Dutch Bros Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 7, 2023

There are 15 speakers on the call.

Operator

Ladies and gentlemen, greetings and welcome to the Dutch Bros, Inc. Third Quarter 2023 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. As a reminder, this conference is being recorded.

Operator

It is now my pleasure to introduce your host, Patty Warren, Director of IR and Corporate Development. Please go ahead.

Speaker 1

Thank you. Good afternoon and welcome. I'm joined by Joss Ricky, CEO Christine Barone, President and Charlie Gimli, CFO. We issued our earnings press release The earnings press release along with the supplemental An information deck has been posted to our Investor Relations website at investors. Dutchbros.com.

Speaker 1

Please be aware that all statements in our prepared remarks And in response to your questions, other than those of historical facts, our 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 ks 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.

Speaker 1

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 Jeff.

Speaker 2

Thank you, Patty. Good afternoon, everyone. By all accounts, Q3 was a fantastic quarter. 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%.

Speaker 2

We delivered record performance Since our IPO across both our top and bottom line with $265,000,000 in revenue $53,000,000 in adjusted EBITDA, reflecting increases of 33% 91% respectively year over year. It was also a strategically important quarter for the liquidity We upsized our credit facility by $150,000,000 and executed a follow on equity offering that we believe positions our balance sheet The 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.

Speaker 2

When I joined our Co Founder, Travis Forsman

Speaker 3

and the

Speaker 2

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 5 key initiatives that would guide us through the next 5 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 experience team. At the center of it all, we set the goal of continued connection with the communities we serve.

Speaker 2

Over the subsequent 5 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 9 new states, demonstrating that the Dutch Bros brand resonates far beyond our home markets.

Speaker 2

In Q2 of 2022, we surpassed $1,000,000,000 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 5 100th company operated shop, representing 38% more shops at the end of Q3 compared to a year To put this in perspective, we started 2018 with just 37 company operated jobs. This is really incredible and we've been able to develop the systems and capacity to scale this segment quickly and profitably.

Speaker 2

Through all of the changes and progress we've made over these past 5 years, it is important to remember that we're growing in order to share opportunities for our crews, Right 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. Trab's 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 5 plus years, I want to say thank you.

Speaker 2

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 Dux Pros 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.

Speaker 4

Thank you, Joss. 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. We prepared this company to compete on a national stage and have set us up for the growth that lies ahead. Thank you. I share Josh's excitement for the exceptional performance we delivered in Q3 across our key metrics.

Speaker 4

We once again delivered on our new unit growth targets as we have quarter after quarter. In Q3, we opened 39 new shops Across 11 states and entered Kentucky and Alabama, we now have Dutch 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 drove a 33% increase in revenue year over year. We are extremely pleased with the profitability we delivered in Q3, headlined by $53,000,000 in adjusted EBITDA for the quarter. This is almost double the $28,000,000 in adjusted EBITDA we reported in 3 2022 and reflects our commitment to growth with profitability.

Speaker 4

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 Growth 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 remains our primary focus and our greatest strength. Our people pipeline is robust.

Speaker 4

We have more than 325 qualified operator candidates in the pipeline with an average tenure of 7 years. At scale, we anticipate that each operator will be capable of leading 3 to 7 shops on average. Over the past 2 years, we've noted nearly 50 people to the position of operator. These new operators started as early as just with debt growth, Working their way up to the ranks and embodying our brand values 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.

Speaker 4

Our shop expansion strategy is motivated by our commitment to create opportunities for our people. We intend to continue to look for opportunities 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 1st, We made changes to our shop manager pay structure in 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.

Speaker 4

We believe these changes will more closely align manager pay with more 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 shocks, permitting delays and rising interest rates. We continue to work diligently to manage these And we remain confident in our 2023 development targets. We have also engaged in a purposeful strategy to rapidly gain share in new markets And achieve efficiency. As we have discussed in the past, we believe this approach to market entry and its associated higher levels of infill It's been a key driver in the moderation of Newshop ABB.

