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KONA > SEC Filings for KONA > Form 10-Q on 6-Nov-2012All Recent SEC Filings

Show all filings for KONA GRILL INC

Form 10-Q for KONA GRILL INC


6-Nov-2012

Quarterly Report


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

The following discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and notes thereto included in Item 1 of Part I of this Form 10-Q and the audited consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2011 contained in our 2011 Annual Report on Form 10-K.

Certain information included in this discussion contains forward-looking statements that involve known and unknown risks and uncertainties, such as statements relating to our future economic performance, plans and objectives for future operations, expectations, intentions and other financial items that are based on our beliefs as well as assumptions made by and information currently available to us. Factors that could cause actual events or results to differ materially from those indicated by these forward-looking statements may include the matters under Item 1A, "Risk Factors" in this report, our Annual Report on Form 10-K for the year ended December 31, 2011 and other reports filed from time to time with the SEC.

Overview

We own and operate 23 restaurants located in 16 states. We offer freshly prepared food, attentive service, and a contemporary ambiance that create a satisfying yet affordable dining experience that we believe exceeds many traditional casual dining restaurants with which we compete. Our high-volume upscale casual restaurants feature a diverse selection of mainstream American favorites as well as a variety of appetizers and entrees with an international influence, including an extensive selection of sushi items. Our menu items are freshly prepared and incorporate over 40 signature sauces and dressings that we make from scratch, creating broad-based appeal for the lifestyle and taste trends of a diverse group of guests. We believe that our diverse menu and generous portions, combined with an average check of approximately $25 per guest, offers our guests an attractive price-value proposition.

The restaurant industry is significantly affected by changes in economic conditions, discretionary spending patterns, consumer confidence, and other factors. Customer traffic and sales patterns have shown improvement since 2010 to date as evidenced by our positive comparable restaurant sales for the previous eight quarters and eleven consecutive quarters of positive guest traffic. For the quarter ended September 30, 2012, our comparable restaurant sales grew 0.2% from the prior year period, improving on same store sales that had shown 10.6% growth from the 2010 period. For the first nine months of 2012, our same store sales grew 3.6% from the prior year period, improving on same store sales that had shown 9.2% growth from the 2010 period. We believe continued improvement in consumer confidence and spending in general, will be important and necessary catalysts to drive guest traffic and higher guest check averages in casual dining restaurants in general and our restaurants in particular.

We closed our West Palm Beach, Florida and Sugar Land, Texas restaurants during the third quarter of 2011. We settled all lease termination costs for the West Palm Beach and Sugar Land locations in the third quarter of 2011 and 2012, respectively. The decision to close these restaurants was based on these restaurants' past operating performance. The closures enable us to focus on our existing restaurant portfolio while also allowing us to concentrate on developing new restaurants. As a result of the restaurant closures, all historical operating results as well as lease termination and exit costs attributable to these restaurants are reflected within discontinued operations in the consolidated statements of comprehensive income for all periods presented.

We target our restaurants to achieve an average annual unit volume of $4.5 million following 24 months of operations. Our typical new restaurants experience gradually increasing unit volumes as guests discover our concept and we generate market awareness.

We experience various patterns in our operating cost structure. Cost of sales, labor, and other operating expenses for our restaurants open at least 12 months generally trend consistent with restaurant sales, and we analyze those costs as a percentage of restaurant sales. We anticipate that our new restaurants will take approximately six months to achieve operating efficiencies as a result of challenges typically associated with opening new restaurants, including lack of market recognition and the need to hire and sufficiently train employees, as well as other factors. We expect cost of sales and labor expenses as a percentage of restaurant sales to be higher when we open a new restaurant, but to decrease as a percentage of restaurant sales as the restaurant matures and as the restaurant management and employees become more efficient in operating that unit. Occupancy and a portion of restaurant operating expenses are fixed. As a result, the volume and timing of newly opened restaurants has had, and is expected to continue to have, an impact on cost of sales, labor, occupancy, and restaurant operating expenses measured as a percentage of restaurant sales. The majority of our general and administrative costs are fixed costs. We expect our general and administrative spending to decrease as a percentage of restaurant sales as we leverage these investments and realize the benefits of higher sales volumes.


