First Watch Restaurant Group, Inc. (NASDAQ:FWRG) Q3 2023 Earnings Call Transcript

First Watch Restaurant Group, Inc. (NASDAQ:FWRG) Q3 2023 Earnings Call Transcript November 1, 2023

Operator: Thank you for standing by and welcome to the First Watch Restaurant Group, Inc. Third Quarter 2023 Earnings Conference Call, occurring today November 1, 2023 at 8:00 AM Eastern Time. Please note that all participants are currently in a listen-only mode. Following the presentation, the conference call will be opened for analyst questions and instructions on how to ask a question will be given at that time. This call will be archived and available for replay at investors.firstwatch.com under the News & Events section. I’d like to turn the conference over to Steve Marotta, Vice President of Investor Relations at First Watch to begin.

Steve Marotta: Hello, everyone. I am joined by First Watch’s Chief Executive Officer and President, Chris Tomasso; and Chief Financial Officer, Mel Hope. This morning, First Watch issued earnings release for the third quarter of 2023 on Globe Newswire and filed its quarterly report on Form 10-Q with the SEC. These documents can be found at investors.firstwatch.com. Let me cover a few housekeeping matters before introducing Chris. This conference call will include forward-looking statements that are subject to various risks and uncertainties that could cause the company’s actual results to differ materially from these statements. Such statements include without limitation, statements concerning the condition, the company’s industry and its operation, performance and financial condition, growth strategy and future expenses.

Any such statements should be considered in conjunction with cautionary statements in the company’s earnings release and the Risk Factors disclosure in the company’s filings with the SEC, including quarterly report on Form 10-Q. First Watch undertakes no obligation to update these forward-looking statements whether as a result of new information, future developments or otherwise, except as may be required by law. Lastly, management’s remarks today will include references to various non-GAAP measures including restaurant level operating profit, restaurant level operating profit margin, adjusted EBITDA and adjusted EBITDA margin. Investors should review the reconciliation of these non-GAAP measures to the comparable GAAP results contained in the company’s earnings release filed this morning.

And with that, I will turn the call over to Chris.

Christopher Tomasso: Good morning. Before we share the details of another terrific quarter of growth, I would like to first note that this earning season marks our eighth quarter since our IPO. While we’re still early in our journey, I am proud of how this organization has established itself as a public company, build credibility with investors, and consistently produced positive results at a high rate of growth over a multiyear time horizon. To everyone listening this morning from the First Watch Organization, thank you. Now, onto our third quarter. Our organization once again delivered outsized performance, top to bottom. In the quarter, First Watch generated $219.2 million in total revenues, a 17.3% increase versus a year ago.

We opened 13 systemwide restaurants, surpassing the significant milestone of 500 restaurants, ending the quarter with 505 First Watch restaurants across 29 states. Our same restaurant sales increased 4.8%, once again supported by positive dining room traffic. As we’ve noted in past quarters, expected softness in our off-premises channel has persisted as consumer behavior continues to shift and moderate post pandemic. Finally, bottom line growth benefited from easing food and beverage inflation and effective four-wall management by our operators. We also continue to outperform the industry, highlighting the benefit of our differentiation to other full-service operators through our focus on the breakfast, brunch, and lunch dayparts. As compared to Black Box Intelligence, First Watch bested the industry by nearly 400 basis points, illustrating our ability to grow traffic share.

Our share growth is also supported by Placer AI, which showed our consolidated traffic share gaining several hundred basis points against the full-service segment. My confidence in our ability to successfully navigate virtually any environment is higher than ever, especially in light of our consistent growth. Of course, given the macroeconomic backdrop, we remain cautious with respect to the state of the consumer. While we have observed and in fact benefited from the strength and resilience of the consumer throughout the year, there’s reason to believe that the weight of the environment is beginning to have an impact, but as we have experienced in prior downturns, consumers are less willing to gamble with their discretionary dollars and would rather seek out more familiar and enjoyable experiences that are consistent and deliver value like First Watch.

