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IRG > SEC Filings for IRG > Form 10-Q on 30-Oct-2012All Recent SEC Filings

Show all filings for IGNITE RESTAURANT GROUP, INC.

Form 10-Q for IGNITE RESTAURANT GROUP, INC.


30-Oct-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.

You should read the following discussion together with "Selected Historical Consolidated Financial and Operating Data" and the historical financial statements and related notes included in our Current Report on Form 8-K dated October 30, 2012. The statements in this discussion regarding industry outlook, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in "Risk Factors" and "Forward-Looking Statements." Our actual results may differ materially from those contained in or implied by any forward-looking statements.

Our fiscal year ends on the Monday nearest to December 31 of each year. Fiscal years 2012 and 2011 are 52-week years. The first three quarters of our fiscal year consist of 12 weeks and our fourth quarter consists of 16 weeks for 52-week fiscal years and 17 weeks for 53-week fiscal years.

Overview

Ignite Restaurant Group, Inc. operates two restaurant businesses, Joe's Crab Shack and Brick House Tavern + Tap. Each of our restaurant businesses offers a variety of high-quality food in a distinctive, casual, high-energy atmosphere. Joe's Crab Shack and Brick House Tavern + Tap operate in a diverse set of markets across the United States. As of September 10, 2012, we owned and operated 129 Joe's Crab Shack and 16 Brick House restaurants in 33 states.

Joe's Crab Shack is an established, national chain of casual seafood restaurants. Joe's serves a variety of high-quality seafood items, with an emphasis on crab. Joe's is a high-energy, family-friendly restaurant that encourages guests to "roll up your sleeves and crack into some crab."

Brick House Tavern + Tap is a casual restaurant business that provides guests a differentiated "gastro pub" experience by offering a distinctive blend of menu items in a polished setting. Brick House seeks to strike a balance between providing guests with an elevated experience while also appealing to "every-man, every-day."

Restatement

We have completed our previously reported internal assessment of our lease accounting policies and a review of our historical accounting for fixed assets and related depreciation and certain other accounting areas. Accordingly, we have restated our previously issued financial statements for the twelve and thirty-six week periods ended September 12, 2011.

Lease Accounting

When accounting for leases that included stated fixed rent increases, we historically recognized rent expense on a straight line basis over the current lease term with the term primarily commencing when actual rent payments began. Additionally, we did not record straight line rent on leases which contained CPI adjustments that also were subject to stated minimum rent increases. Following an internal assessment, we deemed it necessary to correct errors related to its accounting treatment of certain leases. We have corrected the treatment of these leases to recognize rent expense on a straight line basis over the effective lease term, including cancelable option periods where failure to exercise the options would result in an economic penalty. The effective lease term commences on the date when we establish effective control over the property. Furthermore, we now calculate straight line rent on properties with CPI adjustments that are subject to a stated minimum required rent increase. The changes to the


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recognition of rent expense are timing in nature and do not change the total cash payments or aggregate rent expense over the effective life of the lease term. The total amount of the increases to historical rent expense will be offset by the same aggregate amount of the adjustments in the form of lower rent expense in the future years of the effective lives of the impacted leases.

The lease accounting errors date back to 2006, the year of our origination. The non-cash charges impact deferred rent expense, which is primarily included in occupancy expenses, and pre-opening expense (the deferred rent portion only). The lease accounting related restatement items reduced income before income taxes by $327 thousand for the twelve weeks ended September 12, 2011, and $868 thousand for the thirty-six weeks ended September 12, 2011. The increases in rent expense and preopening expense resulted in a corresponding increase in deferred rent liability.

The lease accounting related restatement items do not impact our historical cash flows, revenues or comparable restaurant sales. Additionally, these lease accounting restatement items do not impact historical restaurant-level profit or Adjusted EBITDA.

Fixed Asset Review

Also as a follow-up to the lease accounting review, we undertook a detailed review of our historical accounting for fixed assets and related depreciation expense, including a review of fixed asset additions from our inception, a restaurant-level inventory of fixed assets at all 144 restaurant locations at the time of the review, a detailed roll-forward of fixed assets to identify appropriate disposals, a reassessment of useful lives for all assets and the recalculation of depreciation as necessary. As a result, we deemed it necessary to correct our accounting related to fixed asset capitalization, useful lives and disposals, including demolition expenses in certain locations unrelated to new store development.

Capitalization. During the review we identified that we had incorrectly capitalized certain asset additions rather than expensing them as repairs and maintenance. Through an extensive review and reassessment of fixed asset additions, we have identified items that were incorrectly capitalized and expensed them as repairs and maintenance to the appropriate period and corrected the associated asset balance, historical depreciation expense and accumulated depreciation.

