable . Most importantly, we have great people. We have outstanding and engaged broistas in our shops and a strong pipeline of operators ready to open our new markets. These factors give us great confidence in our future. With that, I’ll turn it over to Charley to review our financials.
Charley Jemley: Thanks, Christine. Both Joth and Christine noted what a strong quarter we had, and how pleased we were with our unit openings, same-shop sales revenue and adjusted EBITDA results. The company-operated shop segment delivered outstanding performance, generating $236 million in net sales and $73 million in shop contributions in the quarter. This represents a year-over-year net sales increase of 36% and company-operated shop contribution growth of more than 65%. As a percentage of net sales, company-operated shop contribution was 31%, an expansion of 540 basis points year-over-year. These strong four-wall economics give us flexibility and position us to invest in areas that support and sustain growth. Margin expansion is taking place up and down the P&L, including 120 basis points in cost of goods, 230 basis points in labor, 110 basis points in occupancy and other.
We believe this margin expansion is primarily a function of pricing, efficiency improvements we have made in key areas throughout shop operations and the portfolio effect of moving into lower operating cost markets. Labor was 26% of net sales, down from 28.3% in 2022. The benefit from the changes we began implementing in Q4 2022 continue as well as leverage from year-over-year pricing actions. These gains were partially offset by our decision at the beginning of 2023 to increase starting wages in federal minimum wage markets and an ongoing initiative to ensure our retail teams are the best in the business, we’re continuing to make meaningful system-wide investments in those teams. Specifically, this will take the form of investments in shop manager wages and incentives that began November 1.
We estimate these investments will cost between $1.5 million and $2 million in the two months that they are in place in the fourth quarter alone and continue to be part of our cost structure going forward. Shifting now to SG&A. For the quarter, SG&A was approximately $50 million, which includes about $10 million in stock-based compensation. Therefore, with the exclusion of stock-based compensation and other nonrecurring expenses, adjusted SG&A was approximately $41 million, falling to 15.3% of revenue compared to 17.5% in Q3 last year. While we are still scaling and adding resources, we are making a concerted effort to stage them in over time. Now on to a few comments on the health of our balance sheet and liquidity. Last quarter, I commented that having a well-capitalized balance sheet is a priority to position the company to take full advantage of the long growth runway ahead in a responsible and thoughtful manner.
During the quarter, we not only upgraded our credit facility by adding an additional $150 million in capacity and also raised approximately $330 million in primary equity proceeds net of discounts, fees and expenses. We proceeded to pay down our revolving credit facility, which at the time was approximately $203 million and retained approximately $130 million of cash on our balance sheet. We will use this cash infusion for general corporate purposes, including funding our growth over the coming quarters. The primary equity capital raise achieved three outcomes: First, we believe the transaction will be accretive given the projected reduction in interest expense under our credit facility. Second, it provides the flexibility we believe will be required to manage through the total project cost escalation we have experienced since the time of our IPO.
And third, it enabled a reset to our capital structure, positioning the company to have both ample liquidity and optionality with the belief that our four-wall economics are some of the best in the industry, the ability to execute without undue capital constraints is vital to reaching our growth potential. As a collective result of all these actions and under current assumptions and market conditions, we do not currently foresee a need to raise additional primary equity capital. Total liquidity is now around $700 million, consisting of $150 million in cash and equivalents and $350 million undrawn revolver plus $200 million in undrawn delayed draw term loans. At the end of the quarter, the net cash position was approximately $54 million, made up of $150 million in cash and cash equivalents and $96 million in term loans.
Moving on to 2023 guidance. Our expectation for total system shop openings in 2023 remains unchanged. We expect to open at least 150 new shops, of which at least 130 will be company operated. Our expectation for capital expenditures remains unchanged, which we expect to be in the range of $225 million to $250 million. This includes approximately $15 million to $20 million and spending in 2023 for a new roasting facility, which is projected to open in 2024. Our estimate of system same-shop sales growth remains in the low single digits. Our expectation that revenue would be at the lower end of the range of $950 million to $1 billion remains unchanged. Given strong growth in company-operated shop revenue and its contribution to our bottom line, along with the continuance of SG&A leverage, we now estimate adjusted EBITDA will be between $150 million to $155 million, up $15 million from last quarter’s guidance.
