Thank you for standing by and welcome to the First Watch Restaurant Group Incorporated First Quarter 2022 earnings conference call. At this time, all participants are 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 is being recorded today, May 10, 2022 at 8 am Eastern Time and 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 Raphael Gross, partner at ICR, to begin.

Good morning, everyone, and welcome. I am 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 2022 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 now 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 those from these statements. These 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 and its filings with the SEC, including its most recent annual report on Form 10-0K and 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 EBIT 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'd now like to turn the call over to Chris.

Good morning. Just a few short weeks ago, I shared our results from a record 2021 and I'm happy to once again share that our strong performance has carried into 2022. Before I dive into that performance, I want to take a minute to talk about why we believe we've been able to deliver exceptional results like we reported this morning, and give you a little background on those results. We're in the position we are today because of how we came to be back in the early 80s. Back then, you would have been hard pressed to find another restaurant that served breakfast, brunch and lunch without moonlighting as a dinner place. Daytime dining was almost unheard of. And First Watch was built differently. The fun side of the story of our beginnings and our daytime only hours is that our founders wanted to be able to play golf in the afternoons. That was certainly true. But more importantly, they wanted to give our staff the same opportunity to have evenings free to spend with their families. After spending many years in the restaurant industry themselves, working many long days and late nights, they set out to create a concept where those with the spirit of hospitality could have a fulfilling career in an industry they love and still have quality time to spend with their family and friends doing things they enjoy. That focus on family and our quality of life has been a part of First Watch ever since even before work-life balance was a trending topic. And frankly, it's one of the attributes that drew me personally to First Watch it in the first place nearly 16 years ago. When I joined back in 2006, I had two young children, one of whom actually graduated from…

Thank you. We appreciate you joining us this morning. As Chris mentioned at the beginning of the call, our first quarter performance accelerated at the end of the period and our teams powered through the periods' operating challenges to deliver some solid financial results. In late March of this year, which happened to be very close to the end of our first quarter, we filed our first annual report on Form 10-K. In that reporting cycle, and when we held our earnings call, we furnished some expectations about our first quarter based on what we experienced during the first two-thirds of the quarter. Frankly, we beat our own expectations. During March, we experienced a surge in our restaurant sales across all channels, which allowed us to further leverage our fixed costs and expand our restaurant-level operating profit margin which finished the quarter at 19.6%. Furthermore, the increased sales and traffic we experienced in March have continued into our second quarter. Our same-restaurant sales growth was 27.2%, driven by our same restaurant traffic growth of 21.9%, which we achieved despite the negative impacts in January from the Omicron variant and from winter storms. As we've mentioned before, we believe our emphasis on building same restaurant sales through traffic growth is a key measure of our success. Not only did our first quarter traffic grow by nearly 22% on a one-year comp basis, it also exceeded 2019's pre-pandemic traffic by 3.4%. After we chose not to increase our prices in 2021, we did take a 3.9% menu price increase in early January of 2022. As we've shared before, we believe we have additional pricing power should we determine to revisit our menu prices later this year due to continued inflation in our variable costs. As for that inflation, our market basket was…

. Our first question comes from Chris O'Cull from Stifel.

Chris, you mentioned the March sales that continued into April. Mel, I think you did as well. But did you guys quantify what the comp was in April?

We don't issue comps, don't speak publicly about it on a period-by-period basis.

Can you help us understand, Mel, what the benefit to the margin was of that surge in the comp as you went through the quarter? And how we be thinking about restaurant margin in the second?

In that third period with the surge in sales, we saw most of that come out in labor. Our labor ran very efficiently during that period. The sales were surging and we were still running on thin crews. And so, one of the things that we've taken steps in is to catch up on our staffing, consistent with the kind of surge in sales that we're seeing now.

I was pleased to see the full-year inflation guidance intact, with many companies having raised theirs recently. Is this because the company had contracts in place on commodities that have recently spiked or is there another way that company is mitigating the commodity inflation?

Most of our contracts run 30 to 45 days out in terms of fixing the pricing. We do had a couple of things that we priced during the year, but I think as much as anything, it's the effect of our supply chain team solving for those kinds of issues in real time, and we do expect – we did run higher inflation, but we have built it into our plan certainly for the first and second quarter. And we should expect to see some tapering off, simply partly as we start to roll over a little bit of inflation last year.

Our next question comes from Jeffrey Bernstein from Barclays.

