10-Q: First Watch Q2 Profit Plunges Amid Rising Costs

First Watch Restaurant Group reported a significant drop in second-quarter net income and margins despite strong revenue growth, driven by higher operating costs and inflation.

Summary

• Total revenues increased 19.1% to $307.9 million for the thirteen weeks ended June 29, 2025, compared to $258.6 million in the prior year period.
• Net income decreased by 76.3% to $2.1 million, or $0.03 per diluted share, in Q2 2025, down from $8.9 million, or $0.14 per diluted share, in Q2 2024.
• System-wide sales grew 15.8% to $346.2 million in Q2 2025.
• Same-restaurant sales growth was 3.5%, and same-restaurant traffic growth was 2.0%, marking the first quarter of positive traffic growth since Q1 2023.
• The company opened 17 system-wide restaurants and acquired 19 franchise-operated restaurants, bringing the total to 600 system-wide restaurants across 31 states.
• Restaurant level operating profit margin decreased to 18.6% from 21.9% in the prior year, primarily due to inflation in commodities, increased wage rates, and higher occupancy and pre-opening expenses.
• Adjusted EBITDA decreased 14.0% to $30.4 million, with Adjusted EBITDA margin falling to 9.9% from 13.7%.

Sentiment

Score: 3

Explanation: The sentiment is negative due to a substantial decline in net income and key profitability margins (operating profit, EBITDA) despite strong revenue growth. This indicates significant cost pressures and reduced operational efficiency. While positive traffic growth is a good sign, it is overshadowed by the severe impact on the bottom line and the ongoing material weaknesses in internal controls.

Positives

• Total revenues increased by 19.1% to $307.9 million.
• System-wide sales increased by 15.8% to $346.2 million.
• Same-restaurant sales growth was positive at 3.5%.
• Same-restaurant traffic growth was positive at 2.0%, the first positive traffic growth since Q1 2023.
• Opened 17 new system-wide restaurants and acquired 19 franchise-operated restaurants, expanding the footprint to 600 restaurants in 31 states.
• Expect positive traffic trends to continue through the second half of the year.
• Anticipate moderation in elevated egg costs in the second half of the year.

Negatives

• Net income decreased significantly by 76.3% to $2.1 million.
• Net income per diluted share fell to $0.03 from $0.14.
• Income from operations margin decreased to 2.4% from 6.4%.
• Restaurant level operating profit margin decreased to 18.6% from 21.9%.
• Adjusted EBITDA decreased by 14.0% to $30.4 million, and Adjusted EBITDA margin decreased to 9.9% from 13.7%.
• Food and beverage costs as a percentage of restaurant sales increased to 23.6% due to commodity inflation (eggs, coffee, bacon, avocados) and increased portion sizes.
• Labor and other related expenses as a percentage of restaurant sales increased to 33.2% due to wage rate increases and higher health insurance costs.
• Pre-opening expenses increased by 91.8% to $3.507 million due to more new restaurants opened and under construction.
• General and administrative expenses increased by 22.1% to $33.185 million due to higher marketing expenses, compensation, licenses, and professional fees.
• Interest expense increased by 18.4% to $4.003 million due to increased borrowings for franchise acquisitions.
• Cash and cash equivalents decreased to $19.177 million as of June 29, 2025, from $33.312 million at December 29, 2024.
• Long-term debt, net, increased to $250.009 million as of June 29, 2025, from $189.043 million at December 29, 2024.

Risks

• Vulnerability to changes in consumer preferences and economic conditions, including inflation and recession.
• Uncertainty regarding geopolitical conflicts (Russia-Ukraine war, Middle East war/unrest) and their impact on macroeconomic conditions, including inflation.
• Inability to successfully open new restaurants or establish new markets.
• Inability to effectively manage growth, potentially leading to negative impacts on sales at existing restaurants.
• Lower than expected same-restaurant sales growth.
• Changes in the cost of food, particularly commodity inflation.
• Unprofitability or closure of new restaurants or lower performance in existing restaurants.
• Inability to compete effectively for customers.
• Unsuccessful financial performance of franchisees, limited control over their operations, and potential conflicts of interest.
• Geographic concentration of system-wide restaurants in the southeast U.S.
• Damage to reputation and negative publicity, including inability to manage social media impact.
• Limited number of suppliers and distributors for frequently used ingredients, leading to potential shortages or disruptions.
• Information technology system failures or breaches of network security.
• Failure to comply with federal and state laws and regulations related to privacy, data protection, advertising, and consumer protection.
• Potential liability with gift cards under property laws of some states.
• Failure to enforce and maintain trademarks and protect other intellectual property, including litigation risks.
• Dependence on executive officers and key employees, and inability to identify, hire, train, and retain qualified individuals.
• Labor shortages, increased labor costs, or health care costs, and potential unionization activities.
• Risks associated with leasing property subject to long-term and non-cancelable leases.
• Costly and complex compliance with federal, state, and local laws, including trade and tax policies.
• Vulnerability to natural disasters, unusual weather conditions, pandemic outbreaks, political events, war, and terrorism.
• Inability to secure additional capital to support business growth.
• High level of indebtedness and potential failure to comply with covenants under the credit facility.
• Interests of the largest stockholder may differ from those of public stockholders.
• Material weaknesses in internal control over financial reporting continue to exist, which could affect the ability to prevent or detect material misstatements.

