FWRG - NASDAQ

Greetings, and welcome to the First Watch Restaurant Group Third Quarter 2024 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Steven Marotta, Vice President, Investor Relations. Thank you, sir. You may begin.

Hello, everyone. I'm 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 third quarter of fiscal year 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 limitation, statements concerning the conditions 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 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. During today's call, references to same-restaurant sales and traffic growth compares to the 13-week periods ended September 29, 2024 and October 1, 2023, in order to compare like-for-like periods. Otherwise, any reference to percentage growth when discussing third quarter performance is a comparison to the third quarter of 2023, unless otherwise indicated. And with that, I will turn the call over to Chris.

Good morning. Thank you all for joining us this morning to discuss our third quarter 2024 financial results. Before I begin, I'd like to express my appreciation to the many of you in the investment community who reached out to us with concern regarding the recent hurricanes. We're grateful for your thoughtfulness. Now let's jump right in. Our third quarter performance highlights include strong adjusted EBITDA growth, traffic momentum within the quarter and our continued demonstration of solid operational execution. In the quarter, we generated $291.8 million in system-wide sales, $251.6 million in total revenues, $25.6 million in adjusted EBITDA and $2.1 million in net income. In addition, we recognized increased restaurant-level operating profit margin and our teams opened nine new system-wide restaurants across eight states, seven of which are company-owned and two that are franchise owned. While overall same-restaurant traffic was slightly lower in the third quarter versus the second quarter, there were several factors at play that masked improvement later in the quarter. First, as we noted on the last earnings call, July traffic was abnormally negative for us and the industry. Despite that sluggish start, following July, our traffic trends improved and dining room traffic turned positive in the last period of the quarter, which we believe was partially driven by a favorable response to targeted marketing campaigns we tested during the quarter. Secondly, around midyear, we saw third-party delivery traffic move more negative, acting as a drag to consolidated traffic and concealing improving trends in both our dining room and direct off-premise traffic. As we've stated previously, our primary focus remains on growing our dining room and direct off-premise channels, although we are exploring plans to address the changes in third-party delivery dynamics. Moving to operations. Our teams once again delivered solid execution and another quarter of improvement in employee turnover. Turnover is the lifeblood of any restaurant organization as our business is about people, not just food. Reducing turnover and increasing tenure supports knowledge transfer, reduces training time and facilitates better execution, all of which are manifested in our results. Several ongoing initiatives highlight the aim to control what we can control, including efforts to: one, increase our rate of internal promotes within the First Watch organization; two, improve scheduling, including the addition of new labor tools and app-based scheduling, and three, strengthen our training program for new managers. Even more than delivering another quarter of focused cost management, our labor management is building a strong foundation for our continued unit growth as we march toward 2,200 domestic units. Given our operators' successful optimization of restaurant-level performance and the dining room traffic trend, we're confident increasing the midpoint of our adjusted EBITDA guidance. And before I leave the topic of our teams, I want to mention a recognition that they received just last month. While we've earned quite a number of accolades, this one is really extra special. First Watch's culture is guided by our You First vision with the core value to Just Be Kind. We know that if we take care of our people, they will in turn take care of our customers. This core principle was established by our founders and is practiced widely across our organization every day. With this in mind, I'm pleased to share that First Watch was recognized as the number one Most Loved Workplace in America by Newsweek and the Best Practice Institute following a survey of more than 2.6 million employees across hundreds of companies around the country. This is the third consecutive year First Watch has been recognized on this list, but it's our first time in the number one spot. To us, this recognition highlights what makes First Watch and our You First culture so special and distinguishable. To all of our teams listening, I want to thank you for all that you do every day to make First Watch great. This award is a recognition of our focus on people, and I couldn't be prouder of this team. Next, I'd like to dive a little bit deeper into our demand generation efforts that I just referenced. In