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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
For the quarterly period ended March 25, 2012
 
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
For the transition period from
 
Commission File No.  000-53577
 
DIVERSIFIED RESTAURANT HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
 
Nevada
 
03-0606420
(State or other jurisdiction
of incorporation or organization)
 
(I.R.S. Employer
Identification Number)
 
27680 Franklin Road
Southfield, Michigan 48034
(Address of principal executive offices)
 
Registrant’s telephone number: (248) 223-9160
 
No change
(Former name, former address and former
fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [X] No [  ]
 
APPLICABLE ONLY TO CORPORATE ISSUERS:
 
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:  18,956,100 shares of $.0001 par value common stock outstanding as of May 9, 2012.
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. 
 
Large accelerated filer
[  ]
 
Accelerated filer
[  ]
         
Non-accelerated filer
[  ]
 
Smaller reporting company
[X]
(Do not check if a smaller reporting company)
       
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]
 
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
 
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.  Yes [  ]       No [  ]
 
 
 

 
 
  INDEX
 
PART I.  FINANCIAL INFORMATION
1
Item 1.  Financial Statements
1
Consolidated Balance Sheets
1
Consolidated Statements of Operations
2
Consolidated Statements of Stockholders' Equity (Deficit)
3
Consolidated Statements of Cash Flows
 4
Notes to Interim Consolidated Financial Statements
5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
15
Item 3. Quantitative and Qualitative Disclosure About Market Risks
18
Item 4. Controls and Procedures
18
PART II. OTHER INFORMATION
19
Item 1. Legal Proceedings
19
Item 1A. Risk Factors
19
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
19
Item 3. Defaults Upon Senior Securities
19
Item 5. Other Information
19
Item 6. Exhibits
19
 
 
 

 
 
PART I.  FINANCIAL INFORMATION
 
Item 1.  Financial Statements
 
DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 
   
March 25
   
December 25
 
 ASSETS
 
2012
   
2011
 
             
Current assets
           
Cash and cash equivalents
 
$
2,150,576
   
$
1,537,497
 
Accounts receivable - other
   
8,809
     
20,497
 
Inventory
   
553,005
     
601,765
 
Prepaid assets
   
197,764
     
207,608
 
Total current assets
   
2,910,154
     
2,367,367
 
                 
Deferred income taxes
   
88,530
     
272,332
 
Property and equipment, net - restricted assets of VIE
   
1,449,988
     
1,457,770
 
Property and equipment, net
   
21,804,707
     
22,064,544
 
Intangible assets, net
   
1,117,355
     
1,113,997
 
Other long-term assets
   
74,099
     
74,389
 
                 
Total assets
 
$
27,444,833
   
$
27,350,399
 
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
Current liabilities
               
Accounts payable
 
$
1,096,288
   
$
1,682,462
 
Accrued compensation
   
979,734
     
760,548
 
Other accrued liabilities
   
690,549
     
649,784
 
Current portion of long-term debt (including VIE debt of $89,414)
   
2,979,397
     
2,967,135
 
Current portion of deferred rent
   
177,387
     
180,480
 
Total current liabilities
   
5,923,355
     
6,240,409
 
                 
Deferred rent, less current portion
   
1,712,135
     
1,750,017
 
Other liabilities - interest rate swap
   
593,310
     
613,999
 
Long-term debt, less current portion (including VIE debt of $1,117,670 and $1,140,025, respectively)
   
16,612,084
     
16,841,355
 
Total liabilities
   
24,840,884
     
25,445,780
 
                 
Commitments and contingencies (Notes 9 and 10)
               
                 
Stockholders' equity
               
Common stock - $0.0001 par value; 100,000,000 shares authorized; 18,956,100 and 18,936,400 shares, respectively, issued and outstanding
   
1,888
     
1,888
 
Additional paid-in capital
   
2,824,209
     
2,771,077
 
Retained earnings (accumulated deficit)
   
(607,443
)
   
(1,253,831
)
Total DRH stockholders' equity
   
2,218,654
     
1,519,134
 
                 
Noncontrolling interest in VIE
   
385,295
     
385,485
 
                 
Total stockholders' equity
   
2,603,949
     
1,904,619
 
                 
Total liabilities and stockholders' equity
 
$
27,444,833
   
$
27,350,399
 
 
The accompanying notes are an integral part of these interim consolidated financial statements.

 
1

 
 
DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 
   
Three Months Ended
 
   
March 25
   
March 27
 
   
2012
   
2011
 
             
Revenue
           
Food and beverage sales
 
$
17,749,818
   
$
15,094,616
 
Franchise royalties and fees
   
-
     
-
 
Total revenue
   
17,749,818
     
15,094,616
 
                 
Operating expenses
               
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
               
    Food, beverage, and packaging
   
5,517,972
     
4,251,632
 
Labor
   
4,405,434
     
3,753,672
 
Occupancy
   
915,119
     
783,445
 
Other operating costs
   
3,422,179
     
2,797,944
 
General and administrative expenses
   
1,274,518
     
1,116,062
 
Pre-opening costs
   
47,871
     
254,136
 
Depreciation and amortization
   
973,058
     
775,361
 
                 
Total operating expenses
   
16,556,151
     
13,732,252
 
                 
Operating profit
   
1,193,667
     
1,362,364
 
                 
Change in fair value of derivative instruments
   
20,689
     
(5,840
)
Interest expense
   
(312,541
)
   
(286,810
)
Other income (expense), net
   
33,773
     
(6,985
)
                 
Income before income taxes
   
935,588
     
1,062,729
 
                 
Income tax provision
   
249,390
     
309,988
 
                 
Net income
   
686,198
     
752,741
 
                 
Less:  Income attributable to noncontrolling interest
   
(39,810
)
   
(38,500
)
                 
Net income attributable to DRH
 
$
646,388
   
$
714,241
 
                 
Basic earnings per share
 
$
0.03
   
$
0.04
 
Fully diluted earnings per share
 
$
0.03
   
$
0.04
 
                 
Weighted average number of common shares outstanding
               
Basic
   
18,941,708
     
18,876,000
 
Diluted
   
19,044,287
     
19,063,203
 
 
The accompanying notes are an integral part of these interim consolidated financial statements.

 
2

 
 
DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (UNAUDITED)
 
                     
Retained
         
Total
 
               
Additional
   
Earnings
         
Stockholders'
 
   
Common Stock
   
Paid-in
   
(Accumulated
   
Noncontrolling
   
Equity
 
   
Shares
   
Amount
   
Capital
   
Deficit)
   
Interest
   
(Deficit)
 
                                     
Balances - December 26, 2010
   
18,876,000
   
$
1,888
   
$
2,631,304
   
$
(3,096,017
)
 
$
338,640
   
$
(124,185
)
                                                 
Issuance of restricted shares
   
60,400
     
-
     
-
     
-
     
-
     
-
 
                                                 
Share-based compensation
   
-
     
-
     
139,773
     
-
     
-
     
139,773
 
                                                 
Net income
   
-
     
-
     
-
     
1,842,186
     
153,845
     
1,996,031
 
                                                 
Distributions from noncontrolling interest
   
-
     
-
     
-
     
-
     
(107,000
)
   
(107,000
)
                                                 
Balances - December 25, 2011
   
18,936,400
   
$
1,888
   
$
2,771,077
   
$
(1,253,831
)
 
$
385,485
   
$
1,904,619
 
                                                 
Issuance of restricted shares
    20,000       -       -       -       -       -  
                                                 
Forfeitures of restricted shares
    (300 )     -       -       -       -       -  
                                                 
Share-based compensation
   
-
     
-
     
53,132
     
-
     
-
     
53,132
 
                                                 
Net income
   
-
     
-
     
-
     
646,388
     
39,810
     
686,198
 
                                                 
Distributions from noncontrolling interest
   
-
     
-
     
-
     
-
     
(40,000
)
   
(40,000
)
                                                 
Balances - March 25, 2012
   
18,956,100
   
$
1,888
   
$
2,824,209
   
$
(607,443
)
 
$
385,295
   
$
2,603,949
 
 
The accompanying notes are an integral part of these interim consolidated financial statements.

