Greetings, and welcome to the Dutch Bros Fourth Quarter 2022 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] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Paddy Warren. Please go ahead.

Good afternoon, and welcome. I'm joined today by Joth Ricci, CEO; and Charley Jemley, CFO. We issued our earnings press release for the fourth quarter and year end December 31, 2022, after the market closed today. The earnings press release, along with the supplemental information deck, have also now been posted on our Investor Relations website at investors.dutchbros.com. Please be aware that all statements in our prepared remarks and in response to your questions, other than those of historical fact are forward-looking statements and are subject to risks, uncertainty and assumptions that may cause actual results to differ materially. They are qualified by the cautionary statements in our earnings press release and the risk factors in our latest SEC filings, including our most recent Annual Report on Form 10-K and Quarterly Report on Form 10-Q. We assume no obligation to update any forward-looking statements. We will also reference non-GAAP financial measures on today's call. As a reminder, non-GAAP financial measures are neither substitutes for or superior to measures that are prepared under GAAP. Please review the reconciliations of non-GAAP measures to comparable GAAP results in our earnings press release. With that, I would now like to turn the call over to Joth.

Thank you, Paddy. Good afternoon, everyone. We appreciate your continued interest in Dutch Bros. In 2022, we delivered another year of growth with 133 new shop openings systemwide, a testament to our team's ability to execute our proven strategy. Despite the well-documented economic disruption, we've exceeded our new shop development targets for the third consecutive year and have now doubled our shop count since March of 2019. Although we continue to see signs of broader economic uncertainty, we entered 2023 well positioned to continue building market share and execute against our long-term goal of 4,000 shops over the next 10 years to 15 years. As we look forward, I'd like to share a few points that underscore why we feel confident in our long-term positioning. Our drive-through model is focused on speed, quality and service. Our goal is to be the highlight of our customers day, which we believe helps to cultivate lasting relationships. More than 95% of our sales are beverages, which we believe leads to more daily repetition than if we were serving food. We enjoy high AUVs without the supply chain and operational complexity of a restaurant, and our menu evolves to consumer preferences. More than 80% of our beverages are cold, which enables high levels of customization and can service several dayparts. We are particularly excited about the category growth of energy drinks and encouraged by our positioning within this competitive market. We have now opened at least 30 systemwide shops in each of the last six quarters, demonstrating the strength of our people systems and development pipeline. In 2023, we are targeting a 150 new shops, which positions us to achieve our five-year goal of 800 systemwide shops by year end. We will be within striking distance of $1 billion in revenue in 2023 and…

Thanks Joth. Here's a quick recap of Q4 financial results. Quarterly revenues surpassed $200 million for the first time, going 44% compared to the same period in 2021. Adjusted EBITDA more than doubled compared to the same period in 2021, and total company-operated shop contribution margin was 28.5%, up 940 basis points year-over-year. Recall that this contribution margin of 28.5% includes 220 basis points of preopening expenses. In Q4 2022 for the first time since launching the Dutch Rewards loyalty program in early 2021, we were in a position to recognize breakage. In late 2021, we notified customers that points earned in 2022 onward will expire in six-month increments and that points earned prior to 2022 would be grandfathered and with a one-year expiration. Going forward, given this backlog is behind us, we expect expirations will be more modest. In terms of the impact of breakage, note the following. Q4 company-operated shop contribution margin was approximately 210 basis points higher as a result of the breakage recognition compressed into the quarter. For the full year 2022 results, company-operated shop contribution margin was $4.9 million higher as a result of the 2021 expirations only, with an impact of 50 basis points. Let's move on to new shop performance. When we assess performance, a key aspect is achieving a company-operated shop contribution margin of 30% in the second year of the shop's operations. Despite all the headwinds we faced in 2022, we are on track with this objective. We have 172 company-operated shops in the class of 2019 and after that we consider mature, and they have reached margin efficiency and move past their initial preopening expenses. In 2022, these shops achieved a 29.4% contribution margin which as a reminder includes all the disruption we discussed earlier this year. Please refer to…

[Operator Instructions] Your first question comes from David Tarantino with Baird. Please go ahead.