Speaker 4

Last quarter, we outlined a shift in our real estate strategy, which we believe will position us for long term Seth, this new approach is underpinned by 3 key elements. 1st, widening our initial reach as we enter new markets and allowing our brand awareness to build. We expect to achieve the same ultimate density, though our TAM remains unchanged at 4,000 shots. 2nd, shifting back towards more build to suit leases, which require a lower upfront cash commitment. We're developing new prototypes to efficiently and effectively penetrate markets and generate strong new merch.

Speaker 4

We anticipate beginning to feel the effects of these changes in 2025 as the impacts work through our robust pipeline. As we grow, we believe maintaining financial discipline and strict underwriting standards allows us to balance creating opportunities for our people while supporting long term unit development goals. In Q3, we continue to see margins expand, driven primarily by a combination of pricing, shop level operational improvements and moderating SG and A growth. Not only did total company operated SHOP contribution almost double from Q3 2022, approximately $73,000,000 this quarter, These shops delivered 5.40 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.

Speaker 4

We believe our 4 wall model also provides us a certain level of flexibility to adjust and adapt as we expand. Moderating growth in SG and 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 and 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.

Speaker 4

We successfully executed through a variety of tactics. 1st, innovation keeps the brand fresh and fun. We launched 3 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 Caramel Pumpkin Brulee and Sweater Weather Chai. We intend to use innovation to drive And we are continuing to enhance our rewards program and find new ways to delight our customers. Rewarding and recognizing customers as part of a 30 year legacy at Dutch Bros.

Speaker 4

In Phase 1, we digitized our existing program and rapidly scaled it by Converting to a spin based approach. Introduced in early 2021, rewards 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 2nd phase of our rewards journey in March. We will move from a broad based give back We are beginning to activate specific campaign and target dayparts.

Speaker 4

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 green shoots. As we look forward, we plan to continue to use our increasing capabilities to inflict specific behavior. We are still at the beginning of our journey and we believe we have Significant runway to continue refining personalized offers. 3rd, selective promotion helps open new experiences.

Speaker 4

We're enjoying success with our FilaTrey 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 Filatrade, we will continue to execute on multiple space promotional activities, encourage trial and group visitation. Next 4th, Seed Media brings awareness.

Speaker 4

While approximately 63% of our transactions were attributable Our rewards numbers this quarter, we recognize an opportunity to connect with a wider range of customers in various stages of their journey with Touchbird. We have increased paid media spend in an effort to bring new customers to Dutch Bros, build brand awareness in new markets and keep the brand top of mind for 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 Q3 results and the steps we're taking to build on our 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.

Speaker 4

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 9 consecutive quarters of opening 3 or more shops on our way to 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.

Speaker 4

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 rent space. Most importantly, we have great people. We have outstanding and engaged breweries in our shops and a strong pipeline of operators ready to open our new markets. These factors give us great confidence in our future.

Speaker 4

With that, I'll turn it over to Charlie to review our financials.

Speaker 5

Thanks, Christine. Both Joc 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 $236,000,000 in net sales $73,000,000 in SHOP contribution in the quarter. This represents a year over year net sales increase of 36 percent 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 5.40 basis points year over year.

Speaker 5

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 and L, including 120 basis points in cost of goods, 230 basis points in labor, and 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 The portfolio effective 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.

Speaker 5

These gains were partially offset by our decision at the beginning of 2023 To increase starting wages in federal minimum wage markets, in an ongoing initiative to assure 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 $1,500,000 $2,000,000 in the 2 months They are in place in the 4th quarter alone and continue to be part of our cost structure going forward. Shifting now to SG and A. For the quarter, SG and A was approximately $50,000,000 which includes about $10,000,000 in stock based compensation.

Speaker 5

Therefore, with the exclusion of stock based compensation and other non recurring expenses, adjusted SG and A was approximately $41,000,000 Falling to 15.3 percent 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 It's 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 $150,000,000 in capacity and also raised approximately $330,000,000 in Primary equity proceeds net of discounts, fees and expenses.