 
3

 
 
DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
   
Three Months Ended
 
   
March 25
   
March 27
 
   
2012
   
2011
 
             
Cash flows from operating activities
           
Net income
 
$
686,198
   
$
752,741
 
Adjustments to reconcile net income to net cash provided by operating activities
               
Depreciation and amortization
   
973,058
     
775,361
 
Loss on disposal of property and equipment
   
-
     
23,875
 
Share-based compensation
   
53,132
     
21,981
 
Change in fair value of derivative instruments
   
(20,689
)
   
5,840
 
Deferred income taxes
   
183,802
     
277,281
 
Changes in operating assets and liabilities that provided (used) cash
               
Accounts receivable - other
   
11,688
     
(57,307
)
Inventory
   
48,760
     
(40,725
)
Prepaid assets
   
9,844
     
83,002
 
Other current assets
   
-
     
43,348
 
Intangible assets
   
(12,949
)
   
(77,866
)
Other long-term assets
   
290
     
10,308
 
Accounts payable
   
(586,174
)
   
(172,399
)
Accrued liabilities
   
259,951
     
374,476
 
Deferred rent
   
(40,975
)
   
109,697
 
Net cash provided by operating activities
   
1,565,936
     
2,129,613
 
                 
Cash flows from investing activities
               
Purchases of property and equipment
   
(695,848
)
   
(2,558,994
)
Net cash used in investing activities
   
(695,848
)
   
(2,558,994
)
                 
Cash flows from financing activities
               
Proceeds from issuance of long-term debt
   
440,641
     
1,740,906
 
Repayments of long-term debt
   
(657,650
)
   
(491,013
)
Distributions
   
(40,000
)
   
(40,000
)
Net cash provided by (used in) financing activities
   
(257,009
)
   
1,209,893
 
                 
Net increase in cash and cash equivalents
   
613,079
     
780,512
 
                 
Cash and cash equivalents, beginning of period
   
1,537,497
     
1,358,381
 
                 
Cash and cash equivalents, end of period
 
$
2,150,576
   
$
2,138,893
 
 
The accompanying notes are an integral part of these interim consolidated financial statements.

 
4

 
 
DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
 
1.           BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Nature of Business
 
Diversified Restaurant Holdings, Inc. ("DRH") is the owner, operator, and franchisor of the unique, full-service, ultra-casual restaurant and bar Bagger Dave's Legendary Burger Tavern® ("Bagger Dave's") and a leading Buffalo Wild Wings® ("BWW") franchisee. The original company was founded by T. Michael Ansley, President and CEO, in late 2004 as an operating center for seven BWW locations that Mr. Ansley owned and operated as a franchisee. DRH was formed on September 25, 2006, to provide the framework and financial flexibility to grow as a franchisee of BWW and to develop and grow our unique Bagger Dave's restaurant concept. It became a publicly-traded company in 2008 as a result of a self-underwritten initial public offering. DRH and its wholly-owned subsidiaries, including AMC Group, Inc, ("AMC"), AMC Wings, Inc. ("WINGS"), and AMC Burgers, Inc. ("BURGERS"), develop, own, and operate Bagger Dave's and BWW restaurants located throughout Michigan and Florida.
 
DRH created the Bagger Dave’s concept, brand, menu, and business plan throughout 2006 and 2007 and launched its first store in January 2008. DRH received licensing approval to franchise Bagger Dave's in the states of Michigan, Ohio, Indiana, Illinois, Wisconsin, Kentucky, and Missouri in 2010. The Company doubled the number of Bagger Dave’s stores in 2011 and, as of May 9, 2012, there were six Bagger Dave’s restaurants operating in the Greater Detroit region of Michigan with three additional restaurants under development. In November 2011, DRH executed its first area development agreement to franchise six stores in the Midwest. The first franchised unit is scheduled to open in mid 2012. For more information, please visit www.baggerdaves.com.
 
DRH is also a leading BWW franchisee and, as of May 9, 2012, operated 22 BWW restaurants (14 in Michigan and eight in Florida), with two under construction in Detroit, Michigan and Largo, Florida. Mr. Ansley opened his first affiliated BWW in December 1999 and, since then, has received numerous awards from Buffalo Wild Wings, Inc. ("BWWI") including awards for the Highest Annual Restaurant Sales in 2004, 2005, and 2006, and in September 2007, Mr. Ansley was awarded Franchisee of the Year by the International Franchise Association ("IFA"). The IFA's membership consists of over 12,000 franchisee members and over 1,000 franchisor members. DRH remains on track to fulfill its Area Development Agreement, which requires a total of 32 BWW restaurants by 2017, or an additional 16 more restaurants over the next five years.
 
The following organizational chart outlines the corporate structure of DRH and its wholly-owned subsidiaries, all of which are wholly-owned by the Company.  A brief textual description of the entities follows the organizational chart.  
 
 
AMC was formed on March 28, 2007 and serves as the operational and administrative center for DRH. AMC renders management and advertising services to WINGS and its subsidiaries and BURGERS and its subsidiaries.  Services rendered by AMC include marketing, restaurant operations, restaurant management consultation, hiring and training of management and staff, and other management services reasonably required in the ordinary course of restaurant operations.
 
 
5

 
 
WINGS was formed on March 12, 2007 and serves as a holding company for its BWW restaurants.  WINGS, through its subsidiaries, holds 22 BWW restaurants that are currently in operation.
 
WINGS was formed on March 12, 2007 and serves as a holding company for its BWW restaurants. The Company is economically dependent on retaining its franchise rights with BWWI. The franchise agreements have specific initial term expiration dates ranging from January 29, 2014 through March 25, 2031, depending on the date each was executed and the duration of its initial term. The franchise agreements are renewable at the option of the franchisor and are generally renewable if the franchisee has complied with the franchise agreement. When factoring in any applicable renewals, the franchise agreements have specific expiration dates ranging from January 29, 2019 through March 25, 2046. The Company believes it is in compliance with the terms of these agreements at March 25, 2012.  The Company is under contract with BWWI to enter into 14 additional franchise agreements by 2017 (see Note 10 for details).  
 
BURGERS was formed on March 12, 2007 and serves as a holding company for its Bagger Dave's restaurants. Bagger Dave's Franchising Corporation, a subsidiary of BURGERS, was formed to act as the franchisor for the Bagger Dave's concept and has rights to franchise in the states of Michigan, Ohio, Indiana, Illinois, Wisconsin, Kentucky, and Missouri.  In November 2011, DRH executed its first area development agreement to franchise six stores in the Midwest; the first franchised unit is scheduled to open in mid 2012. 
 
Principles of Consolidation
 
The consolidated financial statements include the accounts of DRH, its wholly-owned subsidiaries, and Ansley Group, LLC (collectively, the "Company"), a real estate entity under common control which is consolidated in accordance with Financial Accounting Standards Board ("FASB") guidance related to variable interest entities.  All significant intercompany accounts and transactions have been eliminated upon consolidation.
 
