First Watch Restaurant Group, Inc.: Form 10-Q for the period ended Sep 24, 2023

Cautionary Statement

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited interim consolidated financial statements and notes thereto included in Part I, Item 1 of this Form 10-Q and our audited consolidated financial statements and notes included in our 2022 Form 10-K. As discussed in “Cautionary Note Regarding Forward-Looking Statements,” the following discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may materially differ from those discussed in such forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those identified in our 2022 Form 10-K, including under “Item 1A. Risk Factors” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Overview

First Watch is an award-winning Daytime Dining concept serving made-to-order breakfast, brunch and lunch using fresh ingredients. A recipient of hundreds of local “Best Breakfast” and “Best Brunch” accolades, First Watch’s award winning chef-driven menu includes elevated executions of classic favorites for breakfast, brunch and lunch. In 2023, First Watch was named the top restaurant brand in Yelp’s inaugural list of the top 50 most-loved brands in the U.S. In 2023 and 2022, First Watch was named a Top 100 Most Loved Workplace® by Newsweek and the Best Practice Institute. In 2022, First Watch was recognized with ADP’s coveted Culture at Work Award. The Company is majority owned by Advent International Corporation, (“Advent”), one of the world’s largest private-equity firms. The Company’s common stock trades on Nasdaq under the ticker symbol “FWRG.”

The Company operates and franchises restaurants in 29 states under the “First Watch” trade name and as of September 24, 2023, the Company had 402 company-owned restaurants and 103 franchise-owned restaurants.

Recent Developments

Financial and operational highlights for the thirteen weeks ended September 24, 2023 (“third quarter of 2023”) as compared to the thirteen weeks ended September 25, 2022 (“third quarter of 2022”) reflect continued success and sustained growth despite a challenging macro environment and include the following:

• Total revenues increased 17.3% to $219.2 million in the third quarter of 2023 from $186.9 million in the third quarter of 2022
• System-wide sales increased 14.9% to $270.3 million in the third quarter of 2023 from $235.2 million in the third quarter of 2022
• Same-restaurant sales growth of 4.8% (+38.8% relative to the third quarter of 2019*)
• Same-restaurant traffic decline of 1.9% (+6.5% same-restaurant traffic growth relative to the third quarter of 2019*)
• Income from operations margin increased to 3.6% during the third quarter of 2023 from 1.4% in the third quarter of 2022
• Restaurant level operating profit margin** increased to 18.7% in the third quarter of 2023 from 17.3% in the third quarter of 2022
• Net income increased to $5.4 million, or $0.09 per diluted share, in the third quarter of 2023 from $46.0 thousand in the third quarter of 2022
• Adjusted EBITDA** increased to $21.6 million in the third quarter of 2023 from $17.0 million in the third quarter of 2022
• Opened 13 system-wide restaurants (10 company-owned and 3 franchise-owned) across 10 states and acquired 11 franchise-owned restaurants resulting in a total of 505 system-wide restaurants (402 company-owned and 103 franchise-owned) across 29 states

* Comparison to the thirteen weeks ended September 29, 2019 (“third quarter of 2019”) is presented for enhanced comparability due to the economic impact of COVID-19.

** See Non-GAAP Financial Measures Reconciliations section below.

Business Trends

In the third quarter of 2023, we benefited from a decline in the average costs of our consolidated market basket combined with price increases, primarily to cover inflation, implemented over the past year.

Our same-restaurant sales grew 4.8% with marginally positive in-restaurant dining traffic growth, though off-premises occasions continued to decline in comparison to last year, similar to industry-wide trends. We continue to believe the decline of our off-premises traffic reflects customers foregoing a comparatively high-ticket dining occasion combined with customers returning to the full experience of our restaurants’ dining room service.

We expect full year commodity deflation to be in the range of negative 1.0% to flat. In addition, we expect hourly labor cost inflation to remain in the range of 9.0% to 11.0%, with overall restaurant-level labor cost inflation to range between 8.0% and 10.0% in 2023.

During the thirty-nine weeks ended September 24, 2023, we acquired 17 operating restaurants and one restaurant under development from our franchisees in continuation of this component of our growth strategy. Furthermore, we continue to execute on our long-term growth associated with new restaurant openings and we are staffed with over 120 managers to lead and operate our future new company-owned restaurants.