Hi. Good afternoon. Charley, I was interested in learning a little bit more about the factors underpinning the profit outlook for 2023, so I know you mentioned the labor investments, but could you help us frame up what you're assuming for contribution margin at the shop level and I guess, separately or secondly, I was hoping that you could maybe elaborate on why you're not pricing against some of that inflation at this point? Thanks.

Hi David. Thank you. So on the shop contribution margin with all the puts and takes, we expect that to be flat. We have wage investments as I noted in my comments, two big items that'll essentially be offset by the rewards refresh benefits we talked about. There are other inflationary costs as we absorb the full year of those things that happened in '22 and '23. And at this point, we are not pricing in any big movements in our commodities at this stage. And then let me get to second part of your question. So, I think we're all aware of where our traffic trends are right now and what the consumer has been through. And at this point, given that we just refresh rewards, we take prices and typically in two windows in the spring and the fall. We just made the rewards move, it wouldn't be appropriate for us to make a pricing move at this stage. And also just looking at where our consumer is, we'd like to be able to absorb all these changes without rising prices in '23 and let the consumer environment settle down. It's really important that we maintain a good value for money position in our business and not look at that on a short-term basis.

Got it. And then on the rewards program change, I guess, can you elaborate on what the financial impact of that would be, presumably be less of a discount, but you mentioned some opportunities to reinvest behind that? So I guess, how should we think about the P&L implications of that move?

So it starts out as lower discount promotion costs as we will bring the cost of the program back to what we originally intended it to be given we've had a lot of menu price increases, so points earned will go lower as we mentioned from five points to three points that has an effect on discounts going forward. And then, Joth talked about in his comments that what we'd like to do is really move to the next phase of our rewards program and do more targeted incentives and offers to customers to get them to try different things and experience new things and we're going to spend a fair portion of that back in incentivizing particular things for customers.

Got it.

It's all important to note, David, that we announced this today, but you won't feel the impact of it until the second quarter onward.

Yes, understood. Thank you very much.

Thank you.

Next question, Sharon Zackfia with William Blair. Please go ahead.

Hi, thanks for taking the question. I guess first question, could you give us an update on initiatives that you have to kind of improve efficiencies or speed within the box and maybe unlock some increased throughput? And then secondarily, Charley, I think you are running maybe 10% of price in the fourth quarter, maybe I had that mistaken, but it just seems like you'd be carrying more price residually into 2023 is in the low single but I think it was in the press release. So can you kind of walk us through what price you rollout when this year that would be helpful? Thank you.

Yes. So the price rollover for the full year of 2023 is approximately 4% that will carry over. There's also, so if you, sorry Sharon, if you're trying to map to the low single-digit comp number, you've got that we guided to, you've got positive pricing rollover, but you've also got the sales transfer piece to factor in.

Thanks for that.

The list of operational improvements are long, but let's maybe -- let's touch on a few key ones. One is we've discussed cap systems and implementation of tap systems at Dutch Bros. We started with a test in a single shot in the fourth quarter of 2022. We've just launched five new locations in Texas. We're testing in San Antonio and another one in Dallas. We expect everything from production to delivery to back-end inventory to the speed of drink making to the quality of the product as we hand it to the customer. We believe that every one of those shows improvement and we believe that probably at the next quarter, we'll be able to start to share what we think will happen in metrics related to tap system implementation. The other big one is around rewards and we did just announce the changes to our point system, but really big unlock continues for us to be our Dutch Pass program and the loading of dollars and continuing to work with our customers to load more dollars into Dutch Pass. If we can get more people to pay with Dutch Pass, we can remove the unnecessary part of the transaction or just bumbling around the credit card or cash and just make it a quick scan of a QR code and move through the line. So, if those are the two big unlocks, that we know really help -- will really affect the business of short and long term. And then I know the team is working on several other smaller operational improvements to continue to work on speed.