prior quarters, we highlighted our strategy of focusing on demand generation efforts rooted in customer data and analytics and done the First Watch way. This multiyear initiative aims to develop strategies to efficiently attract new customers as well as remain top of mind for current category users. In the nearer term, we believe the opportunity exists to increase impressions to spur the next breakfast and brunch occasion for those active category users. By using data sets that give us confidence in one-to-one targeting, we are leveraging customer analytics to sharpen our plans and enhance marketing spend efficiency to reach specific audiences, whether lapsed or frequent customers or those who may have recently visited a competitor. In the third quarter, we deployed or increased usage of early versions of this strategy through our own database as well as various digital and social media networks, and other channels, including streaming video and connected TV to name a few. We're encouraged by our preliminary results, which we believe contributed to our traffic improvements in the restaurants and look forward to furthering our efforts in this area. Investments in technology remain a core aim across the business. Beyond demand generation, our teams continue to focus on efficiencies stemming from our investments, including KDS, pay at the table, point-of-sale and waitlist management enhancements. One example of our collective efforts is reducing ticket times again by over 15% in the third quarter versus the same period a year ago, with the majority of our restaurants regularly reporting below 10 minutes, a remarkable achievement for a full-service restaurant that features a highly modified menu and cooks to order. The combination of increased restaurant-level operating efficiencies and demand generation tactics is supporting market share gains during a time when the morning meal occasion overall is experiencing softness. To that point, during the third quarter, our same-restaurant traffic and sales were better than the Black Box Casual Dining segment. Finally, turning to development and given that we still have so many new restaurants scheduled to open in the fourth quarter, I thought it was timely to dive a bit deeper into the topic of our new restaurant development. Our team's execution on our strategy continues to deliver impressive results, is fueling our growth and continues to extend our segment-leading position. Last 12 months’ revenue from all NROs since 2022 is outperforming their underwriting expectations by roughly 10%. Our long-standing track record of high-performing prolific unit growth has increased confidence with top-tier developers. Now more than ever, we received first looks into great locations, including new plan centers as well as prominent existing sites, many of which are the result of vacating restaurant brands. For instance, we opened 13 formerly occupied freestanding restaurant locations in the last 24 months, and they are among the highest performers in our system with AUVs tracking over 15% higher than all other NROs in the same period. Our current pipeline now includes more than 25 of these prominent locations, which are slated to open over the next few years. Thanks to the hard work of so many throughout our organization, we experienced an immaterial same-restaurant sales impact from Hurricane Milton at the start of Q4. The storm did, however, cause some construction-related disruptions across the Southeast and beyond, impacting many of our new restaurants under near-term development. We know that strong restaurant openings are key to ensuring strong long-term restaurant performance. As such, we never compromise on any aspect of a new restaurant opening, which is why we've decided to reschedule five previously anticipated December openings into January 2025. In the fourth quarter, we expect to open 23 new restaurants. And with the expectation of increasing the size of the system by 10% or more annually, we're currently shepherding more than 120 projects in our development pipeline, many of which are slated to open in 2025 and 2026. In closing, I'm proud of our performance, our teams and our results. Our customer proposition is highly differentiated with a culinary forward menu, fresh ingredients, high touch point customer service, fast ticket times and easy accessibility at the corner of Main and Main [ph]. The daypart remains highly fragmented and largely occupied by legacy players who continue to struggle with relevancy, which makes our opportunity even more significant. First Watch's clear and growing leadership in the daytime dining daypart, combined with significant scale advantages associated with our 547 restaurants across 29 states, positions us well within a large addressable market and provides a clear path to 2,200 restaurants. Before I turn the call over to Mel, I'd like to welcome our two newest Board members, Charlie Jemley and Michael Fleisher. Both are accomplished CFOs who have deep operational experience as senior executives at public companies in the consumer space and both bring additional corporate governance proficiencies. They are terrific assets for First Watch. And with that, I'll turn it over to Mel.