We consolidate all variable-interest entities (VIEs) where we are the primary beneficiary.  For VIEs, we assess whether we are the primary beneficiary as prescribed by the accounting guidance on the consolidation of VIEs.  The primary beneficiary of a VIE is the party that has the power to direct the activities that most significantly impact the performance of the entity and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the entity.  We consolidated Ansley Group, LLC because we lease and maintain substantially all of its assets to operate our Clinton Township, Michigan BWW restaurant and we guarantee all of its debt.
 
Basis of Presentation
 
The consolidated financial statements as of March 25, 2012 and December 25, 2011, and for the three-month periods ended March 25, 2012 and March 27, 2011, have been prepared by the Company pursuant to accounting principles generally accepted in the United States of America (“GAAP”) and the rules and regulations of the Securities and Exchange Commission (“SEC”). The financial information as of March 25, 2012 and for the three-month period ended March 25, 2012 and March 27, 2011 is unaudited, but, in the opinion of management, reflects all adjustments and accruals necessary for a fair presentation of the financial position, results of operations, and cash flows for the interim periods.
 
The financial information as of December 25, 2011 is derived from our audited consolidated financial statements and notes thereto for the fiscal year ended December 25, 2011, which is included in Item 8 in the Fiscal 2011 Annual Report on Form 10-K, and should be read in conjunction with such financial statements.
 
The results of operations for the three-month period ended March 25, 2012 are not necessarily indicative of the results of operations that may be achieved for the entire year ending December 30, 2012.
 
Fiscal Year
 
The Company utilizes a 52- or 53-week accounting period that ends on the last Sunday in December. This quarterly report on Form 10-Q is for the three-month period ended March 25, 2012 and March 27, 2011, each comprising 13 weeks.
 
Concentration Risks
 
Approximately 75% and 76% of the Company's revenues during the three months ended March 25, 2012 and March 27, 2011, respectively, are generated from food and beverage sales from restaurants located in Michigan.
 
Use of Estimates
 
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclose contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period.  Actual results could differ from those estimates.
 
 
6

 
 
Interest Rate Swap Agreements
 
The Company utilizes interest rate swap agreements with a bank to fix interest rates on a portion of the Company’s portfolio of variable rate debt, which reduces exposure to interest rate fluctuations.  The Company does not use any other types of derivative financial instruments to hedge such exposures, nor does it use derivatives for speculative purposes.
 
 The interest rate swap agreements do not qualify for hedge accounting. As such, the Company records the change in the fair value of the swap agreements in change in fair value of derivative instruments on the consolidated statements of operations. The Company records the fair value of its interest rate swaps on the balance sheet in other assets or other liabilities depending on the fair value of the swaps. See Note 6 and Note 12 for additional information on the interest rate swap agreements.  
 
Recent Accounting Pronouncements
 
In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-05 “Presentation of Comprehensive Income.” ASU 2011-05 amended ASC 220 “Comprehensive Income” to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. The guidance requires entities to report the components of comprehensive income in either a single, continuous statement or two separate but consecutive statements. We adopted this guidance effective March 25, 2012 and the adoption did not have an impact to our consolidated financial statements for the period ending March 25, 2012. As a result of the Company’s April 2, 2012 debt restructure, this pronouncement will impact our financial reporting beginning with the period ending June 24, 2012.  
 
Reclassifications
 
Certain reclassifications have been made to the prior year consolidated financial statements to conform to the current year's presentation.
 
2.           SIGNIFICANT BUSINESS TRANSACTIONS
 
On June 7, 2011, the Company, together with its wholly-owned subsidiaries, entered into a First Amended and Restated Development Line of Credit Agreement (the "DLOC Agreement") with RBS, N.A. ("RBS").  The DLOC Agreement provides for an $8 million credit facility with RBS (the "Credit Facility").  The Credit Facility consists of a new $7 million development line of credit (“DLOC”) and a $1 million revolving line of credit (“Revolving Line of Credit”). The Credit Facility is secured by a senior lien on all Company assets.
 
The Company used the Credit Facility to increase its number of BWW franchise restaurant locations in the states of Michigan and Florida and to develop additional Bagger Dave’s restaurant locations in the Midwest. The DLOC is for a term of 18 months (the “Draw Period”) and amounts borrowed bear interest at between 3% - 4% over LIBOR as adjusted monthly, depending on the Lease Adjusted Leverage Ratio (as defined in the DLOC). During the Draw Period, the Company may make interest-only payments on the amounts borrowed. The Company may convert amounts borrowed during the Draw Period into one or more term loans bearing interest at 3% - 4% over LIBOR as adjusted monthly, with principal and interest amortized over seven years (20 years for real estate) and with a maturity date of June 7, 2018. Any amounts borrowed by the Company during the Draw Period that are not converted into a term loan by December 7, 2012, will automatically be converted to a term loan on the same terms as outlined above. The DLOC includes a carrying cost of .25% per year of any available but undrawn amounts, payable quarterly; however, RBS has granted a zero carrying cost on the unused DLOC through December 25, 2011.  The Company also secured a $1 million Revolving Line of Credit, which has a maturity date of June 7, 2012.  Advances on the Company’s Revolving Line of Credit must be repaid within ninety consecutive days.
 
On April 2, 2012, the Company, together with its wholly-owned subsidiaries, entered into a $16 million senior secured term loan (“2012 Term Loan”), secured by a senior lien on all Company assets.  The Company will use approximately $15.7 million of the 2012 Term Loan to repay substantially all of its outstanding senior debt and interest rate swap liabilities and the remaining $0.3 million for working capital.  See Note 6 for additional information on the 2012 Term Loan.
 
3.           PROPERTY AND EQUIPMENT
 
Property and equipment are comprised of the following assets:
 
   
March 25
2012
   
December 25
2011
 
Land
 
$
469,680
   
$
469,680
 
Land (restricted assets of VIE)
   
520,000
     
520,000
 
Building
   
2,745,296
     
2,745,296
 
Building (restricted assets of VIE)
   
1,570,967
     
1,570,967
 
Equipment
   
10,279,686
     
10,596,964
 
Furniture and fixtures
   
3,577,935
     
3,060,014
 
Leasehold improvements
   
19,240,141
     
19,148,471
 
Restaurant construction in progress
   
403,244
     
-
 
Total
   
38,806,949
     
38,111,392
 
Less accumulated depreciation
   
(14,911,275)
     
(13,955,881
)
Less accumulated depreciation attributable to restricted assets of VIE
   
(640,979)
     
(633,197
)
Property and equipment, net
 
$
23,254,695
   
$
23,522,314
 
 
 
7

 
 
4.           INTANGIBLES
 
 Intangible assets are comprised of the following:
 
   
March 25
2012
   
December 25
2011
 
Amortized intangibles:
           
Franchise fees
 
$
303,750
   
$
303,750
 
Trademark
   
49,138
     
30,852
 
Loan fees
   
164,429
     
164,429
 
Total
   
517,317
     
499,031
 
Less accumulated amortization
   
(121,862
)
   
(112,271
)
Amortized intangibles, net
   
395,455
     
386,760
 
                 
Unamortized intangibles:
               
Liquor licenses
   
721,900
     
727,237
 
Total intangibles, net
 
$
1,117,355
   
$
1,113,997
 
 
Amortization expense for the three months ended March 25, 2012 and March 27, 2011 was $9,591 and $9,726, respectively.  Based on the current intangible assets and their estimated useful lives, amortization expense for fiscal years 2012, 2013, 2014, 2015, and 2016 is projected to total approximately $37,600 per year.
 
5.           RELATED PARTY TRANSACTIONS
 
The 2010 acquisition of certain affiliates was accomplished by issuing unsecured promissory notes to each selling shareholder that bear interest at 6% per year, mature on February 1, 2016, and are payable in quarterly installments of approximately $157,000, with principal and interest fully amortized over six years.  The outstanding balance on the notes is $2,118,535 and $2,254,657 at March 25, 2012 and December 25, 2011, respectively.  These notes were repaid in full in conjunction with the 2012 Term Loan effective April 2, 2012; refer to Note 6 for further details.
 