Key Performance Indicators

Throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operations” we commonly discuss the following key operating metrics which we believe will drive our financial results and long-term growth model. We believe these metrics are useful to investors because management uses these metrics to evaluate performance and assess the growth of our business as well as the effectiveness of our marketing and operational strategies.

***New Restaurant Openings (“***NROs”): the number of new company-owned First Watch restaurants commencing operations during the period. Management reviews the number of new restaurants to assess new restaurant growth and company-owned restaurant sales.

***Franchise-owned New Restaurant Openings (“***Franchise-owned NROs”): the number of new franchise-owned First Watch restaurants commencing operations during the period.

Same-Restaurant Sales Growth: the percentage change in year-over-year restaurant sales (excluding gift card breakage) for the comparable restaurant base, which we define as the number of company-owned First Watch branded restaurants open for 18 months or longer as of the beginning of the fiscal year (“Comparable Restaurant Base”). For the thirteen and thirty-nine weeks ended September 24, 2023, there were 327 restaurants in our Comparable Restaurant Base. For the thirteen and thirty-nine weeks ended September 25, 2022, there were 303 restaurants in our Comparable Restaurant Base. Measuring our same-restaurant sales growth allows management to evaluate the performance of our existing restaurant base. We believe this measure is useful for investors to provide a consistent comparison of restaurant sales results and trends across periods within our core, established restaurant base, unaffected by results of store openings, closings, and other transitional changes.

Same-Restaurant Traffic Growth: the percentage change in traffic counts as compared to the same period in the prior year using the Comparable Restaurant Base. Measuring our same-restaurant traffic growth allows management to evaluate the performance of our existing restaurant base. We believe this measure is useful for investors because an increase in same-restaurant traffic provides an indicator as to the development of our brand and the effectiveness of our marketing strategy.

System-wide restaurants: the total number of restaurants, including all company-owned and franchise-owned restaurants.

System-wide sales: consists of restaurant sales from our company-owned restaurants and franchise-owned restaurants. We do not recognize the restaurant sales from our franchise-owned restaurants as revenue.

Non-GAAP Financial Measures

To supplement the consolidated financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), we use the following non-GAAP measures, which present operating results on an adjusted basis: (i) Adjusted EBITDA, (ii) Adjusted EBITDA margin, (iii) Restaurant level operating profit and (iv) Restaurant level operating profit margin. Our presentation of these non-GAAP measures includes isolating the effects of some items that are either nonrecurring in nature or vary from period to period without any correlation to our ongoing core operating performance. These supplemental measures of performance are not required by or presented in accordance with GAAP. Management believes these non-GAAP measures provide investors with additional visibility into our operations, facilitate analysis and comparisons of our ongoing business operations because they exclude items that may not be indicative of our ongoing operating performance, help to identify operational trends and allow for greater transparency with respect to key metrics used by management in our financial and operational decision making. Our non-GAAP measures may not be comparable to similarly titled measures used by other companies and have important limitations as analytical tools. These non-GAAP measures should not be considered in isolation or as substitutes for analysis of our results as reported under GAAP as they may not provide a complete understanding of our performance. These non-GAAP measures should be reviewed in conjunction with our consolidated financial statements prepared in accordance with GAAP.

We use Adjusted EBITDA and Adjusted EBITDA margin (i) as factors in evaluating management’s performance when determining incentive compensation, (ii) to evaluate our operating results and the effectiveness of our business strategies and (iii) internally as benchmarks to compare our performance to that of our competitors.

We use Restaurant level operating profit and Restaurant level operating profit margin (i) to evaluate the performance and profitability of each operating restaurant, individually and in the aggregate and (ii) to make decisions regarding future spending and other operational decisions.

Adjusted EBITDA: represents Net income before depreciation and amortization, interest expense, income taxes, and items that we do not consider in our evaluation of ongoing core operating performance as identified in the reconciliation of Net income, the most directly comparable measure in accordance with GAAP, to Adjusted EBITDA, included in the section Non-GAAP Financial Measure Reconciliations below.

Adjusted EBITDA Margin: represents Adjusted EBITDA as a percentage of total revenues. See Non-GAAP Financial Measure Reconciliations below for a reconciliation to Net income margin, the most directly comparable GAAP measure.

