Chuy's Holdings, Inc.

Good day, everyone, and welcome to the Chewy's Holdings second quarter 2023 earnings conference call. Today's call is being recorded. At this time, all participants have been placed in a listen-only mode, and the lines will be open for your questions following the prepared remarks. On today's call, we have Steve Hislop, President and Chief Executive Officer, and John Howey, Vice President and Chief Financial Officer of Chewy's Holdings Incorporated. At this time, I'll turn the call over to Mr. Howey. Please go ahead, sir.

Thank you, Operator. Good afternoon. By now, everyone should have access to our second quarter 2023 earnings release. If not, it can be found on our website at chewies.com in the Investors section. Before we begin our formal remarks, I need to remind everyone that part of our discussion today will include forward-looking statements. These forward-looking statements are not a guarantee of future performance, and therefore you should not put undue reliance on them. These statements are also subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. We refer all of you to our recent SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial conditions. Looking ahead, We plan to release our third quarter 2023 earnings on Thursday, November 2nd, after the market closed. With that out of the way, I'd like to turn the call over to Chewy's President and CEO, Steve.

Thank you, John. Good afternoon, everybody, and thank you for joining us on our call today. Our results marked another strong quarterly performance with second quarter revenue growth of over 7%, including a 3.2% improvement in comparable restaurant sales. During the quarter, we saw solid comparable sales growth across all periods. Moreover, our strong top-line momentum has continued and we are pleased with the results we've seen thus far into the third quarter. In terms of profitability, we grew restaurant-level operating margin dollars by over 21% and generated an industry-leading restaurant-level margin as of a percent of revenue of 21.6%, which represents a 250 basis point improvement over last year. We are proud of what our team was able to accomplish during the quarter and believe that these results are a testament to the continued progress we are making on the various initiatives we've put in place to drive sustainable top-line growth and profitability. Moving on to our growth drivers, we continue to focus on menu innovations through our Chewy's Knockouts, our CKO platform. In April, we introduced our guests to several exciting menu items, including the Tex-Mex Burrito Bowl, Grilled Grouper Tacos, and Creamy Green Chili Chicken Enchiladas. The CKO perform continues to resonate with our guests as our April CKO drove incremental traffic and mix at a higher percentage of the sales than our previous CKOs. To build upon this excitement, in late July, we launched our most recent CKO with Hatch Green Chili Burger, steak burrito bowl, and chicken tenga enchiladas. Early feedback from our guests thus far has been very encouraging. Our off-premise channel also performed very well during the quarter, mixing at approximately 28% of total sales as compared to 27% a year ago. The delivery channel helped drive our off-premise growth with over a 30% increase in volume, mixing now at approximately 10.6%, of our second quarter sales, an increase of approximately 210 basis points versus last year. In addition, we saw a significant improvement in our catering channel as we continue to build out our catering markets, representing 3.5% of our second quarter sales, an increase of approximately 80 basis points versus last year. Over time, we continue to believe our off-premise business will represent at least the mid-20s of our sales, with catering contributing approximately 4% to 6% of the total sales. In terms of our marketing initiatives, our optimized digital media strategy effectively communicates our defining differences from our incredible value for our made-from-scratch food and drink to our exciting CKO offerings and overall differentiated experience at every Chewy's restaurant. This includes the use of TikTok, organic influencer programs on Instagram and Facebook, YouTube video advertising, and a promotional advertising partnership with DoorDash. Lastly, let me provide some update on our development plan. During the second quarter, we successfully opened one new restaurant in Oklahoma City, Oklahoma. Subsequent to the end of the second quarter, we opened one additional restaurant in Harker Heights, Texas. We're pleased to report that all of our recent openings have performed to our expectation. Additionally, in the second quarter, we closed one restaurant in the state of Illinois's This was a unique opportunity to exit the lease of a satellite location at no cost to the company, and we do not currently expect any additional strategic closures. As we look ahead, we remain excited about our organic growth opportunities. For 2023, due to the continued permitting and inspection delays that are outside of our control, we are now expected to open five new restaurants, three of which have already opened and the remaining units scheduled for the fourth quarter. Unit growth remains a core piece of our long-term growth model with our strategic focus on markets where our concept is proven with high AUVs and brand awareness. We continue to believe we can achieve 10% unit growth over time, and the growth we expect to achieve in 2023 and 2024 will be important steps to get there. With that, I'll now turn the call over to our CFO, John Howey, to discuss our first quarter results in greater detail.