Lease lives. Additionally, during the review of asset additions and the initial work performed around the proper determination of effective lease lives, we identified that we had not consistently considered the impact of the economic life or the effective lease term on the depreciable life of certain assets. As a result, we reassessed the depreciable lives of our assets, made changes where necessary and recalculated depreciation accordingly.

Disposals. Finally, during the course of the fixed asset review, we concluded that we had not appropriately recognized loss on disposal for the undepreciated balance of assets that had been disposed or for existing store demolition costs not related to new store development, including remodels or catastrophic loss. We also determined that we had not removed certain assets and the related accumulated depreciation from the balance sheet upon disposal. Through an extensive asset roll-forward process, we identified the items that were retired through replacement, sale, or demolition, recognized the loss on disposal in the appropriate period and corrected the associated asset balance, historical depreciation expense and accumulated depreciation.

The fixed asset accounting related restatement items include increases in the loss on disposal of assets and other operating expenses and reductions in depreciation expense on our statements of operations and reductions of property and equipment, net and accumulated depreciation on our balance sheet. The fixed asset accounting restatement adjustments reduced income before income taxes by $244 thousand for the


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twelve weeks ended September 12, 2011 and $836 thousand for the thirty-six weeks ended September 10, 2011.

Other Items

In conjunction with the lease accounting and fixed asset accounting review, we undertook a broader review of our existing accounting policies and concluded it was necessary to make additional adjustments to our historical financial statements.

Sale-leaseback. During the course of the fixed asset review, we determined that we incorrectly accounted for certain deferred costs associated with a sale-leaseback transaction in 2008. The correction resulted in a $9 thousand reduction to amortization expense for the twelve weeks ended September 12, 2011 and $27 thousand for the thirty-six weeks ended September 12, 2011.

Advertising production costs. We incorrectly recognized production costs related to television commercials in 2011 and 2012 over the time the commercials had run as opposed to expensing them when the commercials first aired. The correction to reflect this change resulted in a decrease in advertising expense of $32 thousand for the twelve weeks ended September 12, 2011 and an increase of $191 thousand for the thirty-six weeks ended September 12, 2011, but will have no effect on total expenses for the full year in 2011 or 2012. Going forward, our policy is to expense advertising media costs as incurred, while production costs will be expensed in the period the advertising first takes place.

Vacation accrual. We determined that we had not appropriately recognized an accrual for earned but unpaid vacation in 2011. The correction to reflect this change resulted in a $169 thousand and $567 thousand increase in labor and benefits and general and administrative expense for the twelve and thirty-six weeks ended September 12, 2011, but had no effect on income tax benefit for the full year.

Liquor licenses. Historically we have capitalized the purchase of transferable liquor licenses for certain restaurant properties and shown the use of cash as a component of operating activities in the consolidated statement of cash flows. During the accounting review we determined that this would more appropriately be classified as a use of cash from investing activities. This amounted to an increase in net cash provided by operating activities of $21 thousand for the twelve and thirty-six weeks ended September 12, 2011, with a corresponding increase in net cash used in investing activities for the same period. This reclassification has no impact on the consolidated balance sheet or the consolidated statement of operations.

Professional fees. As previously reported, we also adjusted $175 thousand of general and administrative expense from the twelve weeks ended March 26, 2012 into 2011, of which $74 thousand was for the twelve weeks ended September 12, 2011 and $164 thousand for the thirty-six weeks ended September 12, 2011. The error correction relates to professional fees for quarterly reviews completed by our independent registered public accounting firm in 2011 that were previously recorded in the first quarter of 2012.

Income tax provision. We identified errors in our accounting for uncertain tax positions which dated back to the beginning of fiscal year 2009. We performed a comprehensive recalculation of our uncertain tax positions to ensure that the appropriate amounts were recognized in each period. This correction resulted in an increase in income tax expense and other long-term liabilities of $88 thousand and $235 thousand for the twelve and thirty-six weeks ended September 12, 2011, respectively. We also identified errors in the accounting related to the changes in the valuation allowance recorded on our net deferred tax assets during the fiscal quarters of 2011. Prior to the fourth quarter of 2011, we maintained a full valuation allowance. We did not appropriately account for changes to the valuation allowance in quarterly periods prior to that time. The correction in the accounting for the valuation allowance resulted


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in a $1.3 million and $2.4 million decrease to income tax expense and a corresponding increase in deferred tax assets for the twelve and thirty-six weeks ended September 12, 2011, but had no effect on income tax benefit for the full year.

Income tax effect of restatement adjustments. The restatement adjustments were analyzed to determine which amounts had a corresponding impact on our income tax expense and the result is reflected as the income tax effect of restatement adjustments.

