Hello, and welcome to the First Watch Restaurant Group First Quarter 2023 Conference. All participants will be in listen-only mode. Please note, today's event is being recorded. I would now like to turn the conference over to your host today, Steve Marotta. Ms. Marotta, please go ahead.

Good morning, everyone, and welcome. I'm joined here today by First Watch's Chief Executive Officer and President, Chris Tomasso, and Chief Financial Officer, Mel Hope. This morning, First Watch issued its earnings release for the first 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 first cover a few housekeeping issues 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 conditions of the company's industry and its operations, performance and financial condition, growth strategies and future expenses. Any such statements should be considered in conjunction with cautionary statements in the company's earnings release and the risk factor disclosure in our filings with the SEC, including quarterly report on Form 10-Q. First Watch assumes 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 would like to turn it over to Chris.

Thanks, Steve. Good morning, everyone. I'd like to start by addressing yesterday's announcement that we acquired 6 franchised restaurants in the Omaha market. As we speak, we have a team of First Watch leaders on the ground, ensuring a seamless transition as we onboard more than 200 new team members. We previously shared our interest in and intent to acquire franchise-owned restaurants as an element of our long-term growth strategy. As of today, we have 14 franchisees who operate 109 restaurants. Of those, 60 are subject to purchase options. Our franchise-operated restaurants performed in line with our company-owned units, and these 6 are no exception. We expect this accretive acquisition to deliver roughly $1 million in adjusted EBITDA for the balance of the year. Now I'd like to shift to our great first quarter results, which reflect our focus on serving more demand. In the first quarter, we opened 10 new First Watch restaurants in 7 states from Florida to Arizona. System-wide sales were $264.7 million, up 24% versus the prior year, and total revenues were $211.4 million, up 22% versus the prior year. Our restaurant level operating profit was $44.1 million, resulting in a margin of 21.2%, and adjusted EBITDA was $27.4 million, up 42% versus last year. I could not be prouder of our teams and their delivery of one of the best quarters I remember over my time here at First Watch. We achieved same-restaurant traffic growth of 5.1%, which once again outpaced our competitive set. This traffic growth helped drive same-restaurant sales growth of 12.9%. As a reminder, our same-restaurant traffic growth in Q1 2022 was a strong 21.9%. We delivered an exceptional quarter despite the difficult March comparison we alluded to on our previous call. When we look at March and that tougher comparison, I think it's important to note that we did not see a deceleration, and our average weekly traffic count actually held steady throughout the quarter. Compared to pandemic highs, we did experience a softening of off-premises, similar to others in the industry. However, this was offset by growing dining room traffic as more and more people see us as a place to gather and connect with others. You've heard us talk often about our focus on growing traffic share, which has been a hallmark of our growth for decades. Our teams across the system are continually focused on strengthening our operational acumen to help serve our consumer-led demand. Their focus on controllable and predictable restaurant-level operations helps us leverage increased sales. While the macro backdrop may be changing and potentially become more challenging, we continue to be highly confident in our long-term outlook based upon steps we've taken and decisions we've made leading up to this point. As a reminder, while others were aggressively taking price in 2021, we maintained our pricing structure through the entire year with a focus on increasing customer count, which resulted in us earning incremental market share. Our development pipeline is robust with high-quality sites in new, emerging, and mature markets. Our customer satisfaction scores remain strong, and our value scores continue to show that the customer is recognizing our outstanding dining experience. In short, the future is bright. Finally, I'd like to end by proudly sharing two impressive recognitions from independent third parties that we recently received related to the First Watch experience and brand. In March, we were named by Forbes as one of its 2023 customer experience All-Stars, joining some remarkable brands that were highly ranked by consumers for loyalty and customer experience. What made me proud is that First Watch was chosen completely unaided from more than 2,000 unique brands, making the recognition that much more special. Then in April, we were also recognized by Yelp and its inaugural most-loved brands in the U.S., coming in as the number 1 restaurant brand and the number 4 overall brand. After 4 decades of being the best kept secret in the restaurant industry, it's exciting for me to see others begin to take notice of the experience that our teams are delivering every day. Now I'll turn it over to Mel to discuss our first quarter financial performance in greater detail.