Speaker 5

We proceeded to pay down our revolving credit facility, which at the time was approximately $203,000,000 and retained approximately $130,000,000 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 3 outcomes. 1st, we believe the transaction will be accretive given the projected reduction in interest expense under our credit facility. 2nd, 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.

Speaker 5

And 3rd, it enabled a reset to our capital structure, positioning the company to have both ample liquidity and optionality. With the belief that our 4 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,

Speaker 6

We

Speaker 5

do not currently foresee a need to raise additional primary equity capital. Total liquidity is now around $700,000,000 Consisting of $150,000,000 in cash and equivalents and $350,000,000 undrawn revolver plus $200,000,000 in undrawn delayed draw term loans. At the end of the quarter, the net cash position was $54,000,000 made up of $150,000,000 in cash and cash equivalents, dollars 96,000,000 in term loans. Moving on to 2023 guidance. Our expectation for total system shop openings in 2023 remains unchanged.

Speaker 5

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 $225,000,000 to $250,000,000 This includes Approximately $15,000,000 to $20,000,000 in 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 9 $50,000,000 to $1,000,000,000 remains unchanged. Given strong growth in company operated shop revenue and its contribution to our bottom line Along with the continuance of SG and A leverage, we now estimate adjusted EBITDA will be between $150,000,000 to $155,000,000 up $15,000,000 from last quarter's guidance.

Speaker 5

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 4th 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 building capability Now 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.

Speaker 5

Thank you. And now we will take your questions. Operator, please open the lines.

Operator

Thank you. Ladies and gentlemen, we will now be conducting a question and answer It may be necessary to pick up your handset before pressing the star keys. Our first question is from Chris O'Cull with Stifel. Please go ahead.

Speaker 7

Hello. This is Ella on for Chris.

Speaker 8

I was hoping we could dig into traffic trends during the quarter and whether you saw some meaningful like Meaningful change in cadence over the course of 3Q. And then as you step back, what do you believe has really being most effective in driving incremental business in recent periods?

Speaker 4

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 I'm really pleased with the overall direction in which traffic is headed. When we look at Q2 versus Q3, we saw a couple of things. 1, we had A little bit of a harder lap, than we had last year.

Speaker 4

The second thing is, as we took pricing in Q3. As we take pricing, we typically see a little bit of dip To see from a traffic perspective with that pricing. We also had a really strong LTO in Q2 with the Mango Nada. 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 And think through the things that are most effective in doing that.

Speaker 4

One, is 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.

Speaker 4

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. 3rd, 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.

Speaker 4

As we continue to expand our paid media bet, what we'll be looking at is really driving brand awareness as well. When we look at the number of shops We have a new market, 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 trials. So we think the best introduction to Dutch Bros is through a friend Who already love Dutch Bros. And so we're going to continue doing promotions that allow friends to share with friends.

Speaker 4

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.

Speaker 8

Thank you, Christine. That's really helpful. And I have another question about the performance in Texas. So maybe if you can provide like update on store performance impacts as in whether you've continued to The deterioration you expected in AUV performance.

Speaker 4

Yes. So we actually don't provide regular States on state level performance. We did provide some updates when we did our follow on offering in early September. And as we shared at that point, we're very pleased with kind of how the Texas market is developing. We Enter the Texas market in January of 2021, so less than 3 years ago, we have 148 shops now In Texas at the end of Q3, as we've gone into that market, we've rapidly been able to build scale and we believe that our brand awareness is catching up with us a So again, given the rapid, rapid growth that we've had in the state, we're quite pleased with where the AUPs are.

Speaker 9

Thank you.

Operator

Our next question is from Jeffrey Bernstein with Barclays. Please go ahead.

Speaker 3

Great. Thank you very much. Two questions as well. First one, just a follow on in terms of The traffic trends, I think you noted a little bit of easing from the Q2 to Q3, oftentimes in conjunction with that price increase. So I was wondering if you can share maybe how much pricing you're running in the 3rd Q4 and maybe how you think about that.