Restaurant Level Operating Profit: represents restaurant sales, less restaurant operating expenses, which include food and beverage costs, labor and other related expenses, other restaurant operating expenses, pre-opening expenses and occupancy expenses. Restaurant level operating profit excludes corporate-level expenses and other items that we do not consider in the evaluation of the ongoing core operating performance of our restaurants as identified in the reconciliation of Income from operations, the most directly comparable GAAP measure, to Restaurant level operating profit, included in the section Non-GAAP Financial Measure Reconciliations below.

Restaurant Level Operating Profit Margin: represents Restaurant level operating profit as a percentage of restaurant sales. See Non-GAAP Financial Measure Reconciliations below for a reconciliation to Income from operations margin, the most directly comparable GAAP measure.

Selected Operating Data

(dollars in thousands)

(1) Reconciliations from Income from operations and Income from operations margin, the most comparable GAAP measures, to Restaurant level operating profit and Restaurant level operating profit margin, are set forth in the schedules within the Non-GAAP Financial Measures Reconciliations section below.

(2) Reconciliations from Net income and Net income margin, the most comparable GAAP measures, to Adjusted EBITDA and Adjusted EBITDA margin, are set forth in the schedules within the Non-GAAP Financial Measures Reconciliations section below.

Same-Restaurant Sales Growth (Decline) and Same-Restaurant Traffic Growth (Decline)

24

Results of Operations

Thirteen and Thirty-Nine Weeks Ended September 24, 2023 Compared to Thirteen and Thirty-Nine Weeks Ended September 25, 2022

The following table summarizes our results of operations and the percentages of certain items in relation to Total revenues or, where indicated, Restaurant sales for the thirteen and thirty-nine weeks ended September 24, 2023 and September 25, 2022:

(dollars in thousands)

(1) Percentages are calculated as a percentage of restaurant sales.

Restaurant Sales

Restaurant sales represent the aggregate sales of food and beverages, net of discounts, at company-owned restaurants. Restaurant sales in any period are directly influenced by the number of operating weeks in the period, the number of open restaurants, customer traffic and average check. Average check growth is driven by our menu price increases and changes to our menu mix. In both the thirteen and twenty-six week comparative periods in the table below, the trend of declining off-premises occasions is reflected as the change in the relative contribution of the Third-party delivery sales and Take-out sales to the Total Restaurant sales.

(dollars in thousands)

The increase in total restaurant sales during the thirteen weeks ended September 24, 2023 as compared to the same period in the prior year was primarily due to (i) same-restaurant sales growth of 4.8%, mainly driven by menu price increases, and (ii) $23.3 million from restaurants not in the Comparable Restaurant Base, which included $14.6 million from our 31 NROs between September 25, 2022 and September 24, 2023 and $7.1 million from restaurants we had acquired from our franchisees.

The increase in total restaurant sales during the thirty-nine weeks ended September 24, 2023 as compared to the same period in the prior year was primarily due to (i) same restaurant sales growth of 8.5%, driven by same-restaurant traffic growth of 0.7% and menu price increases and (ii) $57.0 million from restaurants not in the Comparable Restaurant Base, which included $32.6 million from our 31 NROs between September 25, 2022 and September 24, 2023 and $8.9 million from restaurants we had acquired from our franchisees.

Franchise Revenues

Franchise revenues are comprised of sales-based royalty fees, system fund contributions and the amortization of upfront initial franchise fees, which are recognized as revenue on a straight-line basis over the term of the franchise agreement. Franchise revenues in any period are directly influenced by the number of open franchise-owned restaurants.

(dollars in thousands)

(1) Not meaningful.

The increase in franchise revenues during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year was primarily driven by (i) the increase in sales from franchise-owned restaurants and (ii) $0.3 million and $0.8 million, respectively, from 17 franchise-owned NROs between September 25, 2022 and September 24, 2023. The increase was partially offset by $0.3 million and $0.2 million lower franchise fees, respectively, as a result of the acquisitions of restaurants from our franchisees during the thirteen and thirty-nine weeks ended September 24, 2023.

Food and Beverage Costs

The components of food and beverage costs at company-owned restaurants are variable by nature, change with sales volume, are impacted by product mix and are subject to increases or decreases in commodity costs.

(dollars in thousands)

Food and beverage costs as a percent of restaurant sales decreased during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year primarily due to (i) lower commodity costs across the market basket, driven mostly by decreases in pork and avocado prices and (ii) leveraging restaurant sales.