Fees for monthly accounting and financial statement compilation services are paid to an entity owned by a director and stockholder of the Company. Fees paid during the three months ended March 25, 2012 and March 27, 2011, respectively, were $92,847 and $69,355.
 
Current debt (see Note 6) also includes a promissory note to a DRH stockholder in the amount of $250,000 at March 25, 2012 and March 27, 2011.  The note is a demand note that does not require principal or interest payments.  Interest is accrued at 8% per annum and is compounded quarterly.  The Company has 180 days from the date of demand to pay the principal and accrued interest.  This note was repaid in full in conjunction with the 2012 Term Loan effective April 2, 2012; refer to Note 6 for further details.
 
See Note 9 for related party operating lease transactions.
 
 
8

 
 
6.           LONG-TERM DEBT
 
Long-term debt consists of the following obligations:
 
   
March 25
2012
   
December 25
2011
 
Note payable to a bank secured by a senior lien on all company assets. Scheduled monthly principal and interest payments are approximately $113,000 through maturity in May 2017. Interest is charged based on a swap arrangement designed to yield a fixed annual rate of 7.10%.  This note was repaid in full in conjunction with the 2012 Term Loan effective April 2, 2012; refer below for further details.
 
$
7,049,910
   
$
7,326,128
 
                 
Note payable to a bank secured by a senior mortgage on the Brandon Property and a personal guaranty. Scheduled monthly principal and interest payments are approximately $8,000 for the period beginning July 2010 through maturity in June 2030, at which point a balloon payment of $413,550 is due. Interest is charged based on a fixed rate of 6.72%, per annum, through June 2017, at which point the rate will adjust to the U.S. Treasury Securities Rate plus 4% (and every seven years thereafter).
   
1,117,469
     
1,122,413
 
                 
Note payable to a bank secured by a junior mortgage on the Brandon Property. Matures in 2030 and requires monthly principal and interest installments of approximately $6,300 until maturity. Interest is charged at a rate of 3.58% per annum.
   
874,416
     
882,769
 
                 
Note payable to a bank, secured by a senior lien on all company assets. Scheduled interest payments are charged at a rate of 3% over the 30-day LIBOR (the rate at March 25, 2012 was approximately 3.24%). In November 2011, a DLOC converted into this term loan. The monthly interest payment approximates $2,700. The note will mature in May 2017. The DLOC includes a carrying cost of .25% per year of any available but undrawn amounts.
   
1,470,692
     
1,030,052
 
                 
Note payable to a bank secured by a senior lien on all company assets. Scheduled monthly principal and interest payments are approximately $19,500 through maturity in May 2017. Interest is charged based on a swap arrangement designed to yield a fixed annual rate of 5.91%.  This note was repaid in full in conjunction with the 2012 Term Loan effective April 2, 2012; refer below for further details.
   
1,149,133
     
1,195,853
 
                 
Note payable to a bank secured by a senior lien on all company assets. Scheduled monthly principal and interest payments are approximately $40,000 through maturity in May 2017. Interest is charged based on a swap arrangement designed to yield a fixed annual rate of 6.35%.  This note was repaid in full in conjunction with the 2012 Term Loan effective April 2, 2012; refer below for further details.
   
2,503,166
     
2,602,375
 
                 
Note payable to a bank secured by a senior lien on all company assets. Scheduled monthly principal and interest payments are approximately $24,500 through maturity in May 2017. Interest is charged based on a swap arrangement designed to yield a fixed annual rate of 6.35%.  This note was repaid in full in conjunction with the 2012 Term Loan effective April 2, 2012; refer below for further details.
   
1,616,143
     
1,676,000
 
                 
Unsecured note payable that matures in August 2013 and requires monthly principal and interest installments of approximately $2,200, with the balance due at maturity. Interest is 7% per annum.  This note was repaid in full in conjunction with the 2012 Term Loan effective April 2, 2012; refer below for further details.
   
229,357
     
231,940
 
                 
Note payable to Ford Credit secured by a vehicle purchased by Flyer Enterprises, Inc. to be used in the operation of the business. This is an interest-free loan under a promotional 0% rate. Scheduled monthly principal payments are approximately $430. The note matures in April 2013.
   
5,576
     
6,864
 
                 
Notes payable – variable interest entity. Note payable to a bank secured by a senior mortgage on the property located at 15745 Fifteen Mile Road, Clinton Township, Michigan 48035, a DRH corporate guaranty, and a personal guaranty. Scheduled monthly principal and interest payments are approximately $12,500 through maturity in 2025. Interest is charged at a rate of 4% over the 30-day LIBOR (the rate at March 25, 2012 was approximately 4.24%).
   
1,207,084
     
1,229,439
 
                 
Notes payable – related parties
   
2,368,535
     
2,504,657
 
                 
Total long-term debt
   
19,591,481
     
19,808,490
 
                 
Less current portion (includes VIE debt of $89,414)
   
(2,979,397
)
   
(2,967,135
)
                 
Long-term debt, net of current portion
 
$
16,612,084
   
$
16,841,355
 
 
 
9

 
 
On April 2, 2012, the Company, together with its wholly-owned subsidiaries, entered into a $16 million senior secured term loan (“2012 Term Loan”), secured by a senior lien on all Company assets. The Company will use approximately $15.7 million of the 2012 Term Loan to repay substantially all of its outstanding senior debt and interest rate swap liabilities and the remaining $0.3 million for working capital. The 2012 Term Loan is for a term of seven years and bears interest at one-month LIBOR plus a LIBOR Margin (as defined in the agreement) which ranges from 2.50% to 3.40%, depending on the Company’s lease adjusted leverage ratio. Simultaneously, the Company entered into an interest rate swap agreement to fix the interest on the 2012 Term Loan. The notional amount of the swap agreement is $16 million at inception and amortizes to $0 at maturity in March 2019. Under the swap agreement, the Company pays a fixed rate of 1.41% and receives interest at the one-month LIBOR. Principal and interest payments on the 2012 Term Loan are amortized over seven years, with monthly principal payments of approximately $190 thousand plus accrued interest.
 
Scheduled principal maturities of long-term debt for each of the five years succeeding March 25, 2012, and thereafter, are summarized as follows, both based on the long-term debt terms that existed at March 25, 2012 and taking into account the 2012 Term Loan:
 
Year
 
Amount Based on
March 25, 2012 Terms
   
Amount Revised for
April 2, 2012 Term Loan
 
2013
 
$
2,979,397
   
$
2,434,861
 
2014
   
3,193,401
     
2,638,833
 
2015
   
3,139,900
     
2,641,228
 
2016
   
3,251,032
     
2,644,014
 
2017
   
2,978,215
     
2,647,336
 
Thereafter
   
4,049,536
     
7,668,962
 
                 
Total
 
$
19,591,481
   
$
20,675,234
 
 
Interest expense was $312,541 and $286,810 (including related party interest expense of $42,131 and $57,080) for the three months ended March 25, 2012 and March 27, 2011, respectively.  
  
The above agreements contain various customary financial covenants generally based on the performance of the specific borrowing entity and other related entities.  The more significant covenants consist of a minimum debt service coverage ratio and a maximum lease adjusted leverage ratio, both of which we are in compliance with as of March 25, 2012.
 
