# First Watch Restaurant Group, Inc. (FWRG) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from First Watch Restaurant Group, Inc.'s 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1789940/000178994024000012/fwrg-20231231.htm
Accession: 0001789940-24-000012
Filing date: 2024-03-05
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/FWRG/
All MD&A years: /company/FWRG/mda/
Previous year: /company/FWRG/mda/fy2022/ (FY 2022)
Next year: /company/FWRG/mda/fy2024/ (FY 2024)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This section and other parts of this Annual Report on Form 10-K contain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995 (“PSLRA”), which are subject to known and unknown risks, uncertainties and other important factors that may cause actual results to be materially different from the statements made herein. All statements other than statements of historical fact are forward-looking statements. Forward-looking statements discuss our industry outlook, our expectations for the future of our business and our liquidity and capital resources as well as other non-historical statements. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “aim,” “anticipate,” “believe,” “estimate,” “expect,” “forecast,” “future,” “intend,” “outlook,” “potential,” “project,” “projection,” “plan,” “seek,” “may,” “could,” “would,” “will,” “should,” “can,” “can have,” “likely,” the negatives thereof and other similar expressions. Our actual results may differ materially from those contained in or implied by these forward-looking statements.

These statements are based on current expectations and are subject to numerous risks and uncertainties. All forward-looking statements are expressly qualified in their entirety by these cautionary statements. You should evaluate all forward-looking statements made in this Annual Report on Form 10-K in the context of the risks and uncertainties disclosed in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors” and in this Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

The forward-looking statements included in this Annual Report on Form 10-K are made only as of the date hereof. We undertake no obligation to publicly update any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law. If we do update one or more forward-looking statements, no inference should be made that we will make additional updates with respect to those or other forward-looking statements.

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 United States. 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 L.P., 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 December 31, 2023, the Company had 425 company-owned restaurants and 99 franchise-owned restaurants. The Company does not operate outside of the United States.

The Company’s 52- or 53-week fiscal years end on the last Sunday of each calendar year. Its fiscal quarters are comprised of 13 weeks each and end on the 13th Sunday of each quarter, save for 53-week years during which the fourth quarter ends on the 14th Sunday of the fourth quarter. All references to 2023 reflect the results of the 53-week fiscal year ended December 31, 2023. All references to 2022 and 2021 reflect the 52-week fiscal years ended December 25, 2022 and December 26, 2021, respectively. We report financial and operating information in one segment.

Key Performance Indicators

Throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operations” we commonly discuss the following key operating metrics that 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.

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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”). There were 327 restaurants and 301 restaurants in our Comparable Restaurant Base in 2023 and in 2022, respectively. There were 205 restaurants in the four-year 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.

Average Unit Volume (“AUV”): the total restaurant sales (excluding gift card breakage) recognized in the Comparable Restaurant Base, divided by the number of restaurants in the Comparable Restaurant Base during the period. This measurement allows management to assess changes in consumer spending patterns at our restaurants and the overall performance of our restaurant base.

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 (loss) 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

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Net income (loss), 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 (loss) 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 (Loss) 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 (Loss) from operations margin, the most directly comparable GAAP measure.

Financial Highlights

The financial results of 2023 reflect the continued growth of the Company. Our AUV increased 10.7% to $2.3 million in 2023 from $2.0 million in 2022. The Company continued to accelerate the pace of new restaurant openings with 37 NROs in 2023 and we executed on our growth strategy as we acquired 23 operating restaurants from our franchisees in 2023.

Financial highlights 2023, which was a 53-week fiscal year, include the following:

•Total revenues increased 22.1% to $891.6 million from $730.2 million in 2022

•System-wide sales increased 20.6% to $1.1 billion from $914.8 million in 2022

•Same-restaurant sales growth of 7.6%* (up 38.9% relative to 2019**)

•Same-restaurant traffic growth of 0.2%* (up 7.5% relative to 2019**)

•Income from operations increased to $41.3 million from $16.9 million in 2022

•Income from operations margin increased to 4.7% from 2.4% in 2022

•Restaurant level operating profit*** increased to $175.7 million from $128.9 million in 2022

•Restaurant level operating profit margin*** increased to 20.0% from 17.9% in 2022

•Net income increased to $25.4 million from $6.9 million in 2022

•Adjusted EBITDA*** increased to $99.5 million from $69.3 million in 2022

•Opened 51 system-wide restaurants (37 company-owned and 14 franchise-owned) across 19 states resulting in a total of 524 system-wide restaurants (425 company-owned and 99 franchise-owned) across 29 states

___________________

*Comparison to the 53 weeks ended January 1, 2023, is provided for enhanced comparability.

**Comparison to the 53 weeks ended January 5, 2020, is provided for enhanced comparability.

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

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Business Trends

Throughout 2023 and as compared to the prior year, First Watch continued to see dining room traffic grow. The off-premises occasions, including higher-cost third-party delivery occasions declined for the Company. The Company’s same-restaurant sales grew 7.6% during the year on the strength of modest 7% menu price increases and overall traffic growth.

We continued to experience a decline in the average cost across our consolidated market basket relative to the prior year. Though still high, full-year average costs were 50 basis points lower than 2022. We expect inflation to trend upward during the fiscal year ending December 29, 2024 (“2024”) in the range of 2% to 4%.

In 2023, our manager and hourly team member turnover improved sequentially throughout each quarter. At year end, we were staffed with over 120 managers to lead and operate our future new company-owned restaurants. We experienced overall restaurant-level labor cost inflation of 8% and we expect 5% to 7% labor inflation in 2024.

