THE ONE GROUP HOSPITALITY, INC. The following management's discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes to those statements included elsewhere in this Annual Report on Form 10K.
Business Summary
We are a global hospitality company that develops, owns and operates, manages
and licenses upscale and polished casual, high-energy restaurants and lounges
and provides turn-key food and beverage ("F&B") services for hospitality venues
including hotels, casinos and other high-end locations. Turn-key F&B services
are food and beverage services that can be scaled, customized and implemented by
us at a particular hospitality venue and customized for the client. We were
established with the vision of becoming a global market leader in the
hospitality industry by melding high-quality service, ambiance, high-energy and
cuisine into one great experience that we refer to as "Vibe Dining". All our
restaurants, lounges and F&B services are designed to create a social dining and
high-energy entertainment experience within a destination location. We believe
that this design and operating philosophy separates us from more traditional
restaurant and foodservice competitors.
Our primary restaurant brands are STK, a multi-unit steakhouse concept that
combines a high-energy, social atmosphere with the quality and service of a
traditional upscale steakhouse, and Kona Grill , a bar-centric grill concept
featuring American favorites, award-winning sushi, and specialty cocktails in a
polished casual atmosphere. Our F&B hospitality management services include
developing, managing and operating restaurants, bars, rooftop lounges, pools,
banqueting and catering facilities, private dining rooms, room service and mini
bars tailored to the specific needs of high-end hotels and casinos. Our F&B
hospitality clients operate global hospitality brands such as the W Hotel ,
Hippodrome Casino , and ME Hotels .
We opened our first restaurant in January 2004 in New York, New York , and, as of
December 31, 2019 , we owned, operated, managed or licensed 55 venues including
20 STKs and 24 Kona Grills in major metropolitan cities in North America , Europe
and the Middle East and including F&B services provided to four hotels and
casinos in the United States and Europe . For those restaurants and venues that
are managed or licensed, we generate management and incentive fee revenue based
on a percentage of the location's revenues and net profits.
The table below reflects our venues by restaurant brand and geographic location
as of December 31, 2019 :
Venues
STK(1) Kona Grill ONE Hospitality(2) Total
Domestic
Owned 10 24 2 36
Managed 1 - 1 2
Licensed 1 - - 1
Total domestic 12 24 3 39
International
Owned - - - -
Managed 3 - 8 11
Licensed 5 - - 5
Total international 8 - 8 16
Total venues 20 24 11 55
(1) Locations with an STK and STK Rooftop are considered one venue location. This
includes the STK Rooftop in
(2) Includes concepts under the Company's F&B hospitality management agreements
and other venue brands such as ANGEL, Bagatelle, Heliot, Hideout, Marconi and
Radio.
Acquisitions
On October 4, 2019 , we acquired substantially all of the assets of Kona Grill
Inc. and its affiliates ("Kona Grill ") comprising 24 domestic restaurants. We
purchased the assets for a contractual price of $25.0 million plus approximately
24
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The purchase was financed with proceeds from the credit and guaranty agreement we entered into withGoldman Sachs Bank USA in conjunction with the acquisition ("Goldman Sachs Credit Agreement"). Over the next twelve months, we intend to integrateKona Grill by leveraging our corporate infrastructure, our bar-business knowledge and unique Vibe Dining program, to elevate the brand experience and drive improved performance.
Uncertainties Related to COVID-19
The negative effect of the novel coronavirus ("COVID-19") on our business is
significant. We experienced an initial decline in restaurant revenue that began
in early March 2020 as business travel decreased. Public anxiety about the
spread of COVID-19 has since increased. On March 11, 2020 , the World Health
Organization declared COVID-19 a pandemic disease, and on March 13, 2020 ,
President Trump declared a state of emergency concerning COVID-19. Other
government agencies have since recommended that people not visit restaurants or
bars. In some jurisdictions in the U.S. , people have been instructed to shelter
in place to reduce the spread of COVID-19. In response to these conditions, and
out of concern for our customers and partners, we have temporarily closed
several restaurants and we have shifted operations at others to provide only
take-out and delivery service. We expect that we will not be able to return to
normal operations for weeks or months, and we expect that our results of
operations to be materially and negatively affected by these actions in the
first and second quarters of 2020.
We have implemented measures to reduce our costs during the COVID-19 period,
including significant reductions in employees, deferral of capital projects, and
we expect to return to more normal operations late in the second quarter of 2020
or early in the third quarter of 2020. Our resumption of normal operations is
subject to events beyond our control, including the effectiveness of
governmental efforts to halt the spread of COVID-19.
Executive Summary
On
Total revenue increased$35.1 million , or 41.0% to$120.7 million for the year endedDecember 31, 2019 compared to$85.6 million for the year endedDecember 31, 2018 . Approximately$23.7 million of the increase in total revenue was attributable to addition of the ownedKona Grill restaurants in the fourth quarter of 2019. The remaining increase in total revenue was primarily due to overall sales growth from existing restaurants, the openings of new owned and licensed STK restaurants, and the addition of one international, managed location. Operating income increased$7.0 million to$12.8 million for the year endedDecember 31, 2019 from$5.8 million for the year endedDecember 31, 2018 . The increase in operating income was driven by theKona Grill acquisition, which resulted in an$11.0 million bargain purchase gain and additional operating income of$2.6 million . This increase was partially offset by a non-cash write down of$2.7 million related to our cost method investments and$2.5 million of transaction costs incurred in 2019. The transaction costs included transaction and integration costs incurred with theKona Grill acquisition and internal costs associated with capital raising activities, primarily associated with the Goldman Sachs Credit Agreement and a credit agreement withBank of America, N.A .
Our Growth Strategies and Outlook
Our growth model is primarily driven by the following:
Kona Grill Acquisition. OnOctober 4, 2019 , we acquired substantially all of the assets ofKona Grill , which comprised of 24 domestic restaurants. Over the next twelve months, we intend to integrateKona Grill by leveraging our corporate infrastructure, our bar-business knowledge and unique Vibe Dining program, to elevate the brand experience and drive improved performance. Expansion of STK. We expect to continue to expand our operations domestically and internationally through a mix of owned, licensed and managed STK restaurants using a disciplined and targeted site selection process. We have identified over 75 additional major metropolitan areas across the globe where we could grow our STK brand to 200 25 Table of Contents restaurants over the foreseeable future. We expect to open as many as five to six STKs annually, primarily through management or licensing agreements, provided that we have sufficient interest from prospective licensees, acceptable locations and quality restaurant managers available to support that pace of growth.