At March 25, 2012, the Company had three interest rate swap agreements to fix interest rates on a portion of the Company’s portfolio of variable rate debt.  The notional amounts on the swaps combined are $10,702,209 as of March 25, 2012 and amortize down to $0 through their maturity in May 2017.  Under the swap agreements, the Company pays a fixed rate of 3.1% (notional amount of $7,049,910), 1.91% (notional amount of $1,149,133), and 2.35% (notional amount of $2,503,166), respectively.  The Company receives interest at the one-month LIBOR under all three agreements.  In conjunction with the 2012 Term Loan, these swaps were terminated and the outstanding fair value liability on April 2, 2012 of $657,359 was rolled into the 2012 Term Loan balance and is included in the above debt maturities schedule.

The fair value liabilities of the swap agreements were $593,310 and $613,999 at March 25, 2012 and December 25, 2011, respectively.  The increase in fair value liability of the swap agreements was $20,689 for the three months ended March 25, 2012 and the decrease in fair value liability of the swap was $5,840 for the three months ended March 27, 2011 and is recorded in the consolidated statements of operations.
 
7.           CAPITAL STOCK (INCLUDING PURCHASE WARRANTS AND OPTIONS)
 
In 2011, the Company established the Stock Incentive Plan of 2011 (“Stock Incentive Plan”) to attract and retain directors, consultants, and employees and to more fully align their interests with the interests of the Company’s shareholders through the opportunity for increased stock ownership.  The plan permits the grant and award of 750,000 shares of common stock by way of stock options and/or restricted stock.  Stock options must be awarded at exercise prices at least equal to or greater than 100% of the fair market value of the shares on the date of grant.  The options will expire no later than 10 years from the date of grant, with vesting terms to be defined at grant date, ranging from a vesting schedule based on performance to a vesting schedule that extends over a period of time as selected by the Compensation Committee of the Board of Directors or other committee as determined by the Board (the “Committee”).  The Committee also determines the grant, issuance, retention, and vesting timing and conditions of awards of restricted stock.  The Committee may place limitations, such as continued employment, passage of time, and/or performance measures, on restricted stock.  Awards of restricted stock may not provide for vesting or settlement in full of restricted stock over a period of less than one year from the date the award is made.  The Stock Incentive Plan was approved by our shareholders on May 26, 2011. 
 
 
10

 
 
During fiscal 2011 and on March 1, 2012, restricted shares were issued to certain employees at a weighted-average grant date fair value of $5.00 and $3.10,  respectively.  Restricted shares are granted with a per share purchase price at 100% of the fair market value on the date of grant.  Stock-based compensation expense will be recognized over the expected vesting period in an amount equal to the fair market value of such awards on the date of grant.  The restricted shares transactions are summarized below:
 
   
Number of Restricted
Stock Shares
 
Unvested, December 25, 2011
   
60,400
 
Granted
   
20,000
 
Vested
   
0
 
Expired/Forfeited
   
(300
Unvested, March 25, 2012
   
80,100
 
 
Under the Stock Incentive Plan, there are 669,900 shares available for future awards.
 
On July 30, 2007, DRH granted options for the purchase of 150,000 shares of common stock to the directors of the Company. These options vest ratably over a three-year period and expire six years from issuance. At March 25, 2012, these options are fully vested and can be exercised at a price of $2.50 per share.
 
On July 31, 2010, prior to the Stock Incentive Plan, DRH granted options for the purchase of 210,000 shares of common stock to the directors of the Company.  These options vest ratably over a three-year period and expire six years from issuance.  Once vested, the options can be exercised at a price of $2.50 per share.
 
Stock-based compensation of $53,132 and $21,981 was recognized, during the three-month period ended March 25, 2012 and March 27, 2011, respectively, as compensation cost in the consolidated statements of operations and as additional paid-in capital on the consolidated statement of stockholders' equity to reflect the fair value of shares vested as of March 25, 2012.  The fair value of stock options is estimated using the Black-Scholes model.  The fair value of unvested shares is $109,907 as of March 25, 2012.  The fair value of the unvested shares will be amortized ratably over the remaining vesting term.  The valuation methodology used an assumed term based upon the stated term of three years and a risk-free rate of return represented by the U.S. 5-year Treasury Bond rate and volatility factor based on guidance as defined in FASB ASC 718, Compensation–Stock Compensation.  A dividend yield of 0% was used because the Company has never paid a dividend and does not anticipate paying dividends in the reasonably foreseeable future. 
 
In October 2009, one member of the Board of Directors exercised 6,000 vested options at a price of $2.50 per share.  Consequently, at March 25, 2012, 354,000 shares of authorized common stock are reserved for issuance to provide for the exercise of the Company’s stock options.
 
The Company has authorized 10,000,000 shares of preferred stock at a par value of $0.0001.  No preferred shares are issued or outstanding as of March 25, 2012.  Any preferences, rights, voting powers, restrictions, dividend limitations, qualifications, and terms and conditions of redemption shall be set forth and adopted by a Board of Directors' resolution prior to issuance of any series of preferred stock.
 
8.           INCOME TAXES
 
The provision for income taxes consists of the following components for the three-month period ended March 25, 2012 and March 27, 2011, respectively:
 
   
Three Months Ended
 
   
March 25
2012
   
March 27
2011
 
Federal
           
Current
 
$
-
   
$
-
 
Deferred
   
217,706
     
223,988
 
                 
State
               
Current
   
65,588
     
32,707
 
Deferred
   
(33,904
)
   
53,293
 
                 
Income tax provision
 
$
249,390
   
$
309,988
 
 
 
11

 
 
The provision for income taxes is different from that which would be obtained by applying the statutory federal income tax rate to loss before income taxes.  The items causing this difference are as follows:
 
   
March 25
2012
   
March 27
2011
 
             
Income tax provision at federal statutory rate
 
$
318,095
   
$
350,733
 
State income tax provision
   
31,684
     
86,000
 
Permanent differences
   
39,201
     
37,707
 
Tax credits
   
(139,590
   
(105,629
Other
   
-
     
(58,823
                 
Income tax provision
 
$
249,390
   
$
309,988
 
 
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.  The Company expects the deferred tax assets to be fully realizable within the next several years. Significant components of the Company's deferred income tax assets and liabilities are summarized as follows:
 
   
March 25
2012
   
December 25
2011
 
Deferred tax assets:
           
Net operating loss carry forwards
 
$
1,294,667
   
$
1,861,906
 
Deferred rent expense
   
34,010
     
50,471
 
Start-up costs
   
234,363
     
135,535
 
Tax credit carry forwards
   
1,229,151
     
1,089,561
 
Other
   
414,134
     
393,713
 
Total deferred tax assets
   
3,206,325
     
3,531,186
 
                 
Deferred tax liabilities:
               
Tax depreciation in excess of book
   
3,117,795
     
3,258,854
 
Total deferred tax liabilities
   
3,117,795
     
3,258,854
 
Net deferred income tax assets
 
$
88,530
   
$
272,332
 
 
If deemed necessary by management, the Company establishes valuation allowances in accordance with the provisions of FASB ASC 740 ("ASC 740"), "Income Taxes".  Management continually reviews realizability of deferred tax assets and the Company recognizes these benefits only as reassessment indicates that it is more likely than not that such tax benefits will be realized.
 
The Company expects to use net operating loss and general business tax credit carryforwards before its 20-year expiration.  A significant amount of net operating loss carry forwards were used when the Company purchased nine affiliated restaurants in 2010, which were previously managed by DRH.  Federal net operating loss carry forwards of $931,552, $28,611, $1,696,500, and $544,711 will expire in 2031, 2030, 2029 and 2028, respectively.  General business tax credits of $139,590, $561,396, $335,621, $86,678, $59,722, and $46,144 will expire in 2032, 2031, 2030, 2029, 2028 and 2027, respectively.
 