The adjustments do not impact our revenues, comparable restaurant sales or free cash flows. The impacts of these restatements on our Statements of Operations, Adjusted EBITDA and restaurant-level profit are summarized below (in thousands, except per share amounts):


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                                                Twelve Weeks      Thirty-Six
                                                   Ended         Weeks Ended
                                               September 12,    September 12,
                                                    2011             2011
Income from operations
As reported                                    $       11,494   $       23,210
Adjustments:
Depreciation expense                                        5               17
Repairs and maintenance expense                          (161 )           (497 )
Loss on disposal of property and equipment                (88 )           (356 )
Deferred rent                                            (327 )           (868 )
Vacation accrual                                         (169 )           (567 )
Other                                                     (33 )           (328 )
Net adjustment to income from operations                 (773 )         (2,599 )
As restated                                    $       10,721   $       20,611

Net income
As reported                                    $        7,521   $       12,654
Adjustments:
Net adjustment to income from operations                 (773 )         (2,599 )
Income tax effect of restatement adjustments              236              793
Income tax error adjustments                            1,248            2,222
Net adjustment to net income                              711              416
As restated                                    $        8,232   $       13,070

Net income per share
As reported                                    $         0.39   $         0.66
Adjustments                                              0.04             0.02
As restated                                    $         0.43   $         0.68

Adjusted EBITDA (1)
As reported                                    $       17,063   $       39,148
Adjustments:
Repairs and maintenance expense                          (161 )           (497 )
Non-development demolition costs                           (7 )            (26 )
Vacation accrual                                         (169 )           (567 )
Other                                                     (42 )           (355 )
Net adjustment to Adjusted EBITDA                        (379 )         (1,445 )
As restated                                    $       16,684   $       37,703

Restaurant-level profit (2)
As reported                                    $       21,632   $       53,491
Adjustments:
Repairs and maintenance expense                          (140 )           (471 )
Other                                                     (91 )           (596 )
Net adjustment to restaurant-level profit                (231 )         (1,067 )
As restated                                    $       21,401   $       52,424


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(1) Adjusted EBITDA is a non-GAAP financial measure. See "Results of Operations" for a discussion of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income.

(2) Restaurant-level profit is a non-GAAP financial measure. See "Results of Operations" for a discussion of restaurant-level profit and a reconciliation of restaurant-level profit to revenues.

Outlook

We believe that a significant portion of the casual dining industry, particularly the traditional bar & grill segment, has become undifferentiated and the competitive landscape presents a significant growth opportunity for distinctive casual dining restaurants. Similar to the way the bar & grill segment emerged as an alternative to traditional family dining restaurants in the 1990s, we believe that distinctive casual dining restaurants like ours are now positioned to capture market share from conventional bar & grill restaurants. We intend to continue to position our restaurants to capitalize on that trend by constantly refining our brands, elevating food and service, and offering an aspirational experience to our guests. We expect that the casual dining segment will follow broader macroeconomic trends. However, we expect the factors above will continue to position our restaurant businesses favorably against our casual dining competitors.

The financial results provided herein partially reflect the fact that we had been a private company until our initial public offering in May 2012, and as such had not incurred costs typically found in publicly traded companies. We expect that those costs will increase our general and administrative expenses annually similar to other public companies now that we have completed our initial public offering.

Results of Operations

The following table presents the consolidated statement of operations for the twelve and thirty-six weeks ended September 10, 2012 and September 12, 2011 expressed as a percentage of revenues.


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                                          Twelve Weeks Ended              Thirty-Six Weeks Ended
                                    September 10,    September 12,    September 10,    September 12,
                                        2012             2011             2012             2011
                                                     (As restated)                     (As restated)

Revenues                                    100.0 %          100.0 %          100.0 %          100.0 %
Costs and expenses
Restaurant operating costs
Cost of sales                                31.3             31.8             31.3             31.5
Labor and benefits                           25.9             25.6             26.5             26.9
Occupancy expenses                            6.3              6.8              6.7              7.1
Other operating expenses                     17.0             17.2             17.1             17.6
General and administrative                    5.7              4.6              6.1              5.4
Depreciation and amortization                 3.4              3.4              3.6              3.5
Pre-opening costs                             0.4              1.1              1.0              1.1
Restaurant impairments and
closures                                      0.0              0.0              0.0              0.0
Loss on disposal of property and
equipment                                     0.1              0.1              0.1              0.1
Total costs and expenses                     90.2             90.5             92.4             93.2
Income from operations                        9.8              9.5              7.6              6.8
Interest expense, net                        (1.0 )           (1.7 )           (1.7 )           (2.1 )
Gain on insurance settlements                   -              0.0              0.1              0.0
Income before income taxes                    8.8              7.7              5.9              4.6
Income tax expense                            1.9              0.5              1.3              0.3
Net income                                    6.9 %            7.3 %            4.6 %            4.3 %



* The percentages reflected have been subject to rounding adjustments. Accordingly, figures expressed as percentages when aggregated may not be the arithmetic aggregation of the percentages that precede them.