Speaker 3

I don't know how you measure the affordability or How you think about pricing into a slowing macro? Just trying to size up, maybe you have data on trends by income cohort. Just trying to get a sense for your confidence in your ability to take that incremental price without degradation of traffic over time. And then I had one follow-up.

Speaker 5

Thanks. Hey, Jeff. It's Charlie. I'll talk about the pricing facts and then I'll kick it over to Christine to give the qualitative answers. So Pricing impact on same shop sales in the 3rd quarter is approximately 8% to 9%.

Speaker 5

That is then going to drop To between 4% 5% for the 4th quarter.

Speaker 4

Yes. And then as we think about pricing and look at where we have opportunity, We're actually building in a new layer to the work that we do from a pricing perspective. So we're looking at willingness Effective and feel comfortable with what we've taken. And although that we don't have plans right now to take additional price, I do believe that we have room for that.

Speaker 3

Okay. Are you able to look at your or Look at your customer base by income level to be able to size up maybe traffic trends across different income levels? Like How do you test that just to get confidence that you have that pricing power?

Speaker 4

Yes. So we don't look at our base by income level right now, but the couple of So we do, do is we're looking at things by geography. This last pricing move we took, we actually took in tranches. And so we were able to look pretty surgically at what we did with the pricing move and look specifically at how different geographies responded As we did into those pricing moves over those different times. And the other thing that we look at is we look a lot at our rewards data and Understand kind of what's happening with frequency over those customers.

Speaker 4

We look at different frequency that they come in with and what happens when we take different pricing moves and do different Promotions, things like that. So we're looking at price from a number of different angles.

Speaker 3

Got it. And just my follow-up, you mentioned some new markets. I'm sure it's too new, but Alabama and Kentucky being most recently. But whether it's those dates or whether New markets over the past 12 months, the receptivity into new markets, can you talk qualitatively about what you've seen versus Perhaps your expectation, obviously, it's a brand going into new markets, so probably get some mixed results depending on where you're headed. So I'm just curious over the past year, the newest markets you've entered Whether it's cities or states, if you can just share any best or worst, how the performance has gone thus far?

Speaker 3

Thank you.

Speaker 4

Yes, we're absolutely still super excited by what we're seeing with response as we go into new markets, new cities, new states and have just an incredible responsiveness to the brand. We send pictures around of how the awesome long lines that we get to See, it's really like a party when we open a new Dutch Bros and love to see how excited both the Brewistas are and the customers are When they get to visit us for the first time and it's pretty amazing to be 800 shops in and still have this Really awesome reception as we go in Internet markets.

Operator

Great. Thank you.

Speaker 4

Thank you.

Operator

Thank you. Our next question is from Sara Senatore with Bank of America. Please go ahead.

Speaker 10

Great. Thank you. I have a question on the units and then just a follow-up on the pricing and the margin Construct, so the unit growth, I guess, you mentioned that your the TAM is unchanged. Does

Speaker 8

the rate of growth change?

Speaker 10

I know last year around this time you gave forward Guidance on unit growth, I was just wondering if this sort of rule you have of increasing the number of new units by 15% every year still holds or If having to widen out the development, radius, if you will, kind of changes the rate of growth. So that's the first and then like I said, just a second question.

Speaker 4

So a couple of things just on changing kind of the overall TAM. When we look at what we're doing from a development strategy, it really is just taking a little bit more time in many cases, maybe just a matter of months as we go into a new market and that's really just to allow the brand, to that brand awareness to build a little bit. I think the lines are double edged sword, right? So we have that our customers learn about us sometimes from seeing those awesome long lines as we go into a market. And then they also become the thing that they want us to change and they want us to shorten our line so that they can come more often.

Speaker 4

And so but we do think that that's an important element of Brand building as people kind of seeing that brand, seeing others love the brand and coming into the market that way. On the specific some of the unit questions, I'll hand it over to Charlie for some of that.