Thanks, Steve. Revenues for the second quarter increased 7.3% to $119 million compared to $110.9 million in the same quarter last year. The increase was primarily related to improved improvement in our comparable restaurant sales as well as an additional 53 operating weeks from new restaurants opened subsequent to the second quarter of 2022. In total, we had approximately 1,289 operating weeks during the second quarter of 2023. and off-prem sales were approximately 28% of total revenue as compared to 27% a year ago. Comparable restaurant sales in the second quarter increased 3.2% versus last year, primarily driven by a 5.8% increase in average check, partially offset by a 2.6% decrease in average weekly customers. Effective pricing during the quarter was just shy of 7%. and we expect to carry approximately 3.25% to 3.5% pricing the remainder of the year. Turning to expense, cost of sales as a percentage of revenue decreased 310 basis points to 24.7%, driven by leverage on menu price increases, as well as overall commodity deflation of approximately 4% during the quarter. Based on the current market conditions, We continue to expect flat commodity inflation for the fiscal year with deflation of low single digits for the third quarter. Labor costs as a percentage of revenue increased approximately 40 basis points to 29.5%, primarily due to hourly labor inflation of approximately 5% at our comparable restaurants, as well as incremental improvement in our hourly staffing levels as compared to last year. This was partially offset by many price increases taken subsequent to the second quarter of 2022. We continue to expect hourly labor rate inflation of mid-single digits for the fiscal year and third quarter, in addition to a continuation of year-over-year staffing level increases. Operating costs as a percentage of revenue increased 10 basis points to 15.9%. driven by higher delivery service charges from increase in delivery sales and an increase in repairs and maintenance costs, partially offset by lower utilities and higher sales leverage on insurance costs as compared to last year. General administrative expenses increased to $7.7 million in the second quarter from $6.5 million in the same period last year, driven mainly by higher performance-based bonuses. As a percentage of revenue, G&A increased to 6.5% from 5.9% during the same period last year. In summary, net income for the second quarter of 2023 increased 2.8 million or 36.4% to 10.7 million or 59 cents per diluted share compared to 7.9 or 41 cents per diluted share in the same period last year. During the second quarter of 2023, We incurred $0.5 million, or $0.02 per diluted share, in impairment, closed restaurant, and other costs, compared to $0.07, or $0.03 per diluted share, in the same period last year. The decrease was primarily related to a reduction in rent paid on previously closed restaurants. Taking that into account, adjusted net income for the second quarter of 2023 increased by $2.7 million or 31.6% to $11.1 million or $0.61 per diluted share compared to $8.4 million or $0.44 per diluted share in the same period last year. Moving to our liquidity and balance sheet as of the end of the quarter, we had $82.6 million in cash and cash equivalents, no debt outstanding $35 million available under our revolving credit facility. We also purchased 83,521 shares of our common stock during the quarter for a total of $3 million. As of June 25, 2023, we had $47 million remaining under our $50 million repurchase program, which will expire on December 31, 2024. With that, let me provide an update on our outlook. For 2023, we are now expecting an adjusted EPS of $1.80 to $1.85, which includes an estimated $0.08 to $0.10 per share positive impact due to the fourth quarter of 2023 containing 14 weeks versus 13 weeks in fiscal 2022. This is based in part on the following annual assumptions. G&A expense of $30 to $31 million, five new restaurants, net capital expenditures of approximately 30 to 35 million, restaurant pre-opening expenses of approximately 2.5 to 2.7 million, effective annual tax rate of approximately 13% to 14%, and annual weighted diluted shares outstanding of 18.1 to 18.2 million shares. With that, I'll turn the call back over to Steve.

