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EX-32.1 - EXHIBIT 32.1 - Diversified Restaurant Holdings, Inc.ex32110q-q32015.htm
EX-31.2 - EXHIBIT 31.2 - Diversified Restaurant Holdings, Inc.ex31210q-q32015.htm
EX-32.2 - EXHIBIT 32.2 - Diversified Restaurant Holdings, Inc.ex32210q-q32015.htm
EX-31.1 - EXHIBIT 31.1 - Diversified Restaurant Holdings, Inc.ex31110q-q32015.htm

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 September 27, 2015  
 
[_] 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:  26,287,017 shares of $.0001 par value common stock outstanding as of November 4, 2015.
 
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
[ X ]
 
 
 
 
Non-accelerated filer
[   ]
Smaller reporting company
[   ]
 
(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
 
Item 1.  Financial Statements
 
DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (unaudited)
 
 
September 27,
 
December 28,
ASSETS
 
2015
 
2014
Current assets
 
 
 
 
Cash and cash equivalents
 
$
15,163,324

 
$
18,688,281

Investments
 

 
2,917,232

Accounts receivable
 
641,775

 
1,417,510

Inventory
 
1,953,823

 
1,335,774

Prepaid assets
 
1,646,780

 
397,715

Deferred income taxes
 
198,093

 

Total current assets
 
19,603,795

 
24,756,512

 
 
 
 
 
Deferred income taxes
 
7,000,933

 
2,960,640

Property and equipment, net
 
89,105,047

 
71,508,950

Intangible assets, net
 
4,141,146

 
2,916,498

Goodwill
 
50,097,081

 
10,998,630

Other long-term assets
 
1,152,387

 
305,804

Total assets
 
$
171,100,389

 
$
113,447,034

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
7,650,649

 
$
7,043,143

Accrued compensation
 
2,016,713

 
2,786,830

Other accrued liabilities
 
2,397,203

 
1,357,510

Current portion of deferred rent
 
394,382

 
377,812

Current portion of long-term debt
 
10,000,000

 
8,155,903

Total current liabilities
 
22,458,947

 
19,721,198

 
 
 
 
 
Deferred rent, less current portion
 
3,218,240

 
3,051,445

Unfavorable operating leases
 
696,764

 
693,497

Other long-term liabilities
 
5,360,356

 
3,212,376

Long-term debt, less current portion
 
113,855,195

 
53,612,496

Total liabilities
 
145,589,502

 
80,291,012

 
 
 
 
 
Commitments and contingencies (Notes 10 and 11)
 

 

 
 
 
 
 
Stockholders' equity
 
 
 
 
Common stock - $0.0001 par value; 100,000,000 shares authorized; 26,297,144 and 26,149,824, issued and outstanding, respectively.
 
2,584

 
2,582

Additional paid-in capital
 
35,988,801

 
35,668,001

Accumulated other comprehensive loss
 
(1,503,857
)
 
(175,156
)
Accumulated deficit
 
(8,976,641
)
 
(2,339,405
)
Total stockholders' equity
 
25,510,887

 
33,156,022

 
 
 
 
 
Total liabilities and stockholders' equity
 
$
171,100,389

 
$
113,447,034

The accompanying notes are an integral part of these interim consolidated financial statements.

2


DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 27, 2015
 
September 28, 2014
 
September 27, 2015
 
September 28, 2014
Revenue
 
$
47,077,816

 
$
32,782,092

 
$
123,389,986

 
$
93,264,727

 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
 
 
 
 
 
 
 
 
Food, beverage, and packaging costs
 
13,505,404

 
9,456,106

 
35,514,577

 
26,784,277

Compensation costs
 
13,035,995

 
8,405,116

 
32,944,958

 
24,170,212

Occupancy costs
 
3,529,935

 
1,873,693

 
8,334,752

 
5,052,643

Other operating costs
 
10,480,932

 
7,220,083

 
26,252,961

 
19,627,639

General and administrative expenses
 
4,027,338

 
2,133,564

 
12,199,188

 
6,345,810

Pre-opening costs
 
653,789

 
609,664

 
2,323,679

 
2,063,800

Depreciation and amortization
 
4,452,436

 
2,865,794

 
10,860,459

 
7,612,125

Impairment and loss on asset disposals
 
532,124

 
33,013

 
3,000,591

 
353,333

Total operating expenses
 
50,217,953

 
32,597,033

 
131,431,165

 
92,009,839

 
 
 
 
 
 
 
 
 
Operating income (loss)
 
(3,140,137
)
 
185,059

 
(8,041,179
)
 
1,254,888

 
 
 
 
 
 
 
 
 
Interest expense
 
(1,842,640
)
 
(483,057
)
 
(2,833,898
)
 
(1,436,092
)
Other income, net
 
34,475

 
67,789

 
778,736

 
86,426

 
 
 
 
 
 
 
 
 
Loss before income taxes
 
(4,948,302
)
 
(230,209
)
 
(10,096,341
)
 
(94,778
)
 
 
 
 
 
 
 
 
 
Income tax benefit
 
(1,366,767
)
 
(48,100
)
 
(3,459,105
)
 
(180,030
)
 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(3,581,535
)
 
$
(182,109
)
 
$
(6,637,236
)
 
$
85,252

 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
(0.14
)
 
$
(0.01
)
 
$
(0.25
)
 
$
0.00

Fully diluted earnings per share
 
$
(0.14
)
 
$
(0.01
)
 
$
(0.25
)
 
$
0.00

 
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding
 
 
 
 
 
 
 
 
Basic
 
26,251,621

 
26,107,627

 
26,184,219

 
26,074,797

Diluted
 
26,251,621

 
26,107,627

 
26,184,219

 
26,174,593

 
 












The accompanying notes are an integral part of these interim consolidated financial statements. 

3


DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (unaudited)
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 27, 2015
 
September 28, 2014
 
September 27, 2015
 
September 28, 2014
 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(3,581,535
)
 
$
(182,109
)
 
$
(6,637,236
)
 
$
85,252

 
 
 
 
 
 
 
 
 
Other comprehensive income (loss)
 
 
 
 
 
 
 
 
Unrealized changes in fair value of interest rate swaps, net of tax of $576,729, $(43,284), $686,442 and $(26,191) respectively
 
(1,119,532
)
 
84,021

 
(1,332,505
)
 
50,841

Unrealized changes in fair value of investments, net of tax of $0, $2,232, $(1,958) and $(6,969), respectively
 

 
(4,333
)
 
3,804

 
13,526

Total other comprehensive income (loss)
 
(1,119,532
)
 
79,688

 
(1,328,701
)
 
64,367

 
 
 
 
 
 
 
 
 
Comprehensive income (loss)
 
$
(4,701,067
)
 
$
(102,421
)
 
$
(7,965,937
)
 
$
149,619

 
 




































The accompanying notes are an integral part of these interim consolidated financial statements.