In 2019, we opened an owned STK restaurant in
Expansion through New F&B Hospitality Projects. We expect our F&B hospitality services business to be an important driver of our growth and profitability, enabling us to generate management fee income with minimal capital expenditures. We believe we are well positioned to leverage the strength of our brands and the relationships we have developed with global hospitality providers to drive the continued growth of our F&B hospitality business. We continue to receive inbound inquiries regarding new opportunities globally, and we continue to work with existing hospitality clients to identify and develop additional opportunities in their venues. We expect to enter into one to two new F&B hospitality agreements annually. In 2019, we opened one managed rooftop bar concept, ANGEL, inFlorence, Italy . Increase Same Store Sales and Increase Our Operating Efficiency. In addition to expanding into new cities and hospitality venues, we intend to continue to increase revenue and profits in our existing operations through continued focus on high-quality, high-margin food and beverage menu items. We believe that our operating margins will improve through growth in same store sales ("SSS"), as defined below in Key Performance Indicators, and a reduction of store-level operating expenses. For the year endedDecember 31, 2019 , our domestic STK SSS increased 8.3% compared to the same prior year period. OnOctober 4, 2019 , we acquired the 24 domestic ownedKona Grill restaurants. Kona Grill SSS for these acquired restaurants increased 3.9% for the fourth quarter of 2019 as compared to the same prior year period. As our footprint increases, we expect to benefit by leveraging system-wide operating efficiencies and best practices through the management of our general and administrative expenses as a percentage of overall revenue. We continue to look at opportunities to decrease our general and administrative expenses by outsourcing non-core activities and through increases in staff productivity. General and administrative expenses as a percentage of revenues improved 350 basis points for the year endedDecember 31, 2019 as compared to the prior year
Key Performance Indicators
We use the following key performance indicators in evaluating our restaurants and assessing our business:
Same Store Sales. SSS represents total food and beverage sales at domestic owned and managed restaurants opened for at least a full 18-month period, which removes the impact of new restaurant openings in comparing the operations of existing restaurants. For STK SSS, this measure includes total revenue from our owned and managed STK locations, excluding revenues from our owned STK restaurant located in theW Hotel inLos Angeles, California due to the impact of the F&B hospitality management agreement with the hotel. Revenues from locations where we do not directly control the event sales force are excluded from this measure. Our comparable restaurant base for STK SSS consisted of nine domestic restaurants for the year endedDecember 31, 2019 . For Kona Grill SSS, the 24 acquired domestic ownedKona Grill restaurants are included in the comparable restaurant base. STK SSS increased 8.3% for the compared to the same prior year period. Kona Grill SSS increased 3.9% for the period from acquisition onOctober 4, 2019 toDecember 31, 2019 as compared to the same prior year period. Number of Restaurant Openings. Number of restaurant openings reflects the number of restaurants opened during a particular fiscal period. For each restaurant opening, we incur pre-opening costs, which are defined below. Typically, new restaurants open with an initial start-up period of higher than normalized sales volumes (also referred to in the restaurant industry as the "honeymoon" period), which decrease to a steady level approximately 18 to 24 months after opening. However, operating costs during this initial period are also higher than normal, resulting in restaurant operating margins that are generally lower during the start-up period of operation and increase to a steady level approximately 18 26 Table of Contents
to 24 months after opening. Some new restaurants may experience a "honeymoon" period that is either shorter or longer than this time frame.
In 2019, we opened an owned STK restaurant inNashville, Tennessee , two licensed STK restaurants located inDoha, Qatar andSan Juan, Puerto Rico , and a managed rooftop bar concept, ANGEL, inFlorence, Italy . Average Check. Average check is calculated by dividing total restaurant sales by total entrees sold for a specified period. Our management team uses this indicator to analyze trends in customers' preferences, customer expenditures and the overall effectiveness of menu changes and price increases. For our comparable STK restaurants, our average check was$109.00 compared to$106.00 for the years endedDecember 31, 2019 and 2018, respectively. The average check was$26.00 forKona Grill restaurants for the period fromOctober 4, 2019 toDecember 31, 2019 . Average Comparable Restaurant Revenue. Average comparable restaurant revenue consists of the average sales of our comparable restaurants over a certain period of time. This measure is calculated by dividing total comparable restaurant sales in a given period by the total number of comparable restaurants in that period. This indicator assists management in measuring changes in customer traffic, pricing and development of our brand. Our average comparable STK restaurant revenues was$11.1 million and$10.2 million for the years endedDecember 31, 2019 and 2018, respectively. Our average comparableKona Grill restaurant revenues was$1.0 million for the period fromOctober 4, 2019 toDecember 31, 2019 . In 2019, the average restaurant revenues forKona Grill restaurants was$4.2 million .
Key Financial Terms and Metrics
We evaluate our business using a variety of key financial measures:
Segment reporting
In the fourth quarter of 2019, in conjunction with theKona Grill acquisition, we implemented certain organizational changes, including the reorganization of our internal reporting structure to better facilitate our strategy for growth, operational efficiency and management accountability. As a result of these organizational changes, we identified our reportable operating segments as follows:
· STK. The STK segment consists of the results of operations from STK restaurant
locations, competing in the full-service dining industry, as well as
management, license and incentive fee revenue generated from the STK brand and
operations of STK restaurant locations.
·
Grill restaurant locations.
· ONE Hospitality. The ONE Hospitality segment is comprised of the management,
license and incentive fee revenue and results of operations generated from our
other brands and venue concepts, which include ANGEL, Bagatelle, Heliot,
Hideout, Marconi, and Radio. Additionally, this segment includes the results of
operations generated from F&B hospitality management agreements with hotels,
casinos and other high-end locations.
· Corporate. The Corporate segment consists of the following: general and
administrative costs, stock-based compensation, depreciation and amortization,
acquisition related gains and losses, pre-opening expenses, lease termination
expenses, transaction costs, and other income and expenses. This segment also
includes our major off-site events group, which supports all brands and venue
concepts, and revenue generated from gift card programs.
See Note 18 to our consolidated financial statements set forth in Item 15 of the Annual Report on Form 10K for further information on our segment reporting. Prior year amounts have been revised to conform to the current year segment presentation. Revenues Owned restaurant net revenues. Owned restaurant net revenues consist of food and beverage sales by owned restaurants net of any discounts associated with each sale and of any ancillary F&B hospitality services at owned locations.