Next question, Chris O'Cull with Stifel. Please go ahead.

Hi, thanks, good afternoon. Charley, you pointed out in your presentation that last year was a tale of two halves, so I was hoping you could maybe help us understand how we should think about the cadence of comp and shop margin performance as you kind of progress through the year?

Yes. So, comp will be more front loaded as we rollover as we carry over the pricing from 2022 for full year 4%, it will be zero rollover by the fourth quarter. If you think about the cadence of margin will when you're making those labor investments immediately that we mentioned, so you will feel the margin impact of that on a sequential basis in Q1 then the rewards refresh comes in to create some recovery around that and margins will normalize from the second, third, and fourth quarter and what we I think we're going to see in the business is a more normal seasonality curve to our margins from Q1 to Q4 being our lowest seasonality, Q2 to Q3 being our highest seasonality. 2022 didn't follow that shape because of all the inflation in the first half and then as catching up on prices in the second half.

Okay, that's helpful. And then I believe you said you're assuming new stores opened at $1.8 million in annualized sales, but I think the stores have been opening at higher levels. So I'm just curious why not build in a higher volume into the projection. I didn't know if maybe you're seeing anything in terms of variability by geography that cause you to be more conservative.

Yes, no it wasn't that we're assuming $1.8 million going forward. It was that our recent class of stores was averaging $1.8 million, our 22 -- our latest class of 22 stores, whereas the prior classes at average about $2 million. So that was the distinction we made in our comments.

Okay, sorry I misheard that. Thank you.

With actual results.

Yes.

Next question, Andrew Charles with Cowen and Company. Please go ahead.

Great, thanks. Joth, can you talk about how you tested the Dutch Rewards accrual changes, just given how young the program is, just kind of curious what gives you confidence that the changes won't drive a sour customer reaction?

Well, I think as we kind of -- as we've been talking from the day that we started this program, we were really on a journey. The year one for Dutch Rewards was about launching, gathering, understanding consumer preference with that was all about. Year two, we spent a lot of time with testing, iterating, understanding the market level and the individual customer level, how they have responded to points, we did several different promotions that we incentive the customer with different point levels and actually we saw that in many cases, lower points drove the same type of behavior as higher points. And then really year three, I think we can define it as execute and refine and as we think about that we're now taking really the learnings over the last couple of years and all of the data points that I think our team has looked at to have confidence in and how we take the five to three program, how we have basically maintained the free drink offering with points that are in the bank and now we basically move forward to basically at the price adjusted program, so we don't -- we're not too concerned about the change there, and feel like that we think this is fair to the customer, we think this is fair to the initial program that we launched in 2021.

Got it, that's helpful. And my other question Charley is for you, just with the 2023 adjusted EBITDA guidance, it might be semantics, but the slide callout at least $125 million in adjusted EBITDA in 2023, totally get, obviously the labor investments you guys are being proactive on, but just trying to think about it if I bridge to consensus, where is perhaps the conservatism guidance within just the slide pointing at $125 million plus. Is it around those flat shop margins? Is it around potential G&A? Is it sales based on your date performance to just trying to better understand kind of the flex as we try to bridge the consensus numbers?

Yes, some of the flex is we're not pricing in any commodity upsides. We're watching dairy prices closely. So those have come down a little bit, but we don't feel it's wise to take that to the bank until we see it set in from the real. We're making about a $5 million investment in our technology platforms, all of the platforms across the business on a year-over-year basis. So that's part of the factor. And then I think you just take the additional wages that we built in, the $8 million move. And that's really outside the scope of what we normally would have to do and the fact that we're being careful not to price and you can pretty quickly walk yourself up to a number beyond $125 million and why we've been thoughtful about investing and careful about how we guide. We don't want to come back to you.

Makes sense. Thanks guys.

Thank you.

Next question, Sara Senatore with Bank of America. Please go ahead.