Key Measures We Use to Evaluate Our Company

Key measures we use to evaluate and assess our business include the following:

Number of Restaurant Openings. Number of restaurant openings reflects the number of restaurants opened during a particular reporting period.

Same-Store Sales Percentage Change. Same-store sales percentage change reflects the periodic change in restaurant sales for the comparable restaurant base. In calculating the percentage change in same-store sales, we include a restaurant in the comparable restaurant base after it has been in operation for more than 18 months. Same-store sales growth can be generated by an increase in guest traffic counts or by increases in the per person average check amount. Menu price changes and the mix of menu items sold can affect the per person average check amount.

Average Weekly Sales. Average weekly sales represents the average of restaurant sales measured over consecutive Monday through Sunday time periods.

Average Unit Volume. Average unit volume represents the average restaurant sales for the comparable restaurant base.

Sales Per Square Foot. Sales per square foot represent the restaurant sales for our comparable restaurant base, divided by the total leasable square feet for such restaurants.

Restaurant Operating Profit. Restaurant operating profit is defined as restaurant sales minus cost of sales, labor, occupancy, and restaurant operating expenses. Restaurant operating profit does not include general and administrative expenses, depreciation and amortization, or preopening expenses. We believe restaurant operating profit is an important component of financial results because it is a widely used metric within the restaurant industry to evaluate restaurant-level productivity, efficiency, and performance prior to application of corporate overhead. We use restaurant operating profit as a percentage of restaurant sales as a key metric to evaluate our restaurants' financial performance compared with our competitors. This measure provides useful information regarding our financial condition and results of operations and allows investors to more easily determine future financial results driven by growth and allows investors to more easily compare restaurant level profitability.

Key Financial Definitions

Restaurant Sales. Restaurant sales include gross food and beverage sales, net of promotions and discounts.

Cost of Sales. Cost of sales consists of food and beverage costs.

Labor. Labor includes all direct and indirect labor costs incurred in operations.

Occupancy. Occupancy includes all rent payments associated with the leasing of real estate, including base, percentage and straight-line rent, property taxes, and common area maintenance expense. We record tenant improvement allowances as a reduction of occupancy expense over the initial term of the lease.

Restaurant Operating Expenses. Restaurant operating expenses consist of all other restaurant-level operating costs, the major components of which are utilities, credit card fees, advertising, supplies, marketing, repair and maintenance, and other expenses. Other operating expenses contain both variable and fixed components.

General and Administrative. General and administrative includes all corporate and administrative functions that support operations and provide infrastructure to facilitate our future growth. Components of this category include management and staff salaries, bonuses, stock-based compensation and related employee benefits, travel, information systems, human resources, training, corporate rent, professional and consulting fees, and corporate insurance costs.


Depreciation and Amortization. Depreciation and amortization expense consists of the depreciation of property and equipment.

Interest Income and Other, Net. Interest income and other, net consists of interest earned on our cash and investments and any gains or losses on our investments.

Interest Expense. Interest expense includes the cost of servicing our debt obligations, net of capitalized interest.

Discontinued Operations. Discontinued operations include the historical operating results as well as lease termination and exit costs attributable to closed restaurants.

Financial Performance Overview



The following table sets forth certain information regarding our financial
performance for the three and nine months ended September 30, 2012 and 2011.



                                              Three Months Ended           Nine Months Ended
                                                September 30,                September 30,
                                              2012          2011           2012          2011
Restaurant sales growth                           0.2 %        15.9 %          3.5 %        14.6 %
Same-store sales percentage change (1)            0.2 %        10.6 %          3.6 %         9.2 %
Average weekly sales - comparable
restaurant base (2)                        $   79,179     $  79,022     $   80,998     $  78,181
Average unit volume (in thousands) (2)     $    1,041     $   1,039     $    3,171     $   3,060
Sales per square foot (2)                  $      147     $     147     $      440     $     424
Restaurant operating profit (in
thousands) (3)                             $    4,428     $   4,371     $   14,089     $  12,223
Restaurant operating profit as a
percentage of sales (3)                          18.5 %        18.3 %         19.3 %        17.3 %

(1) Same-store sales percentage change reflects the periodic change in restaurant sales for the comparable restaurant base compared to the prior year. In calculating the percentage change for same-store sales, we include a restaurant in the comparable restaurant base after it has been in operation for more than 18 months.