Additionally, revenues from offsite banquets, our major off-site events group,
and our gift card programs are included in owned restaurant net revenues. For
the year ended
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food and beverage sales, before giving effect to any discounts, and food sales comprised the remaining 66%. This indicator assists management in understanding the trends in gross margins of the restaurants. Our primary owned restaurant brands are STK andKona Grill . We specifically look at comparable sales from both owned and managed restaurants to understand customer count trends and changes in average check as it relates to our primary restaurant brands. Management, license and incentive fee revenue. Management, license and incentive fee revenues include fees received pursuant to management and license agreements. Management agreements typically call for a management fee based on a percentage of revenue, a monthly marketing fee based on a percentage of revenues and an incentive fee based on a managed venue's net profits. Similarly, royalties from the licensee in license agreements are generally based on a percentage of the licensed restaurant's revenue. These management, license and incentive fees are recognized as revenue in the period the restaurant's sales occur. Initial licensing fees and upfront fees related to management and license agreements are recognized as revenue on a straight-line basis over the term of the agreement. We evaluate the performance of our managed and licensed properties based on sales growth, a key driver for management and license fees, and on improvements in operating profitability margins, which, combined with sales, drives incentive fee growth. Cost and expenses Owned restaurant cost of sales. Owned restaurant cost of sales includes all owned restaurant food and beverage expenditures. We measure cost of goods as a percentage of owned restaurant net revenues. Owned restaurant cost of sales are generally influenced by the cost of food and beverage items, menu mix, discounting activity and restaurant level controls. See "Item 1A. Risk Factors - Increases in commodity prices would adversely affect our results of operations."
Owned restaurant operating expenses. We measure owned restaurant operating expenses as a percentage of owned restaurant net revenues. Owned restaurant operating expenses include the following:
· Payroll and related expenses. Payroll and related expenses consist of manager
salaries, hourly staff payroll and other payroll-related items, including taxes
and fringe benefits. We measure our labor cost efficiency by tracking total
labor costs as a percentage of owned restaurant net revenues.
· Occupancy. Occupancy comprises all occupancy costs, consisting of both fixed
and variable portions of rent, deferred rent expense, which is a non-cash
adjustment included in our Adjusted EBITDA calculation as defined below, common
area maintenance charges, real estate property taxes, utilities and other
related occupancy costs and is measured by considering both the fixed and
variable components of certain occupancy expenses.
· Direct operating expenses. Direct operating expenses consist of supplies, such
as paper, smallwares, china, silverware and glassware, cleaning supplies and
laundry, credit card fees and linen costs. Direct operating expenses are
typically measured as a variable expense based on owned restaurant net
revenues.
· Outside services. Outside services include music and entertainment costs, such
as the use of live DJ's, promoter costs, security services, outside cleaning
services and commissions paid to event staff for banquet sales.
· Repairs and maintenance. Repairs and maintenance consists of general repair
work to maintain our facilities, and computer maintenance contracts. We expect
these costs to increase at each facility as they get older.
· Marketing. Marketing includes the cost of promoting our brands and, at times,
can include the cost of goods used specifically for complementary purposes.
Marketing costs will typically be higher during the first 18 months of a
restaurant's operations.
General and administrative. General and administrative expenses are comprised of
all corporate overhead expenses, including payroll and related benefits,
stock-based compensation expense, professional fees, such as legal and
accounting fees, insurance and travel expenses. Certain centrally managed
general and administrative expenses are allocated specifically to restaurant
locations and are reflected in owned restaurant operating expenses and include
shared services such as reservations, events and marketing. We expect general
and administrative expenses to be leveraged as we grow, become more efficient,
and continue to focus on best practices and cost savings measures.
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Depreciation and amortization. Depreciation and amortization expense consists principally of charges related to the depreciation of fixed assets including leasehold improvements, equipment and furniture and fixtures and the amortization of the intangible assets related to theKona Grill tradename. Pre-opening expenses. Pre-opening expenses consist of costs incurred prior to opening an owned or managed STK restaurant at either a leased or F&B location. Pre-opening expenses are comprised principally of manager salaries and relocation costs, employee payroll, training costs for new employees and lease costs incurred prior to opening. We expect minimal pre-opening costs as we focus our growth towards our capital light model. Pre-opening expenses have varied from location to location depending on a number of factors, including the proximity of our existing restaurants; the amount of rent expensed during the construction and in-restaurant training periods; the size and physical layout of each location; the number of management and hourly employees required to operate each restaurant; the relative difficulty of the restaurant staffing process; the cost of travel and lodging for different metropolitan areas; the timing of the restaurant opening; and the extent of unexpected delays, if any, in obtaining necessary licenses and permits to open the restaurant.
Other Items
EBITDA and Adjusted EBITDA. EBITDA and Adjusted EBITDA are presented in this Annual Report on Form 10-K and are supplemental measures of financial performance that are not required by, or presented in accordance with, accounting principles generally accepted inthe United States of America ("GAAP"). We define EBITDA as net income before interest expense, provision for income taxes and depreciation and amortization. We define Adjusted EBITDA as net income before interest expense, provision for income taxes, depreciation and amortization, non-cash impairment loss, non-cash rent expense, pre-opening expenses, lease termination expenses, non-recurring gains and losses, stock-based compensation and results from discontinued operations. Not all of the aforementioned items defining Adjusted EBITDA occur in each reporting period but have been included in our definitions of these terms based on our historical activity. We believe that EBITDA and Adjusted EBITDA are appropriate measures of our operating performance, because they eliminate non-cash expenses that do not reflect our underlying business performance. We use these metrics to facilitate a comparison of our operating performance on a consistent basis from period to period, to analyze the factors and trends affecting our business and to evaluate the performance of our restaurants. Adjusted EBITDA has limitations as an analytical tool and our calculation of Adjusted EBITDA may not be comparable to that reported by other companies; accordingly, you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Adjusted EBITDA is a key measure used by management. Additionally, Adjusted EBITDA is frequently used by analysts, investors and other interested parties to evaluate companies in our industry. We use Adjusted EBITDA, alongside other GAAP measures such as net income, to measure profitability, as a key profitability target in our budgets, and to compare our performance against that of peer companies despite possible differences in calculation. Please refer to table on page 32 for our reconciliation of net income to EBITDA and Adjusted EBITDA. 29 Table of Contents Results of Operations
The following table sets forth certain statements of operations data for the periods indicated (in thousands):
For the year ended
December 31,
2019 2018
Revenues:
Owned restaurant net revenue $ 108,775 $ 74,033
Management, license and incentive fee revenue 11,906 11,568
Total revenues 120,681 85,601
Cost and expenses:
Owned operating expenses:
Owned restaurant cost of sales 28,005 18,989
Owned restaurant operating expenses 67,883
45,695
Total owned operating expenses 95,888
64,684
General and administrative (including stock-based
compensation of
11,472 11,119
Depreciation and amortization 5,404 2,824
Bargain purchase gain (10,963) -
Loss on impairment of investments 2,684 -
Lease termination expenses 573 213
Pre-opening expenses 565 1,365
Transaction costs 2,513 -
Equity in income of investee companies - (182)
Other income, net (246) (235)
Total costs and expenses 107,890 79,788
Operating income 12,791 5,813
Other expenses, net:
Interest expense, net of interest income 1,954 1,193
Loss on early debt extinguishment 858 -
Total other expenses, net 2,812 1,193
Income before (benefit) provision for income taxes 9,979 4,620
(Benefit) provision for income taxes (11,154) 713
Net income 21,133 3,907
Less: net income attributable to noncontrolling interest 302 633
Net income attributable to The ONE Group
Hospitality, Inc. $ 20,831 $ 3,274
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The following table sets forth certain statements of operations data as a percentage of total revenues for the periods indicated. Certain percentage amounts may not sum to total due to rounding.