With respect to our new restaurant openings, we have experienced more frequent delays in developers’ delivery of new commercial space as well as increased availability of second-generation sites. Furthermore, our capital invested in new restaurants has increased significantly due in part to inflation, as well as to our strategy of leasing larger dining and kitchen space to serve unmet demand in selected trade areas.

In late January 2024, we increased in-restaurant menu prices approximately 2% to offset the negative effects of inflationary costs.

Development Highlights

During 2023, the Company had a total of 51 new system-wide restaurants in 19 states and we closed one company-owned restaurant. We also acquired 23 operating restaurants from our franchisees in the execution of our growth strategy. See Note 3, Business Acquisitions, in the accompanying notes to the consolidated financial statements for additional information. At December 31, 2023, the Company had a total of 524 system-wide restaurants.

[[GREPCENT_TABLE]]
[["","FISCAL YEAR 2023"],["","Company-owned","","Franchise-owned","","Total"],["Beginning of period","366","","108","","474"],["New restaurants","37","","14","","51"],["Acquisitions of franchise-owned restaurants","23","","","(23)","","","\u2014"],["Closures","(1)","","\u2014","","","(1)"],["End of period","425","","99","","524"]]
[[/GREPCENT_TABLE]]

We expect to open between 43 to 47 company-owned restaurants and 9 to 11 franchise-owned restaurants during 2024. We also plan on closing 1 company-owned restaurant, resulting in a total of 51 to 57, net new system-wide restaurants in 2024.

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Selected Operating Data

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["","2023","","2022","","2021"],["Operating weeks in fiscal year","53","","52","","52"],["System-wide restaurants","524","","474","","435"],["Company-owned","425","","366","","341"],["Franchise-owned","99","","108","","94"],["System-wide sales (in thousands)","$","1,103,089","","","$","914,816","","","$","750,674"],["Same-restaurant sales growth","7.6","%","*","14.5","%","","63.0","%"],["Same-restaurant traffic growth","0.2","%","*","7.7","%","","52.6","%"],["AUV (in thousands)","$","2,250","","","$","2,032","","","$","1,786"],["Income from operations (in thousands)","$","41,267","","","$","16,913","","","$","22,243"],["Income from operations margin","4.7","%","","2.4","%","","3.8","%"],["Restaurant level operating profit (in thousands) (1)","$","175,658","","","$","128,936","","","$","115,404"],["Restaurant level operating profit margin (1)","20.0","%","","17.9","%","","19.5","%"],["Net income (loss) (in thousands)","$","25,385","","","$","6,907","","","$","(2,107)"],["Net income (loss) margin","2.8","%","","0.9","%","","(0.4)","%"],["Adjusted EBITDA (in thousands) (2)","$","99,483","","","$","69,278","","","$","66,301"],["Adjusted EBITDA margin (2)","11.2","%","","9.5","%","","11.0","%"]]
[[/GREPCENT_TABLE]]
________________

* Comparison to the 53 weeks ended January 1, 2023, is provided for enhanced comparability.

(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 Measure Reconciliations section below.

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

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Results of Operations

The discussion that follows includes a comparison of our results of operations for 2023 and 2022.

The following table summarizes our results of operations and the percentages of items in our Consolidated Statements of Operations and Comprehensive Income (Loss) in relation to Total revenues or, where indicated, Restaurant sales for 2023 and 2022:

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022"],["Revenues"],["Restaurant sales","$","877,092","","","98.4","%","","$","719,181","","","98.5","%"],["Franchise revenues","14,459","","","1.6","%","","10,981","","","1.5","%"],["Total revenues","891,551","","","100.0","%","","730,162","","","100.0","%"],["Operating costs and expenses"],["Restaurant operating expenses (1) (exclusive of depreciation and amortization shown below):"],["Food and beverage costs","197,374","","","22.5","%","","172,561","","","24.0","%"],["Labor and other related expenses","294,010","","","33.5","%","","238,257","","","33.1","%"],["Other restaurant operating expenses","134,477","","","15.3","%","","114,476","","","15.9","%"],["Occupancy expenses","68,400","","","7.8","%","","59,919","","","8.3","%"],["Pre-opening expenses","7,173","","","0.8","%","","5,414","","","0.8","%"],["General and administrative expenses","103,121","","","11.6","%","","84,959","","","11.6","%"],["Depreciation and amortization","41,223","","","4.6","%","","34,230","","","4.7","%"],["Impairments and loss on disposal of assets","1,359","","","0.2","%","","920","","","0.1","%"],["Transaction expenses, net","3,147","","","0.4","%","","2,513","","","0.3","%"],["Total operating costs and expenses","850,284","","","95.4","%","","713,249","","","97.7","%"],["Income from operations (1)","41,267","","","4.7","%","","16,913","","","2.4","%"],["Interest expense","(8,063)","","","(0.9)","%","","(5,232)","","","(0.7)","%"],["Other income, net","2,871","","","0.3","%","","910","","","0.1","%"],["Income before income taxes","36,075","","","4.0","%","","12,591","","","1.7","%"],["Income tax expense","(10,690)","","","(1.2)","%","","(5,684)","","","(0.8)","%"],["Net income","$","25,385","","","2.8","%","","$","6,907","","","0.9","%"]]
[[/GREPCENT_TABLE]]
____________

(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.

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Restaurant sales:"],["In-restaurant dining sales","$","716,960","","","$","571,048","","","$","145,912","","","25.6","%"],["Third-party delivery sales","91,433","","","82,049","","","9,384","","","11.4","%"],["Take-out sales","68,699","","","66,084","","","2,615","","","4.0","%"],["Total Restaurant sales","$","877,092","","","$","719,181","","","$","157,911","","","22.0","%"]]
[[/GREPCENT_TABLE]]

The increase in total restaurant sales during 2023 as compared to 2022 was primarily due to (i) $53.5 million from same-restaurant sales growth of 7.6%, mainly driven by menu price increases, (ii) $85.1 million from restaurants not in the

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Comparable Restaurant Base, which included $25.5 million from our 37 NROs and $18.4 million from the 23 restaurants we had acquired from our franchisees and (iii) $19.2 million of restaurant sales during the 53rd week of 2023.