Given our longstanding record of exceeding industry traffic trends, we are well positioned to benefit from the consumers flight to quality. In times like these, the best operators are winning. By that, I mean brands that relentlessly lean into the basics for the benefit of their teams and their customers are winning. We remain confident and unwavering in our commitment to culinary forward food served by highly trained teams, who exemplify our You-First Mission in a warm and inviting atmosphere and at a tremendous value. We deliver an exceptional dining experience at a compelling per person average of just $16.35, ensuring that First Watch remains a reliable experience, as well as an affordable luxury. Our focus on executing the basics at a high level remains key to our success.

Beyond our financial performance, we know we are well positioned when our employees and our customers are happy and by both measures, we’re playing from a position of strength. Both manager and employee turnover have continued to improve throughout the year, including during the third quarter. Our customer experience scores are also at historical highs and continue to be a great indicator of future performance. To further illustrate our focus here, in the quarter, we completed our annual WHY Tour, short for We Hear You, where our Chief People Officer, Laura Sorensen; and Chief Operating Officer, Dan Jones joined me in speaking with hourly team members from every region in the company. For perspective, that’s 22 separate 90-minute tours comprising over 1,900 minutes with more than 300 hourly team members.

There is no more important task that we carry as leaders than to receive feedback and perspective from those that are serving our valued customers everyday. We learn what they love about working for First Watch and how we can do better. Their insights and opinions are invaluable, as we seek to continuously improve, but it’s our tactical reactions to this frontline information that allows us to effect positive change in real time, so that we’re fully supporting our teams and better serving our customers. I finished this year’s tour encouraged that our culture in the restaurants and our team genuine desire to serve our customers and each other is as strong as ever. Our deep bench of human capital gives me confidence in our ability to execute our high growth expansion plans.

Double clicking on the topic of culture, I’m also pleased to share that First Watch was once again named to Newsweek’s list of Most Loved Workplaces. This is especially noteworthy to me because it’s largely generated from more than $2 million employee surveys. We are proud to be the only restaurant brand that made the 2023 list, a remarkable achievement for sure. A strong culture begins and ends with the environment fostered by our general managers in their restaurants on a daily basis. I’ve always viewed the GM position as the most important role at First Watch. While we are one company, we consider ourselves to be a network of individual neighborhood restaurants and each of these are led by a General Manager responsible for creating a positive environment for their team and customers.

Awards like this demonstrates that we are keeping the culture flame bright, as we raise the bar in nationwide expansion. On the topic of nationwide expansion, I’m excited that the quarter ahead will be one of the most prolific in the company’s history and our team is ready. We will open 18 to 21 new systemwide restaurants across 16 states in the fourth quarter alone. In total, we have over 100 restaurants in various stages of development and more than 120 promotion-ready managers ready to lead them. We believe we are well positioned to capitalize on the white space in front of us. We’re in a select group within the public restaurant space, opening new restaurants at a low double-digit pace annually. Our highly portable brand succeeds in both existing and new markets with our top decile restaurant spanning 10 states and 19 DMAs. We are targeting third year AUVs of $2.5 million, with restaurant level operating margins of 18% to 20% and cash on cash returns of 35% or greater.

These attractive unit economics achieved in one 7.5-hour shifts support our long-term goal of 2,200 domestic First Watch restaurants. Finally, we continue to execute our strategy of complementing strong organic unit growth with the acquisition of certain franchise-owned restaurants and related territories. Earlier this year, we acquired 17 restaurants in the Milwaukee, Omaha, and South Carolina, Georgia markets. Today, we are announcing an agreement to purchase an additional franchise partner with six restaurants in the Florida Panhandle and expect that transaction to close later this month. Following these acquisitions, we will have 11 franchisees remaining, who operate 97 restaurants and of those, 46 are subject to purchase options. I’ll reiterate what I said last quarter.