The Company applies the provisions of ASC 740 regarding the accounting for uncertainty in income taxes.  There are no amounts recorded on the Company's consolidated financial statements for uncertain positions.  The Company classifies all interest and penalties as income tax expense.  There are no accrued interest amounts or penalties related to uncertain tax positions as of March 25, 2012.
 
The Company files income tax returns in the United States federal jurisdiction and various state jurisdictions.
 
9.           OPERATING LEASES (INCLUDING RELATED PARTY)
 
Lease terms range from four to 15 years, generally include renewal options, and frequently require us to pay a proportionate share of real estate taxes, insurance, common area maintenance, and other operating costs. Some restaurant leases provide for contingent rental payments based on sales thresholds.
 
Total rent expense was $713,843 and $613,311 for the three-month period ended March 25, 2012 and March 27, 2011, respectively (of which $23,358 and $20,872, respectively, were paid to a related party).  
 
 
12

 
 
Scheduled future minimum lease payments for each of the five years and thereafter for non-cancelable operating leases with initial or remaining lease terms in excess of one year at March 25, 2012 are summarized as follows:
 
Year
 
Amount
 
2013
 
$
3,063,935
 
2014
   
3,132,196
 
2015
   
2,857,526
 
2016
   
2,667,630
 
2017
   
2,321,037
 
Thereafter
   
6,418,024
 
Total
 
$
20,460,348
 
 
10.           COMMITMENTS AND CONTINGENCIES
 
The Company assumed, from a related entity, an "Area Development Agreement" with BWWI in which the Company undertakes to open 23 BWW restaurants within its designated "development territory", as defined by the agreement, by October 1, 2016.  On December 12, 2008, this agreement was amended, adding nine additional restaurants and extending the date of fulfillment to March 1, 2017.  Failure to develop restaurants in accordance with the schedule detailed in the agreement could lead to potential penalties of $50,000 for each undeveloped restaurant, payment of the initial franchise fees for each undeveloped restaurant, and loss of rights to development territory.  As of March 25, 2012, of the 32 restaurants required to be opened under the Area Development Agreement, 16 of these restaurants had been opened for business.  An additional six restaurants not part of this Area Development Agreement were also opened for business as of March 25, 2012. 
 
The Company is required to pay BWWI royalties (5% of net sales) and advertising fund contributions (3% of net sales) for the term of the individual franchise agreements.  The Company incurred $780,186 and $700,964 in royalty expense for the three-month period ended March 25, 2012 and March 27, 2011, respectively.  Advertising fund contribution expenses were $461,660 and $416,040 for the three-month period ended March 25, 2012 and March 27, 2011, respectively.
 
The Company is required, by its various BWWI franchise agreements, to modernize the restaurants during the term of the agreements.  The individual agreements generally require improvements between the fifth year and the tenth year to meet the most current design model that BWWI has approved.  The modernization costs can range from approximately $50,000 to approximately $500,000 depending on the individual restaurants’ needs.
 
The Company is subject to ordinary, routine, legal proceedings, as well as demands, claims and threatened litigation, which arise in the ordinary course of its business.  The ultimate outcome of any litigation is uncertain.  While unfavorable outcomes could have adverse effects on the Company's business, results of operations, and financial condition, management believes that the Company is adequately insured and does not believe that any pending or threatened proceedings would adversely impact the Company's results of operations, cash flows, or financial condition.  Therefore, no separate reserve has been established for these types of legal proceedings.
 
11.            SUPPLEMENTAL CASH FLOWS INFORMATION
 
Other Cash Flows Information
 
Cash paid for interest was $260,930 and $250,968 during the three-month period ended March 25, 2012 and March 27, 2011, respectively.
 
Cash paid for income taxes was $128,000 and $37,943 during the three-month period ended March 25, 2012 and March 27, 2011, respectively.
 
12.           FAIR VALUE OF FINANCIAL INSTRUMENTS
 
The guidance for fair value measurements, ASC 820 Fair Value Measurements and Disclosures, establishes the authoritative definition of fair value, sets out a framework for measuring fair value, and outlines the required disclosures regarding fair value measurements. Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. We use a three-tier fair value hierarchy based upon observable and non-observable inputs as follows:
 
Level 1
Quoted market prices in active markets for identical assets and liabilities;
Level 2
Inputs, other than level 1 inputs, either directly or indirectly observable; and
Level 3
Unobservable inputs developed using internal estimates and assumptions (there is little or no market data) which reflect those that market participants would use.
 
As of March 25, 2012 and December 25, 2011, respectively, our financial instruments consisted of cash equivalents, accounts payable, and debt. The fair value of cash equivalents, accounts payable and short-term debt approximate its carrying value, due to its short-term nature.
 
 
13

 
 
The fair value of our interest rate swaps is determined based on valuation models, which utilize quoted interest rate curves to calculate the forward value and then discount the forward values to the present period. The Company measures the fair value using broker quotes which are generally based on market observable inputs including yield curves and the value associated with counterparty credit risk. Our interest rate swaps are classified as a Level 2 measurement as these securities are not actively traded in the market, but are observable based on transactions associated with bank loans with similar terms and maturities.
 
There were no transfers between levels of the fair value hierarchy during the three months ended March 25, 2012 and the fiscal year ended December 25, 2011, respectively.
 
The following table presents the fair values for those assets and liabilities measured on a recurring basis as of March 25, 2012:
 
FAIR VALUE MEASUREMENTS
 
                           
Asset/(Liability)
 
Description
 
Level 1
   
Level 2
   
Level 3
   
Total
   
Total
 
Interest Rate Swaps
 
$
   
$
(593,310
)
 
$
   
$
(593,310
)
 
$
(593,310
)
 
The following table presents the fair values for those assets and liabilities measured on a recurring basis as of December 25, 2011:
 
FAIR VALUE MEASUREMENTS
 
                           
Asset/(Liability)
 
Description
 
Level 1
   
Level 2
   
Level 3
   
Total
   
Total
 
Interest Rate Swaps
 
$
   
$
(613,999
)
 
$
   
$
(613,999
)
 
$
(613,999
)
 
As of March 25, 2012, our total debt, less related party debt, was approximately $17.2 million and had a fair value of approximately $14.6 million. As of December 25, 2011, our total debt, less related party debt, was approximately $17.3 million and had a fair value of approximately $15.2 million. Related party debt at March 25, 2012 was approximately $2.5 million and had a fair value of approximately $2.4 million.  Related party debt as of December 25, 2011 was approximately $2.5 million and had a fair value of approximately $2.6 million.  The Company estimates the fair value of its fixed-rate debt using discounted cash flow analysis based on the Company’s incremental borrowing rate.
 
 
14

 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
(The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated interim financial statements and related notes included in Item 1 of Part 1 of this Quarterly Report and the audited consolidated financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results from Operations contained in our Form 10-K, for the fiscal year ended December 25, 2011.)
 
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
 
Statements contained in this “Quarterly Report on Form 10-Q” may contain information that includes or is based upon certain “forward-looking statements” relating to our business. These forward-looking statements represent management’s current judgment and assumptions, and can be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements are frequently accompanied by the use of such words as “anticipates,” “plans,” “believes,” “expects,” “projects,” “intends,” and similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors, including, while it is not possible to predict or identify all such risks, uncertainties, and other factors, those relating to our ability to secure the additional financing adequate to execute our business plan; our ability to locate and start up new restaurants; acceptance of our restaurant concepts in new market places; the cost of food and other raw materials.  Any one of these or other risks, uncertainties, other factors, or any inaccurate assumptions may cause actual results to be materially different from those described herein or elsewhere by us. We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date they were made. Certain of these risks, uncertainties, and other factors may be described in greater detail in our filings from time to time with the Securities and Exchange Commission, which we strongly urge you to read and consider. Subsequent written and oral forward-looking statements attributable to us or to persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth above and elsewhere in our reports filed with the Securities and Exchange Commission. We expressly disclaim any intent or obligation to update any forward-looking statements.
 