Great, thank you very much. Quick question on the accounting for the breakage and then I'll have sort of a more in-depth question on the new units and kind of how to think about margin returns. So just so I understand the breakage, was that a tailwind to comp? And so you sort of basically just have this top-line that has no costs associated with it and that's why it was a boost to margins, I'm just trying to think about sort of normalized margins in that context. And then on, I guess if I step back on the marginal returns to the business, CapEx is going to be a bit higher than we may have thought. You being, I think appropriately conservative on EBITDA, but new unit volumes are perhaps a bit lower than they were. I guess, is there anything that sort of structurally different? Is there any reason to think that the economics that you've talked about in the past no longer apply? Just trying to understand how much of this is transitory versus just what it means to be growing in new markets? Thanks.

Thank you. So on the rewards accounting, it does not affect comps, but to the point you made, it is in a revenue number and in the profit number. And $4.9 million and we disclosed this in the release is related to a lot of sign-on points and things that we gave offers we gave back in 2021. So we distinguish between that. The best way to look at is the way we put it in the release for 2022 that prior year piece was about 50 basis points if you normalize for that. In terms of your question around the go-forward cost structure. No. Our objective was to get a weighted 30% cash returns on a ground lease rates. So that's the most severe return we have when we have to build the entire unit ourselves. At those $2 million AUVs and our margins, we were well in excess of that 30% return. And I think as we look at things potentially moderating, meaning the cost side going up, we saw double-digit build cost inflation, we'll probably continue to see double to mid-double-digit inflation going forward that will eat into some of the excess return we had in our investment thesis. But we still believe and our numbers tell us that the strong four-wall model we have, the high margins we have is able to absorb any punishment from build costs in the near term.

Okay, thank you. And just the 1.8 versus the 2 is that because of the infill -- more of the infill, more new markets? Is there anything to sort of pay attention to that?

So we are going deep, especially in Texas where we've had some opportunistic places where we can build out very quickly one particular market. In 12 months, we opened 14 shops. So we see some of that. It's also the portfolio. It depends on the timing when shops open. Sometimes we have high-volume California, Arizona shops waiting in. In the fourth quarter, we had less of that and more of the deeper and the trading markets like the Texas markets we went in. So that will ebb and flow over time.

Understood. Thank you so much.

Next question, John Ivankoe with JPMorgan. Please go ahead.

Hi, thank you. The question is on labor, which is actually down quite a lot relative to our expectations, both on a percentage of sales and per operating week basis. Could you talk about what if anything changed in the fourth quarter? Is that your go-forward model for labor? I understand traffic would have been down, but did you find some efficiencies on labor in the system in the fourth quarter that really do make sense going forward. And also, I'd like to ask about hourly turnover and also hourly tips as well if I can. Thanks.

Yes. Hi John. I see the same numbers you're looking at the fourth quarter, there were 4.5, about 450 basis points of improvement in labor from Q4 this year to last year. It's really three things, there's clearly a lot of pricing and if you look at one of the aspects of our cost structure that has some fixed costs in it, the way we staff our shops, labor allows us to do that. We also really worked hard this year to do our staffing better to take out over-time -- dramatically take out over-time because we're so well positioned and so well staffed, so we got some good leverage out of that and productivity. And going forward, something similar to this will stick because we have made all of these improvements in how we operate. Having said that, we're also going to have the wage investments that I noted. So you'll see us come off of this number that we developed -- that we delivered in Q4, but then in the first quarter, watch that number is going to go back up because of the wage investments that we just announced.

And can I ask about hourly turnover and also the level of hourly tips?

Yes. Hi, John, it is Joth. What's your question?

Hourly turnover year-over-year. I know at one point it was going up and tips were actually going down at one point for the employee level. If those are stabilized or if that's still something that you're looking at?

Yes. Q4 turnover actually is down about 300 bps from it was in Q3. We're and so kind of stabilized in that mid-70s range. What's interesting is that November and December monthly turnover was the lowest that we've had in the last 19 months. So we're definitely seeing -- continue to see a strong labor impact across our shops, but I think it's a really good sign. From a tip standpoint, we think that tips, actually it's stabilizing. And non-federal minimum wage states are actually showing a slight increase in recent quarters. So lot of tip noise that was out there seems to have settled down in the fourth quarter and obviously, we're tracking that closely as we get into 2023.