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.

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Franchise revenues:"],["Royalty and system fund contributions","$","13,464","","","$","10,683","","","$","2,781","","","26.0","%"],["Initial fees","388","","","298","","","90","","","30.2","%"],["Business combinations - revenues recognized","607","","","\u2014","","","607","","","\u2014","%"],["Total Franchise revenues","$","14,459","","","$","10,981","","","$","3,478","","","31.7","%"]]
[[/GREPCENT_TABLE]]

The increase in franchise revenues during 2023 as compared to 2022 was primarily driven by (i) the increase in sales from franchise-owned restaurants, (ii) $0.6 million from 14 franchise-owned NROs and (iii) $0.6 million of deferred franchise revenues recognized in connection with the acquisitions of restaurants from our franchisees. The increase was partially offset by $0.6 million lower franchise fees as a result of the acquisitions of restaurants from our franchisees during 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.

[[GREPCENT_TABLE]]
[["","","FISCAL YEAR"],["(in thousands)","","2023","","2022","","Change"],["Food and beverage costs","","$","197,374","","","$","172,561","","","$","24,813","","","14.4","%"],["As a percentage of restaurant sales","","22.5","%","","24.0","%","","(1.5)%"]]
[[/GREPCENT_TABLE]]

Food and beverage costs as a percent of restaurant sales decreased during 2023 as compared to 2022 primarily due to (i) lower commodity costs across the market basket, driven mostly by decreases in pork and avocado prices, and (ii) leveraging menu price increases.

Food and beverage costs increased during 2023 as compared to 2022 primarily as a result of (i) the increase in restaurant sales, (ii) 37 NROs and (iii) 23 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.

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Labor and other related expenses","$","294,010","","","$","238,257","","","$","55,753","","","23.4","%"],["As a percentage of restaurant sales","33.5","%","","33.1","%","","0.4%"]]
[[/GREPCENT_TABLE]]

Labor and other related expenses as a percentage of restaurant sales increased during 2023 as compared to 2022 primarily as a result of the increase in wages and staffing to serve growing dining room traffic and strategic growth. This increase was partially offset by lower health insurance costs.

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The increase in labor and other related expenses during 2023 as compared to 2022 was primarily due to (i) the increase in wages and staffing levels, (ii) 37 NROs and (iii) 23 restaurants we had acquired from our franchisees. This increase was partially offset by lower 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.

[[GREPCENT_TABLE]]
[["","","FISCAL YEAR"],["(in thousands)","","2023","","2022","","Change"],["Other restaurant operating expenses","","$","134,477","","","$","114,476","","","$","20,001","","","17.5","%"],["As a percentage of restaurant sales","","15.3","%","","15.9","%","","(0.6)%"]]
[[/GREPCENT_TABLE]]

Other restaurant operating expenses as a percentage of restaurant sales during 2023 decreased as compared to 2022 primarily due to (i) leveraging restaurant sales, (ii) lower costs of to-go supplies, (iii) lower insurance costs and (iv) lower third-party delivery fees mainly driven from leveraging in-restaurant dining sales. This decrease was partially offset by higher repairs and maintenance expense.

The increase in other restaurant operating expenses during 2023 as compared to 2022 was driven by the increase in restaurant sales, restaurant growth and restaurant acquisitions from our franchisees resulting in an increase of (i) $11.8 million related to credit card fees, utilities and repairs and maintenance, (ii) $3.9 million related to operating supplies and (iii) $2.2 million related to third-party delivery services fees. The increase was partially offset by lower insurance costs of $0.4 million.

Occupancy Expenses

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

[[GREPCENT_TABLE]]
[["","","FISCAL YEAR"],["(in thousands)","","2023","","2022","","Change"],["Occupancy expenses","","$","68,400","","","$","59,919","","","$","8,481","","","14.2","%"],["As a percentage of restaurant sales","","7.8","%","","8.3","%","","(0.5)%"]]
[[/GREPCENT_TABLE]]

The decrease in occupancy expenses as a percentage of restaurant sales during 2023 as compared to 2022 was primarily due to leveraging restaurant sales.

The increase in occupancy expenses during 2023 as compared to 2022 was primarily due to our NROs and the acquired restaurants from our franchisees.

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.

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Pre-opening expenses","$","7,173","","","$","5,414","","","$","1,759","","","32.5","%"]]
[[/GREPCENT_TABLE]]

Pre-opening expenses have continued to increase over the last few years, in part due to management’s decision to gain early access to facilities during the build-out phase. Early access improves the Company’s influence over the pace and timing of completion of new restaurants.

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The increase in pre-opening expenses during 2023 as compared to 2022 was primarily due to (i) the higher number of restaurants opened and the increase in staffing and wages, as well as (ii) pre-opening rent expense mainly related to the increase in the number of new restaurant openings and restaurants that are expected to open, in addition to 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 and stock-based compensation. General and administrative expenses are impacted by changes in our employee headcount and costs related to strategic and growth initiatives. In preparation for and after the consummation of the Company’s initial public offering (“IPO”) in October 2021, we have incurred and we expect to incur in the future significant additional legal, accounting and other expenses associated with being a public company, including costs associated with our compliance with the Sarbanes-Oxley Act.