Thanks, Chris. Good morning. As Chris mentioned, our first quarter was strong. Our comps benefited early in the quarter from the holiday calendar shift and the fact that we were rolling over periods impacted by the Omicron variant in 2022. As we shared on our last call, March was a more formidable comparison though average traffic levels stayed consistent throughout each month of the quarter. Same-restaurant sales growth was 12.9% for the quarter, driven by same-restaurant traffic growth of 5.1%, which exceeded our own expectations. Total revenues were $211.4 million, representing a 22.1% increase over the first quarter of 2022. Our food and beverage costs were 22.4% of sales in the first quarter compared to 23.1% in the similar period last year. We experienced inflation of about 3% across our market basket, which was lower than we anticipated and driven mostly by decreases in our avocado and pork costs. Labor and other related expenses were 33% of sales in the first quarter. That's down from 34.5% in the fourth quarter of 2022. I'm pleased with the progress that our operators are making here as our labor expenses as a percent of sales improved throughout the quarter. Labor remains an area of great attention as our teams adjust to sales volumes and wage increases while embracing new tools and processes to optimize these costs. Restaurant level operating profit was $44.1 million for the quarter with a margin of 21.2% and compares favorably to the 19.6% restaurant-level operating profit margin in Q1 of 2022. The improvements reflect both labor efficiencies as well as leverage due to the increased sales. General and administrative expenses were $22.7 million, approximately $3.1 million higher than in the first quarter of 2022, primarily due to the increase in headcount to support our growth. Adjusted EBITDA was $27.4 million, with a margin of 13%, exceeding our own expectations for the first quarter. The better-than-expected results were split evenly into three categories. First was discretionary G&A spending that was delayed until later this year. Secondly, was the combination of favorable commodity costs and our operators' success with improving the labor efficiencies. And third was our built-in caution about the formidable March comparison. We opened 10 new system-wide restaurants during the quarter, 4 of which were company-owned and 6 of which were opened by our franchise partners. As a reminder, our company-owned restaurant development schedule is heavily weighted toward the end of the year, the fourth quarter in particular. As our second quarter has begun, the month of April has been noisy with shifts in the Easter and spring break timing. Based on what we've seen internally and across the industry, we believe customers have shown signs of being under pressure. As such, we've marginally tempered traffic expectations for the balance of the year. Here's the update for our full year outlook as follows. We're reiterating same-restaurant sales growth of 6% to 8% in 2023 with positive traffic growth for the full year. We're also reiterating our expectations of openings between 38 and 42 company-owned restaurants and 10 to 12 franchise-owned restaurants. We plan to close 3 company-owned restaurants, resulting in a total of 45 to 51 net new system-wide restaurants. We now expect commodity inflation to be in the range of 2% to 4%, which is lower than our original expectation of 4% to 6%. We continue to expect hourly labor inflation to be in the range of 9% to 11% with an overall restaurant level labor inflation in the range of 8% to 10%. We now expect a blended tax rate in the range of 33% to 36%. We continue to estimate capital expenditures totaling between $100 million and $110 million, not including the capital outlay associated with yesterday's acquisition of franchise-owned restaurants. At this point, given our strong first quarter performance and the acquisition of 6 franchises and restaurants, we're increasing certain elements of our full-year outlook as follows. We now expect total revenue growth in the range of 16% to 20%. That's up from our original outlook of 15% to 19%. For adjusted EBITDA, we expect a range of $80 million to $85 million, which is up from the original range of $76 million to $81 million. The franchise acquisition favorably impacts 2023 total revenue growth by approximately 1% and adjusted EBITDA by approximately $1 million. While we don't guide to quarterly results, we believe it could be helpful to share some of our planning considerations for the balance of 2023. As mentioned on our last conference call, we expect adjusted EBITDA to be weighted toward the first half of the year. More explicitly, we expect over 55% of our adjusted EBITDA will be earned in the first half of the year. Given our planned ramp of both pre-opening expenses and G&A investment in the third quarter, third-quarter adjusted EBITDA is expected to be about the same as it was in the third quarter last year. As a reminder, 2023 is a 53-week fiscal year for us. Our fourth quarter will be a 14-week quarter, and we expect the impact of that extra holiday week to be roughly $10.5 million in sales and $2.5 million in adjusted EBITDA. For further detail on the first quarter, please review our supplemental materials deck on our Investor Relations website beneath the webcast. With that, we'll be happy to open the lines for questions.

