Good afternoon, everyone. My name is Jeff Bernstein, and I'm the restaurant and foodservice distribution analyst here at Barclays. I am thrilled to introduce our next presenting company, First Watch. With us this afternoon from Bradenton, Florida, we have Mel Hope, their CFO, on stage with me. By way of background, for those not familiar in the room or on the webcast, First Watch is a breakfast, brunch, and lunch casual dining chain, just clearing 500 units across the U.S., with a company-owned mix of 80% and on the rise. And with a current 10%+ annual unit growth rate, management is confident long-term guidance for 2,000 U.S. system-wide units. So still a tremendous amount of room for growth, perhaps a quarter of the way there and growing at a double-digit annual unit growth rate.
2,200, and I said 2,000, so they're less than a quarter of the way there. And, with 10%, that gives you another couple of years to build upon.
We're just very precise.
Very precise, yes. So, we wanna thank First Watch and Mel specifically for joining us, and, I've got a handful of questions, but then hope to open it up to the audience if there are any. We'll have somebody walking around with a microphone. Without further ado, thank you, Mel.
Thank you, Jeff. I appreciate you having me.
Yes. Happy holidays.
Likewise.
So we get lots of questions, surprisingly or not, on the consumer. Restaurants have proven to be, I think most people would agree, surprisingly resilient through a lot of different times, but even the most recent period, restaurant industry sales have held up quite well. There was a little bit of a dip from broader restaurant industry data in August and September, and I think that did really raise some concerns of, it's either the headwinds are finally hitting the consumer that we've talked about for so long, or maybe there was a return to some form of seasonality. We've actually heard a number of restaurants say October actually bounced back. So I'm not looking for any data you haven't already disclosed, but I'm just curious, your perspective on the consumer environment?
I guess if you weren't looking at other industry data and you just looked at First Watch results, how would you say the consumer is holding up?
Well, I don't think we would disagree with the macro climate that people are seeing. There's you know, absolutely, the consumer seems to be under some pressure. Our customers have been very loyal to us. One of the things that I think probably differentiates First Watch, and it really goes to the principles of how we show up in the marketplace, is that, you know, we try to be sure that we're there every day with a value. And so while you can have an indulgent breakfast, or brunch at First Watch, we also are very modest in our pricing. We're careful not to get out in front of the consumer.
I think if you look, you'll probably see over the course of the last few years, we've probably trailed the industry in terms of taking price. We price to defend our margins to offset inflation, but we don't try to get out in front of the consumer. So we think we have a pricing advantage, and that by showing up every day with value, that there's something there for our customers every time. And I think that has been part of the secret sauce in terms of our building transactions, 'cause we're focused on that long-term value proposition to the customer so that we're continuing to grow the occasions. Growing traffic is how we really measure how well received we are in the restaurant.
Same-store sales, that's important, but really growing traffic, that's what we key on.
Have you seen what it seems like as a return to some level of normalcy with seasonality taking more of a-
Yeah.
-center?
You know, 100 of our restaurants or more are located in Florida, and Florida probably benefited as much as any state from some, you know, seasonal disruption as a result of COVID. So we have seen some return to seasonality, and I think that, you know, over time, that's just gonna be healthy as we lap some of those. But yeah.
So I talk to friends and family all the time, and I bring up First Watch and other names I cover, and there are a lot of people who aren't as familiar with First Watch, which they will be over time. But maybe you could just remind us, because it is breakfast, lunch... Breakfast, brunch, lunch, maybe your mix of sales, however you look at it, between dayparts or between weekday or weekend.
Right.
Like, how do we think about that mix of-
We talk about lunch, or we talk about weekdays as breakfast and lunch, those dayparts , and then the weekend, we just call brunch. That's if you've ever been to a First Watch, like many breakfast spots, but First Watch especially, the weekends are Super Bowl. So there, it's prime hours, you know, on weekends run from 9:00 A.M. till 2:30 P.M. for many of our restaurants. And so we focus really on the weekday and the weekends, and it runs about 45% as weekdays, and then the remainder is that weekend brunch occasion, which is generally very celebratory. A lot of, you know, a lot of, lot of habitual behavior, a lot of return customers.