4


DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (unaudited)
 
 
 
 
 
 
Additional
 
Accumulated
Other
 

 
Total
 
Common Stock
 
Paid-in
 
Comprehensive
 
Accumulated
 
Stockholders'
 
Shares
 
Amount
 
Capital
 
Loss
 
Deficit
 
Equity
Balances - December 29, 2013
26,049,578

 
$
2,580

 
$
35,275,255

 
$
(245,364
)
 
$
(1,070,908
)
 
$
33,961,563

 
 
 
 
 
 
 
 
 
 
 
 
Issuance of restricted shares
91,966

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
Forfeitures of restricted shares
(2,068
)
 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
Employee stock purchase plan
8,523

 
2

 
41,831

 

 

 
41,833

 
 
 
 
 
 
 
 
 
 
 
 
Share-based compensation

 

 
237,079

 

 

 
237,079

 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive loss

 

 

 
64,367

 

 
64,367

 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 
85,252

 
85,252

 
 
 
 
 
 
 
 
 
 
 
 
Balances - September 28, 2014
26,147,999

 
$
2,582

 
$
35,554,165

 
$
(180,997
)
 
$
(985,656
)
 
$
34,390,094

 
 
 
 
 
 
 
 
 
 
 
 
Balances - December 28, 2014
26,149,824

 
$
2,582

 
$
35,668,001

 
$
(175,156
)
 
$
(2,339,405
)
 
$
33,156,022

 
 
 
 
 
 
 
 
 
 
 
 
Issuance of restricted shares
130,752

 

 
 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
Forfeitures of restricted shares
(5,432
)
 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
Employee stock purchase plan
16,500

 
1

 
58,231

 

 

 
58,232

 
 
 
 
 
 
 
 
 
 
 
 
Share-based compensation

 

 
285,823

 

 

 
285,823

 
 
 
 
 
 
 
 
 
 
 
 
Stock repurchase
(24,500
)
 
(2
)
 
(98,250
)
 

 

 
(98,252
)
 
 
 
 
 
 
 
 
 
 
 
 
Stock options exercised
30,000

 
3

 
74,996

 

 

 
74,999

 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive loss

 

 

 
(1,328,701
)
 

 
(1,328,701
)
 
 
 
 
 
 
 
 
 
 
 
 
Net loss

 

 

 

 
(6,637,236
)
 
(6,637,236
)
 
 
 
 
 
 
 
 
 
 
 
 
Balances - September 27, 2015
26,297,144

 
$
2,584

 
$
35,988,801

 
$
(1,503,857
)
 
$
(8,976,641
)
 
$
25,510,887

 
 


The accompanying notes are an integral part of these interim consolidated financial statements.

5


DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
 
 
 
Nine Months Ended
 
 
September 27, 2015
 
September 28, 2014
Cash flows from operating activities
 
 
 
 
Net income (loss)
 
$
(6,637,236
)
 
$
85,252

Adjustments to reconcile net income (loss) to net cash provided by operating activities
 
 
 
 
Depreciation and amortization
 
10,860,459

 
7,641,090

Amortization of debt discount and loan fees
 
60,574

 

Realized loss on investments
 

 
33,406

Amortization of gain on sale-leaseback
 
(272,454
)
 

Impairment and loss on asset disposals
 
3,000,591

 
353,333

Share-based compensation
 
285,823

 
237,079

Deferred income taxes
 
(3,553,903
)
 
(223,928
)
Changes in operating assets and liabilities that provided (used) cash
 
 
 
 
Accounts receivable
 
775,735

 
1,017,606

Inventory
 
(226,568
)
 
(110,794
)
Prepaid expense
 
(1,249,065
)
 
125,563

Intangible assets
 
(239,621
)
 
(210,937
)
Other long-term assets
 
(846,583
)
 
(77,832
)
Accounts payable
 
2,992,491

 
1,292,321

Accrued liabilities
 
641,756

 
(107,580
)
Deferred rent
 
183,365

 
(356,943
)
Net cash provided by operating activities
 
5,775,364

 
9,697,636

 
 
 
 
 
Cash flows from investing activities
 
 
 
 
Purchases of investments
 

 
(7,469,555
)
Proceeds from sale of investments
 
2,952,302

 
11,106,241

Purchases of property and equipment
 
(19,776,752
)
 
(23,685,771
)
Acquisition of business, net of cash acquired
 
(54,041,489
)
 
(3,202,750
)
Net cash used in investing activities
 
(70,865,939
)
 
(23,251,835
)
 
 
 
 
 
Cash flows from financing activities
 
 
 
 
Proceeds from issuance of long-term debt
 
67,753,463

 
16,448,332

Repayments of long-term debt
 
(5,666,667
)
 
(5,865,644
)
Payment of loan fees
 
(556,157
)
 
(118,739
)
Proceeds from employee stock purchase plan
 
58,232

 
41,833

Repurchase of stock
 
(98,252
)
 

Stock options exercised
 
74,999

 

Net cash provided by financing activities
 
61,565,618

 
10,505,782

 
 
 
 
 
Net decrease in cash and cash equivalents
 
(3,524,957
)
 
(3,048,417
)
 
 
 
 
 
Cash and cash equivalents, beginning of period
 
18,688,281

 
9,562,473

 
 
 
 
 
Cash and cash equivalents, end of period
 
$
15,163,324

 
$
6,514,056

 
         The accompanying notes are an integral part of these interim consolidated financial statements.

6

DIVERSIFIED RESTAURANT HOLDINGS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS


1.           BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Nature of Business
 
Diversified Restaurant Holdings, Inc. (“DRH”) is a fast-growing restaurant company operating two complementary concepts:   Buffalo Wild Wings® Grill & Bar (“BWW”) and Bagger Dave’s Burger Tavern® (“Bagger Dave’s”).  As the largest franchisee of BWW and the creator, developer, and operator of Bagger Dave’s, we provide a unique guest experience in a casual and inviting environment.  We were incorporated in 2006 and are headquartered in the Detroit metropolitan area.  As of September 27, 2015, we had 85 locations in Florida, Illinois, Indiana, Michigan and Missouri.
 
DRH is the largest BWW franchisee. As of November 6, 2015, DRH operates 62 DRH-owned BWW restaurants (20 in Michigan, 15 in Florida, seven in Illinois, five in Indiana and 15 in Missouri), including the nation’s largest BWW restaurant, based on square footage, in downtown Detroit, Michigan. We remain on track to fulfill our area development agreement (“ADA”) with Buffalo Wild Wings International, Inc. (“BWLD”) and expect to operate 80 DRH-owned BWW restaurants by the end of 2020, exclusive of potential additional BWW restaurant acquisitions. 

DRH originated the Bagger Dave’s concept with our first restaurant opening in January 2008 in Berkley, Michigan.  As of November 6, 2015, there are 25 Bagger Dave’s, 17 in Michigan and eight in Indiana.
 
Basis of Presentation
 
The consolidated financial statements as of September 27, 2015 and December 28, 2014, and for the three-month and nine-month periods ended September 27, 2015 and September 28, 2014, have been prepared by DRH and its wholly-owned subsidiaries (collectively, 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. The financial information as of September 27, 2015 and for the three-month and nine-month periods ended September 27, 2015 and September 28, 2014 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 consolidated financial information as of December 28, 2014 is derived from our audited consolidated financial statements and notes thereto for the fiscal year ended December 28, 2014, which is included in Item 8 in the Fiscal 2014 Annual Report on Form 10-K, and should be read in conjunction with such consolidated financial statements.
 
The results of operations for the three-month and nine-month period ended September 27, 2015 are not necessarily indicative of the results of operations that may be achieved for the entire year ending December 27, 2015.
 
Segment Reporting
 
The Company has two operating segments, BWW and Bagger Dave’s. The brands operate within the ultra-casual, full-service dining industry, providing similar products to similar customers. The brands also possess similar economic characteristics, resulting in similar long-term expected financial performance. Sales from external customers are derived principally from food and beverage sales. We do not rely on any major customers as a source of sales. We believe we meet the criteria for aggregating our operating segments into a single reporting segment.
 
Investments
 
The Company’s investment securities are classified as available-for-sale. Investments classified as available-for-sale are available to be sold in the future in response to the Company’s liquidity needs, changes in market interest rates, tax strategies, and asset-liability management strategies, among other reasons. Available-for-sale securities are reported at fair value, with unrealized gains and losses, net of taxes, reported in the accumulated other comprehensive income (loss) component of stockholders’ equity, and accordingly, have no effect on net income. Realized gains or losses on sale of investments are determined on the basis of specific costs of the investments. Dividend income is recognized when declared and interest income is recognized when earned. Discount or premium on debt securities purchased at other than par value are amortized using the effective yield method. See Note 3 for details.