(2) Includes only those restaurants in the comparable restaurant base.

(3) Restaurant operating profit is not a financial measurement determined in accordance with U.S. generally accepted accounting principles and should not be considered in isolation or as an alternative to loss from operations. Restaurant operating profit may not be comparable to the same or similarly titled measures computed by other companies. We believe restaurant operating profit is an important component of financial results because it is a widely used metric within the restaurant industry to evaluate restaurant-level productivity, efficiency, and performance. We use restaurant operating profit as a percentage of restaurant sales as a key metric to evaluate our restaurants' financial performance compared with our competitors.


The following tables set forth our calculation of restaurant operating profit and reconciliation to income from operations, the most comparable GAAP measure.

                                          Three Months Ended September 30,            Nine Months Ended September 30,
                                             2012                  2011                2012                 2011
                                                                         (In thousands)
Restaurant sales                        $        23,887       $        23,838     $       73,035       $       70,591
Costs and expenses:
Cost of sales                                     6,540                 6,404             19,849               19,336
Labor                                             8,040                 7,815             24,199               23,365
Occupancy                                         1,569                 1,742              4,650                5,125
Restaurant operating expenses                     3,310                 3,506             10,248               10,542
Restaurant operating profit                       4,428                 4,371             14,089               12,223
Deduct - other costs and expenses
General and administrative                        1,761                 2,117              5,365                6,147
Gain on insurance recoveries                       (101 )                   -               (101 )                  -
Depreciation and amortization                     1,392                 1,474              4,311                4,419
Income from operations                  $         1,376       $           780     $        4,514       $        1,657

                                           Percentage of Restaurant Sales              Percentage of Restaurant Sales
                                          Three Months Ended September 30,            Nine Months Ended September 30,
                                            2012                    2011                2012                2011
Restaurant sales                                 100.0 %                 100.0 %            100.0 %             100.0 %
Costs and expenses:
Cost of sales                                     27.4                    26.9               27.2                27.4
Labor                                             33.7                    32.8               33.1                33.1
Occupancy                                          6.6                     7.3                6.4                 7.3
Restaurant operating expenses                     13.8                    14.7               14.0                14.9
Restaurant operating profit                       18.5                    18.3               19.3                17.3
Deduct - other costs and expenses
General and administrative                         7.4                     8.9                7.3                 8.7
Gain on insurance recoveries                      (0.4 )                   0.0               (0.1 )               0.0
Depreciation and amortization                      5.8                     6.2                5.9                 6.3
Income from operations                             5.7 %                   3.3 %              6.1 %               2.3 %

Certain percentage amounts may not sum to total due to rounding.

The following table sets forth changes in the number of restaurants opened for the periods indicated:

                                                                    Year Ended
                      Nine Months Ended September 30, 2012       December 31, 2011

Beginning of period                                      23                      25
Openings                                                  -                       -
Closings                                                  -                      (2 )
End of period                                            23                      23


Results of Operations



The following table sets forth, for the periods indicated, the percentage of
restaurant sales of certain items in our financial statements:


                                            Three Months Ended              Nine Months Ended
                                               September 30,                  September 30,
                                           2012             2011           2012            2011

Restaurant sales                              100.0 %         100.0 %         100.0 %        100.0 %
Costs and expenses:
Cost of sales                                  27.4            26.9            27.2           27.4
Labor                                          33.7            32.8            33.1           33.1
Occupancy                                       6.6             7.3             6.4            7.3
Restaurant operating expenses                  13.8            14.7            14.0           14.9
General and administrative                      7.4             8.9             7.3            8.7
Gain on insurance recoveries                   (0.4 )           0.0            (0.1 )          0.0
Depreciation and amortization                   5.8             6.2             5.9            6.3
Total costs and expenses                       94.3            96.7            93.9           97.7
Income from operations                          5.7             3.3             6.1            2.3
Nonoperating income (expense):
Interest income and other, net                  0.0             0.0             0.0            0.0
Interest expense                                0.0            (0.1 )           0.0           (0.1 )
Income from continuing operations
before provision for income taxes               5.7             3.2             6.1            2.2
Provision for income taxes                      0.0             0.1             0.2            0.0

Income from continuing operations               5.7             3.1             5.9            2.2
Loss from discontinued operations,
net of tax                                     (1.6 )          (0.6 )          (0.6 )         (0.4 )
Net income                                      4.1 %           2.5 %           5.4 %          1.8 %

Certain percentage amounts may not sum to total due to rounding.