That's great. Thank you.

Next question, Jeff Farmer with Gordon Haskett. Please go ahead.

Great, thank you. On the labor investments and mandated minimum wage increases, I just have a couple of follow-up questions. So, the first would be what level of sort of blended wage inflation? Does this equate to in 2023 across sort of the two increases?

I can talk in margin points. I don't have in front of me the exact percentage increase, but it's about two margin points. The combination of both of those will be about two margin points.

Okay. And then just again thinking forward on this theoretically, you'll find some mandated minimum wage increases appearing again in 2024, so is it just a dynamic where we're going to see more of these increases as we move forward? Or is this a specifically unique year and that you guys decided to actually raise wages in the federal minimum wage states, which again, that's at your own discretion, so it's just 2023 going to be an outlier year in terms of size of wage rate inflation or is there more to come in terms of what's mandated out there in 2024?

So separate the two things which you have done, kind of in your question, which is the proactive thing we're doing with wages in federal minimum wage states. We wouldn't expect that to continue beyond this year. So, there's always going to be wage escalation, but that sharp move we made is kind of a one-time move. The mandated wage escalation is going to continue to your point, it's going to continue onward in a similar fashion. The unusual situation, I would say, against that is typically we would have used pricing moves to pay for part of that and because of other factors we talked about, we're really trying to get through '23 without having to take our prices up. So going forward, '24, '25, you would expect us to absorb some of that through normal price increases and productivity.

Okay. And then just one more follow-up. I believe this one will be a little bit more straightforward. So you guys had said on commodities, not much movement, I think was the quote. It's been touched upon on this call, but exactly what does that mean for dairy and coffee in terms of inflation for both of those commodities for you guys in 2023?

The slope of the increase is definitely slowed down, but if you reflect on '22, the sharp rise in the first half, we are planning a full 12 months of those higher costs first of all, right, and versus of less than 12 months impact in '22. We are seeing dairy come down, but it's not been there long enough for us to really take that to the bank, and dairy is the biggest piece of this, frankly. So that's our view is annualizing over a partial year of inflation, that's a reality for us. Hope is not a strategy but some hope that dairy moderates downward and we get some upside out of that.

And I apologize, just one more follow-up. I appreciate you guys sort of giving me some latitude here, but you meant this is the last one, you mentioned $5 million technology investment. I'm just curious if that shows up as capitalized or as expense? How does that show up on the P&L, the balance sheet, where are we going to see that $5 million tuck investment?

In the SG&A line.

Okay. I appreciate it. Thank you.

Next question, Nick Setyan with Wedbush Securities. Please go ahead.

Thank you. I wonder if you could just break down the transaction growth versus average check in the quarter?

Yes. So here's the decomp on Q4 same-shop sales. I mentioned negative [6.10] reported. I'll use some round numbers to make it easy, plus 11 on menu pricing, minus 1 from estimated sales transfer, that was actually 130 bps, minus 1 from higher discount promo costs, 2% mix shifts. Notable, we didn't see any sizing trade-down there. It's just a mixture of goods that we sold. And so what's left is the 7% underlying negative traffic. Q3 was negative 3. So on a reported basis, Q4 was we decelerated, so more negative traffic, but we also want everybody to understand we're lapping an amazingly good Q4 2021, it was our best quarter in 2021.

Yes. That's very helpful. Thank you. And just given the really solid January and February to date data across the industry that we're seeing in terms of the top-line trends, any sort of early commentary around how Q1 has started?