Just a question on the full-year guidance. It seemed like the first quarter, I know, handily beat consensus expectations, talked about them, and I think you mentioned it beat your own. I was wondering what leads you to perhaps reiterate the guidance rather than raise the guidance effectively flowing through the first quarter. I'm just wondering whether that's truly conservatism or maybe there are some macro factors that are leaving you cautious, especially with the sales momentum going into the second quarter, just trying to understand what's keeping you from raising the full-year guidance at this point?

I think that's a good question, Jeff. Listen, we gave what we think was some good guidance on the full year. Of $1.3 million of our, call it, out-earning in the first quarter was related to timing and G&A. So, I think we're still within the band of the original guidance that we gave. And we're also looking at the backdrop of a lot of people whispering about the challenging economy and recession and that sort of thing. We're a new registrant and I want to be sure that we're thoughtful about the guidance that we give, but we're really optimistic about the year and enthusiastic about the performance. And a few weeks, we'll take another look and trying to update if we can.

Just because you mentioned the whisper of the macro backdrop, I'm just wondering how you guys see yourself positioning from a potential economic slowdown and maybe whether you've already seen any change in consumer behavior. And it seems like the sales are still strong, but any change in traffic or mix that would lead you to perhaps take a more cautious view with a slowing economic backdrop?

It's Chris. I'd say that looking back on our performance during tough economic times in the past, we performed very well. I kind of referenced that a little bit in my commentary, but also, as we're sitting here now, we don't see any early signs of that, at least when we talk about the increase in our traffic and sales and the momentum that we have. We typically look for check management by the consumer to be the first sign of any potential issues. And we're not seeing that at all. In fact, our PPA is up, and we're pleased with the demand we're seeing, but also with how the consumer is behaving when they're interacting with us.

Lastly, the restaurant margin. I know, in the past, you said you would take price to defend the margins. I know you mentioned earlier that you'll reconsider later in the year. I'm just wondering, what would you be looking forward to raise the margin? And is the goal to hold that margin flat? Or how do you measure that relative value to give you confidence that you have more of that pricing power?

There's no really one metric that's a trigger point for us. We evaluate – probably every restaurant company evaluates pricing, constantly based on margin, and we certainly look at it very closely. So, as we go through the year and we look closely at what our actual experience is and where we have pricing needs or inflation that we're not offsetting, then we'll constantly take a look at it and reevaluate it. But we did have a very good first quarter and we're – I can just tell you that we constantly look at this.

The next question comes from Nicole Miller from Piper Sandler.

Could you just talk a little bit more about 2Q inflation. So, the COGS are up about 130 basis points sequentially? What is the embedded level of inflation? And could you talk a little bit about items that are up or even maybe down?

Our inflation for the second quarter is really tracking pretty close to where we were in the first quarter. I think we built in in our plan and what we're seeing as still a little high, like 15% on the market basket. In the first quarter, the things that tend to run higher are sort of some high volume commodities like bacon and avocados, for example, that we use a great deal of. So, when inflation spikes, they tend to drive the cost a little bit. And we're experiencing the same thing. Plus, to-go packaging continues to be an inflator of our overall restaurant operating costs as packaging, availability, and cost of it just continue to be something that we've learned to have to deal with over the course of the last couple of .

On KDS and just technology at large, remind us – I'm starting to think about KDS, can it go faster? Or is it going slower? Originally, a very offense measure, probably make things easier in the back of the house, makes people happy. Is it just defense now with the challenging macro? Kind of how does that play out and what comes behind it?

It's Chris. I'll take that one. I would say that our philosophy around the benefits of KDS haven't changed at all, which really is to reduce friction and increase our throughput in our high demand period. So, the good news about it is, you're right, the teams have taken to it and they look forward to it coming in their restaurants. And as it relates to the rollout cadence, I'd say that we're encouraged by our ability to get the equipment necessary now. I think you'll see us continue with our aggressive rollout of that. And, again, our goal is to get it rolled out as soon as we can, and as soon as we can train it and get it operational in restaurants. But again, we're opening all new restaurants with it, to start with. So, basically, reiterating everything we said before. It's still very much for us being on offense and really trying to increase those peak demand hours.

The next question comes from Jon Tower from Citi.

Curious if you can dig into – your outlook for new store availability and the pipeline itself, I'm just curious just to know if you're seeing anything in the competitive landscape. Obviously, it seems like the consumer is a bit more challenged than it had been in recent periods. And then, on the flip side, there's quite a bit of inflation out there in the marketplace, whether it's on build costs, the actual inputs themselves. So, I'm just curious what you're seeing on the landscape, if there's more availability than in the past and if guys can perhaps even accelerate unit growth beyond what you're already doing today.