OVERVIEW
 
Diversified Restaurant Holdings, Inc. (“DRH” or the “Company”) is a leading Buffalo Wild Wings® ("BWW") franchisee that is rapidly expanding through organic growth and acquisitions.  WINGS, through its subsidiaries, holds 22 BWW restaurants that are currently in operation; 14 are located in Michigan and eight in Florida.  DRH also created and launched its own unique, full-service, ultra-casual restaurant concept, Bagger Dave’s Legendary Burger Tavern® (“Bagger Dave’s”), in January 2008.  As of March 25, 2012, the Company owned and operated six Bagger Dave’s restaurants in Southeast Michigan. Our seventh Bagger Dave's location is scheduled to open on May 13, 2012.  BURGERS also has a wholly-owned subsidiary named Bagger Dave’s Franchising Corporation that was formed to act as the franchisor for the Bagger Dave’s concept.  We have filed for rights, and been approved, to franchise in Michigan, Ohio, Indiana, Illinois, Wisconsin, Kentucky, and Missouri. The first franchised unit is scheduled to open in mid 2012. 
 
Our organic growth strategy is dependent on three key components.  First is the continued development of our BWW concept as a franchisee.  We expect to open two to three BWW stores each year through 2017 with a combined total of 38 by the end of 2017.  Second is our continued development of our own Bagger Dave’s concept throughout the Midwest consistent with the current capabilities of our supply base.  We intend to open, depending on our ability to find real estate and fund new development, a minimum of three corporate stores in 2012.  Third is our desire to franchise our Bagger Dave’s concept throughout the Midwest.  We have made significant investments, including the hiring of a veteran in the franchise community to seek qualified multi-unit operators, support the development of new franchisee-owned stores, and ultimately manage the franchisee system. 
 
 
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RESTAURANT OPENINGS
 
The following table outlines the restaurant unit information for the years indicated. "Total company owned restaurants" reflects the number of restaurants owned and operated by DRH for each year. Since the Company's inception, it managed nine existing BWW restaurants and on February 1, 2010, these restaurants were acquired by the Company. Comparative results for 2009, 2008, and 2007 are a consolidation of owned and managed restaurants based on the accounting of an acquisition of entities under common control.  As a franchisor of Bagger Dave’s, we’ve also included the number of franchises that are scheduled to open in 2012.
 
   
2012
(estimate)
   
2011
   
2010
   
2009
   
2008
   
2007
 
Beginning of year - corporate owned
    28       22       9       8       2       0  
Beginning of year - acquisitions / affiliate restaurants under common control
    0       0       9       9       9       9  
Summary of restaurants open at the beginning of year
    28       22       18       17       11       9  
Openings
    0       6       4       1       6       2  
Planned openings
    5       0       0       0       0       0  
Closures
    0       0       0       0       0       0  
Total company owned restaurants
    33       28       22       18       17       11  
Franchised restaurants
    1       0       0       0       0       0  
Total number of restaurants
    34       28       22       18       17       11  
 
RESULTS OF OPERATIONS
 
For the three months ended March 25, 2012 ("First Quarter 2012"), revenue was generated from the operations of 22 BWW restaurants and six Bagger Dave’s restaurants. For the three months ended March 27, 2011 ("First Quarter 2011"), revenue was generated from the operations of 21 BWW restaurants (two of which opened in February 2011) and four Bagger Dave’s restaurants (one of which opened in late February 2011).
 
Results of Operations for the Three Months Ended March 25, 2012 and March 27, 2011
 
Our operating results below are expressed as a percentage of total revenue on the basis of comparison to prior periods.
 
   
Three Months Ended
 
   
March 25
   
March 27
 
   
2012
   
2011
 
             
Total revenue
   
100.0
%
   
100.0
%
                 
Operating expenses
               
Restaurant operating costs:
               
     Food, beverage, and packaging costs
   
31.1
%
   
28.2
%
     Labor
   
24.8
%
   
24.9
%
     Occupancy
   
5.2
%
   
5.2
%
 Other operating costs     19.3 %     18.6 %
                 
General and administrative expenses
   
7.2
%
   
7.4
%
Pre-opening costs
   
0.3
%
   
1.7
%
Depreciation and amortization
   
5.5
%
   
5.1
%
Total operating expenses
   
93.4
%
   
91.1
%
                 
Operating profit
   
6.6
%
   
8.9
%
 
Total revenue for First Quarter 2012 was $17.8 million, an increase of $2.7 million or 17.6% over the $15.1 million of revenue generated during First Quarter 2011. The increase was primarily attributable to two factors. First, approximately $1.8 million of the increase was attributable to revenues generated from the opening of six restaurants in 2011 (three Bagger Dave's restaurants and three BWW restaurants) and revenues generated by one BWW restaurant that opened prior to 2011 but did not meet the criteria for same-store-sales for all or part of the three-month period. Second, the remaining $0.9 million increase was related to a 5.9% increase in same-store-sales for 18 BWW restaurants meeting our same-store-sales criteria and a 17.8% increase in same-store-sales for three Bagger Dave's restaurants meeting our same-store-sales criteria.

Our positive same-store-sales are a consequence of many factors.  Factors contributing to both our BWW and Bagger Dave's concepts include unseasonably warm weather in Michigan and price increases, which we frequently review to offset inflationary pressures.  Specific to our BWW restaurants, same-store-sales also benefited from gift card redemption and increased national advertising.  Specific to our Bagger Dave’s concept, double-digit same-store-sales was attributable to the addition of 48 seats to our Berkley, Michigan location, overall customer awareness, increased customer satisfaction due to increased market penetration, and continued improvement of the overall guest experience.
 
 
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Food, beverage, and packaging costs increased by $1.3 million or 29.8% to $5.5 million in First Quarter 2012 from $4.2 million in First Quarter 2011.  The increase was primarily due to the addition of six new restaurants.  Food, beverage, and packaging costs as a percentage of sales increased to 31.1 % in First Quarter 2012 from 28.2% in First Quarter 2011 due to the overall inflationary pressures in food costs driven by a significant increase in bone-in chicken wing costs, which contributed to approximately two-thirds of the increase as a percentage of sales.  Average cost per pound for bone-in chicken wings was $1.22 in First Quarter 2011 vs. $1.84 in First Quarter 2012.
 
Labor increased by $652 thousand or 17.4% to $4.4 million in First Quarter 2012 from $3.8 million in First Quarter 2011.  The increase was primarily due to the addition of six new restaurants.  Labor as a percentage of sales decreased slightly to 24.8% in First Quarter 2012 from 24.9% in First Quarter 2011.
 
Occupancy increased by $132 thousand or 16.8% to $915 thousand in First Quarter 2012 from $783 thousand in First Quarter 2011.  This increase was primarily due to the addition of six new stores. Occupancy as a percentage of sales remained consistent at 5.2% in the First Quarter 2012 and First Quarter 2011.
 
Other operating costs increased by $624 thousand or 22.3% to $3.4 million in First Quarter 2012 from $2.8 million in First Quarter 2011.  This increase was primarily due to the addition of six new stores. Other operating costs as a percentage of sales increased to 19.3% in First Quarter 2012 from 18.6% in First Quarter 2011.
 