On weekends, a lot of people choose to have a, you know, to have a big breakfast at our restaurants over and over on weekends. That seems to be a ritual in some families.
How do you think that positions you, the breakfast, brunch, lunch day part? I think a lot of people think of it as maybe many people aren't going out for breakfast or brunch on a weekday or whatnot.
Right.
So, but yet everyone else I talk to is focused on lunch, happy hour, dinner, late nights. How do you think you're positioned relative-
Well-
to everyone else, we call your peers?
What we've seen is that over, you know, the breakfast day part is a growing day part and continues to be a growing day part in the industry. Most breakfasts are still consumed at home. So when customers are shopping for, you know, for a new, you know, new place to eat, breakfast is becoming more and more a part of the part of the consideration set. And we think that when people are shopping for breakfast, eventually they find, you know, a First Watch, and we have a good history of converting people who are trying us out for the first time into loyal customers. So I think we're well positioned. I think the—I can go back to the value proposition as well.
The value proposition, I think, can keep us in people's consideration set. So when folks are becoming more discriminating about where they're gonna use their wallets or discriminating on where they're gonna go out, I think that we may benefit from some trade up from out-of-dayparts . So maybe people might not do the family dinner for sushi or a $150 family dinner, but they might still come and do a celebratory breakfast on Saturday morning at First Watch, where the value means that they can get in and out for half that.
Right. As I think about, we've got 30-some-odd days left in 2023, but with 2024 upon us, I mean, what would you say you're most excited about for the First Watch business looking at 2024, whether it's sales, margins, or otherwise?
I think, you know, Jeff, what I'm excited about, and I think what the company's excited about, is our growth. We now operate. We're in 29 states. We're in dozens and dozens of trade areas. Every time we birth a new restaurant, in the company, the whole company celebrates. You know, we've been acquiring some of our franchisees, and that frees up some more territory for us to grow in. So the enthusiasm about growing the restaurants and growing the restaurant count and growing the company, that gets me juiced, and that's, you know, that vital part of our growth plan is something that really gets people energized in the company, and it's exciting for us.
Is there anything that you any concerns you carry over from 2023 that you think maybe people are underappreciating that still present potential headwinds in 2024?
Yeah, you know, I'm like anybody, I wonder exactly what, you know, how much under pressure the consumer is in an environment right now. I mean, people are looking for, you know, people are looking for softness in consumer spending and behaviors. But again, I know we're positioned well when people are making that decision. I know our value proposition is there every day. And so I don't worry about that too much. Developers, you know, in order to grow new sites, I think commercial retail development may show some foot dragging, either as a result of interest rates that they haven't seen in, you know, a dozen years, or as a result of other brands not growing quite as quickly.
Their ability to pre-lease a new facility or new development may slow some things down a little bit. So I try to, you know, get a handle on that a little bit. But frankly, what that means for us is that our development teams just have to manage more projects, because if you are gonna have some foot dragging or you're gonna have some fallout, when you're in the restaurant business, you're in the real estate business, right? And you have to kiss a lot of frogs in order to find a few that turn into restaurants. So in order to get into the gestation cycle for a new restaurant, you have to have a whole lot of projects that you're managing.
And so in a time when they're under stress, we're having to manage more projects and more and different venues, so that the ones that complete get to maturity, that we can count on them and that we can stay on schedule. Because our job is to continue to grow, and it's very important to us.
Right. So just because you mentioned that, I think of you guys with 500 units, if you're looking to maintain 10%+ unit growth, I mean, that's 50 stores, which I guess we don't appreciate on the spreadsheet side of the world. But on your side, I mean, how many units does that mean that... And you don't know which 50 are going to open next year, so you've got 100 going on, where you just say-
Well-
-I assume 50 are going to fit in next year?
We're approving sites. Our real estate committee meets monthly, and we look at all the new sites, and we consider them, and we're underwriting to our performance criteria. So we're looking at sites now that'll have 2024, 2025, 2026 opening dates as they come forward. So we look at, you know, we're already planning, you know, I would guess we're probably want to have a third more than you're gonna open. So if you're gonna open 50, you better be looking at 65 or 70 sites for a year, and just knowing that things will change and things will go forward.