Three Months Ended September 30, 2012 Compared with Three Months Ended September 30, 2011

Restaurant Sales. Restaurant sales increased slightly to $23.9 million during the third quarter of 2012 from $23.8 million in the third quarter of 2011. Comparable restaurant sales growth year over year was 0.2%, with higher guest traffic partially offset by a lower average guest check.

Cost of Sales. Cost of sales increased $0.1 million, or 2.1% to $6.5 million during the third quarter of 2012 compared to $6.4 million during the prior year period. The increase was primarily attributable to higher beer and wine costs associated with our happy hour promotions and the company-wide rollout of the Wine Down Wednesday program. The increase was partially offset by lower seafood and produce costs year over year. Cost of sales as a percentage of restaurant sales was 27.4% and grew 0.5% year over year, reflecting mainly the impact of the aforementioned programs.

Labor. Labor costs for our restaurants increased $0.2 million, or 2.9% to $8.0 million during the third quarter of 2012 compared to $7.8 million in the prior year quarter. Labor expenses as a percentage of restaurant sales increased 0.9% to 33.7% during the third quarter of 2012 from 32.8% during the prior year period as a result of deleveraging of hourly labor costs due to softer than anticipated sales volumes.

Occupancy. Occupancy expenses decreased $0.2 million, or 9.9% to $1.6 million during the third quarter of 2012 from $1.7 million during the same quarter in 2011. The lower occupancy expenses are primarily associated with an amendment in our lease agreement for one restaurant that was entered into during the fourth quarter of 2011. Occupancy expenses as a percentage of restaurant sales decreased 0.7% to 6.6% in the third quarter of 2012 compared to 7.3% during the prior year period. The decrease in occupancy costs as a percentage of sales reflects the impact of the aforementioned changes in lease provisions.


Restaurant Operating Expenses. Restaurant operating expenses decreased $0.2 million to $3.3 million year over year. Restaurant operating expenses as a percentage of restaurant sales decreased to 13.8% during the period compared to 14.7% during the third quarter of 2011, driven by lower marketing expenses, reduced credit card fees and a reduction in utilities from lower negotiated rates.

General and Administrative. General and administrative expenses decreased by $0.4 million, or 16.8% from $2.1 million year over year. General and administrative expenses decreased as a percentage of sales by 1.5% to 7.4% in the third quarter of 2012 compared to 8.9% in the prior year period. The year over year decrease in general and administrative expenses in absolute dollars and as a percentage of sales is driven by lower executive compensation and benefits partially offset by higher legal and professional fees associated with corporate activities.

Gain on Insurance Recoveries. We recognized $0.1 million gain from insurance recoveries associated with a restaurant fire in the previous quarter. The gain represents the excess of fair value over net book value of replacement furniture as a result of smoke damage from the fire.

Depreciation and Amortization. Depreciation and amortization expense decreased $0.1 million to $1.4 million in the third quarter of 2012 compared to $1.5 million in the prior year period. Depreciation and amortization expense as a percentage of restaurant sales decreased 0.4% to 5.8% from 6.2% year over year.

Discontinued Operations. Loss from discontinued operations of $386,000 and $146,000 in the third quarter of 2012 and 2011, respectively, represents the historical operating results as well as lease termination and exit costs attributable to the two restaurants closed during the third quarter of 2011. In the third quarter of 2012, we settled with the landlord of the Sugar Land location for $950,000 and recognized the incremental lease termination costs and related attorney fees. See Note 2 to the Unaudited Consolidated Financial Statements.