I think one thing to remember that's different about Dutch is how we've reacted to the various virus events, so we largely stayed open through the episodes in the winter of '21 and the winter of '22. Open meaning we were fully staffed and operating. So many of the -- much of the data you're seeing from a rebound perspective is something we won't have. We won't have a rebound because we never had outages related to that. So our lap is what it is what it is because we didn't go down in those episodes. We've seen some negative weather impacts, especially as we come out to the West Coast in December this year and right now. So we're just -- we're not going to see that Omicron bounce we call it that many of our peers will see in Q1. Now, what's going to happen in Q1 is we will start to move through the March period where we talked about last May that was a difficult period for us, so we may see some better sales lap in the back half of March.

Okay, that's very helpful. And then in terms of just the change in the loyalty, anyway to quantify the lesser discount going forward starting in Q2?

Yes, so it'll ramp. It will start to flow through the P&L in Q2 and build in and peak in Q3. So we're looking at about a 100 to 200 basis points of margin improvement that will come through that. Now, we talked about investment, we're using. We're paying for that with this benefit, right, and not taking price.

Understood. And then just last question, a clarification. When you said and I think you said that again earlier in the call in terms of pay for the labor, investments with this change in the loyalty program, should we take that as across the entire company margin or labor could be flat year-over-year?

Well, there's two labor pieces, right? So there is the wage floor piece that we talked about the $8 million and there's $11 million in minimum wage. I would say that, if you take the rewards refresh, the value of that left to spend back, we're going to do on it. We're still not going to cover that wage investment.

Okay, understood. Thank you very much.

No, obviously.

[Operator Instructions] Your next question comes from Gregory Francfort with Guggenheim Securities. Please go ahead.

Hi guys, thanks for the question. I had two, I know -- I should be only doing one, but the first was just do you have rule of thumb on what G&A should be growing as a portion of revenue, either in '23 and the out years just as we think about that? And then my other one is just Christine's role and her coming in, what responsibilities do you think she can take over and kind of what do you think -- what do you expect her to focus on in her early days as President? Thanks.

Yes, thanks for that. This is Charley. So, what we're trying to do right now is drive that adjusted SG&A number and you can see the reconciliation in our release down below 18% in 2023. When we went public in '21, that number was almost 24%, so thinking about it, right? We want to drive that percentage down, which means, of course, we want G&A to grow slower than the rate of revenue. Ultimately, how slow it grows down the road, don't want to get locked into that, but do want to lock into driving that number below 18% in '23.

And I think it's a great tie-in to the question about Christine because I think that for us, Christine will run all the day-to-day operations of the business. So everything from our retail team to marketing efforts to our operating team to people systems and really executing -- really our AOP. The thing that we looked for in Christine and we really feel like we landed the best candidate in the country for this job was we wanted somebody who could look out, who has been through a larger operating business like this and be able to build our systems to scale. So the number that Charley speaks to is a key component to how we will continue to grow and execute the business at scale and we look at some of our other peers in the industry and understand some of the numbers that we'd like to get to long term. So, Christine's ability really to come in, look at the business at a big picture, lead our team so that we can be big and be small at the same time, our important aspects. So really executing every day, driving the rewards program, building out AUVs, hitting the new shop program, driving our operating and logistics systems behind the scenes to be able to serve across 4,000 locations long term and then building people systems to really operate it with employee base that runs between 50,000 and 75,000 people. I mean, those are all things that we will rapidly be get into, will be follow our growth plan correctly and she has got the experience to do that.

Thank you.

Thank you. I would like to turn the floor over to Joth Ricci for closing remarks.

Thank you. For more than 30 years, Dutch Bros has been in the business of building and nurturing relationships and we have all the building blocks to remain a successful and enduring company, while creating real value for our shareholders. These attributes include a powerful authentic brand, strong people systems that drive company culture and fuel our shop growth, the highly engaged customer following, customizable and uniquely curated beverages, the highly consistent and highly attractive unit-level economics, a portable model that is successful across geographies, the strong and well-capitalized balance sheet that provides ample liquidity and an engaged co-founder and an experienced leadership team. And for our investors, thank you for your time, and as always, the continued support of Dutch Bros. Thank you, everybody.

This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.