But you, again, you have to be. Just to get to that 75, you gotta be looking at another 75 on top of that, that aren't gonna be, aren't gonna fit your needs. It's, in that respect, it is a, it's a real relationship game with, in, in marketplaces. It's cultivating relationships with commercial developers. It's understanding where zip codes are growing and where tax bases are growing in order to make sure we position a restaurant in that favorable market for us.
... and I feel like, you know, with the 10% annual growth guidance, I'm just wondering, when does the law of large numbers kick in? Is that something that you feel like for the next number of years, even on a larger and larger base, there's more and more real estate where you have a better team available, that 10% is not that daunting for you, even if it becomes 60 and 70 units in a year?
If we were, you know, if we were in a confined area, and we said we had to grow like that, it would make me worry, right? But we're now in so many different venues, in so many different states, so many different DMAs, with so much green space in other areas, plus the green space we have in the markets we're already operating in. I feel like we're seeing all the projects that we can that are coming up in an area, that we're part of the. You know, we're on the Rolodex, if anybody even has a Rolodex anymore. But we're on the call list of development companies who are looking to merchandise centers that are gonna be growing next year and the year after, and the year after that.
So I feel like we get the call, and because we have that kind of presence in so many markets, it helps to mitigate that risk that we would be trying to grow too many restaurants in too few places.
Right. I was talking to a growth company earlier, that's always a challenge. I would think there are benefits to open up an existing market-
You bet.
from an economies of scale perspective and brand recognition, and labor, and all these other things
Right.
But yet, so exciting to open up a new market, to plant a flag somewhere else. So how do you think about that over the next couple of years? I mean, is this mostly infill of existing, or do you say, "No, we still want to be..." It's not as efficient to open up in a new market, but it opens you up to a whole other green space.
It does, and we've had some surprises in terms of that, too, on the good side, but I'll come back to that. What we typically do is try to balance our opening schedule so that we open about a third in what we call our existing markets or legacy markets, and then about a third in emerging markets, where we have a presence, but it's not nearly saturated or not close to saturation. And then about a third in newer markets, where we have very few restaurants or brand-new markets. So that's important – that spread is important to us as well, because when we open a store, we open a restaurant with a veteran manager.
So it means that we're pulling a manager out of one of our well-run existing legacy restaurants, and that manager, she's hiring the crews, opening the restaurants, and setting it up for success. Which also gives us a chance to promote somebody within the other restaurant, which is, you know, important to the career path. One of the things that we enjoy and growth companies enjoy is providing that kind of career path for people who are part of a growth company. So we spread it out a little bit. We open a new market once every, call it. We say it's 12-18 months. It's kind of a new market for us.
It's interesting, even if it's not a new market, but it's in a new trade area, we've had some real surprises where we might underwrite a restaurant to be a, I don't know, to open at $2.1 million of annualized sales or something like that, which would be a little bit above our system average, and we want it to grow, grow to $2.5 million in annualized sales in about three years. But we've had a couple of them where we've opened in a new territory, and we said: Okay, we're underwriting to that, and suddenly they've done what appears to be a $3 million restaurant or $3.5 million restaurant. So it's in those places where we're having to learn what is it about, you know, in our -- has our awareness grown?
Are there people looking for First Watch in some of these new areas? Even if it's not a new market, it might be a new Trade Area near to some of those. But that's where the real joy and the surprises are, where we've said, "Boy, this really opens our eyes up to what's the... What is the possibility of some of these larger dining rooms and larger patios that we're starting to construct now?" So it's a fun part of the evolution of the brand.
And being that a third of your business is in totally new markets, just wondering, how do you think about it from a geographical standpoint outside of your core? You know, what are the commonalities where you'd say we've had the greatest success versus, you know what? Let's pull back because maybe this type of market isn't-
Right.
ready for us. Like, what's the divergence between your best and your worst markets?
Geography doesn't have as much to do with it as site selection criteria. So our restaurants, our top performing restaurants, top 10% are, I think, in 10 different states. So it's not geographically driven. It's more driven by the site characteristics. Is it, you know, are we selecting a site that is vibrant out on the, you know, three sides of light, out on the end of a new, a new center, easy access ingress, plenty of rooftops, plenty of foot traffic? Those characteristics tend to drive the performance of the restaurants more than whether or not it's operating in Arizona or in Jacksonville, Florida, or in Baltimore, Maryland.