For the year ended December 31,
2019 2018
Revenues:
Owned restaurant net revenue 90.1 % 86.5 %
Management, license and incentive fee revenue 9.9 % 13.5 %
Total revenues 100.0 % 100.0 %
Cost and expenses:
Owned operating expenses:
Owned restaurant cost of sales (1) 25.7 % 25.6 %
Owned restaurant operating expenses (1) 62.5 % 61.8 %
Total owned operating expenses (1) 88.2 % 87.4 %
General and administrative (including stock-based
compensation of 1.1% and 1.5% for the years ended
December 31, 2019 and 2018 respectively) 9.5 % 13.0 %
Depreciation and amortization 4.5 % 3.3 %
Bargain purchase gain (9.1)% -%
Loss on impairment of investments 2.2 % -%
Lease termination expenses 0.5 % 0.2 %
Pre-opening expenses 0.5 % 1.6 %
Transaction costs 2.1 % -%
Equity in income of investee companies -% (0.2)%
Other income, net (0.2)% (0.3)%
Total costs and expenses 89.4 % 93.2 %
Operating income 10.6 % 6.8 %
Other expenses, net:
Interest expense, net of interest income 1.6 % 1.4 %
Loss on early debt extinguishment 0.7 % -%
Total other expenses, net 2.3 % 1.4 %
Income before (benefit) provision for income taxes 8.3 % 5.4 %
(Benefit) provision for income taxes (9.2)% 0.8 %
Net income 17.5 % 4.6 %
Less: net income attributable to noncontrolling
interest 0.3 % 0.7 %
Net income attributable to The ONE Group
Hospitality, Inc. 17.3 % 3.8 %
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(1) These expenses are being shown as a percentage of owned restaurant net
revenue.
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The following table presents a reconciliation of net income to EBITDA and Adjusted EBITDA for the periods indicated (in thousands):
For the year ended December 31,
2019 2018
Net income attributable to The ONE Group
Hospitality, Inc. $ 20,831 $ 3,274
Net income attributable to noncontrolling interest 302 633
Net income 21,133 3,907
Interest expense, net of interest income 1,954
1,193
(Benefit) provision for income taxes (11,154) 713 Depreciation and amortization 5,404 2,824 EBITDA 17,337 8,637 Bargain purchase gain (10,963) - Loss on impairment of investments 2,684 - Transaction costs (1) 2,513 - Stock-based compensation 1,306 1,313 Loss on debt extinguishment 858 - Lease termination expense (2) 573 213 Pre-opening expenses 565 1,365 Non-cash rent expense (3) 61 (289) Other nonrecurring charges - 145 Adjusted EBITDA 14,934 11,384 Adjusted EBITDA attributable to noncontrolling interest 646 880 Adjusted EBITDA attributable to The ONE Group Hospitality, Inc.$ 14,288
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(1) Primarily transaction costs incurred with the
subsequent integration activities and internal costs associated with capital
raising activities, most recently the
Goldman Sachs Credit Agreement, and costs associated with the preparation of
the Form S-8.
(2) Lease termination expense are costs associated with closed, abandoned and
disputed locations or leases.
(3) Non-cash rent expense is included in owned restaurant operating expenses and
general and administrative expense on the consolidated statements of income
and comprehensive income.
The following tables show our operating results by segment for the periods indicated (in thousands). Prior year amounts have been revised to conform to the current year segment presentation.
STK Kona Grill ONE Hospitality Corporate Total
For the year ended December
31, 2019
Total revenues $ 82,193 $ 23,741 $ 14,093 $ 654 $ 120,681
Equity in income of investee
companies - - - - -
Operating income 11,624 2,612 7,840 (9,285) 12,791
Capital asset additions $ 3,330 $ 195 $ 40 $ 792 $ 4,357
As of December 31, 2019
Total assets $ 82,691 $ 93,829 $ 8,252 $ 21,813 $ 206,585
STK Kona Grill ONE Hospitality Corporate Total
For the year ended December
31, 2018
Total revenues $ 71,203 $ - $ 14,196 $ 202 $ 85,601
Equity in income of investee
companies - - 182 - 182
Operating income 10,450 - 10,267 (14,904) 5,813
Capital asset additions $ 3,321 $ - $ 31 $ 750 $ 4,102
As of December 31, 2018
Total assets $ 47,363 $ - $ 6,415 $ 2,201 $ 55,979
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Results of Operations for the Years Ended
Revenues Owned restaurant net revenue. Owned restaurant net revenue increased$34.8 million , or 46.9%, to$108.8 million for the year endedDecember 31, 2019 from$74.0 million for the year endedDecember 31, 2018 . Approximately$23.7 million of the increase in total revenue was attributable to the addition of the ownedKona Grill restaurants in the fourth quarter of 2019. The remaining increase was primarily due to increased sales at our existing owned locations and the opening of our owned STK restaurants inSan Diego, California inJuly 2018 andNashville, Tennessee inMarch 2019 . STK SSS increased 8.3% with an average check increase of 3.2% for the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 . To drive revenue, among several strategies, we have emphasized happy-hour and pre-dinner time frames. We have also emphasized group dining and increased efforts in digital marketing. Management, license and incentive fee revenue. Management and license fee revenues increased$0.3 million , or 2.9%, to$11.9 million for the year endedDecember 31, 2019 from$11.6 million for the year endedDecember 31, 2018 . Management and license fee revenues increased related to new STK licensed locations that opened in 2019, including a licensed STK restaurant inDoha, Qatar , a licensed STK restaurant inSan Juan, Puerto Rico and a managed rooftop bar concept, ANGEL, inFlorence, Italy . Additionally, in the second half of 2018, we opened two licensed STK restaurants inMexico City, Mexico andDubai, United Arab Emirates . This was partially offset by the loss of management fee revenue from the One 29Park, LLC management agreement, which terminated onSeptember 30, 2018 , and approximately$0.4 million of accelerated recognition of deferred revenue in the fourth quarter of 2018 related to the termination of a license agreement for our operations in Ibiza,Spain . During the first quarter of 2019, we executed a new license agreement for the STK Ibiza location.
