First Watch Restaurant Group, Inc. — Q2 2023 Form 10-Q
Reporting period: The quarter was the 13 weeks ended June 25, 2023; year-to-date figures cover 26 weeks. Comparisons are with the periods ended June 26, 2022. First Watch operates and franchises breakfast, brunch and lunch restaurants in 29 states. At quarter-end, it had 381 company-owned and 111 franchise-owned restaurants.
Financial and operating performance
| Metric | Q2 2023 | Q2 2022 | Year to date 2023 | Year to date 2022 |
|---|---|---|---|---|
| Total revenue | $216.3 million | $184.5 million | $427.7 million | $357.6 million |
| Income from operations | $11.3 million | $5.1 million | $26.7 million | $12.8 million |
| Net income | $8.0 million | $2.7 million | $17.3 million | $7.3 million |
| Diluted EPS | $0.13 | $0.05 | $0.28 | $0.12 |
| Operating margin | 5.3% | 2.8% | 6.3% | 3.6% |
| Adjusted EBITDA (non-GAAP) | $25.8 million | $17.8 million | $53.2 million | $37.2 million |
Q2 revenue grew 17.3%; system-wide sales rose 17.4% to $271.5 million. Same-restaurant sales increased 7.8%, while same-restaurant traffic declined 1.2%. Restaurant-level operating profit margin, a non-GAAP measure, was 20.9%, up from 18.2%. For the first half, same-restaurant sales grew 10.4% and traffic grew 1.9%.
Q2 restaurant sales increased 17.0%. Lower food costs as a share of sales (22.4%, down from 24.9%) and lower other restaurant operating and occupancy costs as a share of sales helped margins. Labor costs increased to 33.2% of restaurant sales from 32.3%, reflecting wage increases and staffing. Interest expense rose to $2.0 million from $1.1 million, primarily due to higher rates.
Cash, debt and liquidity
- Cash and cash equivalents were $66.8 million at June 25, 2023, compared with $49.7 million at December 25, 2022. The company reported $55.6 million of operating cash flow for the first half, versus $31.8 million a year earlier.
- First-half capital expenditures were $29.7 million; investing cash outflow totaled $37.2 million, including $8.0 million for the acquisition of six franchise restaurants. Financing cash outflow was $1.2 million.
- Outstanding term-facility borrowings were $96.3 million; total debt, net of discounts and including finance lease and financing obligations, was $99.1 million. The $75 million revolving facility was undrawn. The term and revolving facilities mature October 6, 2026.
- The company entered into swaps with a $90 million notional amount, paying a weighted-average fixed rate of 4.16% and receiving three-month SOFR, to hedge part of its variable-rate debt. Operating lease liabilities were $427.6 million; approximately $83.8 million of executed operating leases had not yet commenced.
Outlook, developments and risks
- Management expected 2023 market-basket inflation of flat to 2.0% and labor cost increases of 8% to 10%. It raised in-restaurant menu prices 1.0% at the start of Q3. Estimated 2023 capital expenditures were $100 million to $110 million, primarily for new restaurants and remodels. The filing provides no specific full-year revenue or earnings guidance.
- Management said sales growth reflected pricing, favorable mix, new restaurants and stronger dining-room business; off-premises occasions continued to decline year over year. During Q2, nine system-wide restaurants opened, six franchise restaurants were acquired and one company-owned restaurant closed. The company also acquired five restaurants on June 26; a further proposed acquisition of six operating restaurants and one under development was subject to customary closing conditions.
- The quarter included $1.7 million of transaction expenses, primarily related to secondary offerings by the majority owner and franchise-restaurant acquisitions. The company received no proceeds from the secondary offerings and incurred approximately $1.0 million of related costs. A roughly $1.0 million release of a state tax valuation allowance reduced Q2 income tax expense. Hurricane Ian insurance recoveries contributed to other income.
- Management stated that cash, operating cash flow and available borrowing capacity should meet liquidity needs for at least 12 months. Risks include inflation and labor costs, restaurant growth execution, consumer demand, debt and interest rates, long-term lease commitments, and supply, staffing and other operating pressures.
- Disclosure controls and procedures were reported ineffective as of June 25, 2023 because previously identified material weaknesses in internal control over financial reporting remained. Management described remediation efforts but said weaknesses would not be considered remediated until controls operate effectively for a sufficient period and testing confirms this.
- Ordinary-course legal matters were not considered material. A Delaware unclaimed-property voluntary disclosure review remains ongoing; any potential loss is not currently reasonably estimable.
Important facts for investors to verify
- Whether same-restaurant sales growth and margin gains can persist as traffic, labor costs and commodity conditions change.
- How planned restaurant openings, acquisitions and the $100 million–$110 million capital spending estimate affect cash needs and returns.
- Progress in remediating internal-control material weaknesses and the timing of any conclusion that controls are effective.
- Debt-service exposure after the $90 million interest-rate hedge, and the company’s substantial lease commitments.
- Outcomes and potential costs of the Delaware unclaimed-property review and the pending franchisee acquisition, if completed.
- Adjusted EBITDA and restaurant-level operating profit are non-GAAP measures; review the filing’s reconciliations and limitations alongside GAAP results.