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["General and administrative expenses","$","103,121","","","$","84,959","","","$","18,162","","","21.4","%"]]
[[/GREPCENT_TABLE]]

The increase in general and administrative expenses during 2023 as compared to 2022 was mainly due to (i) $15.2 million in compensation expense from performance-based compensation and additional employee headcount to support growth, (ii) $1.4 million of fees associated with investments in technology initiatives, (iii) $1.0 million in marketing expense, (iv) $0.8 million of estimated probable losses recorded in connection with the Delaware Secretary of State’s Abandoned or Unclaimed Property Voluntary Disclosure Agreement Program (“VDA Program”) (see Note 18, Commitments and Contingencies, in the accompanying notes to the consolidated financial statements for additional information), and (v) approximately $0.4 million of costs incurred in connection with the VDA Program. This increase was partially offset by $2.8 million lower 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 during 2023.

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.

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Depreciation and amortization","$","41,223","","","$","34,230","","","$","6,993","","","20.4","%"]]
[[/GREPCENT_TABLE]]

The increase in depreciation and amortization during 2023 as compared to 2022 was primarily due to incremental depreciation of capital expenditures associated with NROs and the acquired restaurants from our franchisees.

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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 and natural disasters.

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Impairments and loss on disposal of assets","$","1,359","","","$","920","","","$","439","","","47.7%"]]
[[/GREPCENT_TABLE]]

In 2023, we recorded total impairment charges of $0.5 million, which primarily related to the long-lived assets of two company-owned restaurants for which management agreed to accelerate the expected closure dates.

In 2022, the amounts represented write-off of assets retired as a result of restaurant closures or replacements of assets.

Transaction Expenses, Net

Transaction expenses, net include (i) costs incurred in connection with the acquisition of franchise-owned restaurants, (ii) costs related to certain equity offerings, (iii) costs related to restaurant closures, (iv) gains or losses associated with lease or contract terminations and (v) 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.

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Transaction expenses, net","$","3,147","","","$","2,513","","","$","634","","","25.2%"]]
[[/GREPCENT_TABLE]]

Transaction expenses, net increased during 2023 as compared to 2022 primarily due to costs incurred in connection with the acquisitions of restaurants from our franchisees. This 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 incurred related to restaurant closures in 2022.

Income from Operations and Income from Operations Margin

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Income from operations","$","41,267","","","$","16,913","","","$","24,354","","","144.0","%"],["Income from operations margin","4.7","%","","2.4","%","","2.3%"]]
[[/GREPCENT_TABLE]]

Income from operations margin increased during 2023 as compared to 2022 primarily due to (i) leveraging restaurant sales and (ii) lower costs for pork, avocados and to-go supplies. This was partially offset by the increase in restaurant-level staffing and wages.

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Income from operations increased during 2023 as compared to 2022 primarily due to (i) the increase in restaurant sales and franchise revenues and (ii) lower costs for commodities and to-go supplies. This increase was partially offset by (i) higher restaurant-level wages and staffing, (ii) higher operating costs and depreciation expense driven by our restaurant growth and acquisitions of franchise-owned restaurants, as well as (iii) higher general and administrative expenses mainly attributable to additional employee headcount and performance-based compensation.

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.

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Interest expense","$","(8,063)","","","$","(5,232)","","","$","(2,831)","","","54.1","%"]]
[[/GREPCENT_TABLE]]

The increase in interest expense during 2023 as compared to 2022 was primarily due to higher interest rates and the increase in outstanding debt.

Other Income, Net

Other income (expense), 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.

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Other income, net","$","2,871","","","$","910","","","$","1,961","","","n/m (1)"]]
[[/GREPCENT_TABLE]]
____________

(1) Not meaningful.

The increase in Other income, net in 2023 as compared to 2022 primarily related to the increase in (i) interest income and (ii) insurance recoveries, net of costs incurred, in connection with Hurricane Ian.

Income Tax Expense

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

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Income tax expense","$","(10,690)","","","$","(5,684)","","","$","(5,006)","","","88.1%"],["Effective income tax rate","29.6","%","","45.1","%","","(15.5)%"]]
[[/GREPCENT_TABLE]]

The change in the effective income tax rates for 2023 as compared to 2022 was mainly due to (i) the change in the valuation allowance, (ii) the benefit of tax credits for FICA taxes on certain employees’ tips, (iii) impacts of executive stock-based compensation and (iv) non-deductible costs associated with underwritten secondary public offerings of the Company’s common stock by entities affiliated with our majority owner, Advent International L.P., and the Registration Statement on Form S-3 filed in 2022.

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Net Income and Net Income Margin

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Net income","$","25,385","","","$","6,907","","","$","18,478","","","n/m (1)"],["Net income margin","2.8","%","","0.9","%","","1.9%"]]
[[/GREPCENT_TABLE]]

___________

(1) Not meaningful.

The increase in net income and net income margin during 2023 as compared to 2022 was primarily due to the increase in income from operations, which was partially offset by higher (i) interest expense and (ii) income tax expense.

Restaurant Level Operating Profit and Restaurant level Operating Profit Margin

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Restaurant level operating profit","$","175,658","","","$","128,936","","","$","46,722","","","36.2","%"],["Restaurant level operating profit margin","20.0","%","","17.9","%","","2.1%"]]
[[/GREPCENT_TABLE]]

Restaurant level operating profit margin during 2023 increased as compared to 2022 primarily due to (i) leveraging restaurant sales and (ii) lower commodity costs across the market basket, driven mostly by decreases in pork and avocado prices and lower costs of to-go supplies. This was partially offset by the increase in restaurant-level staffing and wages.