Food and beverage costs increased during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year primarily as a result of (i) the increase in restaurant sales, (ii) 31 NROs that have opened between September 25, 2022 and September 24, 2023 and (iii) restaurants we had acquired from our franchisees. The increase was partially offset by lower commodity costs across the market basket, driven mostly by decreases in pork and avocado prices.

Labor and Other Related Expenses

Labor and other related expenses are variable by nature and include hourly and management wages, bonuses, payroll taxes, workers’ compensation expense and employee benefits. Factors that influence labor costs include minimum wage and payroll tax legislation, health care costs, the number and performance of our company-owned restaurants and increased competition for qualified staff.

(dollars in thousands)

Labor and other related expenses as a percentage of restaurant sales increased during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year primarily as a result of the increase in wages and staffing to serve growing dining room traffic. This was partially offset by (i) the increase in menu prices and (ii) the decrease in health insurance costs.

The increase in labor and other related expenses during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year was primarily due to (i) investments in labor, including increases in wages and staffing levels, (ii) 31 NROs that have opened between September 25, 2022 and September 24, 2023 and (iii) restaurants we had acquired from our franchisees. This was partially offset by the decrease in health insurance costs.

Other Restaurant Operating Expenses

Other restaurant operating expenses consist of marketing and advertising expenses, utilities, insurance and other operating variable expenses incidental to operating company-owned restaurants, such as operating supplies (including paper products, menus and to-go supplies), credit card fees, repairs and maintenance, and third-party delivery services fees.

(dollars in thousands)

The decrease in other restaurant operating expenses as a percentage of restaurant sales during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year was primarily due to (i) leveraging in-restaurant dining sales, (ii) lower costs of to-go supplies and (iii) lower insurance costs. This was partially offset by the increase in repairs and maintenance expense.

The increase in other restaurant operating expenses during the thirteen weeks ended September 24, 2023 as compared to the same period in the prior year was mainly due to the increase in restaurant sales and restaurant growth, including restaurants we acquired from our franchisees, driving (i) $2.9 million related to repairs and maintenance, utilities, and credit card fees, (ii) $0.5 million in operating supplies expense and (iii) $0.5 million in third-party delivery service fees. The increase was partially offset by $0.4 million lower insurance costs.

The increase in other restaurant operating expenses during the thirty-nine weeks ended September 24, 2023 as compared to the same period in the prior year was mainly due to the increase in restaurant sales and restaurant growth driving (i) $2.2 million in operating supplies expense, (ii) $7.0 million related to credit card fees, utilities and repairs and maintenance expense, in addition to (iii) $1.4 million in third-party delivery service fees.

Occupancy Expenses

Occupancy expenses primarily consist of rent expense, property insurance, common area expenses and property taxes.

(dollars in thousands)

As a percentage of restaurant sales, the decrease in occupancy expenses for the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year was primarily due to leveraging restaurant sales.

The increase in occupancy expenses during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year was primarily due to the increase in the number of company-owned restaurants.

Pre-opening Expenses

Pre-opening expenses are costs incurred to open new company-owned restaurants. Pre-opening expenses include pre-opening rent expense, which is recognized during the period between the date of possession of the restaurant facility and the restaurant opening date. In addition, pre-opening expenses include manager salaries, recruiting expenses, employee payroll and training costs, which are recognized in the period in which the expense was incurred. Pre-opening expenses can fluctuate from period to period, based on the number and timing of new company-owned restaurant openings.

(dollars in thousands)

The increase in pre-opening expenses during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year was primarily due to (i) increased staffing and wages and (ii) pre-opening rent expense mainly related to the increase in the number of restaurants expected to open and the investment in larger, stand-alone company-owned restaurants.

General and Administrative Expenses

General and administrative expenses primarily consist of costs associated with our corporate and administrative functions that support restaurant development and operations including marketing and advertising costs incurred as well as legal fees, professional fees, stock-based compensation and expenses associated with being a public company, including costs associated with our compliance with the Sarbanes-Oxley Act. General and administrative expenses are impacted by changes in our employee headcount and costs related to strategic and growth initiatives.

(dollars in thousands)

28

The increase in general and administrative expenses during the thirteen weeks ended September 24, 2023 as compared to the same period in the prior year was mainly due to $3.7 million in compensation expense from performance-based compensation and additional employee headcount to support growth. This was partially offset by the $1.0 million decrease in stock-based compensation expense mainly due to the accelerated recognition method for certain stock option grants as well as forfeitures of stock option grants, net of the stock-based compensation expense recognized for stock-based awards issued.