Thanks, John. Our passion has always been to provide our guests with the unique Chewy's experience through our high-quality, made-from-scratch food and drinks offered at an incredible value. We believe this is clearly reflected by our performance year to date. Through our continued focus on four-wall operational excellence, thoughtful capital allocation, and exciting pipeline of unit growth, we are well-positioned to capitalize on our positive momentum and the vast opportunity ahead of us. Most importantly, I'd like to thank each and every Chewy's team member for their hard work and dedication to earning the dollar every single day. With that, we're happy to answer any questions. Operator, please open the line for questions.

Thank you. And ladies and gentlemen, at this time, we'll conduct our question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from Joshua Long with Stevens. Please state your question.

Great. Thank you for taking my question. When we think about just the underlying environment and the strong results you reported, Steve, I think you mentioned that there was, you know, solid comps through the quarter. I'm curious if you could talk about that, what you're seeing from the consumer, and then maybe just any other reads you have in terms of how they're using your concept. It feels like, you know, perhaps the mix piece and, you know, the traffic piece is consistent if you kind of look at the underlying piece, but would be curious what your perspective is given kind of the update in the current environment.

You know, we haven't seen, you know, it's been pretty consistent over the last year, year and a half. And we haven't seen a whole bunch of pullback in any one area, maybe slightly in bar mix. And a few months back, probably slightly in apps. But since we added on our bowls, you've seen that rebound a little bit. So we haven't really seen any main issue as far as real differences of our track over the last year.

Got it. That's helpful. And when we think about some of the strengths you called out on the CKO platform, can you talk about how that's progressing versus your expectations? And it seems like that may be in April or in the 2Q period that brought in some incremental guests. And just curious if you attribute that to awareness, just culinary innovation, maybe all of the above, but anything that you could share there in terms of just...

Yeah, all of the above. Thanks for answering the question. Yeah, so a little bit all of the above. You know, we've realized probably one, one and a half percent of traffic, I'd say, by the CKOs. And, you know, obviously, we just finished our third, we have just finished our third, entering our fourth one ever for us. And so, you know, it's really got a level of excitement, starting with our people first, and then obviously, on all our digital marketing and so far that we're doing is really getting people excited about trying some new stuff that's out there. Like we mentioned before, we usually run three items that will run for a total of four weeks in our stores. So four to six weeks. So we're pretty excited about those. You know, coming up in the fourth quarter, you'll see a little bit of a change in some of the CKOs where we're going to do a barbell approach to one item that will start in quarter four. That's coming up. But, yeah, it's built a nice excitement, and really it's nice to have some new things to talk about on a quarterly basis.

Appreciate it. And then one last one, then I'll hop in the queue. When we think about just the overall development environment, we've heard a lot from your peers in terms of just permitting being the primary point of friction. It seems like you might be seeing something similar to that. But just curious how you're thinking about development overall, human capital investments to support that, and then specific to the two units that sound like they might have slipped – as part of your updated unit development guidance. Do you think about those flipping into next year and being additive or does that just kind of push the entire pipeline out?

I'll go with the end first. It's definitely going to just push the whole pipeline out a little bit. That's how that's going to work. You know, with the construction, not only the permits and getting some, you know, people coming out and walking the units, it's still the construction cost is still quite a bit higher than it has been. And, you know, we've seen that kind of flatten out, but it definitely hasn't come back down yet. So we're kind of also looking at that as we move forward. But you'll see us, you know, this year in that five, you know, the five that we mentioned. And then our long-term goal, you know, right around probably in 25 is to get back to that 10% growth rate.

Got it. One more there. Do you think that you can accelerate that in 2024? Because as a, you know, a step function, if you're going to do five this year, can Is that the right number in absolute terms, or can you step that up despite some of the headwinds that we're seeing out there?

I'd say, you know, a couple more than five, you know, we'll be looking at probably for next year, and then, you know, by 25 to get back to that 10% growth, as I mentioned a second ago. Great. Thank you. Thank you.