General and administrative expenses increased by $158 thousand or 14.2% to $1.3 million in First Quarter 2012 from $1.1 million in First Quarter 2011.  This increase was primarily due to the addition of six new restaurants and the hiring of personnel critical to our growth.  General and administrative expenses as a percentage of sales decreased to 7.2% in First Quarter 2012 from 7.4% in First Quarter 2011 primarily due to reductions in both professional fees and targeted local-store marketing.
 
Pre-opening costs decreased by $206 thousand or 81.2% to $48 thousand in First Quarter 2012 from $254 thousand in First Quarter 2011.   The difference in pre-opening costs was due to the timing and overall cost to build and open new stores.  The Company did not have any new stores open in First Quarter 2012 whereas the company opened three new stores in the First Quarter 2011  Pre-opening costs as a percentage of sales decreased to 0.3% in First Quarter 2012 from 1.7% in First Quarter 2011.
  
Depreciation and amortization increased by $198 thousand or 25.5% to $973 thousand in First Quarter 2012 from $775 thousand in First Quarter 2011.  This increase was primarily due to the addition of six new restaurants in 2011.  Depreciation and amortization as a percentage of sales increased to 5.5% in First Quarter 2012 from 5.1% in First Quarter 2011.  The increase was attributable to the additional depreciation and amortization related to the capital assets associated with the six new restaurants opened during fiscal year 2011.
 
INTEREST AND TAXES
 
Interest expense was $312,541 and $286,810 during First Quarter 2012 and First Quarter 2011, respectively.    The increase is due to the additional borrowing for new store development since the First Quarter 2011.
 
For First Quarter 2012, we booked an income tax provision of $249,390 compared to First Quarter 2011 when an income tax provision of $309,988 was recorded.  The effective tax rate of income before taxes was 26.7% for First Quarter 2012 vs. 29.2% for First Quarter 2011.  

LIQUIDITY AND CAPITAL RESOURCES; EXPANSION PLANS
 
Our primary liquidity and capital requirements are for new restaurant construction, remodeling of existing restaurants, and other general business needs. We intend to fund up to 70% of the construction and start-up costs of future BWW and Bagger Dave’s restaurants with a $7.0 million development line of credit with RBS Charter One.  We expect to meet all remaining capital requirements from operational cash flow.  We believe that the cash flow from operations and the development line of credit will be sufficient to meet our operational funding, development and obligations for the foreseeable future. However, to provide additional certainty that our liquidity requirements will be met, we have secured a $1.0 million line of credit for working capital with RBS CharterOne.  To date, we have not drawn upon this line of credit.
 
Cash flow from operations for First Quarter 2012 was $1.6 million compared with $2.1 million for First Quarter 2011.
 
Depending on the timing of new store openings total capital expenditures for fiscal year 2012 are expected to be approximately $10.0 million, the majority of which is for new construction.  Approximately $0.4 million is for upgrading existing stores.

 
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Opening new restaurants is the Company’s primary use of capital and is critical to its growth.  Our completed and planned new construction for 2012 includes:
 
Grandville, Michigan – Bagger Dave’s – scheduled to open in May 2012
 
Bloomfield, Michigan – Bagger Dave’s – scheduled to open in August 2012
 
Largo, Florida – BWW – scheduled to open in September 2012
 
Holland, Michigan – Bagger Dave’s – scheduled to open in October 2012
 
Detroit, Michigan – BWW – scheduled to open in December 2012
 
Although investments in new stores are an integral part of our strategic and capital expenditures plan, we also believe that reinvesting in existing stores is an important factor and necessary to maintain the overall positive dining experience for our guests. Depending on the age of the existing stores, upgrades range from $50 thousand on the interior to $500 thousand for a full remodel of the restaurant. Stores are typically upgraded after approximately five years of operation and fully remodeled after approximately 10 years of operation.

Mandatory Upgrades
 
There are no mandatory remodels for fiscal year 2012.
 
Discretionary Upgrades
 
In fiscal year 2012, the Company will invest additional capital to provide minor upgrades to a number of its existing locations, all of which will be funded by cash from operations. These improvements primarily consist of audio/visual equipment upgrades, patio upgrades and point-of-sale system upgrades.
 
Our Credit Facility has debt covenants that have to be met on a quarterly basis. As of March 25, 2012, we are in compliance with all of the covenants.
 
Item 3. Quantitative and Qualitative Disclosure About Market Risks
 
Not Applicable.
 
Item 4. Controls and Procedures
 
(a) Evaluation of disclosure controls and procedures.
 
We are required to maintain disclosure controls and procedures designed to ensure that material information related to us, including our consolidated subsidiaries, is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms. Management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and fraud. Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.
 
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
 
As of March 25, 2012, an evaluation was performed under the supervision of and with the participation of our management, including our principal executive and principal financial officers, of the effectiveness of the design and operation of our disclosure controls and procedures.  Based on that evaluation, our management, including our principal executive and principal financial officers, concluded that our disclosure controls and procedures were effective as of March 25, 2012.
 
(b) Changes in internal controls over financial reporting.
 
There were no changes in the Company’s internal control over financial reporting during the quarter ended March 25, 2012 that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.
 
Our process for evaluating controls and procedures is continuous and encompasses constant improvement of the design and effectiveness of established controls and procedures and the remediation of any deficiencies that may be identified during this process.
 
 
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PART II. OTHER INFORMATION
 
Item 1. Legal Proceedings
 
Occasionally, we are a defendant in litigation arising in the ordinary course of our business, including claims arising from personal injuries, contract claims, dram shop claims, employment-related claims, and claims from guests or employees alleging injury, illness, or other food quality, health, or operational concerns. To date, none of these types of litigation, most of which are entirely or predominantly covered by insurance, has had a material effect on our financial condition or results of operations. We have insured and continue to insure against most of these types of claims. A judgment on any claim not covered by or in excess of our insurance coverage could materially adversely affect our financial condition or results of operations.
 
Item 1A. Risk Factors
 
There have been no material changes in our risk factors from those previously disclosed in our annual report on Form 10-K, as amended, for the year ended December 25, 2011.
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
Not Applicable.
 
Item 3. Defaults Upon Senior Securities
 
None.
 
Item 5. Other Information
 
None.
 
Item 6. Exhibits
 
(a) Exhibits:
 
3.1
Certificate of Incorporation (filed as an exhibit to the Company's Registration Statement on Form S-1, as filed with the Securities and Exchange Commission on August 10, 2007, and incorporated herein by this reference).
 
3.2
By-Laws (filed as an exhibit to the Company's Registration Statement on Form S-1, as filed with the Securities and Exchange Commission on August 10, 2007, and incorporated herein by this reference).
 
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a).
 
31.2
Certification Chief Financial Officer pursuant to Rule 13a-14(a).
 
32.1
Certification Chief Executive Officer pursuant to 18 U.S.C. Section 1350.
 
32.2
Certification Chief Financial Officer pursuant to 18 U.S.C. Section 1350..
 
101.INS* 
XBRL Instance Document
 
101.SCH* 
XBRL Taxonomy Extension Schema Document
 
101.CAL* 
XBRL Taxonomy Extension Calculation Document
 
101.DEF* 
XBRL Taxonomy Extension Definition Document
 
101.LAB* 
XBRL Taxonomy Extension Label Document
 
101.PRE* 
XBRL Taxonomy Extension Presentation Document
 
* In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed to be “furnished” and not “filed.”
 
 
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SIGNATURES
 
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, there unto duly authorized.
 
     
DIVERSIFIED RESTAURANT HOLDINGS, INC.
 
         
         
Dated:  May 9, 2012
   
By: /s/ T. Michael Ansley 
 
     
T. Michael Ansley
President and Chief Executive Officer
(Principal Executive Officer)
 
         
         
     
By: /s/ David G. Burke
 
     
David G. Burke
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
 
 

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