There hasn't been a prevalent theme or a market where you say the brand just hasn't been accepted?
No.
The real estate is the issue-
No.
If there ever is an issue.
People, our customers, have really enjoyed First Watch, almost without regard to where we put them.
That's great.
It's been delightful.
I bet. You know, looking past the top line for a moment, you haven't given much guidance for next year.
Right.
But directionally speaking, I think most people think there will be less inflation across food and labor and whatnot. Is that a thesis that you would underwrite, or do you see a-
I think-
Big swing in something or that we should be aware of?
You know, there's what I know, and then there's what I feel, and I know that we've, and we've talked about the fact that our inflation, at least on our market basket, seems to have steadied. I don't know that we're gonna enjoy a lot of deflation. I've had people ask me about that before. It doesn't seem like that's how things have trended, but it does seem more stable. And so stability is good. I mean, at least it doesn't front run me too much on where, you know, where our margins are gonna go. Labor, well, I think is gonna continue to go up for us.
We should see some inflation in our labor costs, frankly, as much as anything because of regulatory increases in minimum wage and the impacts in the restaurants of that. So I think we do have inflation that will happen on the cost side of our labor.
Right, and for 2023 now ending, where do those fall out in terms of inflation for overall basket of food and labor?
Labor is running at 8%-10%. In that range, our commodity inflation, at least in the third quarter, we actually did have a little bit of, you know, maybe a basis point or slightly less deflation, but we expected to have a little bit of inflation in the fourth quarter for on the commodity cost. But that's part of what gives me confidence that as we head into 2024, that at least on the market basket, that the commodity inflation seems to have found a level.
Right. So hopefully next year could be modest inflation-
Right
on commodities, but not too crazy.
Right
-in labor of 8-10. When I feel like some of the biggest increases of paying extra to retain workers and signing bonuses and all these other things, maybe some of that eases. So hopefully we're in the mid or somewhere in the single digits-
Yeah
from your perspective.
Yeah, it's interesting. You know, we never faced the kind of labor issues that some of my peers and I have talked about across the industry. We don't do late nights, so I... A number of concepts, I think, struggled with labor on that late-night shift. Our crews can count on, you know, one shift, one menu every day. We close at 2:30 P.M.
And I think that that's appealed to a large enough cohort of hourly workers that our promise that they can, you know, be home for either doing homework or coaching baseball or maybe they have another gig. I think that's been part of the value proposition to the employees that has proven to keep us, you know, a little bit buffered from maybe the more challenging labor environment that others struggled with.
We get asked that a lot, is one area that people perhaps don't fully appreciate, which is your labor model, which I want to make sure to give you a chance to explain. I mean, the fact that it could just end by 2:30 P.M. at the end of the day, that-
Right
... one shift, I mean, can you? Are there metrics that demonstrate the benefits of having a one-shift model, whether it's turnover or retention, or how?
Well, couple of things on that front. One, we look closely at the manager turnover, because the manager is the point guard in the restaurants. That's the person that, you know, really makes it flow. And so our manager turnover has historically been in the 40%, 40%-45% level. I think the industry average is probably 20 basis points higher than that. Ours has been... We've historically been lower than the industry. During, in the aftermath of the worst of COVID, we were kind of middle of the pack, and we've been working it down, and I'm really proud of our operators who have worked down that turnover in the managers, because what we really benefit from a lot of tenure at the manager level. Forget turnover for just a minute.
One of the things that's underappreciated is tenure. You know, when you have a veteran manager or you have veteran staff operating in the back of the restaurant, in the front of the restaurant, their ability to solve for the crises that happen in every shift, right? We ran out of something, or somebody came in, a bus pulled up with a baseball team to feed or something like that. Those events, to have veterans who are able to manage through those times, that's really important. Our tenure of our managers is more than five years in the manager role. That's a useful asset of ours as we solve for that. Our above... The next level up has over 10 years above store supervision.
And so that sort of thing really helps us to solve for the issues that occur in the restaurants, but also make sure that we deliver the culture of the company, which is focused on serving the customer in a really gracious and genuine way.