7

DIVERSIFIED RESTAURANT HOLDINGS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

Goodwill
 
Goodwill is not amortized and represents the excess of cost over the fair value of identified net assets of businesses acquired. Goodwill is subject to an annual impairment analysis or more frequently if indicators of impairment exist. At September 27, 2015 and December 28, 2014, we had goodwill of $50.1 million and $11.0 million, respectively that was assigned to our BWW operating segment. See Note 2 for additional information.
 
The impairment analysis, if necessary, consists of a two-step process. The first step is to compare the fair value of the reporting unit to its carrying value, including goodwill. We estimate fair value using market information (market approach) and discounted cash flow projections (income approach). The income approach uses the reporting unit’s projection of estimated operating results and cash flows that is discounted using a weighted-average cost of capital that reflects market conditions. The projection uses management’s best estimates of projected revenue, costs and cash expenditures, including an estimate of new restaurant openings and related capital expenditures. Other significant estimates also include terminal growth rates and working capital requirements. We supplement our estimate of fair value under the income approach by using a market approach which estimates fair value by applying multiples to the reporting unit’s projected operating performance. The multiples are derived from comparable publicly traded companies with similar characteristics to the reporting unit. If the fair value of the reporting unit is less than its carrying value, the second step of the impairment analysis must be performed in order to determine the amount of impairment loss, if any. The second step compares the implied fair value of goodwill with the carrying amount of that goodwill. If the carrying amount of the goodwill exceeds its implied fair value, an impairment charge is recognized in an amount equal to that excess. As of December 28, 2014, based on our quantitative analysis, goodwill was considered recoverable. At September 27, 2015, there were no impairment indicators warranting an analysis.
  
Impairment or Disposal of Long-Lived Assets
  
We review long-lived assets quarterly to determine if triggering events have occurred which would require a test to determine if the carrying amount of these assets may not be recoverable based on estimated future cash flows. Assets are reviewed at the lowest level for which cash flows can be identified, which is at the individual restaurant level. In the absence of extraordinary circumstances, restaurants are included in the impairment analysis after they have been open for two years. We evaluate the recoverability of a restaurant’s long-lived assets, including buildings, intangibles, leasehold improvements, furniture, fixtures, and equipment over the remaining life of the primary asset in the asset group, after considering the potential impact of planned operational improvements, marketing programs, and anticipated changes in the trade area. In determining future cash flows, significant estimates are made by management with respect to future operating results for each restaurant over the remaining life of the primary asset in the asset group. If assets are determined to be impaired, the impairment charge is measured by calculating the amount by which the asset carrying amount exceeds its fair value based on our estimate of discounted future cash flows. The determination of asset fair value is also subject to significant judgment. In June 2015, DRH management had determined three Bagger Dave's locations were underperforming and it was best to reallocate valuable resources to higher performing locations. In late July 2015, the Board of Directors approved the closure of these three Bagger Dave's locations. The restaurants closed on August 7, 2015. As a result, the Company recorded an impairment loss of $1.8 million in Second Quarter 2015. Additionally, at the date we ceased using the properties, we recorded a liability of $182,567 for the net present value of any remaining lease obligations, net of estimated sublease income. Refer to Note 4 for additional details. For the year ended December 28, 2014 no impairment losses were recognized. We are currently monitoring several restaurants in regards to the valuation of long-lived assets and have developed plans to continue improvement of operating results. As we periodically refine our estimated future operating results, changes in our estimates and assumptions may cause us to realize impairment charges in the future that could be material.

We account for exit or disposal activities, including restaurant closures, in accordance with Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC")Topic 420, Exit or Disposal Cost Obligations. Such costs include the cost of disposing of the assets as well as other facility-related expenses from previously closed restaurants. These costs are generally expensed as incurred. Additionally, at the date we cease using a property under an operating lease, we record a liability for the net present value of any remaining lease obligations, net of estimated sublease income. Any subsequent adjustments to that liability as a result of lease termination or changes in estimates of sublease income are recorded in the period incurred.

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 disclosure of 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.

8

DIVERSIFIED RESTAURANT HOLDINGS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS


Interest Rate Swap Agreements
 
The Company utilizes interest rate swap agreements with Citizens Bank, N.A. (“Citizens”) 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 Company’s interest rate swap agreements qualify for hedge accounting. As such, the Company records the change in the fair value of its swap agreements as a component of accumulated other comprehensive income (loss), net of tax. The Company records the fair value of its interest rate swaps on the Consolidated Balance Sheet in other long-term assets or other long-term liabilities depending on the fair value of the swaps. See Note 7 and Note 14 for additional information on the interest rate swap agreements.
 
Recent Accounting Pronouncements

In April 2015, the FASB issued Accounting Standards Update No. 2015-03, Interest-Imputation of Interest, which updates guidance on the presentation of debt issuance costs. The guidance requires debt issuance costs to be presented as a direct deduction of debt balances on the statement of financial position, similar to the presentation of debt discounts. The guidance is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted. We will comply with this guidance no later than January 1, 2016. We do not expect the standard will have a significant impact on our consolidated financial statements.  
 
In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"), which supersedes nearly all existing revenue recognition guidance under GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing GAAP.  The standard was originally effective for annual periods beginning after December 15, 2016, and interim periods therein.  In July 2015, the FASB voted to delay the effective date of the new standard. As a result of the delay, the revenue recognition standard will be effective for public companies in 2018, with early adoption permitted. We evaluated the impact of the pending adoption of ASU 2014-09, and based on the nature of our business we do not expect the standard will have a significant impact on our consolidated financial statements.  

We reviewed all other significant newly-issued accounting pronouncements and concluded that they either are not applicable to our operations or that no material effect is expected on our consolidated financial statements as a result of future adoption.

2.           ACQUISITIONS

Florida - June 30, 2014

On June 30, 2014, the Company completed the acquisition of substantially all of the assets of Screamin’ Hot Florida, LLC and Screamin’ Hot Trinity, LLC, each a Florida limited liability company. The assets consist of three BWW restaurants in Clearwater, Port Richey and Oldsmar, Florida (the “Restaurants”). The purchase price was $3.2 million in cash, subject to working capital adjustment, and one-half of the transfer fees imposed by BWLD under its franchise agreements for these Restaurants. After the acquisition, the Company owns the entire Tampa, FL BWW market, giving DRH control of the local Advertising Co-Op. This ownership provides DRH a unique opportunity to gain local market scale, in addition to providing greater geographic diversity to the Company’s restaurant portfolio.

The following table summarizes the estimated fair values of net assets acquired and liabilities assumed:

Working capital
$
57,600

Property and equipment
656,146

Franchise fees
72,750

Goodwill
2,419,854

Net Cash paid for acquisition
$
3,206,350



9


The excess of the purchase price over the aggregate fair value of assets acquired is allocated to goodwill. Goodwill will be deductible for tax purposes. The results of operations of these locations are included in our Consolidated Statements of Operations from the date of acquisition. The Company found it impracticable to report the supplemental pro forma information for the Florida 2014 Acquisition due to the lack of available information.

St. Louis - June 29, 2015

On June 29, 2015, the Company, completed the acquisition of substantially all of the assets of A Sure Wing, LLC, a Missouri limited liability company (“ASW”). The assets acquired consist primarily of 18 existing BWW restaurants, 15 in Missouri and three in Illinois. As consideration for the acquisition of the assets, the Company paid $54.0 million in cash at closing, subject to adjustment for cash on hand, inventory and certain prorated items. Seller reimbursed the Company for one-half of all fees imposed by BWLD under its franchise agreements for the transfer of these restaurants. The acquisition provides DRH greater geographic diversity to the Company’s restaurant portfolio.