It's Chris again. I'll take this one as well. We feel very confident in our ability to execute against our development plans, both for the rest of this year and for the following years. Our team's done a really great job of filling that pipeline with sites in various stages of development. We have seen some cost increases, but nothing that our team hasn't been able to manage. It's that, alongside availability of certain elements that we need to build the restaurants. Again, they're managing very well. So, we're on track and we feel good about it. As far as competition for the sites, these are markets that we've been in for a long time, we have relationships with developers in those markets, and we've leveraged those relationships even more so now. And as far as acceleration goes, again, we're sticking to what we put out there for our growth algorithm on new restaurant growth. And, again, just feel very optimistic about our ability to achieve that.

At this point in time, Jon, any projects that's on the calendar for this year, we're already spending dollars into it, and the development teams have probably turned them over more to either construction or site management type of management. Most of our prospecting for new restaurant sites has now turned to 2023 projects, 2024 projects. And that's coming along based on what I can see. This pipeline continues to just fill and be ready. They're looking at way more projects than will actually reach our calendar because some things fall out a bit. But, frankly, our teams out there prospecting for new sites and identifying them. And so, I haven't seen any softness in terms of the pace. I think they're working very hard, but I don't think we're seeing any fall off.

Sorry, let me add one more thing there. The performance of our new restaurants, I think speaks to the quality of the sites that they've been able to get despite increased competition, specifically in the suburbs as we've all heard about. So, the fact that we're able to get these superior sites that are delivering basically third year sales in their first year is what has us so optimistic about our ability to continue our growth.

Just kind of following up on that point, on the new store performance, are you doing anything differently now versus, say, two to three years ago when you get into new markets in terms of building brand awareness? Before you even open those doors, is there their grassroots marketing programs that you have in place now that weren't there before?

I think it actually starts with the sites themselves and the buildings themselves. We use the word prototype here. We obviously don't have a prototype because we don't build from the ground up. But meaning from our perspective, what elements does the restaurant have? And we have spent a lot of time and a lot of effort really evolving that prototype and putting in elements that we've talked about before, whether it's a much larger, more visible patio, indoor/outdoor bars, garage doors that open up to the outside, things like that, that really raise the profile of the restaurant. And we're getting them sites that are at or near the epicenter of the trade area, high profile sites out on the street. And so, in that I've been here 16 years, I can tell you, that's not what we did 16 years ago. And so, just like our concept has evolved, so has our real estate site selection strategy. And I think that's paying off big. We are also much more engaged in digital marketing now. And we leverage that prior to each opening to build anticipation and excitement. And frankly, I think people now are more familiar with our brand. And so, there's an excitement level that comes to us opening in a market that maybe wasn't there 15 years ago, and I think we've earned that over all these years. And I think all those elements, not to mention our great training teams and folks that we send to the restaurants to help open them, all of those things are what is really leading to the success that we're seeing there.

Just last one for me. On the KDS stuff, I know you'd mentioned it was live in 20 stores in the fourth quarter. So, it's still fairly early days, but is there anything you can call out with respect to either comp performance or perhaps even just actual versus theoretical waste at the stores? Just curious, any differentiation you can pull out between those stores versus the rest of the comp base would be great.

It is early days. Again, this almost has as much to do with our ability to hire and train people faster and then to also, again, improve ticket times. I'll give you one factoid. Two of our restaurants that had KDS, they've had KDS in it, they were the top two sales restaurant for the company on Mother's Day, which is our biggest day of the year. So, definitely see that when we're at peak sales hours. And so, we've been able to deliver some higher peak sales hours in those restaurants as well.

The benefits where we have it in the restaurant, so we're already realizing, are just in terms of simplifying the back of the house, operations and the teams just enjoy some efficiencies of having a more predictable flow of food prep and stuff and what the KDS systems are really used for in terms of helping them get things served hot and timely. So, we're already benefiting from those. But as the cohort grows, we should be able to tease out some statistics.

The next question comes from Andy Barish from Jefferies.

Just a couple of things to level-set on where you're on dining room sales and off-premise mix currently, please?

Our dining room traffic has recovered to about 90% to 92% of where it was pre COVID and off-premise is around 22%.

And that off-prem, that's been fairly consistent across our last two or three quarters.

Yeah.

And where are you on the alcoholic beverage rollout in terms of percentage of stores and then the mix in those stores, please?

I don't have the figure in front of me.

We're probably about 70% of the system rolled out right now.

Just a couple of things on the cost side that you've mentioned in the past, Mel. I think you've said you're relatively channel agnostic in terms of margins, but you cited packaging costs. Again, I assume that's still a little bit of a headwind just on the to-go side of things.

It takes a little bit of a bite out of the overall margin. But we have a surcharge associated with our off premises business. And so, it offsets the bulk of that cost.