Speaker 5

You have follow-up there?

Speaker 10

Yes, it was about margins. So, I can The question actually about the margins and I would happy to hear both from you. But these margins are Kind of as high as I've seen in the industry, kind of above 30%. So I guess maybe you could just talk a little bit about that view. You talked about a year for room to reinvest.

Speaker 10

What is kind of a steady state margin at the four wall level?

Speaker 5

Well, they are elevating as you've noted and we did note some investments we're going to make that we made starting November 1st and we'll continue through the end of the quarter and all the way through next year. So you'll see the margin Moderate as a result of that. This is our highest seasonality quarter, so be mindful of that when you're looking at the shape of our margins. But largely where we're sitting today is a general expectation of a good place to be. We also talked about having flexibility and the power of this 4 wall model being so strong and allowing us to adapt to conditions changing in the market.

Speaker 5

And that's our view of our margin situation right now.

Speaker 4

Yes. And then, I wanted to go back and just answer your question on guidance. So, we're planning on doing holistic guidance, at the end of our fiscal year. And, but we do feel good about our long term growth targets.

Speaker 10

But and you'll sort of address the rate of growth Then just understood the TAM is unchanged, but just the pace of growth?

Speaker 4

Absolutely. Yes, we'll do that holistically at the end of the year.

Speaker 10

Okay. Thank you both.

Operator

Thank you. Our next question is from Jeff Farmer with Gordon Haskett. Please go ahead.

Speaker 11

Thank you. I might have missed it, but as it relates to the Q3 same store sales number, did you guys share the Fortressing driven, I guess, would be the sales transfer impact that was seen in Q3?

Speaker 5

We didn't in our script or comments de comp the comp. I did share the pricing piece as the earlier follow-up question. So from a comparable sales buildup, we're pleased with the 4%. We had high single digit positive pricing, About 100 bps of positive from discount mix net. The estimated sales transfer drag is right inside our range 200 to 300 basis points.

Speaker 5

And then the balance of that is going to be our traffic results, building up to the 4.

Speaker 11

Okay. That's helpful. And then, as a follow-up to the broader margin question, which was more of a restaurant level margin or shop level margin, Just sort of drilling down on the labor line, it's you guys touched on this, but it's been impressive. I think it looks like at least 5 quarters that you've Seeing 200 plus basis points of year over year favorability. How should we be thinking about labor costs heading into 2024?

Speaker 5

Well, I think a couple of things on that. First of all, what we noted was our investment in shop manager labor that we're going to make as of November 1. And then certainly we have the California wage incoming at us as of April 1 next year. And we'll continue to Thoughtfully examine our wage and incentive structure at the shop level and make appropriate investments there. And again, that's Why a 31% margin that we're showing today is so powerful because it does allow us the flexibility to deal with navigating those things.

Speaker 4

I would also share, we're really proud of our teams and how they've navigated labor. Our baristas are also our sales force. And so We are really thoughtfully navigating through labor, being careful where we spend, but also making sure we're making the right investments in labor to grow our sales, to make sure that we keep our lines at the length that our customers enjoy. And so I think that it's a really good partnership with very Thoughtful tracking and super proud of just our operations teams for all of the work we're doing in this area.

Speaker 3

Okay. Thank you.

Operator

Thank you. Our next question is from Brian Mullen with Piper Sandler. Please go ahead. Thank you. Just a follow-up question

Speaker 12

on the stores in Texas. In the last call, I think you indicated the stores were still following The same profitability curve as the rest of the system despite AUVs a little lower than the system average. I'm just wondering If that still holds true today, whether you think that would continue to hold true as you look out over the next, I don't know, 12 months? And then just related to that, just talk about how you plan to approach Development there next year, will you still be opening more stores in Texas next year?