Future Outlook

The company expects positive traffic trends to continue through the second half of 2025. Full-year commodity inflation is projected to range between 5% and 7%, with elevated egg costs expected to moderate. Restaurant-level wage inflation for the full year is anticipated to approximate 3% to 4%. Capital expenditures for 2025 are estimated to be $148.0 million to $152.0 million, excluding franchise acquisitions, and will be funded primarily by cash from operations and credit facility borrowings. The company believes its current liquidity is sufficient for at least the next 12 months, with additional liquidity or significant acquisitions to be funded first through additional indebtedness and then equity issuance.

Management Comments

• In the second quarter, our same-restaurant traffic grew 2.0%, our first quarter of positive traffic growth since the first quarter ended March 26, 2023.
• We expect positive traffic trends to continue through the second half of the year.
• We now project our full year commodity inflation to range between 5% and 7%.

Industry Context

The restaurant industry continues to face significant inflationary pressures on commodity costs, particularly for key ingredients like eggs, coffee, and bacon, as well as rising labor costs. Despite these headwinds, First Watch's ability to achieve positive same-restaurant traffic growth suggests strong brand appeal and effective menu pricing strategies, which is a positive differentiator in a challenging economic environment. However, the substantial decline in net income and margins indicates that cost increases are outpacing revenue growth and pricing adjustments, reflecting broader industry challenges in maintaining profitability amidst high operational expenses.

Corporate Governance

Legal Proceedings

• The company is subject to various claims and legal actions that arise in the ordinary course of business.
• The amount of anticipated liability with respect to these matters was not material as of June 29, 2025.
• A significant increase in the number of claims or amounts owing under successful claims could materially adversely affect the business, financial condition, results of operations, and cash flows.

Stakeholder Impact

• Shareholders: Significant decrease in net income and diluted EPS may negatively impact shareholder value and investor confidence.
• Employees: Wage increases and increased health insurance costs are positive for employees, but rising labor costs impact company profitability.
• Customers: Menu price increases and increased portion sizes in some items may affect customer perception and value proposition.
• Suppliers: Commodity inflation, particularly for eggs, coffee, bacon, and avocados, indicates increased costs for suppliers, which are passed on to the company.
• Creditors: Increased long-term debt and interest expense indicate higher leverage, which could be a concern for creditors, though the company states it is in compliance with covenants.

Next Steps

• Continue to manage and mitigate commodity inflation, particularly for eggs, coffee, bacon, and avocados.
• Address rising labor costs and health insurance expenses.
• Manage pre-opening expenses for new restaurant developments.
• Continue to implement and test remediation efforts for identified material weaknesses in internal control over financial reporting.
• Assess the impact of the H.R. 1 'One Big Beautiful Bill' on consolidated financial statements, particularly regarding 100% bonus depreciation.
• Fund estimated capital expenditures of $148.0 million to $152.0 million in 2025 for new restaurant projects and remodels, primarily with cash from operations and credit facility borrowings.

Key Dates

Recommendation

While First Watch demonstrated strong revenue growth and positive same-restaurant traffic, the significant decline in net income and key profitability margins (operating profit, Adjusted EBITDA) is a major concern. This indicates that rising costs, particularly from commodity inflation and labor, are severely impacting the bottom line. The ongoing material weaknesses in internal controls also add a layer of risk. The company's expansion strategy through new openings and acquisitions is capital-intensive, leading to increased debt and interest expense. Given the mixed signals – growth in top-line and traffic versus a sharp decline in profitability and control issues – a 'hold' recommendation is appropriate. Investors should monitor the company's ability to manage cost pressures, improve margins, and remediate internal control weaknesses before considering further investment.

Keywords

Restaurant, Dining, Breakfast, Brunch, Lunch, Casual Dining, Franchise, Food Service, SEC Filing, 10-Q, Financial Results, FWRG, First Watch