Cost and Expenses
Owned restaurant cost of sales. Food and beverage costs for owned restaurants increased approximately$9.0 million , or 47.5%, to$28.0 million for the year endedDecember 31, 2019 from$19.0 million for the year endedDecember 31, 2018 . Approximately$6.6 million of the increase in owned restaurant cost of sales was attributable to the addition of the ownedKona Grill restaurants in the fourth quarter of 2019. The remaining increase was primarily due to increased sales at our existing owned locations and the opening of our owned STK restaurants inSan Diego, California inJuly 2018 andNashville, Tennessee inMarch 2019 . As a percentage of owned restaurant net revenues, cost of sales increased slightly from 25.6% for the year endedDecember 31, 2018 to 25.7% for the year endedDecember 31, 2019 primarily due to the addition of theKona Grill restaurants which have a slightly lower revenue margin on cost of sales than the STK brand restaurants. This increase was partially offset by the positive impacts of operating initiatives in the STK restaurants including reduction of restaurant-level waste coupled with selective price increases. Food revenues as a percentage of total food and beverage revenues were 66% and 64% for the years endedDecember 31, 2019 and 2018, respectively. Food costs as a percentage of food revenues are typically higher than beverage costs as a percentage of beverage revenues. Owned restaurant operating expenses. Owned restaurant operating expenses increased$22.2 million , or 48.6%, to$67.9 million for the year endedDecember 31, 2019 from$45.7 million for the year endedDecember 31, 2018 . Approximately$14.6 million of the increase in owned restaurant operating expense was attributable to the addition of the ownedKona Grill restaurants in the fourth quarter of 2019. As a percentage of owned restaurant net revenues, owned restaurant operating expenses increased 70 basis points to 62.5% for the year endedDecember 31, 2019 from 61.8% for the year endedDecember 31, 2018 primarily as a result of higher labor costs with the newly acquiredKona Grill restaurants and the openings of two owned STK restaurants inSan Diego, California inJuly 2018 andNashville, Tennessee inMarch 2019 .
General and administrative. General and administrative costs increased
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as a result of the additional overhead related to the Kona Grill acquisition,
however the increase was partially offset by reduced external professional fees
and STK related corporate occupancy costs.
Depreciation and amortization. Depreciation and amortization expense increased
approximately $2.6 million to $5.4 million for the year ended December 31, 2019
from $2.8 million for the year ended December 31, 2018 . The increase was
primarily related to the addition of 24 owned Kona Grill locations in the fourth
quarter of 2019 and the opening of our owned STK restaurants in San Diego,
California in July 2018 and in Nashville, Tennessee in March 2019 .
Bargain purchase gain. On October 4, 2019 , we acquired substantially all of the
assets of Kona Grill for a contractual price of $25.0 million plus approximately
$1.5 million of consideration paid primarily for the apportionment of rent and
utilities. We acquired approximately $37.0 million of net assets, including
$7.7 million in current liabilities, which resulted in a bargain purchase gain
of approximately $11.0 million .
Loss on impairment of investments. On December 31, 2019 , we determined that,
because of the short term remaining on the lease (November 2020 ) and current
market conditions, we are unable to recover the carrying amount of the
investments in Bagatelle Investors and Bagatelle NY. As a result, we recorded a
non-cash write down of $2.7 million related to our cost method investments for
the year ended December 31, 2019 . Refer to Note 10 of our consolidated financial
statements set forth in Item 15 of this Annual Report on Form 10-K for further
information on our nonconsolidated investments
Lease termination expense. Lease termination expenses for the years ending
December 31, 2019 and 2018 were $0.6 million and $0.2 million , respectively.
These costs are associated with closed, abandoned and disputed locations or
leases. The lease termination expenses increased primarily due to settlements
paid to a landlord related to disputed lease terms and the costs to close a New
York, New York corporate office.
Pre-opening expenses. Pre-opening expenses for the years ending December 31,
2019 and 2018 were $0.6 million and $1.4 million , respectively. In 2018,
preopening expenses were primarily related to the development of our restaurant
in San Diego, California , which opened in July 2018 . In 2019, our preopening
expenses related to the development of our STK restaurant in Nashville,
Tennessee , which opened in March 2019 .
Transaction costs. In the year ended December 31, 2019 , we incurred transaction
costs of approximately $2.5 million . These costs were primarily related to the
Kona Grill acquisition, which closed on October 4, 2019 , and the internal costs
associated with entering into the Goldman Sachs Credit Agreement, the proceeds
of which were used to finance the Kona Grill acquisition. Additionally, the
transaction costs include internal costs associated to entering into the Bank of
America Credit Agreement on May 15, 2019 and costs to register shares on Form
S-8 in conjunction with shareholder approved changes to our employee equity
compensation plan. Refer to Note 3 and Note 8 to our consolidated financial
statements set forth in Item 15 of this Annual Report on Form 10-K for
additional details regarding the Kona Grill acquisition and our debt financings.
Equity in income of investee companies. Equity in income of investee companies
was approximately $0.2 million for the year ended December 31, 2018 . We did not
recognize any equity in income of investee companies for the year ended
December 31, 2019 . Refer to Note 10 of our consolidated financial statements set
forth in Item 15 of this Annual Report on Form 10-K for further information on
our nonconsolidated investments.
Interest expense, net of interest income. Interest expense, net of interest
income was approximately
Loss on early debt extinguishment. OnMay 15, 2019 , we entered into a credit agreement withBank of America, N.A . ("Bank of America Credit Agreement ") and incurred approximately$0.4 million of debt issuance costs. In conjunction with entering into theBank of America Credit Agreement , we prepaid the outstanding debt balances to early extinguish the$2.6 million of outstanding term loans with BankUnited, the$5.3 million of outstanding promissory notes withAnson Investments Master Fund LP , and the$1.0 million outstanding promissory note with 2235570Ontario Limited . As a result, we recognized a$0.4 million loss on early debt extinguishment primarily caused by the recognition of the unamortized discounts related to warrants issued with the promissory notes and the recognition of unamortized 34
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debt issuance costs related to the debt extinguished.The Bank of America Credit Agreement was replaced with the Goldman Sachs Credit Agreement onOctober 4, 2019 in conjunction with theKona Grill acquisition. As a result, the unamortized debt issuance costs of$0.4 million was recognized as a loss on early debt extinguishment. (Benefit) provision for income taxes. The benefit for income taxes for the year endedDecember 31, 2019 was$11.2 million compared to income tax expense of$0.7 million for the year endedDecember 31, 2018 . Our effective tax rate was (111.8%) and 15.4% for years endedDecember 31, 2019 and 2018, respectively. Our effective tax rate differs from the statutoryU.S. tax rate of 21% primarily due to the following: (i) a full valuation allowance of$10.8 million on theU.S. deferred tax assets, net, of which$10.3 million was reversed in 2019; (ii) taxes owed in foreign jurisdictions such as theUnited Kingdom ,Canada andItaly ; and, (iii) taxes owed in state and local jurisdictions. Net income attributable to noncontrolling interest. Net income attributable to noncontrolling interest decreased by$0.3 million to$0.3 million for the year endedDecember 31, 2019 compared to$0.6 million for the year endedDecember 31, 2018 .