The first question comes from Jeffrey Bernstein with Barclays.

Great. Two questions. The first one on your comments about April. We've heard from a number of others that it has been noisy. Stripping out the shifts, it sounds like you mentioned that you're seeing some signs of pressure on the consumer. I'm wondering where perhaps you're seeing that. I mean, obviously, the first quarter results were very strong and ahead of expectations. Just wondering, maybe you can share some April specific comp commentary or where directionally you're seeing somewhat of the pressure. How do you recognize that there is some pressure coming down? And then I had one follow-up.

Most of the transaction pressure seems to be in the off-premises business.

Are there any metrics in terms of maybe where off-premises was at its peak or trough or what's gone on at least over the past few months?

I don't have a long history of where it is in front of me, but the decline has been pretty sequential since about the middle of the quarter. At the same time, our dining room traffic has continued to recover from the pre-pandemic levels. So there's a little bit of an offset going on there.

And Jeff, it's Chris. To be clear, we're not seeing anything from a consumer behavior inside our restaurants that you would typically see with check management. Our beverage attachment is actually up and our shareables have remained steady. As Mel said, we're really responding more to commentary about the macro environment in general. That, coupled with the choppiness that we saw in April, we believe was mostly attributable to the shift in calendars. That's really what we were referring to.

Understood. My follow-up was just on the outlook. It seems like inflation concerns, at least around the commodity side, are easing a little bit based on your guidance. Just wondering if you can maybe share from a pricing perspective what you were running in the first quarter, whether you think you're seeing any resistance? And maybe what your outlook is for the rest of the year, whether you plan on taking more or what pricing would be if you didn't take any more?

For the first quarter, we were carrying just under 7% price, like 6.9%. I think for the second quarter, we'll be carrying almost 8% in price.

Understood. Is there any sign of pushback from that elevated level of price? I know there's been some concern that food at home is now being reined in and maybe restaurants are considering being a little bit more cautious just to not be glaringly above food at home?

Yes. If you remember, we've been pretty conservative on our pricing. From an absolute standpoint, we don't consider where we are to be in an aggressive position. We still feel like we're lagging when you look at what everybody has taken over the past 18 months to 2 years. We still believe we have pricing power. It's not contemplated in any of the guidance that we put out today, but we feel really good about where we are from a relative value standpoint and just an overall environment standpoint. We're following through on what we said about people looking for experiences, consistency, and value. Our pricing is a big part of that.

And the next question comes from Sara Senatore with Bank of America.

I wanted to ask about the off-premises business and see if I understand. Is that because the pricing differential, you think that that is perhaps weighing on that? I'm wondering if there's a way to shift those consumers. I know off-prem has been viewed as incremental, but if you are to keep the customers with First Watch, whether it's dining room or some kind of carryout option. I'm trying to understand the dynamic that would affect off-prem more than on-premise. In terms of the outlook for commodities, that was actually the inflation rate was probably half, I guess, what we had expected. I know you mentioned avocados and pork, but is that something where you could see continued benefits just because I don't think either one of those are in your Top 2, but it seemed like a pretty meaningful divergence from what we had anticipated.

