First Watch Restaurant Group, Inc. Q2 FY2024 Earnings Call

Thank you for standing by, and welcome to the First Watch Restaurant Group, Inc. Second Quarter Earnings Conference Call occurring today, August 6, 2024, 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 open 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 would now like to turn the conference over to Steven Marotta, Vice President of Investor Relations at First Watch to begin.

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 its earnings release for the second quarter of fiscal 2024 on Globe Newswire and filed its quarterly report on Form 10-Q with the SEC. These documents can be found at investors.firstwatch.com. 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 limitations, statements concerning the condition of the company’s industry and its operations, performance and financial condition, outlook, growth plans and 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 the company’s filings with the SEC, including our Annual Report on Form 10-K and quarterly reports 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 margins, 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. During today’s call, references to same-restaurant sales and traffic growth compares the 13-week periods ended June 30, 2024, and July 2, 2023, in order to compare like-for-like periods. Otherwise, any reference to percentage growth when discussing second quarter performance is a comparison to the second quarter of 2023 unless otherwise indicated. And with that, I will turn the call over to Chris.

Thanks, Steve. Good morning. I’m pleased to report another quarter of solid operating results and adjusted EBITDA growth, and I thank everyone in our organization for their hard work. I remain extremely proud of our teams for continuing to control what we can control and delivering exceptional customer experiences, both of which are key factors in sustaining our profitability improvements as evidenced by our adjusted EBITDA performance. As expected, traffic was challenging during the quarter given the macro headwinds throughout most of our industry. Despite that, we are operating at a very high level and are comfortable reiterating our fiscal year 2024 total revenue and adjusted EBITDA guidance. In Q2, we generated $299 million in system-wide sales, $258.6 million in total revenues, and $35.3 million in adjusted EBITDA, the latter of which represented a 37% increase versus last year. Additional second quarter highlights include sequentially better same restaurant traffic compared to the first quarter, a positive mix, improved labor productivity, and better than expected contributions from both our new restaurant openings and strategic franchisee acquisitions completed over the past year. We opened seven total new restaurants in six states during the second quarter, six of which are company-owned and one that’s franchise-owned. We also completed our largest First Watch franchisee acquisition on April 15 when we purchased 21 restaurants along with the development rights in the Raleigh-Durham, North Carolina DMA. Our results in our internal KPIs demonstrate that we continue to operate our restaurants with remarkable efficiency. Our new restaurant openings by vintage and across geographies have been outstanding, performing at or above their sales expectations, and our pipeline for future growth is stronger than ever. As of today, we have more than 130 new restaurant projects in our pipeline and we are on track with our long-term target of delivering annual new restaurant growth in the low-double digits as a percentage of our system. As we continue to expand the system, the pipeline remains a significant driver of long-term value creation and earnings growth. As we stated on our last earnings call, we believe our traffic headwinds are more macro than micro and our insights indicate that much of the industry-wide pressure is occurring primarily during the weekday breakfast and lunch dayparts as consumers look to trim weekday occasions. Our business is strong, and our long-term strategy remains intact and compelling. In the second quarter, our customer experience scores improved versus the same period last year. Growth in our per person average check exceeded carried pricing as a result of positive mix through menu innovation. Our ticket times were more than 20% faster than last year. Our employee turnover improved again, marking six straight quarters. It’s clear that our investments in technology, both customer-facing and our enhanced business intelligence tools for our operations teams are bearing fruit, exemplified by a record Mother’s Day that featured positive 1.8% same restaurant traffic, positive 5.4% same restaurant sales, better than 20% faster ticket times, and higher customer experience scores. Moreover, data indicates that First Watch’s traffic share increased against the direct daytime dining competitive set. We believe that while aggressive promotions drive short-term traffic in some instances, we view that tactic as sacrificing margin from loyal customers while also attracting temporary discount-motivated customers with low recurrence rates. Our approach is in stark contrast to the broad-based discounting that many in our industry are deploying. We are focused on targeting demand generation across our own communication channels as well as paid digital media.