The increase in adjusted EBITDA reflects stronger-than-expected year-to-date profitability, partially offset by the increased shop labor investments. And as we noted earlier, we intend to execute a series of business building initiatives throughout the fourth quarter. These initiatives include aggressively using our rewards program to attract new customers and retain existing ones with a particular focus on building engagement in newer markets. In addition to using rewards as a key lever, we also intend to bring even more focused investments to building capability in our consumer-facing technologies and investing in the talent required to grow the business. To summarize, it is important we balance profit delivery with wise investments in our future, growing at this pace and through a company-led model requires the ability to flex and adjust as needed, always taking a long-term view.
Thank you, and now we will take your questions. Operator, please open the lines.
Operator: [Operator Instructions]. Our first question is from Chris O’Cull, with Stifel.
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Q&A Session
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Unidentified Analyst: Hello. This is Ella on for Chris. I was hoping we could dig into traffic trends during the quarter and whether you saw some meaningful change in cadence over the course of 3Q? And then as you step back, what do you believe has really been most effective in driving incremental business in recent periods?
Christine Barone: Yes, absolutely. So, we’re very pleased with our 4% same-shop sales growth in the quarter. And as we look at traffic specifically, we saw a little bit of deceleration between Q2 and Q3 but are really pleased with the overall direction in which traffic is headed. When we look at Q2 versus Q3, we saw a couple of things. One, we had a little bit of a harder lap than we had last year. The second thing is as we took pricing in Q3. As we take pricing, we typically see a little bit of dip in traffic as we first take that pricing. But we’re very pleased with the results of the pricing that we took and saw what we would have expected to see from a traffic perspective with that pricing. We also had a really strong LTO in Q2 with the Mangonada.
And as we look forward, we want to continue kind of that unique type of momentum that we have in that type of LTO. Going forward, as we look at ways to drive traffic and think through the things that are most effective in doing that. One, it’s really innovation. And we’ve done a number of things to enhance our innovation over the last couple of quarters dropping in some short-term LTOs like the Poppin’ Candy Firecracker Rebel. And then as we look forward into next year, we’re going to continue doing that. But we’re also going to be looking tightly at consumer trends, what’s going on in the market to look at longer-term offerings that are truly innovative and new to the market. Secondly, as I shared in my prepared remarks, we believe there’s a lot of momentum with the rewards program.
We’re really on a journey within rewards thinking about starting with a high just spend-based program that in March of this year, we took some of that rich base reward out and moved it to really incentivize customer behavior. As we continue to progress in the rewards program, we’re learning a lot about the types of offers that our customers respond to. And what you’ll see going forward is really more and more personalization in that rewards program. So, segmenting our customer base further for offers, looking at different points levels and different rewards levels that will really drive our customers in that program. Third, in paid media, so we have increased spend a little bit in our paid media. We’ve really been focused on driving sales at the bottom of the funnel, so that immediate return of kind of showing someone an ad and getting them into the shop as we continue to expand our paid media that what we’ll be looking at is really driving brand awareness as well.
When we look at the number of shops that we have in new markets, we think there’s a significant opportunity to continue to drive brand awareness in those markets. And finally, we’ve been doing a number of things with promotions really to drive trial. So, we think the best introduction to Dutch Bros is through a friend who already loves Dutch Bros. And so, we’re going to continue doing promotions that allow friends to share with friends. We’re also learning that as we kind of learn more from the rewards program, we can shift some of those promotions into our rewards program. And so, we’ll continue to be doing that as we move forward with traffic. We also believe that we have a significant opportunity as we move forward to build different sales layers into our business, specifically looking at different channels that we could drive business through.
Thank you. I hope that answered your question.
Unidentified Analyst: That’s really helpful. And I have another question about the performance in Texas. So maybe if you can provide an update on store performance impact as in whether you’ve continued to the deterioration you expect in AUV performance?