Restaurant level operating profit during 2023 increased as compared to 2022 primarily due to (i) same-restaurant sales growth, primarily driven by menu price increases, (ii) 37 NROs, (iii) 23 restaurants acquired from our franchisees and (iv) lower costs for commodities, driven mostly by decreases in pork and avocado prices, and lower costs of to-go supplies. This was partially offset by the increase in (i) operating costs and expenses driven by our restaurant growth and (ii) restaurant-level staffing and wages.

Adjusted EBITDA and Adjusted EBITDA Margin

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","Change"],["Adjusted EBITDA","$","99,483","","","$","69,278","","","$","30,205","","","43.6","%"],["Adjusted EBITDA margin","11.2","%","","9.5","%","","1.7%"]]
[[/GREPCENT_TABLE]]

The increase in Adjusted EBITDA and Adjusted EBITDA margin during 2023 as compared to 2022 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 the increase in compensation expense.

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Non-GAAP Financial Measure Reconciliations

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

.

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","2021"],["Net income (loss)","$","25,385","","","$","6,907","","","$","(2,107)"],["Depreciation and amortization","41,223","","","34,230","","","32,379"],["Interest expense","8,063","","","5,232","","","20,099"],["Income taxes","10,690","","","5,684","","","2,477"],["EBITDA","85,361","","","52,053","","","52,848"],["Stock-based compensation (1)","7,604","","","10,374","","","8,596"],["Transaction expenses (income), net (2)","3,147","","","2,513","","","(1,156)"],["Strategic transition costs (3)","892","","","2,318","","","2,402"],["Impairments and loss on disposal of assets (4)","1,359","","","920","","","381"],["Delaware Voluntary Disclosure Agreement Program (5)","1,250","","","149","","","\u2014"],["Recruiting and relocation costs (6)","465","","","681","","","351"],["Severance costs (7)","26","","","155","","","265"],["Insurance proceeds in connection with natural disasters, net (8)","(621)","","","115","","","\u2014"],["Loss on extinguishment of debt","\u2014","","","\u2014","","","2,403"],["COVID-19 related charges (9)","\u2014","","","\u2014","","","211"],["Adjusted EBITDA","$","99,483","","","$","69,278","","","$","66,301"],["Total revenues","$","891,551","","","$","730,162","","","$","601,193"],["Net income (loss) margin","2.8","%","","0.9","%","","(0.4)","%"],["Adjusted EBITDA margin","11.2","%","","9.5","%","","11.0","%"],["Additional information"],["Deferred rent expense (income) (10)","$","2,090","","","$","2,418","","","$","(2,011)"]]
[[/GREPCENT_TABLE]]
_____________________________

(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 (Loss).

(2) Represents (i) costs incurred in connection with the acquisition of franchise-owned restaurants, (ii) costs related to certain equity offerings, (iii) costs related to restaurant closures, (iv) gains or losses associated with lease or contract terminations and (v) 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.

(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 (Loss).

(4) Represents impairment charges and costs related to the disposal of assets due to retirements, replacements, restaurant closures and natural disasters.

(5) Represents estimated probable loss and 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 (Loss).

(6) Represents costs incurred for hiring qualified individuals as we assessed the redesign of our systems and processes. These costs are recorded within General and administrative expenses on the Consolidated Statements of Operations and Comprehensive Income (Loss).

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

(8) 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 (Loss).

(9) Represents costs incurred in connection with the economic impact of the COVID-19 pandemic.

(10) 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 (Loss).

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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:

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022","","2021"],["Income from operations","$","41,267","","","$","16,913","","","$","22,243"],["Less: Franchise revenues","(14,459)","","","(10,981)","","","(8,850)"],["Add:"],["General and administrative expenses","103,121","","","84,959","","","70,388"],["Depreciation and amortization","41,223","","","34,230","","","32,379"],["Transaction expenses (income), net (1)","3,147","","","2,513","","","(1,156)"],["Impairments and loss on disposal of assets (2)","1,359","","","920","","","381"],["Costs in connection with natural disasters (3)","\u2014","","","382","","","\u2014"],["COVID-19 related charges (4)","\u2014","","","\u2014","","","19"],["Restaurant level operating profit","$","175,658","","","$","128,936","","","$","115,404"],["Restaurant sales","$","877,092","","","$","719,181","","","$","592,343"],["Income from operations margin","4.7","%","","2.4","%","","3.8","%"],["Restaurant level operating profit margin","20.0","%","","17.9","%","","19.5","%"],["Additional information"],["Deferred rent expense (income) (5)","$","1,891","","","$","2,219","","","$","(2,075)"]]
[[/GREPCENT_TABLE]]
_____________________________

(1) Represents (i) costs incurred in connection with the acquisition of franchise-owned restaurants, (ii) costs related to certain equity offerings, (iii) costs related to restaurant closures, (iv) gains or losses associated with lease or contract terminations and (v) 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.

(2) Represents impairment charges and costs related to the disposal of assets due to retirements, replacements, restaurant closures and natural disasters.

(3) Represents costs incurred in connection with Hurricane Ian. The costs include inventory obsolescence and spoilage as well as compensation for employees, which were recorded in Food and beverage costs and Labor and other expenses on the Consolidated Statements of Operations and Comprehensive Income (Loss).

(4) Represents costs incurred in connection with the economic impact of the COVID-19 pandemic.

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

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Liquidity and Capital Resources

Liquidity

As of December 31, 2023, the Company had cash and cash equivalents of $49.6 million. The Company had $92.5 million of principal amount outstanding of its existing $100.0 million term loan A facility (the “Term Facility”), excluding unamortized debt discount and deferred issuance costs, and the Company had drawn $30.0 million on its existing $75.0 million revolving credit facility (the “Revolving Credit Facility”) as of December 31, 2023. 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.