Our next question comes from David Tarantino with Baird. Please state your question.

Hi, good afternoon. First question is on the recent sales trends. I think, Steve, you mentioned that you were pleased with what you've seen so far in Q3. I was wondering if you could elaborate on what you're seeing more specifically. I know you have less pricing than you had in Q2, so any color would be helpful. Thank you.

You're welcome. It's really trending fairly similar to P6 in that Two plus range, two to three.

Okay. And that's the total comp?

Yes, sir.

The total comp, yeah. And as you mentioned, you know, we had about three to three and a half percent pricing roll off. So that's talking, you know, you're talking about a one percent negative traffic possibly?

Yep.

Got it. Okay. That's good. That's helpful. And then You know, John, if I look at your guidance and the performance you've had on restaurant margin, it looks like maybe this year is shaping up to be at least at the high end, if not above the high end of that long-term target you shared previously. So I was wondering if you could kind of frame up how you're thinking about the margin structure longer term, and is it possible to think about 20%. plus type restaurant margins, you know, as you look at the business?

Well, I mean, it's all related to kind of the volumes and how those shake out. But what we're seeing for the rest of the year, you know, we're looking in the third quarter with those prices coming off. We're not going to have the sales leverage that we've had in the first two quarters. And so, you know, we're going to see a little less margin here in the third quarter. And then in the fourth quarter, obviously we have the extra week, but we're also rolling over the addition of our extra delivery partner in the fourth quarter. So that's going to flatten that out a little bit as well. So I think that will temper the margins a little bit than what we're seeing right now. But long term, I mean, we're still looking at that, you know, 300 and 350 basis points above. So in that 19 to 20 percent range.

Got it. Thank you very much.

Thanks, David. Our next question comes from Brian Mullen with Piper Sandler. Please state your question.

Hi. Good afternoon, guys. This is actually Aisling on for Brian. My question is about your recent catering business and how that is coming along versus, you know, your own internal expectations of that and what kind of impact has it had to your off-premise business? Thanks.

Yeah, we're excited. Obviously, you know, we're in 16 state, well, how many, 16 markets, 17 markets currently on the catering. And we're excited. I think I mentioned in my prepared statement, we're about 80 basis points higher than the year. And so we're very, very excited about that. We'll continue to add certain trucks and refill some of our markets as we continue forward. But we believe long-term, We believe that catering number can be in that 4% to 6% range over the next few years.

That's great. Thank you for the color. I'll pass it back.

Thank you. Your next question comes from Brian Vaccaro with Raymond James. Please state your question.

Hey, thanks and good evening. I just wanted to circle back on commodities and John, could you provide some more color on the items you're seeing favorability on driving that recent deflation and also remind us where you are on your beef contracts specifically?

Sure.

So I'll just start with the beef. Beef, we're contracted through the rest of the year, just a little spillover in the next year, but not much. So it's really just basically through the rest of the year and those are at prices a little less than last year. So that's some of that deflation. We're also seeing significant deflation, obviously, in chicken, as I think most people are coming off of the all-time highs from last year. Seeing deflation in dairy as well. And then some of our produce. But we expect kind of the produce that always kind of jumps up here in the third and fourth quarter. We're also seeing inflation in some of our grains and oils. and things in our grocery basket. But those are really the big items.

Okay, great. Thank you for that. And on labor, you talked about increasing staffing levels, which I think makes a lot of sense as Diamond continues to recover. But could you provide any perspective just on how much average hours were up or some other way that you might be able to quantify that? And maybe more broadly just speak to, you know, what you're seeing in terms of turnover And are you seeing any tangible benefits of more tenured teams driving better ops, increasing guest satisfaction, et cetera? Maybe just speak to that dynamic a little bit.

Well, I'll speak to turnover. Turnover, you know, from an hourly standpoint, we're still a little over 100%. From a management standpoint, a little over 26%, 27%. And as far as the hourly, I don't have that figure for you as far as the increase over last year. But what we have been doing is replacing a lot of our overtime hours with kind of full-time positions now, which obviously when you're replacing with fresh people, that's going to help the guest experience as well. So you don't have as much overtime. So that's also good. you know, helping out. But we're continuing to get, you know, fully staffed on each and every shift, and that helps the customer experience.