The following table summarizes the estimated fair values of net assets acquired and liabilities assumed:

Working capital
$
413,232

Fixed assets
13,993,000

Intangible assets
505,000

Favorable lease
112,344

Unfavorable lease
(58,797
)
Goodwill
39,098,451

Net Cash paid for acquisition
$
54,063,230


The excess of the purchase price over the aggregate fair value of assets acquired is allocated to goodwill. Goodwill will be deductible for tax purposes. The results of operations of these locations are included in our Consolidated Statements of Operations from the date of acquisition.

The following table summarizes the unaudited pro forma financial information as if the acquisition had occurred at the beginning of the period presented:

 
Three Months Ended
 
Nine Months Ended
 
September 27, 2015
 
September 28, 2014
 
September 27, 2015
 
September 28, 2014
Revenue
$
47,077,816

 
$
42,978,743

 
$
144,385,934

 
$
122,876,283

Net income (loss)
(3,581,535
)
 
418,230

 
(5,695,267
)
 
1,433,179

Basic earnings (loss) per share
(0.14
)
 
0.02

 
(0.22
)
 
0.05

Diluted earnings (loss) per share
(0.14
)
 
0.02

 
(0.22
)
 
0.05


The results of operations from the acquisition are included in the Company's results beginning June 29, 2015. The actual amounts of revenue and net income are included in the accompanying Consolidated Statement of Operations for the period of June 29, 2015 to September 27, 2015 is $10.2 million and $645,608, respectively.

3.           INVESTMENTS
 
Investments consist of available-for-sale securities that are carried at fair value. Available-for-sale securities are classified as current assets based upon our intent and ability to use any and all of the securities as necessary to satisfy the operational requirements of our business. Based on the call date of the investments, all securities have maturities of one year or less. Unrealized losses are charged against net earnings when a decline in fair value is determined to be other than temporary. In the First Quarter 2015, DRH opted to discontinue investing in debt securities and determined investing in a highly liquid money market account was a better fit for the Company's liquidity needs. As of September 27, 2015, the outstanding investments as of December 28, 2014 had fully matured and have been redeemed.
  

10

DIVERSIFIED RESTAURANT HOLDINGS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

The amortized cost, gross unrealized holding gains, gross unrealized holding loss, and fair value of available-for-sale securities by type are as follows: 
 
 
December 28, 2014
 
 
 Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Loss
 
Estimated
Fair Value
Debt securities:
 
 
 
 
 
 
 
 
Obligations of states/municipals
 
1,190,261

 

 
(4,278
)
 
1,185,983

Corporate securities
 
1,732,734

 

 
(1,485
)
 
1,731,249

Total debt securities
 
$
2,922,995

 
$

 
$
(5,763
)
 
$
2,917,232

 
As of December 28, 2014, $2.9 million of investments were in a loss position with a cumulative unrealized loss of $5,763. The Company may have incurred future impairment charges if decline in market values continued and/or worsened and the impairments would no longer be considered temporary. All investments with unrealized losses had been in such position for less than 12 months.
 
Gross unrealized gains and losses on available-for-sale securities, recorded in accumulated other comprehensive loss, as of December 28, 2014, was as follows:
 
 
December 28,
2014
Unrealized gains
 
$

Unrealized loss
 
(5,763
)
Net unrealized loss
 
(5,763
)
Deferred federal income tax benefit
 
1,959

Net unrealized loss on investments, net of deferred income tax
 
$
(3,804
)

4.          PROPERTY AND EQUIPMENT
 
Property and equipment are comprised of the following assets:
 
 
September 27, 2015
 
December 28, 2014
Land
 
$
37,500

 
$
3,087,514

Building
 
2,339,219

 
2,339,219

Equipment
 
35,590,640

 
29,251,119

Furniture and fixtures
 
8,773,814

 
7,458,292

Leasehold improvements
 
74,779,976

 
56,971,815

Restaurant construction in progress
 
5,631,811

 
4,731,045

Total
 
127,152,960

 
103,839,004

Less accumulated depreciation
 
(38,047,913
)
 
(32,330,054
)
Property and equipment, net
 
$
89,105,047

 
$
71,508,950


On October 6, 2014, the Company entered into a sale leaseback agreement for $24.6 million with a third-party Real Estate Investment Trust. The arrangement includes the sale of 12 properties, six Bagger Dave’s locations and six BWW locations. In June 2015 and August 2015, we closed on two of the 12 properties, with total proceeds of $5.6 million. We closed on the remaining ten properties in 2014. In connection with the closing of the sale leaseback transaction in June 2015 and August 2015, the Company recorded losses of approximately $0.2 million and $0.2 million, respectively, which is included in impairment and loss on asset disposals on the Consolidated Statements of Operations. For additional details, refer to Form 10-K filed on March 13, 2015.


11

DIVERSIFIED RESTAURANT HOLDINGS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

Based on impairment indicators that existed during the quarter ended June 28, 2015, the Company performed an impairment analysis and recorded an impairment charge of $1.8 million related to three underperforming Bagger Dave's locations, two located in Michigan and one in Indiana. On August 6, 2015, the Company announced the closure of these restaurants. The impairment charge was recorded to the extent that the carrying amount of the assets were not considered recoverable based on the estimated discounted cash flows and the underlying fair value of the assets.

5.        INTANGIBLE ASSETS
 
Intangible assets are comprised of the following:
 
 
September 27, 2015
 
December 28, 2014
Amortized intangibles:
 
 
 
 
Franchise fees
 
$
1,270,642

 
$
647,363

Trademark
 
66,826

 
64,934

Non-compete agreement
 
76,560

 
76,560

Favorable lease
 
351,344

 
239,000

Loan fees
 
652,417

 
130,377

Total
 
2,417,789

 
1,158,234

Less accumulated amortization
 
(478,745
)
 
(377,839
)
Amortized intangibles, net
 
1,939,044

 
780,395

 
 
 
 
 
Unamortized intangibles:
 
 
 
 
Liquor licenses
 
2,202,102

 
2,136,103

Total intangibles, net
 
$
4,141,146

 
$
2,916,498

 
Amortization expense for the three-month periods ended September 27, 2015 and September 28, 2014 and nine-month periods ended September 27, 2015 and September 28, 2014 was $29,316, $15,935, $72,380, and $45,144, respectively. Amortization of favorable/unfavorable leases and loan fees are reflected as part of occupancy and interest expense, respectively.
  
The aggregate weighted-average amortization period for intangible assets is 11.7 years.  

6.           RELATED PARTY TRANSACTIONS
 
Fees for monthly accounting and financial statement services are paid to an entity owned by a member of the DRH Board of Directors and a stockholder of the Company. Fees paid during the three-month periods ended September 27, 2015 and September 28, 2014 and nine-month periods ended September 27, 2015 and September 28, 2014, were $168,225, $131,050, $453,445 and $378,988, respectively.
 
See Note 10 for related party operating lease transactions.

12

DIVERSIFIED RESTAURANT HOLDINGS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS


7.           LONG-TERM DEBT
 
Long-term debt consists of the following obligations:
 
 
September 27, 2015
 
December 28, 2014
Note payable - $120.0 million term loan; payable to RBS with a senior lien on all the Company’s personal property and fixtures. Scheduled monthly principal payments are approximately $833,333 plus accrued interest through maturity in June 2020. Interest is charged based on one-month LIBOR plus an applicable margin, which ranges from 2.25% to 3.5%, depending on the lease adjusted leverage ratio defined in the terms of the agreement. The rate at September 27, 2015 was approximately 3.7%.

 
$
118,333,333

 
$

 
 
 
 
 
Note payable - $30.0 million development line of credit; payable to RBS with a senior lien on all the Company’s personal property and fixtures. Payments are due monthly once fully drawn and matures in June 2020. Interest is charged based on one-month LIBOR plus an applicable margin, which ranges from 2.25% to 3.5%, depending on the lease adjusted leverage ratio defined in the terms of the agreement. Once fully drawn, payments will be due monthly; the note matures June 2020.
 