Yes. Thanks, Sarah. This is Chris. I'll take the first one. In my opinion, the off-premises business is, frankly, the new check management kind of bellwether. For years, our industry focused on check management as signs of the consumer perhaps feeling some pressure. Let's just be honest. The delivery and third-party delivery occasion is very expensive, and it doesn't surprise me that that's where we see not just with us, but with almost everybody in the industry where the consumer is starting to pull back. It's a discretionary occasion, and I think that's where you're starting to see it. Not a surprise to us. We're happy to have more people in our dining room, frankly. We've been accommodating and leveraging third-party services as consumers have shifted that way, but it’s not surprising that’s the first place to feel pressure in a tougher consumer environment.

In terms of commodity, yes, we did enjoy some better costing, and we adjusted downward our expectations regarding full-year inflation. We're still paying more dollars than we were last year. It's just that the pace at which the inflation has grown seems to be slowing down rapidly. I do think we expect that there's going to be some continuation during the year.

Understood. And then just Chris, on the off-premises pressure, that makes sense as check management. I know third-party delivery doesn't give you a ton of information about those consumers, but are you able to talk to them directly again? Are there ways for you to sort of bring them into the restaurant or continue as First Watch even as they try to escape some of the really high fees associated with delivery?

Yes. I think we believe the same thing we believed when the off-premises business was growing, which is that it's an incremental occasion for us, a unique customer. Again, this is an occasion that is falling by the wayside. Over the last two years, third-party or off-premises was a way to introduce First Watch food at least to a new consumer. As they become more discretionary and not doing those third-party occasions, if we wow them with the food like we believe we did, hopefully, they will come in and give us a try in the restaurants where we can really turn them into loyal fans. For now, we still think that’s an incremental visit as our dining room traffic grew alongside the third party. As always, we're focused on our in-restaurant dining experience now more than ever.

And the next question comes from Brian Vaccaro with Raymond James.

I just wanted to circle back a little more and make sure I understood what you're saying on recent trends. The year-on-year comparisons can be confusing and a bit disorienting. I was hoping to look through a sequential lens. It sounds like your sequential transactions remain strong through April. You noted some fraying, if you will, or drifting on the off-premises side. Did dine-in transactions, are they still holding up well in April? Are there any changes also worth noting in terms of day of the week or time of day trends that might offer any insights?

I don't know about daypart kind of data. I don't think we've spoken much publicly about that. But with regard to the trend in April, the dining rooms held up pretty well. April was, as I mentioned, choppy. It was choppy in all the channels, but the dining rooms held up pretty well. The April traffic seemed to just kind of bounce around a little bit. We often see that in our April as we come off the first quarter.

I wanted to ask about the sales mix as it seems to have returned to healthy levels in the first quarter. How did your alcohol sales mix perform during the quarter, especially after you recently expanded your offerings? Can you share any insights on how the latest seasonal limited-time offers performed compared to typical results?

Alcohol has been pretty consistent. It's now in 87% of our restaurants, which is up slightly from Q4. It's still sitting around 6% of mix in the restaurants that have the program. So really not a big shift there. The second part of your question about the LTOs, I think it's been fairly consistent year-over-year and quarter-to-quarter. Q1 is usually good for us because it's our jump start and people have their New Year's resolution. So not a big shift there. I think the upside came from the increased traffic and getting the full effect of our price increase.

Could you provide some additional background on the transaction? I understand it's been your intention for some time, and you've mentioned it as a possibility before. How did this transaction come about? Does this franchisee own other stores that they might consider selling? What were the financial details of the transaction, including what you paid for the stores?

This franchisee, we purchased the 6 stores that this franchisee had, the 6 First Watch restaurants. We repurchased development rights and other intangibles along with the restaurants, and the total proceeds we paid were a little over $8 million.

And the next question comes from Jon Tower with Citigroup.