The increase in general and administrative expenses during the thirty-nine weeks ended September 24, 2023 as compared to the same period in the prior year was mainly due to (i) $9.9 million in compensation expense from performance-based compensation and additional employee headcount to support growth, (ii) $1.0 million of fees associated with investments in technology initiatives and (iii) $0.4 million of professional service costs incurred in connection with the Delaware Voluntary Disclosure Agreement Program related to unclaimed or abandoned property. This was partially offset by (i) the decrease in stock-based compensation expense of $2.5 million mainly due to the accelerated recognition method for certain stock option grants as well as forfeitures of stock option grants, net of the stock-based compensation expense recognized for stock-based awards issued during the thirty-nine weeks ended September 24, 2023 and (ii) the decrease of $0.7 million in insurance costs.

Depreciation and Amortization

Depreciation and amortization consists of the depreciation of fixed assets, including leasehold improvements, fixtures and equipment and the amortization of definite-lived intangible assets, which are primarily comprised of franchise rights. Franchise rights includes rights which arose from the purchase price allocation in connection with the merger agreement through which the Company was acquired by funds affiliated with or managed by Advent in August 2017 as well as reacquired rights from our acquisitions of franchise-owned restaurants.

(dollars in thousands)

The increase in depreciation and amortization during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year was primarily due to incremental depreciation of capital expenditures associated with NROs and the acquired restaurants from our franchisees.

Impairments and Loss on Disposal of Assets

Impairments and loss on disposal of assets include (i) the impairment of long-lived assets and intangible assets where the carrying amount of the asset is not recoverable and exceeds the fair value of the asset, (ii) the write-off of the net book value of assets that have been retired or replaced in the normal course of business and (iii) the write-off of the net book value of assets in connection with restaurant closures.

(dollars in thousands)

There were no impairment losses recognized on intangible assets or fixed assets during the thirteen and thirty-nine weeks ended September 24, 2023 and September 25, 2022.

Transaction Expenses, Net

Transaction expenses, net include (i) revaluations of contingent consideration payable to previous stockholders for tax savings generated through the use of federal and state loss carryforwards and general business credits that had been accumulated from operations prior to August 2017, (ii) gains or losses associated with lease or contract terminations, (iii) costs incurred in connection with the acquisition of certain restaurants from our franchisees, (iv) costs related to restaurant closures and (v) costs related to certain equity offerings.

(dollars in thousands)

The decrease in Transaction expenses, net during the thirteen weeks ended September 24, 2023 as compared to the same period in the prior year was primarily due to costs incurred by us during the thirteen weeks ended September 25, 2022 totaling $1.6 million in connection with the sale of the Company’s common stock by funds managed by our majority owner, Advent through secondary public offerings. The decrease was partially offset by costs incurred in connection with the acquisitions of certain restaurants from our franchisees.

The increase in Transaction expenses, net during the thirty-nine weeks ended September 24, 2023 as compared to the same period in the prior year was primarily due to costs incurred in connection with the acquisition of certain restaurants from our franchisees. The increase was partially offset by (i) lower costs incurred by us in connection with the sale of the Company’s common stock by funds managed by Advent through secondary public offerings and (ii) costs related to the closures of company-owned restaurants incurred during the thirty-nine weeks ended September 25, 2022.

Income from Operations

(dollars in thousands)

(1) Not meaningful.

Income from operations margin increased during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year primarily due to (i) leveraging restaurant sales, (ii) lower costs for pork, avocados and to-go supplies and (iii) lower transaction costs. This was partially offset by the increase in restaurant-level wages and staffing.

Income from operations increased during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year primarily due to (i) the increase in restaurant sales and franchise revenues and (ii) lower costs for commodities and to-go supplies. This was partially offset by (i) the increase in restaurant-level wages and staffing, (ii) higher operating costs and depreciation expense driven by our restaurant growth and acquisitions of certain franchise-owned restaurant, as well as (iii) higher general and administrative expenses mainly attributable to wage increases, performance-based compensation and additional employee headcount.

Interest Expense

Interest expense primarily consists of interest and fees on our outstanding debt and the amortization expense for debt discount and deferred issuance costs.