Liquidity and Capital Resources
Our principal liquidity requirements are to meet our lease obligations, our working capital and capital expenditure needs and to pay principal and interest on our outstanding indebtedness. Subject to our operating performance, which, if significantly adversely affected, would adversely affect the availability of funds, we expect to finance our operations for at least the next 12 months, including costs of opening currently planned new restaurants, through cash provided by operations, borrowings on our Goldman Sachs Credit Agreement and construction allowances provided by landlords of certain locations. We believe the combination of our cash provided by operations and our Goldman Sachs Credit Agreement are adequate to support our immediate business operations and plans. As ofDecember 31, 2019 , we had cash and cash equivalents of approximately$12.3 million and long-term debt of$48.3 million , which consisted of our Goldman Sachs Credit Agreement and equipment financing agreements. In 2019, we made principal payments of approximately$28.5 million towards our long-term debt, which included$22.5 million of early debt extinguishment payments. In the year endedDecember 31, 2019 , our capital expenditures, net of approximately$0.5 million of landlord incentives which were primarily used to fund capital expenditures for the construction of new, owned restaurants, was$3.9 million . Our future cash requirements will depend on many factors, including the pace of our expansion, conditions in the retail property development market, construction costs, the nature of the specific sites selected for new restaurants, and the nature of the specific leases and associated tenant improvement allowances available, if any, as negotiated with landlords. Additionally, under our current capital light strategy, we plan to enter into management and license agreements for the operation of STK restaurants where we are not required to contribute significant capital upfront. Our operations have not required significant working capital, and, like many restaurant companies, we have negative working capital. Revenues are received primarily in credit card or cash receipts, and restaurant operations do not require significant receivables or inventories, other than our wine inventory. In addition, we receive trade credit for the purchase of food, beverages and supplies, thereby reducing the need for incremental working capital to support growth. Negative Effects of COVID-19 The negative effect on our business from the COVID-19 is significant. We experienced an initial decline in restaurant revenue that began in earlyMarch 2020 as travel began to decrease. Public anxiety with respect to COVID-19, and government recommendations and measures to avoid public gatherings especially within restaurants and bars, will materially and adversely affect our operations and financial results. We expect that we will not be able to return to normal operations for weeks or months, and we expect that our results of operations to be materially and negatively affected by these actions in the first and second quarters of 2020. We have implemented measures to reduce our costs during the COVID-19 period, including significant reductions in employees, deferral of capital projects, and we expect to return to more normal operations late in the second quarter of 35
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2020 or early in the third quarter of 2020. Our resumption of normal operations is subject to events beyond our control, including the effectiveness of governmental efforts to halt the spread of COVID-19.
Goldman Sachs Credit Agreement
OnOctober 4, 2019 , in conjunction with the acquisition ofKona Grill , we entered into the Goldman Sachs Credit Agreement, which replaced theBank of America Credit Agreement and provides for a secured revolving credit facility of$12.0 million and a$48.0 million term loan. The term loan is payable in quarterly installments, with the final payment due inOctober 2024 . The revolving credit facility also matures inOctober 2024 . Additionally, our consolidated adjusted EBITDA as defined by the Goldman Sachs Credit Agreement for determining covenant compliance includes pro forma adjustments for the annualization of theKona Grill restaurant performance which includes results before the acquisition date.
The Goldman Sachs Credit Agreement contains several financial covenants, including the following:
· A minimum consolidated fixed charge coverage ratio of (i) 1.35 to 1.00 as of
the end of any fiscal quarter ending on or prior to
to 1.00 as of any fiscal quarter thereafter;
· A maximum consolidated leverage ratio of (i) 2.75 to 1.00 as of the end of any
fiscal quarter ending on or prior to
the fiscal quarter ending
quarters ending
of the fiscal quarter ending
quarter ending
21, 2021 and (viii) 1.50 to 1.00 as of the end of any fiscal quarter
thereafter. For purposes of calculating this ratio for the first four quarters,
the agreement provides for a pro forma adjustment to reflect one full year of
· Maximum consolidated capital expenditures not to exceed (i)
and (ii)
· Minimum consolidated liquidity not to be less than
Our ability to borrow under our revolving credit facility is dependent on several factors. Our total borrowings cannot exceed a leverage incurrence multiple of (i) 2.50 to 1.00 as of the end of any fiscal quarters ending on or prior toJune 30, 2020 , (ii) 2.25 to 1.00 as of the fiscal quarters endingSeptember 30, 2020 andDecember 31, 2020 , (iii) 2.00 to 1.00 as of the fiscal quarter endingMarch 31, 2021 (iv) 1.75 to 1.00 as of the fiscal quarter endingJune 30, 2021 , (v) 1.70 to 1.00 as of the fiscal quarter endingSeptember 30, 2021 , (vi) 1.65 to 1.00 as of the fiscal quarter endingDecember 31, 2021 , and (vii) 1.50 to 1.00 as of the end of any fiscal quarter thereafter. In addition, after giving effect to borrowings under the revolving credit facility, our cash and cash equivalents cannot exceed$4,000,000 . The Goldman Sachs Credit Agreement has several borrowing and interest rate options, including the following: (a) a LIBOR rate (or a comparable successor rate) subject to a 1.75% floor or (b) a base rate equal to the greatest of (i) the prime rate, (ii) the federal funds rate plus 0.50%, (iii) the LIBOR rate for a one-month period plus 1.00% or (iv) 4.75%. Loans under the Goldman Sachs Credit Agreement bear interest at a rate per annum using the applicable indices plus a varying interest rate margin of between 5.75% and 6.75% (for LIBOR rate loans) and 4.75% and 5.75% (for base rate loans). The Goldman Sachs Credit Agreement contains customary representations, warranties and conditions to borrowing including customary affirmative and negative covenants, which include covenants that limit or restrict the Company's ability to incur indebtedness and other obligations, grant liens to secure obligations, make investments, merge or consolidate, alter the organizational structure of the Company and its subsidiaries, and dispose of assets outside the ordinary course of business, in each case subject to customary exceptions for credit facilities of this size and type. As ofDecember 31, 2019 , we were in compliance with the covenants required by the Goldman Sachs Credit Agreement. Based on current projections, we believe that we would continue to comply with the covenants in the Goldman Sachs Credit Agreement throughout the twelve months following the issuance of the financial statements. 36 Table of Contents See contractual obligations below and Note 8 and Note 20 to our consolidated financial statements set forth in Item 15 of this Annual Report on Form 10K for further information on our long-term debt and commitments and contingencies. Debt Extinguishments OnMay 15, 2019 , we entered into theBank of America Credit Agreement , which was subsequently replaced with the Goldman Sachs Credit Agreement described above onOctober 4, 2019 .The Bank of America Credit Agreement provided for a secured revolving credit facility of$10.0 million and a$10.0 million term loan. The term loan was payable in quarterly installments, with the final payment due inMay 2024 . The revolving credit facility also matured inMay 2024 . In conjunction with entering into theBank of America Credit Agreement , we incurred$0.4 million of debt issuance costs. OnOctober 4, 2019 , the unamortized debt issuance costs of$0.4 million was recognized as a loss on early debt extinguishment. In conjunction with entering into theBank of America Credit Agreement onMay 15, 2019 , we prepaid the outstanding debt balances to early extinguish the$2.6 million of outstanding term loans with BankUnited, the$5.3 million of outstanding promissory notes withAnson Investments Master Fund LP , and the$1.0 million outstanding promissory note with 2235570Ontario Limited . We recognized a$0.4 million loss on early debt extinguishment primarily caused by the recognition of the unamortized discounts related to warrants issued with the promissory notes and the recognition of unamortized debt issuance costs related to the debt extinguished. Additionally, we prepaid the$1.2 million of outstanding cash advances due to theTOG Liquidation Trust , a related party.