Speaker 5

I'll go reverse first. We will open more shops obviously in Texas next year. The pace at which we open in Texas won't change dramatically. The question about productivity of new shops. So on a like for like AUV adjusted basis, Our newer shops at like volume, new shops are more productive than existing shops.

Speaker 5

And that's as we've moved east, we've benefited from lower operating costs on average than our existing West Coast markets.

Speaker 12

Okay, thanks. And just to follow-up, last call, I think again today in the prepared remarks, you mentioned Essentially value engineering the cost of the prototypes, which is exciting or interesting to hear about. I'm just wondering if you could discuss any progress Has been made on that front, how far along are you on that work and when you expect to see some benefits to the system from undevelopment?

Speaker 5

So there's really three ways to get our investment down. 1 is the mix of mold to suits and ground leases. More build to suits takes down your upfront investment. There are prototype changes, there are freestanding units or looking at in line end caps To bring your total capital cost down. And then there's just like for like on the actual prototype itself taking costs out.

Speaker 5

We have made some progress taking part of that cost escalation out, but we're realistic to know that we won't get Any significant measure of that cost back, 30% to 40% escalation would be hard to get back, but we are working Diligently to cut around the corners we can to take a portion of that out. And we have some good ideation on that and things in motion in our prototypes. Those won't show up until our pipeline kind of exhaust itself out 18 to 24 months. I just want to be practical and realistic with the listener that even if we took all those costs out today, we wouldn't get those into our pipeline.

Speaker 4

Yes. And I think the place where, we've seen a little bit of shorter term progress is in really thoughtfully thinking about the equipment, that goes into each of our shops. Yes, we have more shops in an area. We don't need extra equipment in a shop and so really being thoughtful about that. I think we've also shared our pre open numbers.

Speaker 4

And as you look at pre opening, as we have an existing shop in the market, we're really Taking advantage of that to train our employees up and so we've seen a drop in those numbers as well.

Speaker 6

Thank you.

Operator

Thank you. Our next question is from Sharon Zackfia with William Blair. Please go ahead.

Speaker 7

Hi. This is Tanya Anderson on for Sharon Zackfia. I just wanted to follow-up on the California wage increase. What is your average wage and how do you plan to offset it? And if it's price, how much do you think would be necessary?

Speaker 7

And Would you like look to protect penny profit or percent margin? Thanks.

Speaker 5

So as you know, the wage is going to 20. We are in the low $16 an hour at present. We have not yet determined What moves we will make from a pricing perspective, but we are actively looking at productivity And other options such that pricing becomes the default that we have to make. And we're also Really looking wisely at whether it is a margin percentage protection strategy or a penny profit protection strategy. And as we get to our guidance for 2024 and we really articulate the full context of that, when we're finished with our evaluation, We'll share what our thinking is on that.

Speaker 7

Okay. Thanks. And then just anything that's driving the greater the strength in the franchise versus

Speaker 5

Nothing, I would say, executionally or operationally that's different, which would be really the spirit of wanting to And that question, it's really just the mix of geographies, etcetera, of where they are versus where we are. But nothing really we can point to That would tell you anything is different operationally between the two groups.

Speaker 4

Yes. And I think the other piece, the sales transfer piece that Charlie spoke about Is we obviously would be infill that we have in Texas that those are all company owned shops. So we do have a greater impact of sales transfer in the company owned Okay. Thanks.

Operator

Thank you. Our next question is from Gregory Francfort with Guggenheim Securities. Please go ahead.

Speaker 1

Hey, thanks for the question. I have 2 quick ones. The first is just the investment in the shop manager wages. I'm curious what drove that? Was that just maybe compression versus True wages over the last 12 to 24 months or any other reason for that investment today?

Speaker 4

Yes, I think a number of things. I think for us it's really important to Stay ahead of the market and where we think investments are needed. And, one of the big things we're doing is in order to continue to get Great, great folks ready for that next level. We've looked at responsibilities in that role and we're thoughtful about Making some changes to responsibilities in those roles and wanted to reflect that in some of the added pay. We also thought we had an opportunity to align incentives with revenue growth and We're thinking through the profitability of the shops, so we made those changes for those reasons.

