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All reported results were an order of magnitude larger in Q3’22 vs. a year ago, largely as a result of acquisitions, also influenced by openings, higher same store sales and average unit volumes. Recall that FAT Brands now oversees a 17-brand portfolio of franchised restaurant concepts, comprised of over 2300 locations that generate $2.2B of annual sales. The five largest brands are Fatburger, Johnny Rockets, Round Table Pizza, Fazoli’s and Twin Peaks. Twin Peaks is the only brand with a material number of company operated locations, 28 out of the 92- unit current total, with AUVs above $5M and compelling store level profits and return on investment.
THE QUARTER
Adjusted EBITDA in Q3’22 was $24.6M (up from $7.2M in ’21) with a GAAP loss of $23.4M. The material reconciling adjustments were addbacks of: Interest Expense of $24.5M, D&A of $6.9M, Share Based Compensation of $2.0M. Additional non-recurring adjustments were Acquisition Costs of $2.0, Provision for Bad Debts of $5.5M and Litigation Costs of $6.9M, the last two of which are expected to be at least partially recoverable
Management has, since late ’21, been guiding to a post-Covid run rate of $90-95M of Adjusted EBITDA with over 100 openings in ‘22, and both objectives are being met. In Q3’22, systemwide sales growth was 57% vs. ‘21, with SSS growth of 7.0% and there were 38 new store openings, the new total for ’22 expected to be 125. For nine months, Adjusted EBITDA was $69M, and guidance of about $25M in Q4 would take it to $94M for the full year. Importantly, franchisees signed for over 180 new locations during Q3, bringing the development pipeline to over 1,000, “expected to represent a 60% increase in EBITDA over the next several years”.
THE DEBT
While management continues to work to reduce its debt service, anticipating a re-rating and a lower interest rate, a process that was expected to be well under way by now, the current volatility in debt markets has predictably inhibited this effort. While marking time in this regard, $43M of Series B Preferred Stock has been redeemed by the use of one of its securitization facilities that carries a lower rate. The savings will be material and the plan is to convert another $95M in the next two or three quarters. Fortunately: unit growth, sales growth, and efficiencies inherent in operating a multi-branded administrative platform are steadily improving operating cash flow, so the current debt structure can be serviced even if the terms are not improved. Moreover, FAT owns at least five brands that could be monetized over time in a variety of ways to materially reduce the debt. At the same time the factors above, augmented by increased cash flow from dough manufacturing should generate a steadily increasing amount of free cash flow.
THE OUTLOOK
According to commentary on the conference call, more than 90 new locations are currently under construction, with 130-150 due to open in ’23. The portfolio wide pipeline of over 1000 locations represents forty three percent unit growth and an incremental $60M of EBITDA. Regarding Twin Peaks, the single most important brand, there are over 100 locations in the franchise development pipeline, with 15-20 franchised and 3-4 company operated to open in ’23 and in each subsequent year. The newest class of stores is generating about a $6M AUV, and same store sales are running up about 13% through nine months of ’23. In the Fast Casual segment, the pipeline has 350 new Fatburger’s and Johnny Rockets. Within QSR there are over 400 restaurants, including Fazoli’s, Round Table Pizza, Great American Cookies and Marble Slab Creamery. Co-branding is an important focus, which spreads the cost of the physical facility and increases sales per square foot. There are over 100 pairings of Buffalo’s Express and Fatburger, 225 co-branded Great American Cookies and Marble Slab Creamery, and one tri-branded Fatburger, Hot Dog on a Stick and Buffalo’s Express. Non-traditional locations are also a new focus, with 13 opened in the past year.
Another important opportunity is the dough manufacturing facility that was purchased in mid’21. It generated $7.8M of revenues in Q3, $25M for nine months, and is generating about $15M of EBITDA while operating at only 33% of capacity. The 55 acquired Nestle Toll House Café stores are being converted to Great American Cookies (GAC) and will take the manufacturing facility to 38% of capacity with materially improved cash flow. At the same time, franchisees of Nestle (to become GAC) will be able to purchase dough at 20% less than previously. More broadly relating to FAT’s multi-branded portfolio, based on $600M of total purchasing power, franchisees will be able to save 200-300 bp within their cost of goods.
THE BOTTOM LINE
The run rate of improving EBITDA and free cash flow generation should continue to build quarter by quarter, with contributions in ‘23 as follows: (1) Corporate efficiencies amounting to $2M at least (2) New franchised units open, at the rate of 5-6% per year, generating about $5M of new royalties annually (3) Higher royalty generating sales, from inflation at least, generating an incremental $2M (4) At least 2 new corporate “store years” at Twin Peaks, out of 3-4 planned openings, which should generate $2M of EBITDA, depending on timing of openings (5) Manufacturing facility, improved utilization, $3M. In total, our estimate is that total Incremental operating EBITDA phasing in during ’23 could amount to $14M. The Company has so far made no estimate, and we are not including the effect of “fill in” acquisitions, but our analysis above takes the annualized run rate of EBITDA in ’23 to about $108-110M.
Roger Lipton