(dollars in thousands)

The increase in interest expense during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year was primarily due to higher interest rates, which was partially offset by the decrease in outstanding debt due to expected principal repayments.

Other Income, Net

Other income, net includes items deemed to be non-operating based on management’s assessment of the nature of the item in relation to our core operations.

(dollars in thousands)

(1) Not meaningful.

The increase in Other income, net during the thirteen and thirty-nine weeks ended September 24, 2023 was primarily due to (i) insurance recoveries, net of costs incurred, in connection with Hurricane Ian and (ii) the increase in interest income.

Income Tax Expense

Income tax expense primarily consists of various federal and state taxes.

(dollars in thousands)

The change in the effective income tax rates for the thirteen and thirty-nine week period ended September 24, 2023 as compared to the same periods in the prior year was primarily due to (i) the change in the valuation allowance for federal deferred tax assets, (ii) the decrease in the valuation allowance for state net operating loss carryforwards, (iii) the benefit of tax credits for FICA taxes on certain employees’ tips, (iv) impacts of executive stock-based compensation and (v) non-deductible costs associated with the secondary offerings.

Net Income

(dollars in thousands)

(1) Not meaningful.

The increase in net income and net income margin during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year was primarily due to the increase in income from operations. This was partially offset by (i) the increase in interest expense and (ii) the increase in income tax expense.

Restaurant Level Operating Profit and Restaurant level Operating Profit Margin

(dollars in thousands)

Restaurant level operating profit margin during the thirteen and thirty-nine weeks ended September 24, 2023 increased as compared to the same period in the prior year primarily due to (i) leveraging the increase in restaurant sales and (ii) lower costs for pork, avocados and to-go supplies. This was partially offset by the increase in wages and staffing levels.

Restaurant level operating profit during the thirteen and thirty-nine weeks ended September 24, 2023 increased as compared to the same periods in the prior year primarily due to (i) same-restaurant sales growth, driven by menu price increases, (ii) 31 NROs between September 25, 2022 and September 24, 2023, (iii) restaurants we had acquired from our franchisees and (iv) lower costs for commodities and to-go supplies. This was partially offset by (i) the increase in operating costs and expenses driven by our restaurant growth and (ii) the increase in restaurant-level wages and staffing.

Adjusted EBITDA and Adjusted EBITDA Margin

(dollars in thousands)

The increase in Adjusted EBITDA and Adjusted EBITDA margin during the thirteen and thirty-nine weeks ended September 24, 2023 as compared to the same periods in the prior year was primarily due to the increase in restaurant level operating profit and restaurant level operating profit margin. This was partially offset by the increase in general and administrative expenses mainly due to wage increases and additional employee headcount to support our growth.

Non-GAAP Financial Measures Reconciliations

Adjusted EBITDA and Adjusted EBITDA margin - The following table reconciles Net income and Net income margin, the most directly comparable GAAP measures to Adjusted EBITDA and Adjusted EBITDA margin for the periods indicated:

(dollars in thousands)

(1) Represents non-cash, stock-based compensation expense which is recorded within General and administrative expenses on the Consolidated Statements of Operations and Comprehensive Income.

(2) Represents costs incurred in connection with the secondary offerings by Advent and the acquisition of certain franchise-owned restaurants.

(3) Represents costs related to process improvements and strategic initiatives. These costs are recorded within General and administrative expenses on the Consolidated Statements of Operations and Comprehensive Income.

(4) Represents professional service costs incurred in connection with the Delaware Voluntary Disclosure Agreement Program related to unclaimed or abandoned property. These costs are recorded in General and administrative expenses on the Consolidated Statements of Operations and Comprehensive Income.

(5) Represents insurance recoveries, net of costs incurred, in connection with Hurricane Ian, which were recorded in Other income, net on the Consolidated Statements of Operations and Comprehensive Income.

(6) Represents costs related to the disposal of assets due to retirements, replacements or certain restaurant closures. There were no impairments recognized during the periods presented.

(7) Represents costs incurred for hiring qualified individuals. These costs are recorded within General and administrative expenses on the Consolidated Statements of Operations and Comprehensive Income.

(8) Severance costs are recorded in General and administrative expenses on the Consolidated Statements of Operations and Comprehensive Income.

(9) Represents the non-cash portion of straight-line rent expense recorded within both Occupancy expenses and General and administrative expenses on the Consolidated Statements of Operations and Comprehensive Income.