Speaker 4

And I think as we looked at kind of the strength of our performance and Where our shop managers were, this felt like a great time to make those investments.

Speaker 1

Got it. And then maybe just a follow-up there. What were the changes in metrics in terms of the incentive? Is it you're incentivizing them more in the bottom line or the top line than you were before?

Speaker 4

Yes. So, I think when we look at our overall priorities, it was it's to align, our shop managers to those overall priorities. And we're certainly very focused right now on driving traffic and driving revenue. So that is the biggest piece. And then We also look at some of the shop level profitability things like looking at labor.

Speaker 4

Again, it's a very delicate balance. We also don't want our shops to under schedule in labor. So we're thoughtful about making sure that they hit just the right balance on that line.

Speaker 1

Awesome. Thanks for the perspective. I appreciate it.

Operator

Thank you. Our next question is from Andrew Charles with TD Cowen. Please go ahead.

Speaker 13

Thank you. This is Zach Ogden on for Andrew. Could you give us an update on where the new shop volumes are tracking relative to that $1,700,000 you last disclosed? And then separately, is there anything you can do to reaccelerate those volumes outside of some of those broader sales drivers you've been talking about?

Speaker 4

Yes. Thanks so much, Zach. So we don't actually share that we did that I think for the offering that we just did, but we don't Those figures on an ongoing basis, what I would say is we think we have a number of different levers that we can use to drive AUVs. So a number of the things that I talked about just in general of what we're doing to drive traffic. We're also focused on building volume in new markets.

Speaker 4

And So thinking through ways to build brand awareness. So we're tracking sentiment in these new markets. We feel really good about How the customers in new markets are behaving as compared to customers in existing markets and really believe it's a brand awareness opportunity that we can go after. So we're doing all kinds of things to really further invest in the communities, Make sure that people know that we're there thinking through how we can partner with the local high schools and make sure that we have some visibility like, Let's say in our sports stadiums, things like that. So, we're excited about the things that we can do in these new markets.

Speaker 13

Okay. Thank you. And then as you look towards 2024, are you going to run Filletrade around once a quarter again? Or are you going to mix that or replace it with separate promotions? Anything on the promotional cadence for next year would be helpful.

Speaker 4

Yes. Look, we haven't planned our promotional cadence for next year yet. We are really looking at our sales kind of on a daily and weekly basis as we decide, which things to do and what will most benefit from. The reason why we like Filatree so much is it really is a deal on 4 separate drinks. And so we think especially in new markets We're building just so much customer love that it's a great way to share with your friends when you come into Dutch Bros.

Speaker 4

And it also just feels a lot like us. I think The breweries continue to comment that this is what it really feels like to be a Dutch Bros when I'm at a fillet tray day. And so We like to have those parties in our shops, but I think that's not the only thing that we do. We love that promotion. I think we'll continue to look at it, But we have a number of other things that are working really well as well.

Speaker 13

Okay, great. Thank you.

Operator

Thank you. Our next question is from Nick Sathian with Wedbush Securities. Please go ahead.

Speaker 14

Thank you. Just to clarify, the 8% to 9% pricing in Q3, that's a system price, right? Can you just tell us what the company owned Pricing was in Q3 and what that should be in Q4?

Speaker 5

We don't disclose that company price, But there's not a lot of difference between company price action and the franchise action.

Speaker 14

Got it. And then just to update EBITDA guidance, obviously, with the breakage last year, it would imply a pretty big Deceleration in the amount of leverage, not just in the labor line, but in occupancy and other, Even with the investments in labor, I guess what's the driver behind occupancy and other In terms of the deceleration of leverage?