As we think about those cost pressures, hopefully less onerous in 2024 than 2023, but the menu pricing, just wondering how you think about it. I know you prefer to be conservative-
Sure
and offer the value on the menu, but some restaurants will say, "All right, this is the amount of price we need to hold our margin percentage," and
Right
They're going to take it. Others say, "Well, that's not our objective of price. Our margins could go down if it's gonna help the consumer drive traffic. That's our preference, and we'll make it up over time." So, like, how does management think about it, when you think about how much price we should take next year?
I've always been remarkable to me how simplistic people think pricing on menus is. And that I sometimes wonder if people just take the menu, and they say, "Okay, well, you can increase that by 10% across the board," and that's what menu pricing is.
That's not it?
It's a lot more subtle than that. But the way we think about it is our typical cadence has been to take a look at pricing early in the first quarter, and we say, what do we think our inflation's gonna be? Historically, that's run, you know, probably 2.5% on average in the first part of the year. And then based on how the year is going, we generally will visit pricing later in the year, maybe in the second quarter or possibly the third quarter to unroll it. That's generally a, you know, less of an amount. But we try to focus. We haven't gone away from the philosophy that we want to drive traffic.
And so we try to be sure that we're not getting ahead of the customer, that we're offsetting inflation sufficiently. But if we think that we're gonna get some mix advantage or we've got some, you know, traffic increases that are sustainable and that sort of thing, then frankly, we'll take a little bit on the margin in order to bring more margin percentage, in order to bring more dollars to the bottom line and to continue to promote the next visit or return visits from loyal customers. But we're trying to build that traffic year over year over year. We think that's the way to win this game long term.
When I think about brunch and lunch on the weekends, I think of alcohol mix, and-
Yeah
- would be a favorable mix. And I remember during your, during the IPO process, it was quite surprising that most of your restaurants didn't offer alcohol, and obviously, that's changed, and-
Right
... I know you were fighting for liquor licenses in pretty much all of your stores.
Right.
Where is that gone to?
Nobody signed more liquor licenses in a shorter period of time than Mel Hope.
Yes. We'll headline our note with that one. So where, where are you at today in terms of the mix of stores, the percentage of sales, and the margins on that versus traditional products?
I think we're about at the 90% level. Is that right? And I don't know that we'll ever get too much higher than that, except over time, it's part of the consideration of how we underwrite new restaurants. But we have, you know, in a system our age, we've got restaurants that, you know, maybe they're in a center where there's a lease restriction from one of the other tenants who don't want alcohol or maybe we're across the street from an elementary school or something like that, where we can't sell alcohol. So there's always gonna be... Or frankly, there's some places where we can't afford the licenses.
But for the most part, we're where we need to be on the current system, and we continue to consider it in every new build. Alcohol as a beverage mix is kind of in that 6%-7% now. And we're happy with that. We, you know, we think we can continue to riff on our new alcohol program. For the most part, thus far, it's been crafted cocktails with a little bit of theater when we serve it.
There's a lot of different areas we can go in that, but we're, you know, we're in the early innings of starting to maximize that line, across the, across the board for, you know, for the customer who wants to have a little bit more of a celebratory occasion.
Where if you were envisioning tremendous success with it, are there certain stores that are at 15%, or do you want to become more of a liquor destination, or are you really kind of happy with that 6%-7%?
I don't think we haven't targeted a place that we want to be. You know, our fresh juice program, which began now probably eight years ago, started similarly in terms of when we rolled it out. It was like 3%-4% mixing in the restaurants, and you know, now our fresh juices appear, they're mixing, you know, 13%-15% in most of the restaurants. I don't think alcohol will ever get that high, and I'm frankly not sure that it should. We're not a place where you'd come and belly up to the bar and order drinks all afternoon. But I do think there's an opportunity for us to continue to drive news.
Every beverage occasion that shifts to alcohol is more margin accretive for us, and I think it helps to eliminate kind of the, what people call the veto, though, when you have a variety of people who come to the restaurant, and they would choose to go elsewhere if they could get a, you know, a Bloody Mary.
Yep. I'm just thinking, having been involved in the 2021 IPO, it's been an unusual time to go through an IPO and to be a public company.