Restaurant level operating profit and Restaurant level operating profit margin - The following table reconciles Income from operations and Income from operations margin, the most comparable GAAP measures to Restaurant level operating profit and Restaurant level operating profit margin for the periods indicated:

(dollars in thousands)

(1) Represents costs incurred in connection with the secondary offerings by Advent and the acquisition of certain franchise-owned restaurants.

(2) Represents costs related to the disposal of assets due to retirements, replacements or certain restaurant closures. There were no impairments recognized during the periods presented.

(3) Represents the non-cash portion of straight-line rent expense recorded within Occupancy expenses on the Consolidated Statements of Operations and Comprehensive Income.

Liquidity and Capital Resources

Liquidity

As of September 24, 2023, we had cash and cash equivalents of $39.9 million and we had outstanding borrowings, excluding unamortized debt issuance costs and deferred issuance costs of $95.0 million. We had availability under our undrawn revolving credit facility of $75.0 million pursuant to our credit agreement dated as of October 6, 2021 (the “Credit Agreement”). Our principal uses of cash include capital expenditures for the development, acquisition or remodeling of restaurants, lease obligations, debt service payments and strategic infrastructure investments. Our working capital requirements are low because our restaurants store very little inventory and our customers pay for their purchases at the time of the sale which frequently precedes our payment terms with suppliers.

We believe that our cash flow from operations, availability under our Credit Agreement and available cash and cash equivalents will be sufficient to meet our liquidity needs for at least the next 12 months. We anticipate that to the extent that we require additional liquidity, or should we decide to pursue one or more significant acquisitions, it will be funded first through additional indebtedness and thereafter through the issuance of equity. Although we believe that our current level of total available liquidity is sufficient to meet our short-term and long-term liquidity requirements, we regularly evaluate opportunities to improve our liquidity position in order to enhance financial flexibility.

We estimate that our capital expenditures will total approximately $85.0 million to $90.0 million in 2023, which will be invested primarily in new restaurant projects and planned remodels. We plan to fund the capital expenditures primarily with cash generated from our operating activities as well as with borrowings from our facilities pursuant to our Credit Agreement.

Summary of Cash Flows

The following table presents a summary of our cash provided by (used in) operating, investing and financing activities for the thirty-nine weeks ended September 24, 2023 and September 25, 2022:

(in thousands)

Cash provided by operating activities during the thirty-nine weeks ended September 24, 2023 increased to $73.0 million from $46.6 million during the thirty-nine weeks ended September 25, 2022 primarily due to (i) the increase in net income of $15.3 million, (ii) the impact of non-cash charges that increased by a net $5.1 million and (iii) the net change in operating assets and liabilities of $6.0 million. The $5.1 million increase in non-cash charges was primarily driven by increases in (i) deferred income taxes, (ii) depreciation and amortization and (iii) non-cash operating lease costs. This increase was partially offset by a decrease in stock-based compensation expense. The net change of $6.0 million in operating assets and liabilities was primarily a result of higher accrued compensation.

Cash used in investing activities increased to $82.6 million during the thirty-nine weeks ended September 24, 2023 from $45.7 million during the thirty-nine weeks ended September 25, 2022 primarily as a result of the increase in capital expenditures to support our restaurant growth and new restaurant technology as well as the acquisition of certain restaurants from our franchisees.

Cash used in financing activities decreased to $0.1 million during the thirty-nine weeks ended September 24, 2023 from $3.4 million during the thirty-nine weeks ended September 25, 2022 primarily due to the increased proceeds from the exercise of stock options, net of employee taxes paid, which was partially offset by higher principal repayments of debt.

Critical Accounting Estimates

Our discussion and analysis of our financial condition and results of operations is based upon the accompanying unaudited interim consolidated financial statements and notes thereto, which have been prepared in accordance with GAAP. The preparation of these unaudited interim consolidated financial statements and related notes requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Certain of our accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, terms of existing contracts, our evaluation of trends in the industry and information available from other outside sources, as appropriate. We evaluate our estimates and judgments on an on-going basis. Our actual results may differ from these estimates. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. There have been no significant changes to our critical accounting policies as disclosed in “Critical Accounting Estimates” in the 2022 Form 10-K.

