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KONA > SEC Filings for KONA > Form 10-Q on 2-Aug-2013All Recent SEC Filings

Show all filings for KONA GRILL INC

Form 10-Q for KONA GRILL INC


2-Aug-2013

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, 2012 contained in our 2012 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, 2012 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 the experience at 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, offer 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 as evidenced by our positive comparable restaurant sales from the fourth quarter of 2010 through the fourth quarter of 2012. Our same-store sales increased 2.5% in the second quarter of 2013 compared to 2.3% same-store sales growth in the second quarter of 2012. The increase in same-store sales in the second quarter of 2013 was primarily attributable to a higher average guest check resulting from our menu price increase at the end of the first quarter. We believe consumer sentiment continues to remain cautious amid continuing macroeconomic uncertainties, as evidenced by the modest guest traffic growth year over year. We also believe 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 continue to focus on growing sales while remaining disciplined with our costs. The average unit volume of our comparable base restaurants was $1.1 million, or $153 per square foot in the second quarter of 2013 compared to $1.1 million, or $149 per square foot in the second quarter of 2012. We generated restaurant operating profit of $5.3 million, or 20.6% as a percentage of restaurant sales, in the second quarter of 2013 compared to $4.9 million, or 19.4%, in the same quarter of last year.

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 consistently with restaurant sales, and we analyze those costs as a percentage of restaurant sales. Our typical new restaurants experience gradually increasing unit volumes as guests discover our concept and we generate market awareness. 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 generally decrease as a percentage of restaurant sales as we leverage these investments and realize the benefits of higher sales volumes. Our general and administrative expenses as a percentage of sales increased to 7.8% for the quarter ended June 30, 2013, compared to 6.1% in the same quarter of last year, driven mainly by higher staffing and support cost for our growth initiatives as well as a reversal of severance charges in the 2012 period associated with a former executive officer. We expect general and administrative costs to increase during the remainder of 2013 as we continue to make investments in real estate development, construction and operations to support our growth objectives.


We opened our last restaurant in October 2010. Since that time, we have focused on increasing sales, improving restaurant-level operating margins and investing in infrastructure for future growth. At the same time, we have engaged in a rigorous site evaluation process to identify sites for new restaurant openings in 2013 and beyond. In December 2012, we signed a lease in Boise, Idaho. In March 2013, we signed two new leases in Fort Worth and The Woodlands, Texas. We currently expect to open the Boise location and The Woodlands restaurant in the fourth quarter of 2013. Therefore, we expect to incur significant preopening expense during the second half of 2013, while revenues from the new restaurants, if opened in that time frame, would likely not be significant prior to 2014. Accordingly, we expect the opening of these units to place downward pressure on our profitability during 2013. Although the actual preopening expenses depend upon numerous factors, historically our cash preopening expenses approximate $400,000 per location, and non-cash preopening rent expense typically ranges from $50,000 to $100,000 per location.

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. As of June 30, 2013 and December 31, 2012, there were 23 restaurants included in the comparable restaurant base.

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 represents 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 and related delivery fees.


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 amortization of tenant improvement allowances as a reduction of occupancy expense over the lease term.

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, training, corporate rent, professional and consulting fees, and corporate insurance costs.

Preopening Expense. Preopening expense consists of costs incurred prior to opening a new restaurant and is comprised principally of manager salaries and relocation, payroll and related training costs for new employees, including food and beverage costs associated with practice and rehearsal of service activities, and rent expense incurred from the date we obtain possession of the property until opening. We expense restaurant preopening expenses as incurred, and we expect preopening expenses, which typically commence approximately six months prior to a restaurant opening, to be similar for each new restaurant opening. Our preopening costs will fluctuate from period to period depending upon the number of restaurants opened, the timing of new restaurant openings, the location of the restaurants, and the complexity of the staff hiring and training process.

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

Write off of Deferred Financing Costs. Write off of deferred financing costs consists of the charge taken for deferred loan fees associated with our previous credit facility.

Interest Expense, net. Interest expense consists of the cost of servicing our debt obligations, the amortization of debt issuance costs and commitment fees on the line of credit. Interest expense is offset by interest earned on investment balances.

Provision for Income Taxes. Provision for income taxes represents amounts due for federal and state income taxes.


Financial Performance Overview



The following table sets forth certain information regarding our financial
performance for the three and six months ended June 30, 2013 and 2012.