On January 5, 2024, (the “Closing Date”), FWR Holding Corporation, a Delaware corporation (“FWR”), an indirect subsidiary of the Company, entered into that certain Amendment No. 2 to Credit Agreement (the “Amendment”), by and among FWR, as borrower, AI Fresh Parent, Inc., a Delaware corporation and indirect subsidiary of the Company (“Holdings”), the subsidiaries of FWR party thereto as guarantors, the lenders party thereto and Bank of America, N.A., as administrative agent and collateral agent (in such capacities, the “Administrative Agent”), which amended its credit agreement dated as of October 6, 2021 ((as previously amended, and as amended by the Amendment, the “Credit Agreement”) by and among FWR, Holdings, the lenders from time to time party thereto and the Administrative Agent. Pursuant to the terms of the Amendment, (i) the Term Facility was replaced with a new $100.0 million term loan A facility, (the “New Term Facility”), on terms substantially identical to the Term Facility, (ii) the Revolving Credit Facility was replaced with a new $75.0 million revolving credit facility (the “New Revolving Credit Facility”) on terms substantially identical to the Revolving Credit Facility, (iii) a new $125.0 million incremental delayed draw term loan facility, (the “New Delayed Draw Term Facility”), was established that will be available to FWR in one or more draws of at least $5.0 million each for a period of 18 months following the Closing Date, and (iv) the New Revolving Credit Facility was increased by $50.0 million in new revolving credit commitments bringing the aggregate committed amount under the New Revolving Credit Facility to $125.0 million. Commitments in respect of the New Delayed Draw Term Facility may be reduced, in whole or in part, at any time prior to 18 months following the Closing Date in the sole discretion of FWR. Loans under the New Term Facility and, once funded, the New Delayed Draw Term Facility will constitute the same class of term loans for all purposes under the amendment to the Credit Agreement.

We believe that our cash flows 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, 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. On November 7, 2022, we filed a Registration Statement on Form S-3 that allows the Company to sell up to 5,000,000 shares of common stock from time to time in one or more offerings.

We estimate that our capital expenditures, not including capital allocated to acquisitions of franchise-owned restaurants, will total approximately $125.0 million to $135.0 million in 2024, which will be invested primarily in new restaurant projects and planned remodels. We plan to fund the capital expenditures and our significant acquisitions 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 2023 and 2022:

[[GREPCENT_TABLE]]
[["","FISCAL YEAR"],["(in thousands)","2023","","2022"],["Cash provided by operating activities","$","95,338","","","$","62,937"],["Cash used in investing activities","(123,370)","","","(63,111)"],["Cash provided by (used in) financing activities","28,070","","","(2,018)"],["Net increase (decrease) in cash and cash equivalents and restricted cash","$","38","","","$","(2,192)"]]
[[/GREPCENT_TABLE]]

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Cash provided by operating activities during 2023 was $95.3 million as compared to $62.9 million during 2022 primarily due to (i) the increase in net income of $18.5 million, (ii) the impact of non-cash charges of $10.8 million and (iii) a net change in operating assets and liabilities of $3.2 million. The increase in the 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 lower stock-based compensation expense. The net change in operating assets and liabilities was primarily due to (i) higher accrued compensation and (ii) the timing of operational payments.

Cash used in investing activities increased to $123.4 million during 2023 from $63.1 million during 2022 primarily as a result of the increase in capital expenditures to support our restaurant growth and the acquisitions of restaurants from our franchisees.

Cash provided by financing activities of $28.1 million during 2023 compared to cash used in financing activities of $2.0 million during 2022 was primarily due to proceeds from borrowings on our revolving credit facility, partially offset by the increase in principal repayments on the Term Facility.

Contractual Obligations

Material contractual obligations arising in the normal course of business primarily consist of operating and finance lease obligations, long-term debt, and purchase obligations. The timing and nature of these commitments are expected to have an impact on our liquidity and capital requirements in future periods. Refer to Note 10, Debt, in the accompanying consolidated financial statements for additional information relating to our long-term debt and Note 12, Leases, in the accompanying consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information related to our operating and financing leases.

Purchase obligations include agreements related to the construction or remodeling of restaurant facilities, the purchase of food, beverages, paper goods and other supplies, equipment purchases, marketing-related contracts, software license commitments, technology and other service contracts in the normal course of business. These obligations are generally pursuant to short-term purchase orders at prevailing market prices and are recorded as liabilities when the related goods are received or services rendered. These commitments are cancellable and there are no material financial penalties associated with these commitments in the event of early termination.

Purchase obligations also include firm minimum commitments in excess of 12 months for certain contracts. Refer to Note 18, Commitments and Contingencies, in the accompanying consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K, which have been prepared in accordance with GAAP. The preparation of these 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, 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. The accounting policies and estimates that we believe to be the most critical to an understanding of our financial condition and results of operations and that require the most complex and subjective management judgments are discussed below.

Business Combinations

We account for acquisitions using the purchase method of accounting. We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values at the acquisition date. The excess of the fair value of purchase consideration over the fair values of identifiable assets and liabilities is recorded as goodwill. The fair values assigned, defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants, are based on estimates and assumptions determined by management. We determine the fair values of tangible and intangible assets acquired generally

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in consultation with a third-party valuation advisor. Critical estimates in valuing certain intangible assets include but are not limited to future expected cash flows and discount rates. In addition, we have estimated the value and economic lives of certain tangible assets based on historical information, industry estimates and averages, which are used to calculate depreciation and amortization expense. If the subsequent actual results and updated projections of the underlying business activity change compared with the assumptions and projections used to develop these values, we could experience impairment charges. If our estimates of the economic lives change, depreciation or amortization expense could be accelerated or extended. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates.