Right.
But is there... Or just say, you know, looking back now, you say, you know what, that was a learning, or that's something that we were not anticipating that's totally different than what you were expecting just two or three years ago?
That's interesting. I think time management has been important to us. I'm thinking about at the, you know... One of the things that I think we've done a good job of is the restaurants don't need to care about the ownership, right? They don't need to care whether we're public or private. We want them to be able to efficiently and effectively serve in the restaurants. And for the most part, I think they do. I don't have managers calling me and asking me why their stock's not doing better.
But I think what I would say has been, you know, as challenging as anything has been, just the time management associated with, you know, adding the disciplines of periodic reporting, making sure that we're talking to a larger constituent of owners, and being sure that we tell our story, even though we may be tired of telling some of the story. Or, being able to make sure that we're educating new folks coming in all the time, to coming in at different places in the story, or catch me up, or I was looking at this a couple of years ago, but it fell off the trail during COVID or something like that.
I think that challenge has probably been as remarkable as anything, because everything else, our crews have continued to deliver. Our development team has continued to focus entirely on you know, finding good sites. Don't sacrifice the principles of the company. Our chef continues to be food forward and develop attractive items. And so I think people have done a good job of staying, you know, staying focused on the areas that made the company successful enough so that going public even made sense. And so there was a good story to tell, and people have stayed on it. It's just more been time management, I'd say. Maybe that's what a CFO answers.
Exactly. We have a few more minutes, but I wanted to see if there was any questions in the audience before I continued. Looks like there's one in the front. There's a microphone coming your way.
With the advent of COVID, a lot of the large metropolitan areas like New York, the commuters aren't commuting as they were, and they're staying probably closer to where you have your restaurants. Has that - What kind of impact has that had on your business?
Yeah, it's a good question. I think we are seeing, as we talked about earlier, some a little bit of a, or maybe a big return to seasonality because I do think that Florida, for example, enjoyed some traffic from people who temporarily relocated down there, or maybe they just took longer periods of time on vacation in Florida and that sort of thing. We've seen a little bit of shift in terms of of business. One little bit of insider information I would tell you is that we have noticed an uptick in alcohol incidence on Fridays, so there are more people who are extending. Yeah.
So, there must be some folks who aren't traveling to the office in the way that they used to. But by and large, I think we've navigated that quite well, and we do have a lot of restaurants that are in neighborhoods. And so much of the business is driven on that weekend. You know, the weekends are bowl games for us, right? That's the Super Bowl every single weekend, and so that has not changed. I mean, it's those continue to be such robust occasions. It makes a big difference to the company that we have that balance there.
With the final minute or so, I get a lot of questions when I bring up First Watch of, well, it's on the smaller cap side, which it is. And then there's often talk, and I think we've talked about before, that there's still some private equity ownership.
Yep.
So, can you just give an update on where the private equity ownership stands today, what your kind of thought process is, whether that has had an impact on how you run the business, or what your outlook is for the next few years?
Yeah
... to increase the flow potentially?
Well, our equity sponsor still owns about 55% of the company. They've been, for us, a great partner and, you know, great vision about about the marketplace, a great source of information and support to us. So as far as the, you know, the support that we get, it's a very management-supportive team. They've they did do several block trades of some size. They've, they've gone to 55% from over 70%, early in the year. So they've, so, so, so there's, there's more liquidity today than there was before. I couldn't tell you that I know what the timeframe is or, you know, for, for continued sales or, or something, you know, something more dramatic.
But they're a good partner to us, they're a good partner to the company, and I think that frankly prospers the whole investor group because of what good partners they are to us.
Yeah. But the reduction from the 70+% to the 55%, was that anything in particular that we could say, oh, you know, their plan is to ultimately not be a large holder of First Watch or from... Like, how do you think about the outlook?
I think that's a better question for them than me.
Yeah.
What I do know is that, private equity companies eventually don't own everything that they own.
Yes. That would be hard to do. All right. Well, I think we've exhausted our, our 40 minutes, but we wanted to thank First Watch and Mel for joining us this afternoon.
I appreciate it.
Hope you have a good day of meetings.
It's a lot of fun.
Thank you.
Thank you. Thank you, all.