All right, that's great. And then just lastly, on the development front, obviously, build-out costs have been pressured in recent years. Are you seeing any green shoots of relief on that front, on the horizon? And maybe you could just level set us just in terms of your unit economics that you're underwriting as you think about the pipeline X 12 to 24 months.

Well, we continue to underwrite. You know, we're looking at the cost in a new unit in that 2.9 to 3.3 is kind of the cost of it, all in net of landlord dollars. But As far as what we're seeing from a construction cost standpoint, we're seeing costs starting to flatten out but not yet come down. You know, I think I've heard somebody else saying we don't want to get these developers used to these prices. And so, you know, hopefully we're trying to get as competitive as we can in some of these pricings so we can bring those costs down. But right now we're not seeing it.

All right, great. I'll pass it along. Thank you.

Thank you. Your next question comes from Todd Brooks with Benchmark Company. Please state your question.

Hey, good evening, everyone. Quick question. There's not much left to ask, but you talked about, Steve, you referred to kind of the June-July trends, and I think there were, Johnny, my size, I'm in the two to three range range. which with the pricing roll-off is very impressive for the July result. I'm just wondering with your geographic footprint, this crushing heat, have you been able to use the patios to the full extent that you normally would seasonally in the summertime? And do you have a sense of maybe is there actually a stronger underlying demand that just this brutal heat is keeping from being able to use the restaurant? Thanks.

Yeah, it's been wild, but is that really exactly? I think if you remember a year ago at this time, we talked about the 60-something days of over 100, and we're just in it again, so it's very similar to a year ago, and yeah, it definitely affects in Texas, obviously, and elsewhere, definitely some of the patio sales. No one's sitting out in the patio at 100 degrees, so that's definitely in effect, but Like I said, it's very similar to a year ago at this particular time.

That's true. Thanks, Steve. You got it, buddy.

Our next question comes from Nick Setian with Wedbush Securities. Please state your question.

Thank you. In terms of the commodity inflation, I appreciate the Q2 disclosure on down 4%. And I'm sorry if I missed this, but what's the Q3 expectation, the Q4 expectation? Or maybe a better way to ask it is sequentially versus Q2. Are we kind of flattish in terms of where the food basket is? Or are we continuing to see it go down?

I think it's flattening out. I mean, if you're looking like Over last year, we're looking, I think we said low single digit deflation for the third quarter. We look something similar to that to flat deflation in the back half in the fourth quarter, which gets us to basically flattish for the year. It's kind of how we're looking at it right now.

And for just giving a map on the lower pricing and that inflation is sort of a mid-25% cog, is the right way to think about Q3? Because it just seems like it would be a big jump from Q2.

Yes, that's kind of what we're looking at.

Okay. Okay. And in terms of just, you know, Q3, Q4, unit level margins, you know, historically Q4 is a little bit lower, but we have the extra week. So, I mean, do they end up being a little bit closer to each other, you know, both of them maybe in the sort of high 17% range?

Come back again on the unit level margins? Is that what you're saying for the Q4? Sure.

Q4 tends to be lower than Q3 historically. But given that extra week, does that kind of help it come up closer to Q3 this year?

Yes. It actually increased it a little bit over Q3.

Okay. Got it. Okay. Thank you very much. Thanks, Max.

Our next question comes from Andy Barish with Jefferies. Please state your question.

Hey, good evening, guys. I wonder if you can give us an update on sort of dining room traffic versus pre-COVID. I know there's been some big changes in seating and hours, but just trying to level set on that. And do you see that as an opportunity, just given some of the shifting consumer behavior out there?