Capital Expenditures and Lease Arrangements
To the extent we open new company-owned restaurants, we anticipate capital expenditures would increase related to the construction of new restaurants as compared to general capital expenditures of existing restaurants. Although we are committed to our capital light strategy, in which our capital investment is expected to be limited, we are willing to consider opening owned restaurants as opportunities arise. For owned restaurants, we have typically targeted an average cash investment of approximately$3.8 million for a 10,000 square-foot STK restaurant, net of landlord contributions and equipment financing and excluding pre-opening costs. In addition, some of our existing restaurants will require capital improvements to either maintain or improve the facilities. We may add seating or provide enclosures for outdoor space in the next twelve months for some of our locations. Our hospitality F&B services projects typically require limited capital investment from us. Capital expenditures for these projects will primarily be funded by cash flows from operations and equipment financing, depending upon the timing of these expenditures and cash availability. We typically seek to lease our restaurant locations for periods of 10 to 20 years under operating lease arrangements, with a limited number of renewal options. Our rent structure varies, but our leases generally provide for the payment of both minimum and contingent rent based on sales, as well as other expenses related to the leases such as our pro-rata share of common area maintenance, property tax and insurance expenses. Many of our lease arrangements include the opportunity to secure tenant improvement allowances to partially offset the cost of developing and opening the related restaurants. Generally, landlords recover the cost of such allowances from increased minimum rents. However, there can be no assurance that such allowances will be available to us on each project that we select for development. 37 Table of Contents Cash Flows
The following table summarizes the statement of cash flows for the fiscal years
ended
For the year ended December 31,
2019 2018Net cash provided by (used in):
Operating activities $ 8,360 $ 6,444 Investing activities (30,397) (3,462) Financing activities 33,121 (2,184) Effect of exchange rate changes on cash (332)
(754)
Net increase in cash and cash equivalents $ 10,752 $
44
Operating Activities. Net cash provided by operating activities was $8.4 million
for the year ended December 31, 2019 compared to $6.4 million for the year ended
December 31, 2018 . The increase was primarily attributable to the increase in
net income and improvements to the changes within our working capital accounts.
This was partially offset by the non-cash impacts of the $11.0 million bargain
purchase gain and the $10.3 million release of the valuation allowance within
deferred taxes.
Investing Activities. Net cash used in investing activities for the year ended
December 31, 2019 was $30.4 million compared to $3.5 million for the year ended
December 31, 2018 . Approximately $26.0 million of the increase in net cash used
in investing activities related to Kona Grill acquisition related payments, net
of cash acquired. The remaining net cash used in investing activities in 2019
and in 2018 was primarily related to the construction of new restaurants and
general capital expenditures of existing restaurants, partially offset by the
receipt of proceeds related to the sale of our interest in One 29 Park, a
restaurant and rooftop bar located in a New York City hotel, which occurred in
the first quarter of 2018.
Financing Activities. Net cash provided by financing activities was
$33.1 million for the year ended December 31, 2019 as compared to net cash used
in financing activities of $2.2 million for the year ended December 31, 2018 . In
2019, we received proceeds from our Goldman Sachs Credit Agreement and Bank of
America Credit Agreement of $50.0 million and $14.8 million , respectively, and
we made principal payments of approximately $28.5 million towards our long-term
debt, which included $22.5 million of early debt extinguishment payments.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.
Contractual Obligations
The following table summarizes our contractual obligations as ofDecember 31, 2019 (in thousands): Less than 1 More than 5 Total year 1 - 3 years 3 - 5 years years Long-term debt obligations$ 48,260 $ 749$ 1,071 $ 46,440 $ - Expected interest payments (1) 19,920 4,282 8,391 7,247 - Standby letters of credit 394 83 165 146 - Operating leases 180,869 12,980 25,900 25,844 116,145 Total$ 249,443 $ 18,097 $ 35,524 $ 79,677 $ 116,145
--------------------------------------------------------------------------------
(1) Represents estimated future cash interest payments based on borrowings
outstanding as of December 31, 2019 at the expected interest rate over the
period outstanding.
38
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Recent Accounting Pronouncements
Refer to Note 2 of our consolidated financial statements set forth in Item 15 of this Annual Report on Form 10K for a detailed description of recent accounting pronouncements. With the exception of the adoption of Accounting Standard Codification Topic 842, Leases, the adopted accounting guidance discussed in Note 2 did not have a significant impact on our consolidated financial position or results of operations. Refer to Note 14 of our consolidated financial statements set forth in Item 15 of this Annual Report on Form 10K for a detailed description of the impact of the adoption of the new leases accounting standard.
Critical Accounting Policies and Estimates
Our discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of our assets, liabilities, net sales and operating expenses and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and various assumptions that we believe to be reasonable under the circumstances and we evaluate these estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies require us to make difficult, subjective or complex judgements that could have a material impact on our financial statements.
Our significant accounting policies are discussed in Note 2 to our consolidated financial statements set forth in Item 15 of this Annual Report on Form 10K.