Thank you, Chris. Good morning, everyone. As they have all year, our restaurant managers and crews continue to operate with efficiency and drove our third quarter profits. The financial headline is that our revenues continue to grow and our third quarter restaurant-level operating profit margin and our adjusted EBITDA margin exceeded the prior year. Total third quarter revenues were $251.6 million, an increase of 14.8%. Our top line growth in the third quarter is attributed to 44 new restaurant openings over the last year, coupled with our franchise acquisitions. This was offset somewhat by negative same-restaurant sales of 1.9%, which includes a same-restaurant traffic decline of 4.4%. We experienced no check management in the third quarter, though planned targeted marketing campaigns did have a small impact on our net per person average. As Chris mentioned, compared to last year, our dining room traffic, which is our most meaningful sales channel and represents more than 4/5 of overall sales and traffic, improved each month during the quarter and turned slightly positive in our ninth period. While off-prem traffic remains negative, we're encouraged by the indications of our improving dining room traffic, which we believe reflects the consistency of our food and service, our modest pricing philosophy and the successful targeted campaigns. On the restaurant cost front, food and beverage was 22.4% of sales compared to 22.6% in the same period last year. As a percent of sales, costs benefited from carried pricing of 3.4% and offset by commodity inflation of 3.4%. Bacon, avocados and eggs were the primary drivers of food inflation during the quarter. During the quarter, restaurant-level labor inflation was 3.8%. Labor and other related expenses were 33.6% of sales in the third quarter, a 30 basis point improvement from 33.9% reported in the third quarter of 2023. This labor efficiency is largely the result of continued gains our operators have driven from the application of new management tools implemented over the last year or so. As with last quarter, our customer experience scores improved again. The combination of labor efficiency, coupled with favorable consumer service scores, reflects our restaurants' commitment to excellent operations. The improvements in food and labor helped lift restaurant-level operating profit margin to 18.9%, 20 basis points better than the prior year. Income from operations margin was 2.5%. General and administrative expenses were $27.7 million, approximately $2.5 million higher than the prior year, primarily due to IT and other miscellaneous expenses, as well as additional headcount. As a percent of third quarter sales, general and administrative expenses was 11%, which was favorable to the prior year by 50 basis points. Adjusted EBITDA was $25.6 million, a $4 million increase versus the $21.6 million reported last year, and adjusted EBITDA margin was 10.2% versus 9.9% margin we realized in the third quarter last year. The year-over-year growth in both adjusted EBITDA and adjusted EBITDA margin was the result of improvement in restaurant-level operations as well as the levering of G&A expenses, as I just mentioned. Net income was $2.1 million and net income margin was 0.8%. With the nine new system-wide restaurants opened during the third quarter, of which seven are company-owned and two are franchise-owned, we ended the third quarter with 547 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 third quarter revenue by about $16.5 million and adjusted EBITDA by about $4 million. We're pleased with the performance of our acquired restaurants. And as such, their expected net impact on fiscal year 2024 adjusted EBITDA has increased to $14 million from $13 million previously. For further details on the third quarter, please review our supplemental materials deck on our Investor Relations website beneath the webcast link. Again, we're proud of our restaurant teams who continue to raise the bar on customer experience in our restaurants while delivering strong profitability. Before we move on to guidance, I'd like to remind investors when making comparisons to the fourth quarter last year to consider the approximate $5 million of adjusted EBITDA benefit to the fourth quarter of 2023 associated with that fiscal year's 53rd week. Additionally, our targeted marketing campaigns in the third quarter were impactful and at least partially a stimulant to same-restaurant traffic improvement through the quarter. Some of these initiatives carried into October as well. The results of our 2024 marketing programs are currently being assessed in order to optimally plan for 2025. For the balance of 2024, our holiday marketing plans are similar to 2023. To update our full year outlook for 2024, we are narrowing our same-restaurant sales growth estimate to around negative 1% with same-restaurant traffic declining 4% to 4.5%, similarly with what we have experienced year-to-date. We are adjusting our annual revenue growth expectations to a range of 16.5% to 17% from the previous range of 17% to 19%, in part due to the hurricane-related delays and our decision to push a handful of our new restaurant openings into early 2025. Approximately 7% of the growth is expected to be the net contribution from the franchise restaurants acquired in 2023 and 2024. For adjusted EBITDA, we're now guiding to the high end of our previous range. Our guidance is now $110 million to $112 million. The net impact from acquisitions is now expected to contribute about $14 million to the current year adjusted EBITDA. We now expect a total of 47 net new system-wide restaurants updated to reflect 43 company-owned restaurants, six franchise-owned restaurants and two system-wide closures. Our 2024 development pipeline is heavily weighted in the fourth quarter with 10 already opened thus far, and we're confident in our team's ability to execute those that are remaining. We now expect a blended tax rate of around 33%. Our expectation of commodity inflation for the year is around 3% and our expected restaurant-level labor cost inflation is around 5%. And finally, we're planning capital expenditures of around $130 million, not including capital invested in franchise acquisitions. And with that, operator, if you'll please open the line for questions.