Well, again, with our addition of our other delivery service and that increasing from a percentage of sales, our dine-in sales are still, from a traffic standpoint, still at about 75% to 80% of what they were prior to the pandemic. And then we've been pretty consistent with that. As you know, we still have taken some of those seats out, and we haven't put those back in just from a productivity standpoint. And also the hours. We haven't brought those hours back either. We've deemed that those haven't been very profitable hours as well. So, yeah, we're still at that 75% to 80% in traffic from a dine-in perspective, but our off-premise has grown a little bit.

Okay. And then on the marketing side, I know you're back up to about 1.5% or so of sales. Is there any new channels or weighting kind of that you're looking at for that media spend?

Yeah, right now we're pretty happy with that percent. And as things change, we're obviously looking at everything. We're doing a little bit, you know, I mentioned a few during my prepared statement, but a couple other things that are fairly new is programmatic TV. And we're doing a lot of stuff with, you know, Yelp and so on on top of that. But we're always looking at things and redistributing. But we're pretty pleased with all the mediums that we're using.

Okay. A few years back, I mean, again, pre-pandemic, you guys were doing outdoor, which seemed to have some effectiveness in highlighting kind of the core values. Anything, you know, along those lines in certain markets or, you know, just keeping it balanced?

Yeah. No, we consider that. I have that in that local store marketing fund that we do, and that's part of the 1.5, 1.45 fund. And those are continuing. We do have quite a bit of outdoor and a lot of local store initiatives that we always will do from a local store profile.

Appreciate it, guys. Stay cool.

Thank you. Thank you, Andy.

Thanks.

Thank you. And a reminder to ask a question, press star 1. Our next question comes from Chris Ockel with Stiefel. Please state your question.

Thanks. Good afternoon, guys. Hi, Chris. My question relates to development. You know, just given the company's strong performance and sizable cash position, why not try to accelerate unit growth in 24 beyond just a handful of locations?

Well, I mean, we're going to grow as fast as, you know, deemed reasonable given the environment. I mean, right now, it's not a matter of finding sites. It's a matter of getting those sites open with the permitting and things like that. So, you know, if we can right now, we're saying that we'd also like some of the costs to come down a little bit. But that's kind of where we're looking right now until we see kind of the construction and the permitting and some of that stuff to turn around a little bit.

Yeah, I need some relief in those areas.

I know you guys have struggled with openings in certain markets like Chicago and Denver. So I'm just wondering, how those experiences are shaping your development plans over the next couple years?

Well, I think that's, you know, why we're looking at kind of the five to seven and focusing on those states, Chris, because as we focus on those states, I think we'll get better brand recognition in some of the other states that we'll interact with in three to five years. But those states we're currently focusing in on have high AUVs, great brand recognition, and quite honestly, they're very favorable from a business standpoint, from a margin standpoint. So those are the states we're focusing in on in the next three to five years.

Is the strategy to follow more of a contiguous market, you know, going from markets in close proximity because you just need that brand awareness as you go into newer markets?

Yeah.

I think so. And I think, you know, if you go back to, I hate to bring up 2013, but we kind of jumped into a lot of new markets. So we'll take that more slowly, I guess, when we start branching into new markets and not all at once in one year. So we'll continue to open in these, you know, states that we have high brand recognition and contiguously next to that state opening some new markets.

And that's over the next, and the states that we're talking about was our growth over the next five years and a little bit beyond. So plenty of room.

Okay. And I apologize if I missed it, but John, did you comment on just the cash position of the company and what you guys may be considering for deploying that cash or returning to shareholders maybe more aggressively?

Yeah, I mean, we continue to want to be somewhat opportunistic in buying back that stock, but we did buy back $3 million this quarter. We still have about $82 to $83 million on the balance sheet, and then continue, obviously, opening stores. But we'd like to get a little more aggressive in buying that stock back. But, again, we want to be somewhat opportunistic in that as well.

Okay. Thanks, guys. Thanks, Chris. Thank you. There are no further questions at this time. I'll now hand the floor over to Steve Hislop for closing remarks.

Thank you so much. John and I appreciate your continued interest and choose and are available to answer any and all questions. Again, thank you and have a good evening.

Thank you. This concludes today's conference. All parties may disconnect. Have a great evening.