Speaker 5

I don't know how you would get to an occupancy or other number Moving in the 4th quarter since we didn't guide the 4th quarter, but I would just characterize the investment in labor we talked about. We'll have some additional SG and A investments around capability building that we'll use to both Drive traffic and drive our ability to activate on all these things and growth through the coming quarters. So that's really what tempers our EBITDA guide to $150,000,000 to $155,000,000 given the over delivery in the 3rd quarter. We'll have some spend backs, both at the shop level and at the SG and A level.

Speaker 14

Okay. Thank you.

Operator

Thank you. Our next question is from Rahul Krotzapalli with JPMorgan. Please go ahead.

Speaker 6

Good afternoon, guys. Thanks for taking my question. On the personalization journey with the rewards Program and loyalty, like can you guys like elaborate on where you are here with 63% transactions coming in? How large Is the average check size from the members versus non members? And also if you can comment on the frequency of the rewards members change?

Speaker 6

And I have a follow-up. Yes.

Speaker 4

So we don't share that detailed level of data about the rewards program. What I would say is, again, It's a program that's really in its infancy, if I can say it that way, that the significant change we made in how we allocate Kind of the spend against it at the end of March has really allowed us to start sending out things like frequency challenges, Daypart, different attracting folks at different dayparts into the program. And so as we do all of those things, we're also experimenting with different points Levels of which, we have customers come in to the shops. And so I think that we will just continue to learn from that Program and get more sophisticated with the level of offers that we're doing within the program.

Speaker 6

Got it. And on the build to suit shift Back in the development pipeline, did you guys discuss the mix going forward as you increase them or ground leases to reduce capital intensity? And can you also discuss like how it can impact the rents to an extent possible?

Speaker 5

Yes. So we haven't discussed the mix. As we look at 2024 objectives and targets will give you some context. And just to temper your expectations, you don't make dramatic shifts And lease type, we make refinements and that's what we're doing. In terms of what it does to rent, A build to suit rent is higher than a ground lease rent.

Speaker 5

But what you're really doing is the trade off of less upfront cash intensity The build, a build to suit versus a ground lease, you're trading that for having more rent on a go forward basis. And you just we thoughtfully make those trade offs.

Speaker 4

Yes. And I would just add as we've shared before that we really expect any of the changes in the pipeline to be in the 2025 pipeline, That the 2024 pipeline has really been built out for some time. And so, we would expect to see minimal Changes to the 2024 pipeline.

Speaker 6

Thanks a lot, guys.

Speaker 4

Thank you.

Operator

Thank you. Our next question is from Drew North with Robert W. Baird. Please go ahead.

Speaker 9

Great. Thanks for taking my question. It's on the topic of cash flows. Wondering if you could provide some additional perspective on how you're thinking about free cash flow over the next couple of years? And then when you think you may return to free cash flow positive when considering all the changes you have underway with your development strategy?

Speaker 5

So the best way to think about that is, A, we have ample liquidity to get through this investment phase. Secondly, the store base, the company shop base is continuing to scale up its cash flow generation. That cash flow generation is going faster than the CapEx required to make the store investments. So Over time, as the company business scales in size and scope, it's going to become more and more self Funding, we have not shared when we think we'll be free cash flow positive. It's largely going to depend on the rate of shop growth, How many shops we build, etcetera.

Speaker 5

And when we get to guiding 24 and we can give some CapEx guide and some adjusted EBIT Got it. You'll see how those factors are playing out.

Speaker 9

Got it. Thanks, Charlie. Thank

Operator

you. As there are no further questions, I would now hand the conference over to Josh Rickey for closing comments.

Speaker 2

Thank you everyone for your questions. And final, it's been the honor of my career to lead Dutch Bros. Through this transformative period. From a regional drive thru beverage To our customers, employees, franchisees, suppliers, communities and investors, thank you all for your continued support. Dutch Bros.

Speaker 2

Success wouldn't be possible without each of you, and it's been an absolute pleasure to be by your side. Thank you.

Operator

Thank you. The conference of Dutch Bros, Inc. Has now concluded. Thank you for your participation. You may now disconnect your lines.

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Earnings Conference Call
Dutch Bros Q3 2023
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