[Operator Instructions] Our first question comes from Jim Salera of Stephens. Please proceed with your question.

I really wanted to drill down on some of the success you guys mentioned on the targeting marketing campaign. And maybe if I could make that into a two-part question. As we think about improving consumer trends in the back half of this year and really going into 2025, is that a lever that you guys think you'll be able to flex to help kind of return traffic on the dining room back to positive growth? And then do you think that, that has any impact on the off-premise channel as well such that it can kind of be a double whammy?

Yes. Jim, it's Chris Tomasso. Thanks for the question. As we mentioned, we put a number of initiatives into test in Q3 on the demand generation front. And also, as we mentioned, we're pleased with some of the results that we saw. I will tell you that we believe that the on-prem and off-prem channels are very distinct. And while there might be a little carryover in the tactics that we use, they really are very specific, which is why we called that out as well. So in talking about controlling what we can control and reading the macro environment, again, none of us having the crystal ball and knowing how long this environment will be in place, we did take some steps to leverage the data that we've been talking about that we've been kind of cultivating and refining and tried a number of different things, and we're pleased with the success. So it's not something that we think will impact in Q4, but it's certainly something that we're considering for our overall plan for next year.

Great. And then maybe if I could just ask a higher-level question. What do you think you would need to see from whether it's full service in general or the consumer more broadly that would make you more confident just kind of broader consumer recovery going into 2025?

I think the step-up in in-restaurant dining, I think, for us is what our bellwether is. And as we've said, we -- that turned positive for us at the end of the quarter. So that's one of the green shoots that we look at looking forward. So, encouraged by that.

Hey, thanks guys. I’ll hop back in the queue.

Our next question comes from Jeffrey Bernstein with Barclays. Please proceed with your question.

Great. Thank you very much. Good morning. Two questions. The first one, just, Chris, you mentioned the industry is seeing some softness in the AM daypart. And for better or for worse, that is your primary focus. I'm wondering what you think are the primary drivers of that and whether or not that's concerning for you or whether you're confident in the recovery. I know some people talk about more back to office during the week is perhaps somewhat more of a headwind for the AM daypart, at least during the week. So, just trying to get your assessment as to that AM segment commentary and your outlook going into '25 on that front. And then I had one follow-up.

Sure. Our take is that the morning meal occasion is the one that's most under pressure right now and that it is really due to the macro environment. And by that, I mean, we said it on calls before, it's not that we've seen trade down into QSR or convenience breakfast. It really has been the occasion across the board. And to answer your question about why we believe that is, we think that as the consumer is thinking about reducing their dine-out dollars during this time, the breakfast occasion is one that's easily one that can be replaced at home. And so we continue to take market share even in this down environment. So we're -- and we're operating the restaurants really, really well. So I think we're weathering this extremely well. And I do believe that there's an absence makes the heart grow fonder, and people will remember why they love breakfast and brunch specifically and that occasion. And that once the consumer environment eases a little bit, I think we'll benefit from that.

And then the follow-up is just on the comp trends. A lot of restaurants have reported over the past 10 days, and many of them are talking about pretty consistent improvement in the trends in September and going into October and early November. I'm wondering whether you've seen similar. And as you think about the traffic component of that, which is obviously the area of focus, your level of confidence that you can revert that trend, whether it's through targeted marketing or otherwise? I know the down 4% was disappointing for you, but are there levers you have to reverse that to flat to positive? Or are there some just internal challenges that make a return to positive less likely into '25? Thank you.