$
5,865,253

 

 
 
 
 
 
Note payable - $56.0 million term loan; payable to RBS with a senior lien on all the Company’s personal property and fixtures. Scheduled monthly principal payments are approximately $666,667 plus accrued interest through maturity in December 2019. Interest is charged based on one-month LIBOR plus an applicable margin, which ranges from 2.25% to 3.15%, depending on the lease adjusted leverage ratio defined in the terms of the agreement. Repaid in conjunction with the $120.0 million term loan.

 

 
56,000,000

 
 
 
 
 
Note payable - $20.0 million development line of credit; payable to RBS with a senior lien on all the Company’s personal property and fixtures. Payments are due monthly once fully drawn and matures in December 2019. Interest is charged based on one-month LIBOR plus an applicable margin, which ranges from 2.25% to 3.15%, depending on the lease adjusted leverage ratio defined in the terms of the agreement. Repaid in conjunction with the $30.0 million development line of credit.
 

 
5,768,399

 
 
 
 
 
Unamortized discount
 
(343,391
)
 

 
 
 
 
 
Total debt
 
123,855,195

 
61,768,399

 
 
 
 
 
Less current portion
 
(10,000,000
)
 
(8,155,903
)
 
 
 
 
 
Long-term debt, net of current portion
 
$
113,855,195

 
$
53,612,496

 
On December 16, 2014, the Company entered into a $77.0 million senior secured credit facility with Citizens (the “December 2014 Senior Secured Credit Facility”).  The December 2014 Senior Secured Credit Facility consisted of a $56.0 million term loan (the “December 2014 Term Loan”), a $20.0 million development line of credit (the “December 2014 DLOC”), and a $1.0 million revolving line of credit (the “December 2014 RLOC”). The Company used approximately $35.5 million of the December 2014 Term Loan to refinance existing outstanding debt with RBS and used approximately $20.0 million of the December 2014 Term Loan to refinance and term out the outstanding balance of the existing development line of credit loan between the Company and RBS.   The remaining balance of the December 2014 Term Loan, approximately $0.5 million, was used to pay the fees, costs, and expenses associated with the closing of the December 2014 Senior Secured Credit Facility.  The December 2014 Term Loan was for a period of 5 years.  Payments of principal were based upon an 84-month straight-line amortization schedule, with monthly principal payments of $666,667 plus accrued interest.  The interest rate for the December 2014 Term Loan was LIBOR plus an applicable margin, which ranges from 2.25% to 3.15%, depending on the lease adjusted leverage ratio defined in the terms of the agreement.  The entire remaining outstanding principal and accrued interest on the December 2014 Term Loan was due and payable on the maturity date of December 16, 2019.  The December 2014 DLOC was for a term of two years and was convertible upon maturity into a term note based on the terms of the agreement at which time monthly principal payments were due based on a 84-month straight-line amortization schedule, plus interest, through maturity on December 16, 2014. The December 2014 RLOC was for a term of two years. The December 2014 Senior Secured Credit Facility was refinanced in June 2015.

In conjunction with the June 29, 2015 acquisition, the Company, entered into a $155.0 million Senior Secured Credit Facility (the “June 2015 Senior Secured Credit Facility”) with Citizens as administrative agent for the Lenders party thereto. The June 2015 Senior Secured Credit Facility consists of a $120.0 million term loan ("June 2015 Term Loan"), a $30.0 million development line of credit ("June 2015 DLOC"), and a $5.0 million revolving line of credit ("June 2015 RLOC"). The Company immediately used approximately $65.5 million of the June 2015 Term Loan to refinance existing outstanding debt and $54.0 million of the June

13

DIVERSIFIED RESTAURANT HOLDINGS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

2015 Term Loan to finance the acquisition. The remaining balance of the June 2015 Term Loan, approximately $0.5 million, was used to pay the fees, costs and expenses arising in connection with the closing of the loans constituting the June 2015 Senior Secured Credit Facility.

The June 2015 Term Loan is for a term of five years. Payments of principal shall be based upon a 12-year straight-line amortization schedule, with monthly principal payments of $833,333 plus accrued interest. The interest rate for the June 2015 Term Loan is LIBOR plus an applicable margin which ranges from 2.25% to 3.5%. The entire remaining outstanding principal and accrued interest on the June 2015 Term Loan is due and payable on June 29, 2020. The June 2015 DLOC is for a term of two years and is convertible upon maturity into a term note based on the terms of the agreement at which time monthly principal payments will be due based on a 12-year straight-line amortization schedule, plus interest at LIBOR plus an applicable margin, through maturity on June 29, 2020. The June 2015 RLOC is for a term of five years and bears interest at LIBOR plus an applicable margin. As of September 27, 2015 no amounts were outstanding. Fees related to term debt and paid directly to lenders are recorded as debt discount. Debt discount totaled $343,391, net of accumulated amortization at September 27, 2015. Debt issuance costs represents legal, consulting, and financial costs associated with debt financing, which totaled approximately $652,416 at September 27, 2015. Debt discount and debt issuance cost are amortized over the life of the debt and are recorded in interest expense using the effective interest method.

For the three month periods ended September 27, 2015 and September 28, 2014 and nine month periods ended September 27, 2015 and September 28, 2014, interest expense pertaining to debt was $1.8 million, $483,057, and $2.8 million and $1.4 million, respectively.
 
The current debt agreement contains 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. In connection with the closure of three locations discussed in Note 4, during the Third Quarter the Company violated one of its non-financial loan covenants related to the number of allowable restaurant closures. In the Third Quarter our primary lender modified our covenants within our debt agreement to allow for the closure of specified locations and one time transaction fees associated with the St. Louis acquisition and the wage-claim settlement, discussed in Note 11. As of September 27, 2015 the Company was in compliance with the loan covenants.
  
At September 27, 2015, the Company has six interest rate swap agreements to fix a portion of the interest rates on its variable rate debt. The swap agreements all qualify for hedge accounting. The swap agreements have a combined notional amount of $102.8 million at September 27, 2015. Under the swap agreements, the Company receives interest at the one-month LIBOR and pays a fixed rate. The April 2012 swap has a rate of 1.4% (notional amount of $8.2 million) and expires April 2019, the October 2012 swap has a rate of 0.9% (notional amount of $3.4 million) and expires October 2017, the July 2013 swap has a rate of 1.4% (notional amount of $9.0 million) and expires April 2018, the May 2014 swap has a rate of 1.54% (notional amount of $12.0 million) and expires April 2018, the January 2015 swap has a rate of 1.82% (notional amount of $20.5 million) and expires December 2019, and the August 2015 forward swap has a rate of 2.28% (notional amount of $49.7 million) and expires June 2020. The fair value of these swap agreements was a liability of $2.3 million and $259,626 at September 27, 2015 and December 28, 2014, respectively. Since these swap agreements qualify for hedge accounting, the changes in fair value are recorded in other comprehensive income (loss), net of tax. See Note 1 and Note 14 for additional information pertaining to interest rate swaps.

8.            STOCKHOLDER'S EQUITY

Restricted stock awards
 
In 2015 and 2014, restricted shares were granted to certain team members and board members at a weighted-average fair value of $3.56 and $4.82.  Restricted shares are granted with a per share purchase price at 100.0% of the fair market value on the date of grant. Based on the Stock Award Agreement, shares vest ratably over three years, one year period or upon the three years anniversary of the granted shares, the vesting terms are determined by the Compensation Committee of the Board of Directors.  Unrecognized stock-based compensation expense of $702,656 at September 27, 2015 will be recognized over the remaining weighted-average vesting period of 2.0 years. The total fair value of shares vested during the nine-months ended September 27, 2015 and September 28, 2014 was $189,358 and $193,593, respectively.  Under the 2011 Stock Incentive Plan, there are 371,483 shares available for future awards at September 27, 2015.