Business Combinations
OnOctober 4, 2019 , we acquired substantially all the assets ofKona Grill , which was accounted for using the acquisition method of accounting prescribed by Accounting Standard Codification Topic 805, Business Combinations. Acquired assets and assumed liabilities were assigned fair values based on widely accepted valuation techniques, in accordance with Accounting Standard Codification Topic 820, Fair Value Measurements. The process for estimating fair values in many cases requires the use of significant estimates, assumptions and judgments, including determining the timing and estimates of future cash flows and developing appropriate discount rates. Unanticipated events or circumstances may occur which could affect the accuracy of our fair value estimates, including assumptions regarding industry economic factors and business strategies. We expect to finalize the purchase price allocation as soon as practicable within the measurement period, but not later than one year following the acquisition date. Income Taxes We recognized deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the respective tax bases of our assets and liabilities. Deferred tax assets and liabilities are measured using current enacted rates expected to apply to taxable income in the years in which we expect the temporary differences to reverse. We routinely evaluate the likelihood of realizing the benefit of our deferred tax assets and may record a valuation allowance if, based on all available evidence, we determine that some portion of the tax benefit will not be realized. In addition, our income tax returns are periodically audited by federal, state and foreign tax authorities. These audits include questions regarding our tax filing positions, including the timing and amount of deductions taken and the allocation of income amongst various tax jurisdictions. We evaluate our exposures associated with our various tax filing positions and record a related liability. We adjust our liability for unrecognized tax benefits and income tax provision in the period in which an uncertain tax provision is effectively settled, the statute of limitations expires for the relevant taxing authority to examine the tax position or when more information becomes available. As ofDecember 31, 2019 , we released approximately$10.3 million of the valuation allowance based on an assessment of the realizability of our deferred tax assets. The remaining valuation allowance of$0.5 million relates to foreign tax credits we do not expect to utilize as a result of generating income in a jurisdiction with a higher income tax 39
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rate than the
Our 2019 taxes were impacted by the enactment of the Tax Cuts and Job Act in
Impairment of Long-Lived Assets and Disposal of Property and Equipment
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be fully recoverable. The impairment evaluation is generally performed at the individual venue asset group level, as we believe this is the lowest level of identifiable cash flows. We believe that historical cash flows, in addition to other relevant facts and circumstances, are the primary basis for estimating future cash flows. Relevant facts and circumstances include, among others, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for the overall business, and significant negative industry or economic trends. Recoverability of restaurant assets is measured by a comparison of the carrying amount of an individual restaurant's assets to the estimated identifiable undiscounted future cash flows expected to be generated by those restaurant assets. This process requires the use of estimates and assumptions, which are subject to a high degree of judgment. If the carrying amount of an individual restaurant's assets exceeds its estimated, identifiable, undiscounted future cash flows, an impairment charge is recognized as the amount by which the carrying amount of the asset exceeds its fair value. Fair value is determined by discounting a restaurant's identifiable future cash flows. From time to time, we have decided to close or dispose of restaurants. Typically, such decisions are made based on operating performance or strategic considerations and must be made before the actual costs or proceeds of disposition are known, and management must make estimates of these outcomes. Such outcomes could include the sale of a leasehold, mitigating costs through a tenant or subtenant, or negotiating a buyout of a remaining lease term. In these instances, management evaluates possible outcomes, frequently using outside real estate and legal advice, and records provisions for the effect of such outcomes. The accuracy of such provisions can vary materially from original estimates, and management regularly monitors the adequacy of the provisions until final disposition occurs.
For the years ended
Leases
Contracts are evaluated to determine whether they contain a lease at inception,
and leases are classified as either operating or financing. For operating
leases, we have recognized a lease liability equal to the present value of the
remaining lease payments, and a right of use asset equal to the lease liability,
subject to certain adjustments, such as prepaid rents, initial direct costs and
lease incentives received from the lessor. For leases that do not have a rate
implicit in the lease, we used our incremental borrowing rate to determine the
present value of the lease payments. Our incremental borrowing rate is the rate
of interest that we would have to borrow on a collateralized basis over a
similar term on an amount equal to the lease payments in a similar economic
environment.
The lease term at the lease commencement date is determined based on the
non-cancellable period for which we have the right to use the underlying asset,
together with any periods covered by an option to extend the lease if we are
reasonably certain to exercise that option, periods covered by an option to
terminate the lease if we are reasonably certain not to exercise that option,
and periods covered by an option to extend (or not to terminate) the lease in
which the exercise of the option is controlled by the lessor.
Certain of our leases also provide for percentage rent, which are variable lease
costs determined as a percentage of gross sales in excess of specified, minimum
sales targets. These percentage rents are recognized as rent expense prior to
the achievement of the specified sales target provided achievement of the sales
target is considered probable.
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We currently lease all of our restaurant locations under leases classified as operating leases. Management makes judgments regarding the probable term for each lease and considers a number of factors to evaluate whether renewal options in the lease contracts are reasonably certain of exercise, such as length of time before option exercise, expected value of the leased asset at the end of the initial lease term, importance of the lease to overall operations, costs to negotiate a new lease, and any contractual or economic penalties. The lease term can impact the lease classification and accounting for a lease as either an operating or financing lease, the incremental borrowing, the rent holidays and/or escalations in payments that are taken into consideration when calculating the rent expense and the related lease liability and right-of-use asset, and the term over which leasehold improvements for each restaurant are depreciated. These judgments may produce materially different amounts of depreciation, amortization and rent expense and materially different lease liabilities and right-of-use assets than would be reported if different assumed lease terms were used. Stock-Based Compensation We used the Black-Scholes model to estimate the fair value of our option awards. The Black-Scholes model requires estimates of the expected term of the option, the risk-free interest rate, future volatility and dividend yield. The Company's assumptions are as follows:
· Expected Term. The expected term of options is based upon evaluations of
historical and expected future exercise behavior with consideration of both the
vesting period and contractual terms of the instruments.
· Risk Free Interest Rate. The risk-free interest rate is based on
rates at the date of grant with maturity dates approximately equal to the
expected term at the grant date.
· Implied Volatility. Implied volatility is based upon an average of the
volatilities of an industry peer group who are publicly traded.
· Dividend Yield. The Company has historically not paid dividends and does not
plan to do so in the foreseeable future.
There is a risk that our estimates of the fair values of our share-based compensation awards on the grant dates may differ from the actual values realized upon the exercise, expiration, early termination or forfeiture of those share-based payments in the future. Certain share-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that are significantly in excess of the fair values originally estimated on the grant date and reported in our financial statements. Although the fair value of our share-based awards is determined in accordance with GAAP, the value calculated may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.
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