Yes, we saw improved trends in our dining room and direct off-premise channel. So again, encouraging from that perspective. And I actually believe that we'll continue to see that should the environment improve. And that, coupled with some of the things that we're able to do from a marketing standpoint now, I think, is going to be our approach going forward. So I mean, it's -- there's no question that this environment has led to a lot of pivoting, if you will. And we've done that, and I think we've managed it very well.

Thank you very much.

Our next question comes from Todd Brooks with The Benchmark Company. Please proceed with your question.

Hey good morning, to you all. Thanks for taking the question. Two questions, if I may. One, there's obviously kind of a silver lining maybe for the environment that we're in now. Daytime dining, a high-growth category. A lot of participants want to grow from that regional player to more of a superregional or national over time, but you have such a scale advantage with the footprint. I'm just wondering if you look longer term and more strategic, the challenges of this environment that you're all slogging through currently, what benefit does that accrue to on the back end of it from First Watch's positioning within the category?

This is Chris. There's no question that we're the leader in this segment. You mentioned the scale, but I think also the 40 years of operational excellence and some of which we reported here today. So -- and as I mentioned, we know we're taking market share. There's a lot of legacy players that are closing locations. We think that gives us a great opportunity as well. So looking forward, I mean, I think maybe there'll be some contraction in our segment, and I think our leadership position will serve us well.

I think one of the things one of the things that I think people miss is the smart things that the company has done even in what has been a choppy environment between acquisitions of restaurants, our offerings, the efficiencies we've driven into the restaurants. As a result, the revenue has grown nearly 15%. We've grown our EBITDA nearly 18% to $25.6 million in the quarter. We've opened over 30 restaurants now for the -- through today this year that are company-owned and with more to come. So I think people look a lot at the same-restaurant sales and our traffic. And of course, those are choppy. But the company is winning. The company is extending its lead. And I think that positions us going into an improving environment as maybe the first out of the box.

That's great. Thanks. And then my second question, you talked about that improving trend in dine-in traffic over the course of the quarter. I was wondering if you could parse out. You've talked in the past about Florida performance versus rest of the fleet. And are you seeing any type of traffic improvement in those stores as well that would allow you to close that gap that you've seen is really that reverse migration headwind has been in place for the last four quarters? Thanks.

Yes. There's a couple of things that we're optimistic about as it relates to stabilization. One is that Florida has become more stable for us. Obviously, the sequentially improving in-restaurant traffic during the quarter with September being positive. Direct off-prem is no longer a real drag on consolidated traffic, although, as I mentioned, third-party continues to be. So, all of those things are a reason for us to be optimistic.

Okay great. Thanks. Thank you, Chris.

Our next question comes from Andy Barish with Jefferies. Please proceed with your question.

Hey guys. Just want to make sure I'm calculating it, but mix looks like it was down about 1 point or so in the quarter. And I just want to tie that into the demand generation. I like that, Chris. That's truly from a former marketing guy. Related to a little bit of promo and discounting, is that kind of how we would have seen that in the quarter?

Little different. PPA was down a little bit, but it was all attributed to the promo effect. Overall, we were -- mix was pretty flat.

Yes. And as Mel said in his prepared remarks, no check management when we look at it, I mean, it's been tracking well all year.

Got it. And again, just going into the fourth quarter, I know you ran a little bit into October, but would you expect that overall mix to kind of flatten out just given backing off on the promotional stuff, it sounds like for the holidays?

I believe that to be the case, yes.

Okay. And then, Mel, just I guess, with that many openings in the 4Q, just maybe level setting on what we should be aware of in terms of where we might see a little bit of restaurant-level margin pressure. And I know it's tough because you're comparing against an extra week last year, which helps margins. But just any color on that might be helpful for the group.

Well, the planned timing of the openings and their path to maturity, obviously, those are the least productive restaurants in terms of delivering at the restaurant-level operating profit margin in a couple of weeks after they open. So it's kind of -- I would say we probably had to push more to December than we prefer. It's a little heavily weighted toward the end of the period now. But all of that's been built into our guidance for our full year guidance that we provide. So I think you may be able to kind of back into their contribution. So we've got 10 of them open now with the plan to open 23 in the period. So we've got 13 yet to go, and we're on pace to open every week, but it is -- we will have some open in December, which is what we typically try to avoid doing actually.