                                               Three Months Ended June 30,            Six Months Ended June 30,
                                                2013                 2012              2013                2012
Restaurant sales growth                               3.2 %                2.0 %            0.3 %               5.1 %
Same-store sales percentage change (1)                2.5 %                2.3 %           (0.1 )%              5.5 %
Average weekly sales - comparable
restaurant base (2)                        $       85,350       $       83,309     $     83,933        $     84,007
Average unit volume (in thousands) (2)     $        1,077       $        1,051     $      2,103        $      2,105
Sales per square foot (2)                  $          153       $          149     $        298        $        298
Restaurant operating profit (in
thousands) (3)                             $        5,322       $        4,857     $      9,713        $      9,660
Restaurant operating profit as a
percentage of sales (3)                              20.6 %               19.4 %           19.7 %              19.6 %

(1) Same-store sales percentage change reflects the periodic change in restaurant sales for the comparable restaurant base. 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 income 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 June 30,             Six Months Ended June 30,
                                                2013                 2012              2013                2012
                                                                        (In thousands)
Restaurant sales                           $       25,796       $       24,992     $      49,292       $      49,147
Costs and expenses:
Cost of sales                                       6,968                6,814            13,421              13,309
Labor                                               8,408                8,211            16,274              16,159
Occupancy                                           1,697                1,548             3,312               3,081
Restaurant operating expenses                       3,401                3,562             6,572               6,938
Restaurant operating profit                         5,322                4,857             9,713               9,660
Deduct - other costs and expenses
General and administrative                          2,010                1,521             3,885               3,605
Preopening expense                                     41                    -                41                   -
Depreciation and amortization                       1,412                1,455             2,841               2,918
Income from operations                     $        1,859       $        1,881     $       2,946       $       3,137




                                                Percentage of Restaurant Sales               Percentage of Restaurant Sales
                                                  Three Months Ended June 30,                   Six Months Ended June 30,
                                                 2013                     2012                2013                    2012
Restaurant sales                                      100.0 %                  100.0 %             100.0 %                 100.0 %
Costs and expenses:
Cost of sales                                          27.0                     27.3                27.2                    27.1
Labor                                                  32.6                     32.9                33.0                    32.9
Occupancy                                               6.6                      6.2                 6.7                     6.3
Restaurant operating expenses                          13.2                     14.3                13.3                    14.1
Restaurant operating profit                            20.6                     19.4                19.7                    19.6
Deduct - other costs and expenses
General and administrative                              7.8                      6.1                 7.9                     7.3
Preopening expense                                      0.2                      0.0                 0.1                     0.0
Depreciation and amortization                           5.5                      5.8                 5.8                     5.9
Income from operations                                  7.2 %                    7.5 %               6.0 %                   6.4 %

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


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 June 30,           Six Months Ended June 30,
                                               2013                2012              2013               2012

Restaurant sales                                   100.0 %             100.0 %          100.0 %            100.0 %
Costs and expenses:
Cost of sales                                       27.0                27.3             27.2               27.1
Labor                                               32.6                32.9             33.0               32.9
Occupancy                                            6.6                 6.2              6.7                6.3
Restaurant operating expenses                       13.2                14.3             13.3               14.1
General and administrative                           7.8                 6.1              7.9                7.3
Preopening expense                                   0.2                 0.0              0.1                0.0
Depreciation and amortization                        5.5                 5.8              5.8                5.9
Total costs and expenses                            92.8                92.5             94.0               93.6
Income from operations                               7.2                 7.5              6.0                6.4
Nonoperating income (expense):
Write off of deferred financing costs                0.3                 0.0              0.1                0.0
Interest expense, net                                0.2                 0.0              0.1                0.0
Income from continuing operations before
provision for income taxes                           6.8                 7.5              5.8                6.4
Provision for income taxes                           0.8                 0.2              0.6                0.2
Income from continuing operations                    6.0                 7.3              5.2                6.2
Loss from discontinued operations                    0.0                 0.2              0.0                0.1
Net income                                           6.0 %               7.1 %            5.2 %              6.0 %

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

Three Months Ended June 30, 2013 Compared with Three Months Ended June 30, 2012

Restaurant Sales. Restaurant sales increased $0.8 million, or 3.2% to $25.8 million during the second quarter of 2013 from $25.0 million in the second quarter of 2012. Comparable restaurant sales growth year over year is 2.5%, driven mainly by higher average guest check as a result of a 3.0% menu price increase implemented in March 2013. Guest traffic increased slightly over the same period in the prior year.

Cost of Sales. Cost of sales increased $0.2 million, or 2.3% to $7.0 million during the second quarter of 2013 compared to $6.8 million during the prior year period. The increase is attributable to the higher sales volumes. Cost of sales as a percentage of restaurant sales decreased 0.3% to 27.0% from 27.3%, reflecting an improvement in seafood costs and the menu price increase taken at the end of March, partially offset by lower wine margins and higher produce costs.

Labor. Labor costs for our restaurants increased $0.2 million, or 2.4% to $8.4 million during the second quarter of 2013 compared to $8.2 million in the prior year quarter. The higher labor costs were attributable to increased labor dollars as well as higher medical and worker compensation costs year over year. Labor expenses as a percentage of restaurant sales decreased 0.3% to 32.6% during the second quarter of 2013 from 32.9% in the second quarter of 2012 due to leverage of hourly wages from increased sales.