If the initial accounting for a business combination is incomplete by the end of a reporting period that falls within the measurement period (not to exceed a year from the date of acquisition), we report provisional amounts in our consolidated financial statements. During the measurement period, we adjust the provisional amounts recognized at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. We record these adjustments to the provisional amounts with a corresponding offset to goodwill. Any adjustments identified after the measurement period are recorded in the Consolidated Statements of Operations and Comprehensive Income (Loss).

The results of operations of acquired businesses are included in the consolidated financial statements from the acquisition date and costs that we incur to complete the business combination, such as legal and other professional fees, are expensed as they are incurred.

Goodwill and Indefinite-Lived Intangibles

Goodwill and indefinite-lived intangibles are tested for impairment annually, on the first day of the fourth quarter of the fiscal year, or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Significant judgments are used to determine if an indicator of impairment has occurred. Such indicators could include negative operating performance of our restaurants, economic and restaurant industry trends, legal factors, significant competition or changes in our business strategy. Any adverse change in these factors could have a significant impact on the recoverability of our goodwill and indefinite-lived intangible assets and could have a material impact on our consolidated financial statements.

We have identified one reporting unit to which we have attributed goodwill. Management may elect to perform a qualitative assessment to determine whether it is more likely than not that the reporting unit and/or asset group is impaired. If the qualitative assessment is not performed, or if it is not more likely than not that the estimated fair value of the reporting unit and indefinite-lived intangible assets exceeds the respective carrying value, a quantitative analysis is required.

If the qualitative assessment is not performed or if we determine that it is not more likely than not that the fair value of the reporting unit exceeds the carrying value, the fair value of the reporting unit is calculated using the best information available, including market information (also referred to as the market approach) and discounted cash flow projections (also referred to as the income approach). The market approach estimates fair value by applying projected cash flow earnings multiples to the reporting unit’s operating performance. The multiples are derived from comparable publicly-traded companies with similar operating and investment characteristics. The income approach uses internal future cash flow estimates, which are influenced by revenue growth rates, operating margins and new restaurant openings, that are discounted using a weighted-average cost of capital that reflects current market conditions. We recognize an impairment loss when the carrying value of the reporting unit exceeds the estimated fair value.

In performing the quantitative assessment for indefinite-lived intangibles, we estimate the fair value of trade names and trademarks using the relief-from-royalty method, which requires assumptions related to projected sales, assumed royalty rates that could be payable if we did not own the trademarks and a discount rate. We recognize an impairment loss when the carrying value of the asset exceeds the estimated fair value.

The subjective estimates associated with management’s judgments and assumptions in fair value calculations at the measurement date are affected by various factors including changes in economic conditions, our operating performance and our business strategies.

During 2023 and 2022, we elected to perform a qualitative assessment for our annual impairment review of goodwill and indefinite-lived intangibles. In considering the qualitative approach related to goodwill, we considered factors including,

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but not limited to, macro-economic conditions, market and industry conditions, the competitive environment, results of prior impairment tests, operational stability, the overall financial performance of the reporting unit and the impacts of the discount rates. Management also considered the specific future outlook for the reporting unit. As it relates to our trade names and trademarks, we evaluate similar factors as the goodwill assessment, in addition to impacts of potential changes to the assumed royalty rate. Based on the results of the qualitative assessment, Management concluded that impairment of goodwill and its indefinite-lived intangibles was not likely and as a result, management was not required to perform a quantitative assessment.

Long-Lived Assets and Definite-Lived Intangible Assets

Long-lived assets deployed at company-owned restaurants include (i) property, fixtures and equipment, (ii) operating lease right-of-use asset, net of the related operating lease liability and (iii) reacquired rights to the extent the restaurant had been acquired by the Company. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability is measured by a comparison of the carrying amount of an asset group to the estimated undiscounted future cash flows expected to be generated by the asset group. The comparison is performed at the lowest level of identifiable cash flows, which is primarily at the individual restaurant level. Significant judgment is used to determine the expected useful lives of long-lived assets and the estimated future cash flows, including projected sales growth, operating margins and ongoing maintenance and improvement of the assets. If the carrying amount of the asset group exceeds its estimated undiscounted future cash flows, an impairment charge is recognized.

Definite-lived intangible assets consist of franchise rights which arose from the purchase price allocation in connection with the Advent Acquisition and also include reacquired rights from the Company’s acquisitions of franchised restaurants. Definite-lived intangible assets are amortized on a straight-line basis over their estimated useful lives and are reviewed for impairment when events or change in circumstances indicate that the carrying amount of such assets may not be recoverable. Significant judgments are used to determine if an indicator of impairment has occurred. Such indicators may include, among others: negative operating performance of our restaurants, economic and restaurant industry trends, legal factors, significant competition or changes in our business strategy. Adverse changes in these factors could have a significant impact on the recoverability of these assets and the resulting impairment charge could be material to our consolidated financial statements.

Recoverability of definite-lived intangible assets is measured by a comparison of the carrying amount of the asset group to the estimated undiscounted future cash flows expected to be generated by the asset group. If the total future undiscounted net cash flows are less than the carrying amount, this may be an indicator of impairment. An impairment loss is recognized when the asset’s carrying value exceeds its estimated fair value, which is generally estimated using discounted future cash flows expected from future use of the asset group.

Leases

We lease our restaurant facilities and corporate offices, as well as certain restaurant equipment under various non-cancelable agreements. At the inception of each lease, we evaluate the expected term which includes reasonably certain renewal options, and the classification as either an operating leases or a finance lease. Lease liabilities represent the present value of future lease payments. To determine the present value of the lease liability, we estimate the incremental borrowing rates corresponding to the reasonably certain lease term as our leases do not provide implicit rates. Assumptions used in determining our incremental borrowing rate include a market yield implied by our outstanding secured term loans interpolated for various maturities using our synthetic credit rating, which is determined using a regression analysis of rated publicly-traded comparable companies and their financial data.