Okay. Thanks guys.

Our next question comes from Brian Vaccaro with Raymond James. Please proceed with your question.

Hi, good morning. Just following up on the comps. Could you give us a better sense of the magnitude of traffic improvement that you saw through the quarter or maybe where recent trends sort of are shaking out? And I'm curious, in past quarters, you've noted that the weekday is softer than the weekend. Maybe you could give just an update on those dynamics as well.

Brian, when you say the magnitude of traffic, I'm trying to understand what it is. You're...

Yes. From an industry perspective, July was definitely worse than August and September. So I want to be cognizant of that and then obviously cognizant of some of the levers that you're pulling. So just trying to get a sense of your traffic was x in the quarter, just what we're seeing more recently versus what we saw earlier in the quarter. Just any sense of magnitude of improvement or just absolute traffic trends?

Yes. I think if you take the two channels that I mentioned, so we saw in-restaurant traffic turn positive in September, and we said that our direct off-prem stabilized. So I think that gives you a feel for where we ended up because we had kind of already talked about July on our last earnings call. So you can make that leap from the improvement from July through the end of the quarter with those two channels, which represent the majority of our sales.

All right. Fair enough. And then any comments on weekday versus weekend trends?

Weekend still is trending better than weekday.

Okay. And I guess as you study the weekday trend, I don't know if you want to triple click, quadruple click, whatever you want to call it. But I'm curious with this discussion around back to office, return to office, do you -- I mean, can you see anything within like the Tuesday to Thursday trends or that would point to kind of a return to office dynamic or anything regionally? And then the other question I had for you, Chris, is during the weekday, when you look at where that softness might be, is there an opportunity -- I understand you don't want to discount or get it more aggressive on price point discounts. But is there an opportunity -- there are other brands that have great everyday value. And they do some early dine programs or some late-night programs, obviously, for their businesses that are mostly dinner. But is there any opportunity to do like an early riser type of thing before 8 a.m. or maybe lunch is softer, I don't know, but if it was, maybe there was some lunch news that you could inject that might drive some weekday -- targeted weekday?

Sure. I'll answer the first part of your question first. On the return to work, I mean, we've looked at it since COVID. And when you hear about office occupancy increasing and things like that, and we haven't seen a correlation there. I think we might get some movement around when somebody uses us if we have a restaurant near their office or near their home. I still think if they're looking at an occasion that we provide that we're still a good option for them. So no real correlation there. Different from a highly urban penetrated concept. So -- and then on the back half of your question, really, our focus there, it comes back to leveraging the data that we're now getting and some of the things that we tested are more timely messages around those occasions to the right consumer at the right time. And I think we've been talking for a while about cultivating this data that we have, and we started to put some of that into play in Q3, and that's what it was about, the right message at the right time to the right consumer, and we're happy with what we've seen. So still not necessarily looking to go down that discounting route or whatnot, but we think we can be better, smarter and more targeted with our messaging now that we have tools, frankly, and data that allows us to do that.

All right. Thanks very much. I’ll pass it along.

Our next question comes from Sara Senatore with Bank of America. Please proceed with your question.

Hi. Thank you. This is Katherine Griffin on for Sara. First, I wanted to ask, I think it was -- Chris, you were talking a little bit earlier about the receptivity to some of your targeted marketing from lapsed users and maybe some customers that have been going to competitors. I'm just curious if you're able to tell if there's anything in common with either cohort. I would guess that these are customers that might be more value seeking. But just want to make sure I understand, I guess, like what -- as far as what the opportunity is to continue to leverage targeted marketing and kind of where you might take share from?

Yes. Great question. I think it's those things and more. We typically don't attract the value-driven customer. And as we all know, right now, there's a lot of consumers out there are just bouncing from discount offer to discount offer, taking advantage of it to help ease their wallet, and we get that. But we're really looking for our target demographic who is also perhaps trying some of our competitors. We'd like to get one more of those occasions, and we're going to leverage our core brand strengths to do that and make sure that we, again, increase the messaging and have the messaging be more relevant. So we think there's a lot of opportunity for us to continue to take market share like we have been. And now we're starting to feel really good about the tools that we have to do that.