For us, converting franchises to company-owned restaurants is compelling from both the financial and strategic perspective and represents a significant growth opportunity for our entire enterprise. And before I turn the call over to Mel, while we still have two more months before turning the calendar on the new year, the effort and execution necessary to generate more than 30% adjusted EBITDA growth, assuming the midpoint of our updated guidance range is a point of pride for our entire organization and energizes all of us to double down on our commitment to serving more demand in our restaurants. And with that, I’ll turn it over to Mel.

Mel Hope: Thanks, Chris, and good morning. As Chris shared, we’re proud of our teams, who continue to deliver strong results quarter after quarter. Same restaurant sales growth increased 4.8% and while traffic declined 1.9%, as we expected, our dining room traffic growth remained positive. Total revenues were $219.2 million, a 17.3% increase over the third quarter of 2022, reflecting both same restaurant sales growth as well as the sales in our newly opened and acquired restaurants, our food and beverage costs were 22.6% of sales in the third quarter, which compared to 24.2% in the same period last year. Costs benefited from 220 basis points of favorability across our market basket compared to last year, which were driven mostly by decreases in pork and avocado costs, as well as leverage from our previous menu pricing actions.

Labor and other related expenses were 33.9% of sales in the third quarter up from 33.3% in the third quarter of 2022 and driven primarily by an increase in the number of managers per restaurant. We ended the period with an average of 3.1 managers per restaurant, compared with 2.8 a year ago. We view a three-manager average as a standard [indiscernible] as it provides the bench strength necessary to support our large number of planned new openings. Restaurant level operating profit was $40.4 million for the quarter with a margin of 18.7%, an increase versus the 17.3% restaurant level operating profit margin in the same period last year. The margin improvement reflects increased leverage from our same restaurant sales growth, improvement in food and beverage costs, and favorability in other restaurant operating expenses primarily driven by lower cost of to go supplies.

General and administrative expenses were $25.2 million, approximately $3.5 million higher than in the prior year, primarily due to higher compensation expense from additional headcount to support our rapid growth. Adjusted EBITDA was $21.6 million, reflecting a margin of 9.9%, an improvement versus the 9.1% margin we realized in the third quarter of 2022. The quarter benefited from just over $1 million in G&A expenses, mostly headcount and departmental projects that’s now expected to be incurred in the fourth quarter. We opened 13 systemwide restaurants during the quarter, of which, 10 were company-owned and three were franchised owned. As we’ve stated throughout the year, our company-owned restaurant development schedule in 2023 is heavily weighted towards the fourth quarter.

This year, we’ve often been asked about our customer check management. We continue to believe our growing dining room traffic reflects our customers preference for meaningful experiences. To borrow from one of Chris’ statements made earlier this year, the industry wide shift away from off premises appears to be a new indicator of check management and while declining off-premises occasions remain a headwind to our consolidated traffic growth, our teams drove profitable growth in the third quarter, due in part to the increased in-restaurant visits. Now, I’d like to update our full year outlook as follows. We are increasing 2023 same restaurant sales growth expectations to a range a 7% to 8%, that’s up from our previous range of 6% to 8% and now expect our full-year traffic will be generally flat.

We’re carrying price of just below 6% in the fourth quarter compared to the prior year. We now expect to open between 37 and 39 company-owned restaurants and 13 to 14 franchise-owned restaurants this year with one company-owned restaurant closures. On a consolidated basis, we expect a total of 49 to 52 net new systemwide restaurants. We now expect total revenue growth in the range of 20% to 21%. That range is an increase from our previous range of 18% to 21% with acquisitions contributing about 2.5% to total revenue growth. We now expect full-year commodity deflation of negative 1% to flat with net commodity cost inflation for the balance of the year. We continue to expect hourly labor cost inflation to remain in the range of 9% to 11% with overall restaurant level labor cost inflation in the range of 8% to 10%.