Occupancy. Occupancy expenses increased $0.2 million, or 9.5% to $1.7 million during the second quarter of 2013 from $1.5 million during the same quarter in 2012. The higher occupancy expenses are primarily associated with higher common area maintenance charges and the lower benefit of tenant allowance amortization at certain restaurant locations as lease options were exercised. Occupancy expenses as a percentage of restaurant sales increased 0.4% to 6.6% compared to 6.2% during the second quarter of 2012, reflecting the lower benefit of tenant allowance amortization.


Restaurant Operating Expenses. Restaurant operating expenses decreased $0.2 million, or 4.5% to $3.4 million during the second quarter of 2013 from $3.6 million during the same prior year period. Restaurant operating expenses as a percentage of restaurant sales of 13.2% improved 1.1% during the period from 14.3% during the second quarter of 2012, driven primarily by improved management of expenses for marketing, training, travel, printing and smallwares.

General and Administrative. General and administrative expenses increased by $0.5 million, or 32.2% to $2.0 million from $1.5 million year over year. General and administrative expenses increased as a percentage of sales by 1.7% to 7.8% in the second quarter of 2013 from 6.1% in the prior year period. The year over year increase is attributable to higher salaries and benefits associated with increased staffing to support our growth strategy, higher travel and legal costs associated with increased real estate development and lease-related activities, increased stock compensation expense as well as a shift in the timing of our annual general manager and executive chef conference. The increase in general and administrative expenses also reflects the reversal of severance charges associated with a former executive officer in the 2012 period.

Preopening Expense. Preopening expense was minimal during the second quarter of 2013. We expect higher preopening expense in the second half of the year as we plan to open two new restaurants in the fourth quarter of 2013.

Depreciation and Amortization. Depreciation and amortization expense was $1.4 million and $1.5 million in the second quarter of 2013 and 2012, respectively. Depreciation and amortization expense as a percentage of restaurant sales decreased 0.3% to 5.5% during the second quarter of 2013 from 5.8% during the prior year period reflecting leverage of these fixed costs from higher average weekly sales and lower depreciation as a result of assets that were fully depreciated in the current period.

Write off of Deferred Financing Costs. In April 2013, we entered into a $20 million credit facility with KeyBank and Stearns Bank. We paid off the outstanding term loan balance with cash on hand and terminated the existing $6.5 million credit facility. In conjunction with this transaction, we wrote off $66,000 in deferred loan fees related to the prior loan agreements in the second quarter of 2013.

Interest Expense. Interest expense increased in the second quarter of 2013 as compared to the prior year quarter. The increase is attributable to the amortization of deferred loan fees and the commitment fees associated with the new credit facility.

Discontinued Operations. Discontinued operations represent the lease termination and legal costs attributable to a restaurant closed in 2011. Our loss from discontinued operations was $47,000 in the second quarter of 2012. All outstanding lease termination obligations were subsequently settled in the third quarter of 2012.

Provision for Income Taxes. During the second quarter of 2013 and 2012, we recorded a provision for income taxes of $195,000 and $60,000, respectively. The year over year increase in the provision is attributable to federal and state taxes on our projected income for the year as we expect to generate taxable income in excess of our federal and state net operating loss carryforwards.

Six Months Ended June 30, 2013 Compared with Six Months Ended June 30, 2012

Restaurant Sales. Restaurant sales increased slightly to $49.3 million during the first half of 2013 from $49.1 million in the first half of 2012 while our comparable restaurant sales remained essentially flat year over year. Our average guest check increase of 1.7%, mainly as a result of a 3.0% menu price increase implemented at the end of March 2013, was partially offset by a guest traffic decline of 1.3% year over year.

Cost of Sales. Cost of sales increased $0.1 million, or 0.8% to $13.4 million during the first half of 2013 compared to $13.3 million during the same period in the prior year. As a percentage of restaurant sales, cost of sales was 27.2% compared to 27.1% during the same prior year period. Higher wine cost associated with our promotional offerings coupled with produce pricing pressure more than offset the benefits of lower seafood cost associated with our commodity sourcing management.


Labor. Labor costs in the first half of 2013 grew 0.7% to $16.3 million compared to $16.2 million in the comparable prior year period. The increase relates to higher management wages, medical and worker compensation costs year over year. Labor expenses as a percentage of restaurant sales were 33.0% compared to 32.9% in the first half of 2012.

Occupancy. Occupancy expenses increased $0.2 million, or 7.5% to $3.3 million in 2013 year to date from $3.1 million during the first half of 2012. The increase is primarily associated with higher common area maintenance charges and the . . .

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