The following table sets forth additional operating information that we use in assessing our performance as of the periods indicated:


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                                            Twelve Weeks Ended                  Thirty-Six Weeks Ended
                                     September 10,      September 12,      September 10,      September 12,
                                         2012               2011               2012               2011

Selected Other Data (1):
Number of restaurants open (end
of period):
Joe's Crab Shack                                129                118                129                118
Brick House Tavern + Tap                         16                 17                 16                 17
Total restaurants                               145                135                145                135
Average weekly sales (in
thousands)                          $            75    $            70    $            70    $            65
Restaurant operating weeks                    1,727              1,607              5,048              4,709
Restaurant-level profit margin
(2)                                            19.7 %             18.9 %             18.7 %             17.3 %
Adjusted EBITDA (in thousands)
(3)                                 $        18,334    $        16,684    $        46,969    $        37,703
Comparable Restaurant Data (1):
Comparable restaurant base (end
of period)                                      122                113                122                113
Average unit volume (in
thousands)                          $           834    $           831    $         2,344    $         2,277
Change in comparable restaurant
sales                                           0.4 %              5.5 %              2.7 %              6.8 %
Average check (Joe's only)          $         23.94    $         22.99    $         23.81    $         23.03



(1) Includes both restaurant brands, unless otherwise noted.

(2) Restaurant-level profit represents revenues (x) less (i) licensing revenue not attributable to core restaurant operations, (ii) cost of sales,
(iii) labor and benefits, (iv) occupancy expenses, and (v) other operating expenses (y) plus non-cash rent. Restaurant-level profit margin is calculated as restaurant-level profit divided by restaurant sales. Restaurant-level profit and restaurant-level profit margin are a supplemental measure of operating performance of our restaurants that do not represent and should not be considered as an alternative to net income or revenues as determined by U.S. generally accepted accounting principles, or U.S. GAAP, and our calculation thereof may not be comparable to that reported by other companies. Restaurant-level profit and restaurant-level profit margin have limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under U.S. GAAP. Management believes restaurant-level profit and restaurant-level profit margin are an important component of financial results because they are a widely used metric within the restaurant industry to evaluate restaurant-level productivity, efficiency and performance. Management uses restaurant-level profit and restaurant-level profit margin as key metrics to evaluate our financial performance compared with our competitors, to evaluate the profitability of incremental sales and to evaluate our performance across periods.

The reconciliation of restaurant-level profit to the most comparable U.S. GAAP measurement is as follows (in thousands, except percentages):


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                                              Twelve Weeks Ended                 Thirty-Six Weeks Ended
                                       September 10,      September 12,     September 10,      September 12,
                                           2012               2011               2012              2011
                                                          (As restated)                        (As restated)
Revenues                              $       129,137    $       113,233    $      352,453    $       303,852
Less: Licensing and other revenues                (44 )             (152 )            (222 )             (401 )
Restaurant sales                              129,093            113,081           352,231            303,451
Restaurant operating costs
Cost of sales                                  40,363             36,043           110,450             95,566
Labor and benefits                             33,411             28,943            93,428             81,771
Occupancy expenses                              8,196              7,683            23,445             21,540
Other operating expenses                       21,996             19,440            60,219             53,376
Deferred rent                                    (321 )             (429 )          (1,091 )           (1,226 )
Restaurant-level profit               $        25,448    $        21,401    $       65,780    $        52,424
Restaurant-level profit margin                   19.7 %             18.9 %            18.7 %             17.3 %

(3) Adjusted EBITDA represents earnings before interest, taxes, depreciation and amortization and further adjustments for deferred rent, restaurant impairments and closures, non-cash gains and losses on disposal of property and equipment, gains on insurance settlements, pre-opening costs and other expenses and items. Adjusted EBITDA is a supplemental measure of operating performance that does not represent and should not be considered as an alternative to net income or cash flow from operations, as determined by U.S. generally accepted accounting principles ("GAAP") and our calculation thereof may not be comparable to that reported by other companies. Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under U.S. GAAP. Some of the limitations are:

Adjusted EBITDA does not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments;

Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

Adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments on our debt;

Adjusted EBITDA does not reflect our tax expense or the cash requirements to pay our taxes;

although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, Adjusted EBITDA does not reflect any cash requirements for such replacements; and

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