Recently Issued Accounting Pronouncements

For a discussion of recently issued accounting pronouncements, see Note 2, Summary of Significant Accounting Policies, in the accompanying notes to the unaudited interim consolidated financial statements.

We are exposed to interest rate risk through fluctuations in interest rates on our debt obligations. On June 23, 2023, we entered into a variable-to-fixed interest rate swap agreement with two financial institutions to hedge $90.0 million of the $95.0 million outstanding variable rate debt. Under the terms of the interest rate swap agreement, the Company will pay a weighted average fixed rate of 4.16% on the notional amount and will receive payments from the counterparties based on the three-month secured overnight financing rate. Refer to Note 8, Interest Rate Swaps, in the accompanying notes to the unaudited interim consolidated financial statements.

Except as described above, there have been no material changes to our exposure to market risks as disclosed in the 2022 Form 10-K.

Evaluation of Disclosure Controls and Procedures

We are responsible for establishing and maintaining disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

Disclosure controls and procedures also include, without limitation, controls and procedures that are designed to ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Due to the material weaknesses in our internal control over financial reporting, which were previously identified and disclosed in connection with our initial public offering and in our periodic reports filed with the SEC, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 24, 2023, our disclosure controls and procedures were not effective. In light of this fact, our management has performed additional analyses, reconciliations, and other post-closing procedures and has concluded that, notwithstanding the material weaknesses in our internal control over financial reporting, the consolidated financial statements for the periods covered by and included in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP.

Previously Identified Material Weaknesses

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of annual or interim financial statements would not be prevented or detected on a timely basis.

Refer to the management report on internal control over financial reporting in Part II - Item 9A of the 2022 Form 10-K filed with the SEC on March 7, 2023 for a discussion of the material weaknesses that continue to exist as of September 24, 2023.

Remediation Efforts

Management continues to implement measures designed to improve the Company’s internal control over financial reporting, including disclosure controls and procedures, to address and remediate the previously identified material weaknesses. To date, such measures include the following:

• Hired new and reassigned existing financial reporting, accounting, and information technology leadership with public company experience to enhance public company financial reporting, technical accounting, and information technology services and solutions.
• Augmented financial reporting capabilities by staffing professionals with special skills in income tax, internal audit, information technology, and legal.
• Established various policies, including a formal delegation of authority policy defining the protocols for reviewing and authorizing commitments, contracts, invoices, and transactions as well as a comprehensive set of information technology policies to govern the Company’s information technology practices.
• Formalized certain roles and reviewed responsibilities, including ensuring appropriate segregation of duties.
• Designed and implemented period-end financial reporting controls, such as controls over the preparation and review of account reconciliations, financial statement disclosures, and the consolidated financial statements as well as establishing a formal management Disclosure Committee to review the draft financial statements and disclosures prior to release, including a sub-certification process from various functional groups.
• Enhanced access restrictions for certain users over general ledger journal entries to further segregate journal entry creation from journal entry approval authority. In addition, we are designing new processes to review and approve journal entries.
• Designed and implemented controls over the accounting for income taxes to ensure the appropriate recording of deferred income taxes, income taxes and related disclosures.
• Designed sufficient user access controls to ensure appropriate segregation of duties and adequately restrict user and privileged access to financial applications, programs and data to appropriate Company personnel.
• Designed and implemented change management controls to ensure that information technology program and data changes affecting financial information technology applications and underlying accounting records are identified, tested, authorized, and implemented appropriately.
• Designed and implemented computer operation controls to ensure critical jobs are monitored and privileges are appropriately granted.
• Implemented a new backup and recovery platform to monitor data backups for all relevant systems in accordance with the applicable policy as well as manage a test recovery process.

While the material weaknesses previously disclosed have not yet been remediated as of September 24, 2023, management is devoting substantial resources to the ongoing remediation efforts. As we continue to evaluate and work to improve our internal control over financial reporting, we may take additional measures to address control deficiencies, or we may modify certain of the remediation measures described above. The material weaknesses will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are designed and operating effectively.

Changes in Internal Control over Financial Reporting

There have been no changes in internal control over financial reporting during the quarter ended September 24, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

In addition to the other information discussed in this report, please consider the factors described in Part I, Item 1A., “Risk Factors” in our 2022 Form 10-K which could materially affect our business, financial condition or future results. There have been no material changes to the risk factors disclosed in our 2022 Form 10-K, but these are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may adversely affect our business, financial condition or results of operations.