Just one other quick question on near term. Did you see some of the egg inflation from some of the bird flu issues or does that move relatively quickly?

Actually, we had a contract – the fact is no. We had a contract that we set in December that fixed the cost of our eggs during the period. And so, the inflation and the cost of eggs that others saw, we didn't experience.

The next question comes from Andrew Charles from Cowen and Company.

One quick one for me. Just, Mel, on the favorable commodities this year – favorable COGS, I should say, in the quarter, how much of that would you attribute just to the improvement in beverages that you guys are seeing between the role of alcohol in 70% of stores and the success of the new Purple Haze juice? Just trying to better understand that amid 15% commodity inflation for the quarter.

This is Chris. Our overall beverage incidence is up. And that's analysis that we did prior to introducing Purple Haze. Obviously, we wanted to test for cannibalization. We've always had two core juices in a seasonal. And so, we did test the Purple Haze coming in as a core juice and what impact that would have and it was accretive, obviously, or we wouldn't have done it. But we've seen our overall beverage incidence increase. And the alcohol which we talked about in the past.

The next question comes from Gregory Francfort from Guggenheim securities.

My first question was just a follow-up to Andy's. I think you said you were mostly fixed on your egg contracts in the first quarter. But I think you also said earlier in the call that most of the contracting you've been doing is 30 to 45 days. Is that part of the reason why things step up in the second quarter, is those contracts are rolling off? Are you continuing to fix eggs maybe longer out than you're doing the rest of the commodity basket?

In this case, we had a contract for eggs and potatoes that are fixed for a longer period of time. We're certainly having to watch that market carefully because of some of the other noise in there. But that's not driving the second quarter inflation.

We've heard from some others that the stacking environment has gotten a little bit better. Can you maybe comment on staffing and turnover and maybe even where you're seeing labor inflation right now?

A couple of things. Certainly, the most pivotal staffing position for us that we monitor most closely is the turnover in managers. Historically, we've run about than the industry. I think now we've kind of – for a while there, we were sort of middle of the path during some of last year, but we're now about 10% better than the industry and our number of managers overall has improved. So, we're seeing some real gains there that are important. I think in terms of overall staffing, in terms of hourly, our front and back of house staff, we have seen an uptick in applications. And I think we've seen some improvement. Overall, we're not precisely where we want to be in terms of developing the kind of bench strength we're used to operating under, but it's improved. It's improved a good bit this year.

Lastly, both you guys have been doing this a long time, Wall Street seems to be very concerned about the consumer environment going forward. What are you looking at as you read the tea leaves and just overall thoughts on maybe where the consumer is headed for the next 9 to 12 months?

Well, I know what we're looking for, right? Chris has mentioned that the response to First Watch's offerings in 2008, which was, I guess, the most analogous downward economic period that we draw from, that the company continued to thrive during that period of time. As we look at what we're seeing right now, we're certainly not seeing any customer response today. And Chris has mentioned the fact that we'd be looking for people managing checks, maybe dropping a beverage or dropping a sharable off their check. And we're not seeing that right now. So I can't tell you where things are headed, for sure. I just know that today, we're not seeing any softness in that kind of behavior.

Greg, what we saw in 2008/2009 was the consumer really just became more discriminate about where they went out to eat and how they spent their money. And we've really worked hard to position ourselves to be there in a sweet spot. Again, I think part of our decision not to take price last year, our relative conservatism around taking price this year thus far, is really meant to make sure that we drive that value proposition In times like that, they look for consistency, they look for value, they look for quality, and we have our entire team focused on all of that to make sure that should what we're hearing happens, again, we believe that we'd be able to perform well relatively good back then.

The next question comes from Sara Senatore from Bank of America.

I wanted to ask about – you mentioned surge in sales and labor running lean. That sort of feels like it's been a theme, actually, for the industry throughout the pandemic, where even last year you saw potentially a benefit to margins from that. Guess what I'm trying to understand is two things. One, is there anything that makes you kind of rethink how your labor matrix might work? Or is there technology? I'm just thinking about going forward, if there's more volatility in the labor market, or even on the other side, is there a way to actually have perhaps a tighter labor model? And then, the other piece of that is just, do you know if there was any impact on your top line, whether it's slower service or anything like that? Again, I'm trying to understand sort of what the implications are other than just having better-than-expected margins for a short period of time.