Provision for Income Taxes. We did not record any income tax provision in the third quarter of 2012 due to a revised estimate of current year taxable income resulting from the timing of certain tax deductions, including the Sugar Land settlement noted above. Income tax expense for the third quarter of 2011 was minimal due to the utilization of our federal and state net operating loss carryforwards in prior year.

Nine Months Ended September 30, 2012 Compared with Nine Months Ended September 30, 2011

Restaurant Sales. Restaurant sales increased $2.4 million, or 3.5% to $73.0 million during the first nine months of 2012 from $70.6 million in the same prior year period. The sales increase is attributable to a 3.6% increase in comparable restaurant sales, driven by higher guest traffic volume of 3.5%.

Cost of Sales. Cost of sales increased $0.5 million, or 2.7% to $19.8 million during the first nine months of 2012 compared to $19.3 million during the same period in prior year. The increase was primarily attributable to incremental food and liquor costs associated with higher sales volumes and promotional offerings partially offsetting the benefits of stabilizing produce costs in the current year. As a percentage of restaurant sales, cost of sales decreased 0.2% to 27.2% year over year, reflecting the leverage of higher sales volume as well as the lower produce costs year over year.

Labor. Labor costs in the first nine months of 2012 grew by $0.8 million, or 3.6% to $24.2 million compared to $23.4 million in the comparable prior year period. The increase was attributable to increased staffing to support the year over year sales growth during 2012. Labor expenses as a percentage of restaurant sales, however, remained flat at 33.1% in both 2012 and 2011, due to our ability to leverage fixed management wages and hourly labor expenses to support the comparable restaurant sales growth year over year.

Occupancy. Occupancy expenses decreased $0.5 million, or 9.3% to $4.6 million in 2012 year to date from $5.1 million during the first nine months of 2011. The lower occupancy expenses are primarily associated with an amendment in our lease agreement for one restaurant. Occupancy expenses as a percentage of restaurant sales decreased 0.9% to 6.4% in 2012 compared to 7.3% in prior year, reflecting the benefits of the aforementioned changes in lease provisions as well as the increased leverage of the fixed portion of these costs from higher average weekly sales.


Restaurant Operating Expenses. Restaurant operating expenses decreased $0.3 million to $10.2 million during the first nine months of 2012 on higher sales volume compared to $10.5 million in the same period in 2011. Lower marketing, credit card fees and utilities more than offset higher repair and maintenance costs and increased training, travel and recruiting expenses. Restaurant operating expenses as a percentage of restaurant sales also decreased 0.9% to 14.0% during the first nine months of 2012 compared to 14.9% for the same period in 2011.

General and Administrative. General and administrative expenses decreased by $0.8 million, or 12.7% from $6.1 million year over year. General and administrative expenses decreased as a percentage of sales year over year by 1.4% to 7.3%. The decrease in general and administrative expenses in absolute dollars and as a percentage of sales is mainly attributable to lower executive compensation and benefits during 2012 partially attributable to severance and related costs for former executives in the prior year.

Depreciation and Amortization. Depreciation and amortization expense decreased $0.1 million or 2.5% to $4.3 million in 2012 year to date. Depreciation and amortization expense as a percentage of restaurant sales decreased 0.4% to 5.9% from 6.3% year over year reflecting leverage of these fixed costs from higher average weekly sales.

Discontinued Operations. Loss from discontinued operations of $433,000 and $288,000 in 2012 and 2011, respectively, represents the historical operating results as well as lease termination and exit costs attributable to the two restaurants closed during the third quarter of 2011. In the third quarter of 2012, we settled with the landlord of the Sugar Land location for $950,000 and recognized the incremental lease termination costs and related attorney fees. See Note 2 to the Unaudited Consolidated Financial Statements.

Provision for Income Taxes. We recorded a provision for income taxes of $120,000 and $44,000, respectively, during 2012 and 2011 year to date. The year over year increase in the provision is attributable to federal and state taxes on higher projected taxable income for the year partially offset by the utilization of federal and state net operating loss carryforwards.

Potential Fluctuations in Quarterly Results and Seasonality

Our quarterly operating results may fluctuate significantly as a result of a variety of factors, including the following:

? timing of new restaurant openings and related expenses; ? fluctuations in commodity and food protein prices;

? restaurant operating costs and preopening costs for our newly-opened . . .

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