Just in terms of thinking about a franchisee acquisition, I don't know how many you've done in the past, but I'm curious to know how these stores typically progress. Obviously, you gave us the accretion numbers, but you just mentioned the idea of repurchasing the development right? So how many more stores could we see from this market coming into your store set? When you open these stores, are these stores generally in line with your existing system right now in terms of profitability and sales?

We have a long history of incorporating franchise restaurants into our system for many years. This has been a key part of the company's growth. Regarding the market size, I sensed you were trying to convey something to me.

Yes. It can probably hold another 5% to 8% in that market as we sit here today.

They typically perform very similarly to our legacy comp restaurants in terms of sales and overall restaurant level operating profit.

Great. So no incremental reinvestment that you need to make to clean up the system at all?

There's no cleanup. We do have to shift over. Oftentimes, they'll have different technology than we do. To completely integrate them, we'll add some of our technology or our controls, our protective items in the restaurant. But for the most part, beyond the purchase, we don't have to invest a great deal.

In general, our franchisees have done an incredible job of introducing the First Watch brand to markets that we probably wouldn't have gotten to as quickly. The restaurants look and feel exactly like a company-owned restaurant. The primary motive for this purchase is just it's an efficient use of capital. We don't see operational enhancement opportunities there per se. Kind of just bringing them into the mothership, if you will, and having more company-owned restaurants because we're predominantly company-owned and want to move that way.

Makes sense. Shifting to the sales piece, I know we've hit on this quite a bit so far in the call. I'm curious, you mentioned that in-store dining traffic at least continues to hold up relatively well. I'm just curious, thinking about going forward to the extent this choppiness persists into May, June, and for the balance of the year. I know historically, as a brand, you don't do any discounting or significant promotions. Can you help us think through what you might do as a response to a potential slowdown on the traffic side in the business?

One of the things Chris says is that we won't do anything unnatural. The brand's focus is on being successful over the long term. We'll continue to focus on quality products and service and entrees. We've always been very careful about pricing. Given our history of being attentive to our customers regarding pricing, I think we're already well-positioned if there is inflation or a recession that causes people to be more discriminating. When people become more discerning about where they will use their dollars, they typically choose restaurant brands that they trust. I think we're well trusted, which puts us in a good position to face that if we experience a deep recession.

And the next question comes from Andrew Barish with Jefferies.

Can you hear me? Yes. Just a couple of expense questions. Yes, I mean, labor made good progress sequentially but was still up year-over-year. I know staffing is better and you've made some changes in some of the in-store labor allocation and positions. Is this kind of a good rate to think about on a go-forward basis in terms of percentage of sales?

Yes, that's a good question and we get it pretty often. When we manage labor in the restaurants at 33% and below, that's a pretty good target for us. We still have work to do on the full year, but we don't want to do anything that degrades the gracious experience the customer enjoys in the restaurants. We're careful not to drive out too much there, so pushing towards 33% and below is where we target. That's where our best restaurants tend to run.

Got you. Anything on the occupancy line? I mean, that clicked down pretty noticeably below 8% of sales other than the leverage and the flow-through from the strong sales?

It's mostly that. It's mostly just the leverage on sales.

And the next question comes from Chris O'Cull with Stifel.

I had a follow-up question around the acquisitions. Chris, and I understand that the company has a lot of experience acquiring franchisees. But it does sound like this is becoming a higher priority than maybe it was a year ago. I'm just curious if there's been any changes to drive that decision?

There's no real change. The timing is this. We've been public for 1.5 years, and in our first year after the IPO, we focused entirely on building back the company operations to pre-pandemic performance. We wanted to be exactly who we were. We knew the acquisition opportunities relative to the options weren't going to go away. We thought it was important to recover and focus on our company operations. In the fullness of time, this acquisition was a good opportunity, and we're delighted to have completed it.

That's a good explanation. Does this change, Mel, the timeline of when you expect the company to be generating free cash flow?

Not materially. You're talking about an $8 million purchase here. So this transaction on its own doesn't shift anything.