We are increasing our adjusted EBITDA guidance to a range of $91 million to $92 million from our previous range of $89 million to $92 million. Acquisitions are expected to contribute about $3 million to our adjusted EBITDA this year. We now expect a blended tax rate in the range of 26% to 28%. We are adjusting our capital expenditures range, not including the capital allocated to the acquisitions of franchise-owned restaurants to $85 million to $90 million, this is down from our previous range of $100 million to $110 million, mostly due to the timing of new restaurant opening. As a reminder, our fiscal 2023 is a 53-week year and our guidance includes the extra week’s contribution, which we estimate to be $10.5 million in total revenues, $2.5 million in adjusted EBITDA.

And as much as we’re in the middle of our budget season, it would be premature to furnish expectations for 2024. However, among our own modeling assumptions for the first quarter, we see no reason to expect off-premises traffic to reverse its trend. Furthermore because of the calendar shift, our most productive week of the year falls into the fourth quarter of 2023 and out of the first quarter of 2024. For further details on the third quarter, please review our supplemental materials deck on our Investor Relations website beneath the webcast and we’ll open the line now for questions. Operator?

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Q&A Session

Operator: Yes. Thank you. At this time, we will begin the question-and-answer session. [Operator Instructions] And today’s first question comes from Jeffrey Bernstein with Barclays.

Jeffrey Bernstein: Great. Thank you very much.

Christopher Tomasso: Hey, Jeff. Good morning.

Jeffrey Bernstein: Good morning. Two questions, the first one on the comp trends, it seems like your absolute results for the third quarter close to 5% were modestly above expectation, but yeah we don’t get to see the granularity within that or any thoughts on the fourth quarter, so I’m just wondering, you said you had a strong quarter yet the weight of the macro, I think was beginning to have an impact, Chris, I think was your reference. I’m wondering if you could provide some color in terms of what you’re seeing whether it’s something specific to First Watch or whether you’re just referring to the broader government data and metrics that lead people to believe there’s a slowdown, but perhaps you’re not yet seeing it. And then, I had one follow-up.

Mel Hope: Yeah, I think the — I think to get to your question, yes, I think the industry is seeing some softness overall, but in terms of the guidance on the fourth quarter, I think we’ve considered what — we’ve considered what we’re seeing in the market today and what we had in the third quarter in terms of the full-year guidance, so I think you can back into pretty much what our thinking is about the fourth quarter.

Jeffrey Bernstein: Okay. But that’s not something that — I mean, you said the industry is seeing some softness, if you were just looking at your own results through the third quarter and through October, would you say that First Watch is seeing some softness, similar to the industry or not yet evident.

Mel Hope: Well, we’ve consistently talked about our traffic particularly where the off-prem traffic is concerned that we’ve seen that kind of seeking a new home. I don’t know exactly where it’s going to land at some point, but that traffic has descended throughout the year, while our dining rooms have remained positive. They’re probably less positive in the third quarter than they were earlier in the year. So there is a — there is that — there is some downward pressure, and I think that’s what First Watch is seeing and that’s what the industry is seeing.

Jeffrey Bernstein: Understood. And my follow up is just on the menu pricing. I think you mentioned that you’ll be running roughly 6% in the fourth quarter, obviously, we’re seeing cost pressures abate, so I’m wondering why you don’t have specific thoughts yet on 2024. How you think about pricing more theoretically, whether you’d be inclined to take incremental price going into next year, or whether based on the caution around the macro, you would perhaps not take that incremental price, I’m just wondering how you think about that outlook going into 2024. Thank you.

Christopher Tomasso: Thanks Jeff. This is Chris. I would just reiterate our previous plan and approach on pricing, which is to price to cover inflation, obviously, we have been and continue to be a price laggard, but the basis for that is that we’re playing the long game here and we have been and all the decisions that we’ve made around staffing and specifically menu pricing have been with that in mind. So we’ll continue to do that. That said, we’ll obviously continue to watch the environment, watch the consumer. Our focus is on more visits. And again, a long-term view and approach. So that’s — we’re going to stay true to that.