Let me come back to the second part of the question. I may have to ask you a question about understanding what your question is. But on the first one, with regard to labor or what we're learning, our company is constantly evaluating efficiency back and the front of the house. And so, I don't think we've made any major changes in the operations. We always look at optimizing our labor, considering the volume or we've got – we've had to digest a significant new sales channel over the course of the last year or so and how do we properly staff around a pretty robust off premises business. So, those things, we're constantly building into the labor matrix. But, frankly, those kinds of savings come in basis points. There's not a lot of low-hanging fruit. In this industry, Sara, you're constantly looking for basis points to shave in terms of overall cost. And so, we've made the same sort of improvements based on the changes in our business that you would expect that a restaurant company would make as we go along.

On the second part of your question, we track NPS, Net Promoter Score, closely. And I'll just tell you that, over the quarter, our NPS score sequentially improved month-over-month. So, as far as your question about either customer experience or whatnot, we believe we're still delivering it at a very, very high level.

Just to give you a little bit more color on, when we have a sales surge like we had in March and really the customer response has been so favorable to spring, that what happens in the early days of that, our restaurant managers across the company have set their schedules according to Department of Labor requirements or state requirements. So they've set schedules for sometimes two and three weeks out. So, if you have an abrupt shift in your sales, like we enjoyed during March, then it takes them a little bit of time just to staff backup and to kind of recalibrate the staffing.

And again, I know I've said this before, but I think it's important. One of the key benefits of being a company-owned system is the opportunity and the ability to share employees from restaurant to restaurant. So, if we see that one restaurant is – sales are increasing exponentially, we can send a server or cook from a neighboring restaurant and help with the staffing there, if we need to. So that's been a good benefit as well.

So, I kind of piece it all together, the service didn't – wasn't degraded, the NPS scores were improved, but the reason to sort of think about staffing back up is just right now you're kind of putting out fires and moving people around, but that's not necessarily a sustainable model, even though the impact on the business didn't materialize.

We'd like to have more bench strength in our restaurants. They're working hard and, obviously, delivering on good results. But we prefer to be staffed at those levels we were prior coming into the – pre-pandemic.

Next question comes from Jared Garber from Goldman Sachs.

Just wanted to circle up on maybe how the consumer, if at all, is using the brand differently? I noticed there's an opportunity at weekday lunch, maybe shifting some folks or getting some repeat business from the weekend brunch crowd. And then, Chris, you also noted that you're seeing some younger consumers come into the brand. And I don't know if that's a one-quarter thing or that's more likely over time, but just wanted to get a sense of maybe what you think is driving that. Is it some of the menu innovation that you're doing? And maybe that sort of Purple Haze drink, it's something that can continue to drive that along with alcohol? So, just wanted to get a sense of how you're seeing the consumer interact with the brand, maybe differently from the past based on some of the strategic initiatives that you guys have put in place?

I think it actually started a number of years ago when we did, what I would call, the shift to urban farm and the focus on our restaurants and our menu and tying that all together. I think we started to see that trend. So, it's not a this-quarter thing. I think we started to see our average age go down over the years. I think when you look at our menu and the innovation around there, when you look at what our restaurants look like going forward, all of our new restaurants that we built, but even the ones that we were going back and remodeling and bringing to that same look and feel, we see an impact. So, I just think we're broadening our appeal and we're basically filling the pipeline with the next generation of First Watch customers because of the actions we've taken. And then, as far as your question about weekdays, the weekday day part is growing faster than our weekends are, and so we're very encouraged by that. I think we've looked at it in terms of three dayparts – weekday breakfast, weekday lunch, and then weekends we just call brunch. And so, the weekday breakfast and weekday lunch are both seeing growth, and so that's been encouraging for us. Now, some of that's been a lot of the suburbanization of the workforce. I think we're seeing a lot of that where people have more time during the week to do things like that. And we're benefiting from that. But I think there – it might also be their introduction to First Watch and I think we're getting them to fall into one of our regular frequency buckets once they experience us. We've always said that we have a very trial to frequency conversion rates. And so, as we get more people to try us, whether it's through our high profile new restaurant sites in new and existing markets, or again, because of this consumer shift, I think that's what you see us benefiting from.

Just one follow-up quickly. Can you just remind us on how much of this system is sort of converted or currently designed in that urban farms design? If I recall, it was the vast majority, but I just want to make sure that I'm correct on that.

Yes, it's now all of it, the whole system.

Congrats.

This concludes our question-and-answer session, I would like to turn the conference back over to Chris Tomasso for any closing remarks.

Great. Thank you all for joining us this morning. Appreciate the thoughtful questions and your time. As you've probably heard me say a couple of times this morning, we're very optimistic about our second quarter and the year ahead, and we really look forward to connecting with you all again in a few months. And with that, hope you have a great day and a great week. Thanks.

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