Thank you, Chris, and good morning everyone. We’re pleased to report strong second quarter profits. We are controlling the controllables, and as a result, our teams continue to generate higher restaurant level operating profit margin and improved adjusted EBITDA margin. Total second quarter revenues were $258.6 million, an increase of 19.5%. Our top line growth in the second quarter was driven by our new restaurant openings and the franchise restaurants we acquired over the past year. Same restaurant sales slipped 30 basis points on negative same restaurant traffic of 4%. Our food and beverage costs were 21.8% of sales in the second quarter, compared to 22.4% in the same period last year. During the quarter, restaurant level labor inflation was 4.6%. Nevertheless, labor and other related expenses were 32.8% of sales in the second quarter, a 40 basis point improvement from 33.2% in the second quarter of 2023. The improvement in labor efficiency illustrates the success of our operators who have been building on our reputation for great service. For the quarter, our customer experience scores have strengthened by roughly 10% versus last year. In short, our restaurants continue to serve our customers more efficiently while our customers are reporting that our service is even better. The improvements in food and labor helped lift restaurant level operating profit margin by 100 basis points versus the prior year, and income from operations margins by 110 basis points. Adjusted EBITDA was $35.3 million, a $9.5 million increase versus the $25.8 million reported last year. We’re pleased to report this significant year-over-year growth in adjusted EBITDA as we continue to open and acquire restaurants. For your financial modeling purposes, the net effect of acquisitions, which includes only the impact of purchases made within the last 12 months, increased both second quarter revenues by about $21 million and adjusted EBITDA by about $5 million. To provide you with more insight on our planning for the rest of the year, third quarter to date same restaurant traffic growth has been below our second quarter results, and we’re anticipating the second half of the year to be at least as challenging as the first half. Our 2024 development pipeline remains heavily weighted in the second half of the year. The outperformance of our non-comp restaurants is largely offsetting our negative same restaurant sales growth, and as such, we’re maintaining our total revenue growth guidance in a range of 17% to 19%. We’re also maintaining the adjusted EBITDA guidance range of $106 million to $112 million. Our expectation of commodity inflation for the year remains unchanged at 2% to 4%, as does our expected restaurant level labor cost inflation in the range of 5% to 7%. Finally, we continue to plan capital expenditures of $125 million to $135 million, not including the capital invested in the franchise acquisitions.

Thank you. We will now be conducting a question-and-answer session. The first question comes from the line of Chris O’Cull with Stifel. Please go ahead.

Great. Thanks, guys. This is Patrick on for Chris. Good morning.

Good morning, Patrick.

Morning. I know you guys called out last quarter that Florida was a region of weakness for the system. And I’m curious if you’ve seen that remain the same and if there’s been a change when you look geographically across any other regions of the country that you have a relatively good penetration in.

Yes. We saw the gap between Florida and the rest of the system widen a little bit, but our position hasn’t changed. We still see that as a normalization of trends in the state kind of coming out of COVID and normalizing, but we’re still all in on Florida from a growth perspective. Florida is still one of the top states for net migration in the U.S. And we continue to see it as an excellent opportunity for us to operate and grow there.

And we don’t have any other regions of the country that we’d call out as being weaker than the rest. Our development process is really data-driven. When we select a site, the success of the site really performs pretty predictably within a narrow band.

Got it. That’s helpful. And then, Chris, I know the company utilizes digital channels to drive greater frequency among current users, and you called some of that out in your prepared remarks. But I was curious how you’re thinking more about what you might call top-of-the-funnel tactics that you can deploy from a marketing perspective that maybe can help reach consumers who have never used First Watch.

Yes. I think we look at and segment the consumer based on demographics, psychographics, but probably more importantly, frequency. We do have a focus on all the channels that I mentioned on the call. So our infrequent users, lapse users, and even users of competitors are our targets.

Hi. Thanks and good morning. Back on the sales, I was also curious to what degree you think maybe return to office dynamics could be impacting your business. Could you elaborate on what you’re seeing weekday versus weekend? Or are there any other data dynamics that you analyze to try to answer that questions?

Yes. We don’t have any data that suggests that it’s due to return to work. We do know that the weekday occasion, specifically weekday lunch, is where we’re seeing the most softness. We believe it’s actually a factor of the consumer just choosing to treat that occasion as one they can have at home in this environment.

So good morning, Brian. The tools that we created last year and have rolled out in the system continue to improve, allowing managers in the restaurant to see their real-time labor costs, helping them with scheduling and staffing during weekdays and peak hours. They’re also successfully achieving more throughput during our peak hours, which improves our labor efficiency.

Just to give you an example, we’ve been testing a digital scheduling platform, and the test went extremely well. We’re rolling it out in Q3. This platform allows employees to look at their schedules and trade shifts, which will improve our efficiency and free up managers to focus on other things.

Hey, guys. Good morning. Wondering, as you kind of tease out the traffic impact, does discounting kind of in the breakfast category from some of the legacy players impact you? Do you think it’s having a near-term impact?

We worked hard years ago to differentiate ourselves from that segment through brand repositioning. What we’re seeing now seems to be more of an occasion issue rather than self-inflicted. We’re focusing on our everyday value and step up our communications around our brand attributes.

Hey, good morning, guys. I had two questions. The first is just from a same-store sales perspective, as we look to the back half, what can you guys do to maybe have an impact on the comps?

I think we are taking steps to reach out to our consumers. We’ve got an opt-in database now of close to 7 million that we’ve been curating over periods of time. We’ll increase the frequency of communications with that group and step up digital activity.

For the back half of the year, we expect heavier expenses along with new restaurant openings. There’s a tendency to experience an uptick in G&A expense during the fourth quarter as we onboard staff and complete projects before the end of the year.

I want to personally thank our teams for their efforts in this and every quarter with a special shout out to our operations leaders for the exceptional results they delivered in these interesting times. We’re guided by our You First philosophy, which defines who we are. Our achievements and future growth are underpinned by standing shoulder to shoulder, rolling up our sleeves, putting others first, and being kind. Thanks everybody for your time today.

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.