Great. Thank you. And then I was curious, you mentioned a little bit about just continuing to look at like technology investments. And I wanted to know where else you see opportunities, whether it's like in the 4 walls or maybe with regard to more like targeted marketing initiatives. Just kind of like what's on your wish list for technology investments, what are you prioritizing?

Yes. I don't think we get full credit for all the tech stack that we've launched in our restaurants, both front of house and back of house, consumer-facing and employee-facing. I ran through a quick list of those in my comments, but the benefit of those has been tremendous, as you can see in our results. So, reducing friction from the customer experience, continuing to deliver tools that make us the most loved workplace because we're removing even friction with our employees. But our focus now and where you'll probably see us leveraging more technology is on the consumer-facing side, specifically around marketing. So I know we're talking a lot about that demand generation efforts right now, but that's where our focus is.

And enhancing what we already do.

Yes.

Great. Thank you.

Our next question comes from Jon Tower with Citi. Please proceed with your question.

Great. Thanks for taking the questions. Just -- I mean, zooming out a little bit, I think your marketing spend as a percentage of sales kind of looks a lot lower than, frankly, brands of similar scale. And I'm just curious, I know in the past, you've talked about the idea of not necessarily wanting to go bump that number higher and/or at least advertise at a national level. But can you maybe help us think about -- do you believe that today, the marketing dollars that you have are appropriate for the size of the business and frankly, where you want the brand to be over time, that 2,200 stores in North America?

That's a great question. What I'd say is that we're not targeting a specific percentage or ratio. What we're looking at is can we efficiently and effectively spend either at the current rate that we're spending now or do we need to increase that to get the results that we want. And all of that's in play and under consideration for 2025.

Got it. Okay. TBD. All right. Then maybe just -- Chris, you mentioned the idea that, obviously, third party has been a bit of a drag on your business for some time. And I'm just curious if you could help us, one, maybe quantify that number in the third quarter? And then two, I think you spoke to the idea of potentially finding some new solutions around it or other ways to improve that going forward. Can you maybe speak to what exactly you're thinking about there?

I'll take the second part, and Mel can take the first part if we even want to report on that. But yes, I mean, look, it's a completely different marketing channel and way to reach the consumer. And frankly, it's a different way the consumer wants to use us. I think the frustrating and challenging part for us and anybody is there's not a lot of control that you have on that from an awareness perspective and whatnot. So we're working closely with our partners. Overall, off-prem is about 17%, 18% of our business and third party is about, call it, half of that. And then we have a couple of players within that half. So -- but just working with them to optimize our presence there and our offering to the consumer and seeing -- I mean, if you really parse out these channels for us, we're very encouraged by our in-restaurant dining trends, very encouraged by the third-party -- or excuse me, by the direct off-prem. Those are the 2 channels that we control. But the real drag on traffic and the headwind to it when you look at it on a consolidated basis has been the third party. So that's why I mentioned that.

The first part of the question, the third-party in terms of traffic has been down mid-teens since really the middle of the year. It's been pushing downward. So that's the challenge.

The other thing I'll say, Jon, is that some of the other brands are spending and treating it almost as a primary growth channel for them, and that's not our approach. We focus on our dining rooms. And honestly, competitive activity has picked up significantly in those channels just as it has in the general consumer space with promotions and whatnot.

Okay. Thank you. I appreciate the color. And then maybe the last one. Chris, you also spoke to the new classes of stores outpacing, I believe, your underwriting from a volume standpoint by about 10%, which is awesome to hear. I'm just curious if you can maybe drill into anything specific about these stores that might be allowing that to happen, right? I know you've talked about building bigger boxes, but obviously, that would have been contemplated in the underwriting. Like what else are you doing to drive that volume improvement?