14

DIVERSIFIED RESTAURANT HOLDINGS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS


The following table presents the restricted shares transactions during the nine-months ended September 27, 2015:
 
Number of
Restricted
Stock Shares
Unvested, December 28, 2014
164,867

Granted
130,752

Vested
(41,979
)
Expired/Forfeited
(5,432
)
Unvested, September 27, 2015
248,208

 
The following table presents the restricted shares transactions during the nine-months ended September 28, 2014:
 
Number of
Restricted
Stock Shares
Unvested, December 29, 2013
116,667

Granted
91,966

Vested
(41,031
)
Expired/Forfeited
(2,068
)
Unvested, September 28, 2014
165,534

   
On July 30, 2010, DRH granted options for the purchase of 210,000 shares of common stock to the directors of the Company.  These options are fully vested and expire six years from issuance, July 30, 2016.  Once vested, the options can be exercised at a price of $2.50 per share. On August 13, 2015, 30,000 shares were exercised at a price of $2.50 per share The intrinsic value of options exercised is $6,300. At September 27, 2015, 180,000 shares of authorized common stock are reserved for issuance to provide for the exercise of these options. The intrinsic value of outstanding options is $59,400 and $476,700 as of September 27, 2015 and September 28, 2014, respectively.
 
Employee stock purchase plan
 
The Company reserved 250,000 shares of common stock for issuance under the Employee Stock Purchase Plan (“ESPP”). The ESPP is available to team members subject to employment eligibility requirements. Participants may purchase common stock at 85.0% of the lesser of the start or end price for the offering period. The plan has four offering periods and each offering period coincides with the fiscal quarter. Shares are purchased on the last day of the offering period. During the nine months ended September 27, 2015 and September 28, 2014, we issued 16,500 and 8,523 shares, respectively. Under the ESPP, there are 217,712 shares available for future purchase at September 27, 2015.

Share Repurchase Program
   
In March 2015, the Board of Directors authorized a program to repurchase up to $1.0 million of the Company's common stock in open market transactions at market prices or otherwise. In April 2015, we repurchased $98,252 in outstanding shares, representing 24,500 shares. The weighted average purchase price per share was $4.01. Upon receipt, the repurchased shares were retired and restored to authorized but unissued shares of common stock.

Stock-Based Compensation

Stock-based compensation of $123,260 and $84,074 was recognized during the three-months ended September 27, 2015 and September 28, 2014, respectively, and $285,823 and $237,079 for nine-months ended September 27, 2015 and September 28, 2014, 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.


15

DIVERSIFIED RESTAURANT HOLDINGS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

Preferred Stock

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 September 27, 2015.  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.

9.           INCOME TAXES
 
The effective income tax rate for the three months and nine months ended September 27, 2015 was 27.6% and 34.3%, respectively, and was 20.9% and 190.0% for the three months and nine months ended September 28, 2014, respectively. The change in the effective income tax rate for the three and nine months ended September 27, 2015 as compared to the three and nine months ended September 28, 2014 is primarily attributable to a decrease in earnings before income taxes.

10.           OPERATING LEASES (INCLUDING RELATED PARTY)
 
Lease terms range from five to 24 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 $2.7 million, $1.4 million, $6.5 million and $3.8 million for the three month periods ended September 27, 2015 and September 28, 2014 and nine-month periods ended September 27, 2015 and September 28, 2014, respectively (of which $0, $34,299, $0, and $130,961 respectively, were paid to a related party).  
 
Scheduled future minimum lease payments (excluding commitments for restaurants under construction) for each of the five years and thereafter for non-cancelable operating leases for existing restaurants with initial or remaining lease terms in excess of one year at September 27, 2015 are summarized as follows: 
Year
Amount
Remainder of 2015
$
2,692,811

2016
10,927,359

2017
10,859,434

2018
10,438,499

2019
9,598,015

Thereafter
53,232,779

Total
$
97,748,897


11.           COMMITMENTS AND CONTINGENCIES
 
The Company’s ADA requires DRH to open 42 restaurants by April 1, 2021.  Failure to develop restaurants in accordance with the schedule detailed in the agreement could lead to potential penalties of up to $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 September 27, 2015 we have opened 26 of the 42 restaurants required by the ADA.  We remain on track to fulfill our obligation under the ADA, and with the remaining sixteen restaurants, we expect the Company will operate 80 BWW restaurants by 2020, exclusive of potential additional BWW restaurant acquisitions.  
  
The Company is required to pay BWLD royalties (5.0% of net sales) and advertising fund contributions (3.0% of net sales globally plus an additional 0.25% or 0.5% of net sales for certain metropolitan cities) for the term of the individual franchise agreements.  The Company incurred royalty fees of $2.1 million, $1.4 million, $5.1 million and $3.9 million for the three month periods ended September 27, 2015 and September 28, 2014 and nine month periods ended September 27, 2015 and September 28, 2014, respectively.  Advertising fund contribution expenses were $1.3 million, $0.8 million, $3.3 million and $2.3 million for the three month periods ended September 27, 2015 and September 28, 2014 and nine month periods ended September 27, 2015 and September 28, 2014, respectively.

The Company is required by its various BWLD franchise agreements to modernize the restaurants during the term of the agreements.  The individual agreements generally require improvements between the fifth and tenth year to meet the most current

16

DIVERSIFIED RESTAURANT HOLDINGS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

design model that BWLD has approved.  The modernization costs for a restaurant can range from approximately $50,000 to approximately $1.3 million depending on an individual restaurant's needs.
 
In October 2015, the Company settled the two collective actions alleging violations of fair labor standards acts and minimum wage laws. The first action, Tammy Wolverton et al v. Diversified Restaurant Holdings, Inc. et al, was filed on March 31, 2014, in the United States District Court for the Eastern District of Michigan and made allegations regarding employees in Michigan. The second action, Lisa Murphy & Andre D. Jordan, Jr. v. Diversified Restaurants Holdings, Inc., et al, was filed in on May 19, 2014, in United States District Court for the Northern District of Illinois, and made allegations involving employees in Illinois, Indiana and Florida.

The actions, in which the plaintiffs were represented by the same legal counsel, contain mirror allegations that tipped servers and bartenders in the Company’s restaurants were required to perform general preparation and maintenance duties, or “non-tipped work,” for which they should be compensated at the minimum wage.

We believe that the Company’s wage and hour policies comply with the law and that we had meritorious defenses to the substantive claims in these matters. However, in light of the potential cost and uncertainty involved, we settled with the plaintiffs for $1.8 million plus payroll taxes. During the quarter ended June 28, 2015, the Company recorded a loss provision of approximately $1.9 million related to these lawsuits, which is recorded in accounts payable on the Consolidated Balance Sheet.
Prior to June 2015, the Company had not received a specific demand from the plaintiff’s for any calculable amount of damages and an actuarial expert retained by the Company estimated potential damages of an immaterial amount. As a result, the Company could not have reasonably concluded whether any significant damages were likely or reasonably possible to result prior to June 2015. During mediation conducted in June and July of 2015, the Company first received settlement demands from the plaintiffs and a reassessment of the matter that provided the Company with information needed to reassess its overall risk exposure. Following this mediation process, the Company determined based on the damages sought, cost of defense, and cost of human capital, the Company’s best course of action was to move forward with settlement negotiations.
Additionally, the Company is subject to ordinary and 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.  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.