I was thinking more around being opportunistic in acquiring franchisees going forward. Do you think the timeline around generating free cash flow is influencing the decision on whether to acquire franchisees?

We view them as a good investment for the near term and the long term. Our free cash flow timing isn't really influencing that. We see them as a great 30-year investment and an efficient use of the company's capital.

Fair enough. I had one other question around menu mix. Chris, I was just wondering how you're thinking about managing the menu mix this year with the seasonal menus and the alcohol program. Are you seeing a need to be more cautious around trying to drive favorable menu mix in the current environment?

Are we being more cautious? Is that what you said? No, I think our focus is more on the value versus the actual price. Menu innovation has been the hallmark of our success for many years. We're actually going to lean into it. You'll see us innovating around the alcohol program. You'll see us innovating around the shareables even more. That doesn't necessarily mean higher prices. A lot of times, we'll introduce items that may be at the same or lower price but deliver higher margins, and that works well. So we’re not being cautious around that at all. We haven't changed our strategy or our philosophy. Our biggest challenge is figuring out how to outdo ourselves. When we look year-over-year at the success we see in those seasonal menus, we're challenged, but we're up for it. We've been doing it for a long time.

And the next question comes from Gregory Francfort with Guggenheim Securities.

The first one I had was just on labor. I think you guys are one of the few that are guiding up closer to 10% labor inflation. We're hearing from others that turnover seems to be starting to break a little bit. Are you seeing that as well in your restaurants? Is that having any impact on entry-level wages? I'm just curious what the dynamic is out there.

Our turnover has been in descent. We still view it as an opportunity, though. We've seen some turnover metrics for our hourly employees begin to improve over time, but we still have work to do. Most of the wage inflation we see is where we have regulatory increases in minimum wage due in some of the states we operate in, Florida being notable.

Okay, understood. Can you provide an update on new store volumes and returns and maybe investment costs? It seems like it's been running ahead of your existing volumes. Curious if that's the dynamic that you're seeing and any updates on what the return profile of new restaurants looks like.

Honestly, the return profiles haven't changed. If you look at our investor deck on the website, we have a unit economic page that shows generally the range we're investing in the restaurants with larger footprints and elements that support our alcohol program and larger patios. The range starts at about $1.4 million net of allowances, but the returns are roughly the same since we began talking years ago. The 3-year restaurant-level operating profit is still targeted at that 18% to 20%.

Got it. Just a last one for me, a lot of commentary on the off-premises side. I'm curious, are you seeing a different dynamic within delivery and takeout? I think this quarter takeout slowed pretty similarly. But as you look to 2Q and your expectation for the rest of the year, are the comments more around delivery? I think takeout would hold up if the consumer were pressured, but just curious any thoughts.

A lot of our takeout customers are also our dining room customers. As we've seen our dining rooms increase, even our takeout business has declined in terms of those volumes.

And the next question is a follow-up from Brian Vaccaro with Raymond James.

Just a quick one on the commodity outlook. Mel, could you remind us what percent of the basket is contracted for the rest of the year? We've noticed the recent crack in egg prices. I think you're contracted, but could you level set what type of year-on-year inflation you expect on eggs specifically?

The portion that is under a full year contract is about 15% of the market basket, including eggs and potatoes. We also have a clear line of sight on pricing for the rest of the market basket for about 45 to 60 days forward. For the full year, it's just the eggs and potatoes. For the eggs specifically, I think we're probably favorable to spot rates now. As the flocks repopulate, we expect that should target around the middle of the year. Our back half may be a little unfavorable to the spot rate, but we have secure supply and fairly good pricing on our eggs.

I think that's the end of our questions. Thanks for your time today. I appreciate it. We're proud of our continued excellent performance and our ongoing operational enhancements that are positioning our restaurants to serve more demand. We're optimistic about the potential afforded by the acquisition of certain franchise restaurants, and we look forward to sharing further news on that front. Thank you for joining us this morning.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.