We assess the impairment of the right-of-use asset at the asset group level whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable.

Changes in management’s judgments and in the assumptions being used may produce materially different amounts in the recognition of the right-of-use assets, lease liabilities and lease expense.

Income Taxes

We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets or liabilities are recognized for the estimated future tax effects attributable to temporary differences between the carrying value and the

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tax basis of assets and liabilities as well as tax credit carryforwards. The estimates we make under this method include, among other items, depreciation and amortization expense allowable for tax purposes, credits for items such as taxes paid on reported employee tip wages, effective rates for state and local income taxes and the deductibility of certain items. In addition, our annual effective income tax rate is adjusted as additional information becomes available during the reporting period.

We recognize deferred tax assets for all deductible temporary differences to the extent that it is probable that taxable income will be available against which the deductible temporary differences can be utilized. A valuation allowance for deferred tax assets is provided when it is more likely than not that a portion of the deferred tax assets will not be realized. Potential for recovery of deferred tax assets is evaluated by estimating the taxable income in any available carry back period, considering future taxable income expected, scheduling of anticipated reversal of taxable temporary differences and considering prudent and feasible tax planning strategies.

We continue to monitor and evaluate the rationale for recording a valuation allowance against deferred tax assets. As we increase earnings and utilize deferred tax assets, it is possible the valuation allowance could be reduced or eliminated. In addition, our ability to utilize net operating loss carryforwards and tax credit carryforwards could be adversely impacted by, among other things, a future “ownership change” as defined under Section 382 of the Internal Revenue Code. Changes in assumptions regarding our level and composition of earnings, tax laws or the deferred tax valuation allowance and the results of tax audits, may materially impact the effective income tax rate.

Stock-Based Compensation and Fair Value of Common Stock

Stock-based compensation expense is measured based on the award’s grant date fair value. Stock-based compensation expense related to time-based stock option awards issued under the 2017 Equity Plan is recognized on an accelerated recognition method over the requisite service period. Prior to our IPO, we had not recognized any stock-based compensation expense for our performance-based stock option awards issued under the 2017 Equity Plan as the satisfaction of the performance conditions were not considered probable. Upon consummation of the Company’s IPO in October 2021, certain performance-based stock option awards issued under the 2017 Equity Plan for which the performance and market conditions were satisfied as a result of the Company’s IPO, converted into time-based stock option awards with the related stock-based compensation expense to be recognized on an accelerated recognition method over the remaining service period. The performance-based stock option awards that did not convert into time-based stock option awards were canceled and unrecognized compensation expense for those canceled performance-based stock option awards was recognized on the date of the Company’s IPO. No awards were granted under the 2017 Equity Plan during 2023 and 2022 and the Company does not intend to grant any further awards under the 2017 Equity Plan. Stock-based compensation expense related to time-based stock option awards issued under the 2021 Equity Plan is recognized on a straight-line basis over the requisite service period. Forfeitures are recognized as they occur for all awards.

We estimate the fair value of stock option awards using the Black-Scholes valuation model, which involves several assumptions and judgments including the expected term of the stock option, expected volatility, the risk-free interest rate and the expected dividend yield. The Company does not have sufficient historical stock option exercise activity and therefore we estimated the expected term of stock options granted under the 2021 Equity Plan using the simplified method, which represents the mid-point between the vesting period and the contractual term for each grant. Prior to the IPO, the expected term of stock option awards was determined based on data from publicly traded companies. The expected volatility of stock option awards is based on the historical volatilities of a set of publicly traded peer companies in a similar industry as the Company lacks company-specific historical or implied volatility information. The risk-free interest rate is determined by reference to the U.S. Treasury yield curve for time periods approximately equal to the expected term of the stock option award. The expected dividend yield is based on the fact that the Company has never paid cash dividends and does not have intentions of paying dividends in the foreseeable future. These assumptions represented management’s best estimate, which involved inherent uncertainties and the application of management’s judgment. As a result, if we had used significantly different assumptions or estimates, our stock-based compensation expense could have been materially different.

The fair value of our common stock and our stock-based awards’ grant date fair value is determined based on the closing price on our common stock on Nasdaq. Prior to our IPO and our common stock being listed on Nasdaq, given the absence of a public trading market for our common stock, the estimated fair value had been determined with input from management exercising reasonable judgment and considering several objective and subjective factors including: (i) third-party valuations of our common stock, (ii) a combination of the income approach and the market approach and (iii) general economic outlook including economic growth, inflation and interest rates.

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In 2021, prior to the IPO, we determined the Company’s equity value using the probability weighted expected return method (“PWERM”), or the hybrid method. Under the hybrid method, multiple valuation approaches are used and then combined into a single probability weighted valuation using a PWERM, which considers the probability of an initial public offering and sale scenarios. The results of the valuation approaches were weighted based on a variety of factors, including: the current macroeconomic environment, current industry conditions and length of time since arms-length market transaction events. Additionally, a discount for lack of marketability was applied to account for the lack of access to an active public market. The resulting value was then allocated to outstanding equity using an option-pricing model. This process involved the use of estimates, judgments, and assumptions that are highly complex and subjective, such as those regarding our expected future revenue, expenses and future cash flows, discount rates, market multiples, the selection of comparable companies, and the probability of possible future events. The assumptions underlying these valuations represented management’s best estimate, which involved inherent uncertainties and the application of management’s judgment. As a result, if we had used significantly different assumptions or estimates, the fair value of our common stock and our stock-based compensation expense could have been materially different.

See Note 17, Stock-Based Compensation, in the accompanying notes to the consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information.

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 consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K.