17


12.          EARNINGS PER SHARE
 
The following is a reconciliation of basic and fully diluted earnings per common share for the three month and nine month periods ended September 27, 2015 and September 28, 2014:
 
 
Three months ended
 
 
September 27, 2015
 
September 28, 2014
Net loss available to common stockholders
 
$
(3,581,535
)
 
$
(182,109
)
 
 
 
 
 
Weighted-average shares outstanding
 
26,251,621

 
26,107,627

Effect of dilutive securities
 

 

Weighted-average shares outstanding - assuming dilution
 
26,251,621

 
26,107,627

 
 
 
 
 
Earnings per share
 
$
(0.14
)
 
$
(0.01
)
Earnings per share - assuming dilution
 
$
(0.14
)
 
$
(0.01
)

 
 
Nine months ended
 
 
September 27, 2015
 
September 28, 2014
Net income (loss) available to common stockholders
 
$
(6,637,236
)
 
$
85,252

 
 
 
 
 
Weighted-average shares outstanding
 
26,184,219

 
26,074,797

Effect of dilutive securities
 

 
99,796

Weighted-average shares outstanding - assuming dilution
 
26,184,219

 
26,174,593

 
 
 
 
 
Earnings per share
 
$
(0.25
)
 
$
0.00

Earnings per share - assuming dilution
 
$
(0.25
)
 
$
0.00


13.            SUPPLEMENTAL CASH FLOWS INFORMATION
 
Other Cash Flows Information
 
Cash paid for interest was $0.9 million, $0.4 million, $1.9 million and $1.3 million during the three month periods ended September 27, 2015 and September 28, 2014 and nine month periods ended September 27, 2015 and September 28, 2014, respectively.
 
Cash paid for income taxes was $0, $22,000, $94,290 and $22,000 during the three month periods ended September 27, 2015 and September 28, 2014 and nine month periods ended September 27, 2015 and September 28, 2014, respectively.

Supplemental Schedule of Non-Cash Operating, Investing, and Financing Activities
 
Noncash investing activities for property and equipment not yet paid during the nine months ended September 27, 2015 and September 28, 2014, was $0.7 million and $1.4 million, respectively.  

14.           FAIR VALUE OF FINANCIAL INSTRUMENTS
 
The guidance for fair value measurements, FASB 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:
 

18

DIVERSIFIED RESTAURANT HOLDINGS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 
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 September 27, 2015 and December 28, 2014, respectively, our financial instruments consisted of cash and cash equivalents; including money market funds, accounts receivable, available-for-sale investments, accounts payable, and debt. The fair value of cash and cash equivalents, accounts receivable, and accounts payable approximate carrying value, due to their short-term nature.
  
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. See Note 1 and Note 7 for additional information pertaining to interest rates swaps.
 
The estimated fair values of the Company’s investment portfolio are based on prices provided by a third party pricing service and a third party investment manager. The prices provided by these services are based on quoted market prices, when available, non-binding broker quotes, or matrix pricing. The third party pricing service and the third party investment manager provide a single price or quote per security and the Company has not historically adjusted security prices. The Company obtains an understanding of the methods, models and inputs used by the third party pricing service and the third party investment manager, and has controls in place to validate that amounts provided represent fair values. Our investments are classified as a Level 2 measurement as these securities are not actively traded in the market, but are observable based on the quoted prices provided by our Portfolio managers.
 
As of September 27, 2015 and December 28, 2014, our total debt was approximately $123.9 million and $61.8 million, respectively, which approximated fair value. The Company estimates the fair value of its variable-rate debt using discounted cash flow analysis based on the Company’s incremental borrowing rate (Level 2).
 
There were no transfers between levels of the fair value hierarchy during the three months ended September 27, 2015 and the fiscal year ended December 28, 2014.

The following table presents the fair values for those assets and liabilities measured on a recurring basis as of September 27, 2015:
 
FAIR VALUE MEASUREMENTS
Description
 
Level 1
 
Level 2
 
Level 3
 
Asset/(Liability)
Total
Cash equivalents
 
$
7,518,833

 
$

 
$

 
$
7,518,833

Interest rate swaps
 

 
(2,278,574
)
 

 
(2,278,574
)
Total
 
$
7,518,833

 
$
(2,278,574
)
 
$

 
$
5,240,259

 
 

19

DIVERSIFIED RESTAURANT HOLDINGS, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

The following table presents the fair values for those assets and liabilities measured on a recurring basis as of December 28, 2014:
 
FAIR VALUE MEASUREMENTS
Description
 
Level 1
 
Level 2
 
Level 3
 
Asset/(Liability)
Total
Interest rate swaps
 
$

 
$
(259,626
)
 
$

 
$
(259,626
)
Debt securities
 
 
 
 
 
 
 
 
Obligations of states/municipals
 

 
1,185,983

 

 
1,185,983

Corporate securities
 

 
1,731,249

 

 
1,731,249

Total debt securities
 

 
2,917,232

 

 
2,917,232

Total
 
$

 
$
2,657,606

 
$

 
$
2,657,606

 

15.     ACCUMULATED OTHER COMPREHENSIVE LOSS
 
The following table summarizes each component of Accumulated Other Comprehensive loss for the three-month and nine-month periods ended September 27, 2015 and September 28, 2014:

 
 
Three Months Ended September 27, 2015
 
Three Months Ended September 28, 2014
 
 
Interest Rate Swap
 
Investments
 
Total
 
Interest Rate Swap
 
Investments
 
Total
Beginning balance
 
$
(384,325
)
 
$

 
$
(384,325
)
 
$
(249,368
)
 
$
(11,317
)
 
$
(260,685
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Gain(loss) recorded to other comprehensive income
 
(1,696,261
)
 

 
(1,696,261
)
 
127,305

 
(6,565
)
 
120,740

Tax benefit (expense)
 
576,729

 

 
576,729

 
(43,284
)
 
2,232

 
(41,052
)
Other comprehensive income (loss)
 
(1,119,532
)
 

 
(1,119,532
)
 
84,021

 
(4,333
)
 
79,688

 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated OCL
 
$
(1,503,857
)
 
$

 
$
(1,503,857
)
 
$
(165,347
)
 
$
(15,650
)
 
$
(180,997
)


 
 
Nine Months Ended September 27, 2015
 
Nine Months Ended September 28, 2014
 
 
Interest Rate Swap
 
Investments
 
Total
 
Interest Rate Swap
 
Investments
 
Total
Beginning balance
 
$
(171,352
)
 
$
(3,804
)
 
$
(175,156
)
 
$
(216,188
)
 
$
(29,176
)
 
$
(245,364
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Gain(loss) recorded to other comprehensive income
 
(2,018,947
)
 
5,762

 
(2,013,185
)
 
77,032

 
20,495

 
97,527

Tax benefit (expense)
 
686,442

 
(1,958
)
 
684,484

 
(26,191
)
 
(6,969
)
 
(33,160
)
Other comprehensive income (loss)
 
(1,332,505
)
 
3,804

 
(1,328,701
)
 
50,841

 
13,526

 
64,367

 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated OCL
 
$
(1,503,857
)
 
$

 
$
(1,503,857
)
 
$
(165,347
)
 
$
(15,650
)
 
$
(180,997
)


20


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 28, 2014. Information included in this discussion and analysis includes commentary on company-owned restaurant, restaurant sales, and same store sales. Management believes such sales information is an important measure of our performance, and is useful in assessing consumer acceptance of the Buffalo Wild Wings® Grill & Bar (“BWW”) and Bagger Dave’s Tavern® (“Bagger Dave’s”) concepts and the overall health of the concepts. However, same store sales information does not represent sales, in accordance with accounting principles generally accepted in the United States of America (“GAAP”), should not be considered in isolation or as a substitute for other measures of performance prepared in accordance with GAAP and may not be comparable to financial information as defined or used by other companies.
 