Yes. Well, when you think about the group that I talked about, those are a class that was '22 to '24, which means we approved those sometimes in 2020 and 2021. So at that time, I'm not sure we had the baseline of information on, say, these stand-alone freestanding former full-service restaurant sites that we have now as a benchmark. So we're just -- the real answer is we're getting better and smarter as we open more of these diverse kind of restaurant platforms. And so that's why we wanted to call out the percentage of those freestanders that are in our pipeline coming up. But I mean, even if you take those out, the classes themselves are doing well. And we've gotten better at locating sites, being near the epicenter, out positioning competitors, the layouts of the restaurants to optimize operations, the dining room configurations. I mean you've heard us talk about this cocktail of things that we've been working on to really optimize our operations. And that's a big part of it is the work that we've done when a restaurant opens, we analyze it within 60 days of it opening and look at optimization so that we can impact whatever the next one is that we're approving that still may not open for a couple of years. So that's why you've seen our -- I think that's a big reason you've seen our AUVs grow so tremendously from $1.6 million to now we're talking about $2.2 million and some of the ones we're approving are now going in at $2.6 million. So I mean, that's a tremendous increase in projected average unit volumes for a restaurant that's only opened 7.5 hours a day.

Awesome. Thanks for taking the questions.

Our next question comes from Gregory Francfort with Guggenheim Securities. Please proceed with your question.

Hey guys. Thanks. The first question, just going back to maybe the marketing. And I think one of the challenges for full service has been just frequency. A lot of the customers visit brands, I don't know, two or three times a year. Can you just remind us what your frequency is? And I guess, is you're kind of pushing into this marketing, do you think there's a bigger opportunity in lower frequency guests who might be lapsed? Or is it the customers coming every month or two that you can really move the needle for? I'm just curious how you kind of segment or think about your customers and who you can move the needle with.

Yes. The first thing I'll tell you is that our frequency pretty much mirrors what you talked about there with casual dining. And we're looking at in terms of another visit, another half visit from all of the cohorts, but really understanding what's the motivation for the visit, what's the occasion for the visit. So the more we know about that, the better we can be in targeting. And we're not -- I would say we're not discriminating against any particular frequency cohort, we kind of have a good feel for the groups and how often they use us and how they use us. And now, for example, what I was talking about earlier is if it's somebody who's weekday lunch, making sure that we hit them with the right message at the right time when they're making a decision on where to go for lunch during the week, and likewise, on brunch on the weekends or weekday breakfast. So we're looking -- if you think back to what we've said all along and how diverse and broad our customer base is, we actually have the opportunity to not have to be so specific and can make an impact, which is what we've been testing.

Got it. Thanks for the perspective. And then maybe for Mel, just as I look at kind of the margin lines, labor, you've done a really good job of leveraging that despite negative comps. Can you talk about kind of what's going on there from an hour efficiency perspective and just your outlook for kind of cost inflation going forward?

Yes. I think the credit goes to the operators, frankly. And we've talked about it for a couple of quarters that we enhanced some of their tools that are provided for managers to actually see more close to real time how their labor is running and how they're -- and they can be more accountable. But to their credit, it's not just providing them the information, it's their actual commitment to focusing on it and holding each other accountable in the restaurants. And so I think the success that we have seen has been the focus that Dan Jones and his team really have applied to scheduling properly and being very attentive to the labor cost line. And it cuts down on many things, like keeps us from paying for inefficient overtime or crews during our hours that are not peak hours. It helps with optimal staffing and that sort of thing. So I would say that it's -- yes, the tools, but it's really -- most of its elbow grease. It's the attention of the restaurants on that line item.

And then just the outlook maybe for food and labor inflation?

I think that in terms of inflation, I think we've given our full year guidance. It's 5% or so.

Okay. Thanks, Mel.

There are no further questions at this time. I would now like to turn the floor back over to Chris Tomasso for closing comments.

Thanks for your thoughtful questions this morning. We appreciate it and for spending time with us here. I want to thank our teams again for their combined efforts. The -- I have to say the entire organization's dedication and kindness was on full display in response to the recent hurricanes. Their collective actions really supported our reopening locations in short order, and again, typifies our You First culture. So I was really pleased with how our teams responded to that. And we look forward to finishing the year strong and continuing to create memorable experiences for every First Watch customer. So thank you, and I hope you all have a great day.