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; and 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 ("SEC"), 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 SEC. We expressly disclaim any intent or obligation to update any forward-looking statements.
 
OVERVIEW
 
Diversified Restaurant Holdings, Inc. (“DRH”) is a fast-growing restaurant company operating two complementary concepts:   BWW and Bagger Dave’s.  As the largest franchisee of BWW and the creator, developer, and operator of Bagger Dave’s and, we provide a unique guest experience in a casual and inviting environment.  We were incorporated in 2006 and are headquartered in the Detroit metropolitan area.  As of September 27, 2015, we had 85 locations in Florida, Illinois, Indiana, Michigan and Missouri.
 
DRH is the largest BWW franchisee. As of November 6, 2015, DRH operates 62 DRH-owned BWW restaurants (20 in Michigan, 15 in Florida, seven in Illinois, five in Indiana and 15 in Missouri), including the nation’s largest BWW restaurant, based on square footage, in downtown Detroit, Michigan. We remain on track to fulfill our area development agreement (“ADA”) with Buffalo Wild Wings International, Inc. (“BWLD”) and expect to operate 80 DRH-owned BWW restaurants by the end of 2020, exclusive of potential additional BWW restaurant acquisitions. 
  
DRH originated the Bagger Dave’s concept with our first restaurant opening in January 2008 in Berkley, Michigan.  As of November 6, 2015, there are 25 Bagger Dave’s, 17 in Michigan and eight in Indiana. In the year ahead, we plan to focus our resources primarily on growing our BWW portfolio, which represents the overwhelming majority of both our revenue and adjusted EBITDA.  Accordingly, we will not commit to any further development of Bagger Dave’s beyond the two restaurants currently under construction.  We currently have two additional Bagger Dave’s under development, one of which will open in November of 2015 and the other in the First Quarter 2016.



21


RESTAURANT OPENINGS
 
The following table outlines the restaurant unit information for each fiscal year from 2011 through 2015.
 
 
2015
(estimate)
 
2014
 
2013
 
2012
 
2011
Summary of restaurants open at the beginning of year
 
 
 
 
 
 
 
 
 
 
DRH-owned BWW
 
42

 
36

 
33

 
22

 
19

Bagger Dave’s
 
24

 
18

 
11

 
6

 
3

Total
 
66

 
54

 
44

 
28

 
22

 
 
 
 
 
 
 
 
 
 
 
Openings:
 
 
 
 
 
 
 
 
 
 
DRH-owned BWW
 
3

 
3

 
3

 
3

 
3

Bagger Dave’s
 
5

 
6

 
7

 
5

 
3

BWW Acquisitions
 
18

 
3

 

 
8

 

Closures
 
(3
)
 

 

 

 

Total restaurants
 
89

 
66

 
54

 
44

 
28


RESULTS OF OPERATIONS
 
For the three-month period ended September 27, 2015 ("Third Quarter 2015") and nine-month period ended September 27, 2015 ("Year to Date 2015"), revenue was generated from the operations of 62 BWW restaurants and 23 Bagger Dave’s restaurants. For the three-month period ended September 28, 2014 ("Third Quarter 2014") and the nine-month period ended September 28, 2014 ("Year to Date 2014"), revenue was generated from the operations of 40 BWW restaurants and 21 Bagger Dave’s restaurants. Quarterly and annual operating results may fluctuate significantly as a result of a variety of factors, including the timing and number of new restaurant openings and related expenses, increases or decreases in same store sales, changes in commodity prices, general economic conditions, and seasonal fluctuations. As a result, our quarterly results of operations are not necessarily indicative of the results that may be achieved for any future period. Same store sales is defined as a restaurant's comparable sales in the first full month following the 18th month of operations for BWW and the 24th month for Bagger Dave's. Changes in comparable restaurant sales reflect changes in sales for the comparable group of restaurants over a specified period of time. Our comparable restaurant base consisted of 68 and 46 restaurants at September 27, 2015 and September 28, 2014, respectively.

Results of Operations for the Three Months Ended September 27, 2015 and September 28, 2014
 
 
 
Three Months Ended
 
 
September 27, 2015
September 28, 2014
Total revenue
 
100.0
 %
100.0
%
 
 
 
 
Operating expenses
 
 
 
Restaurant operating costs:
 
 
 
Food, beverage, and packaging costs
 
28.7
 %
28.8
%
Compensation costs
 
27.7
 %
25.6
%
Occupancy costs
 
7.5
 %
5.7
%
Other operating costs
 
22.3
 %
22.0
%
General and administrative expenses
 
8.6
 %
6.5
%
Pre-opening costs
 
1.4
 %
1.9
%
Depreciation and amortization
 
9.5
 %
8.7
%
Impairment and loss on asset disposals
 
1.1
 %
0.1
%
Total operating expenses
 
106.8
 %
99.3
%
 
 
 
 
Operating income (loss)
 
(6.8
)%
0.7
%


22


Revenue for Third Quarter 2015 was $47.1 million, an increase of $14.3 million, or 43.6%, over the $32.8 million of revenue generated during Third Quarter 2014. The increase was attributable to increased same store sales, acquisition of 18 BWW locations, and the opening of 10 DRH-owned restaurants (four BWW restaurants and six Bagger Dave’s, one opened the last week of Third Quarter 2014). Of the increase, $0.5 million was attributable to the 1.3% same store sales increase of 57 BWW and 11 Bagger Dave’s restaurants. $10.2 million was attributable to the acquisition of 18 BWW restaurants on June 29, 2015. The remaining increase of $3.6 million was a result of restaurants operating outside our comparable sales base, including 12 Bagger Dave’s and five BWW restaurants. The Company's 1.3% increase in same store sales is a result of an increase of 1.5% same store sales for BWW and decrease of 1.5% for Bagger Dave's.
 
Food, beverage, and packaging costs increased by $4.0 million, or 42.8%, to $13.5 million in Third Quarter 2015 from $9.5 million in Third Quarter 2014.  The increase was primarily due to an increased number of restaurants operating in 2015. Food, beverage, and packaging costs as a percentage of revenue decreased to 28.7% in Third Quarter 2015 from 28.8% in Third Quarter 2014 primarily due to the increase of menu prices, partially offset by higher chicken wing prices and increased food costs driven by our new menu rollout at Bagger Dave’s. Average cost per pound for bone-in chicken wings was $1.78 in Third Quarter 2015 compared to $1.50 in Third Quarter 2014.
 
Compensation costs increased by $4.6 million, or 55.1%, to $13.0 million in Third Quarter 2015 from $8.4 million in Third Quarter 2014.  The increase was primarily due to an increased number of restaurants operating in 2015.  Compensation costs as a percentage of sales increased to 27.7% in Third Quarter 2015 from 25.6% in Third Quarter 2014 primarily driven by increased labor to properly execute an extensive menu change at Bagger Dave's. The Company 's investment in hourly labor related to new menu training and execution was approximately 0.8% of sales, the remaining variance from the prior year was driven by wage pressures and minimum staffing standards implemented in the Fourth Quarter 2014 for Bagger Dave's to ensure guest satisfaction.
 
Occupancy costs increased by $1.7 million, or 88.4%, to $3.5 million in Third Quarter 2015 from $1.9 million in Third Quarter 2014.  This increase is primarily due to the increased number of restaurants operating in 2015. Occupancy as a percentage of sales increased to 7.5% in Third Quarter 2015 from 5.7% in Third Quarter 2014, primarily due to the sale leaseback transaction executed in late 2014 and the cost associated with of the early lease termination for the three Bagger Dave's locations closed in the Third Quarter 2015. These non-recurring expenses amounted to approximately 1.0% of sales. The remaining variance stems from the acquisition of 18 BWW locations with higher occupancy costs as a percentage of sales than our prior average.
 
Other operating costs increased by $3.3 million, or 45.2%, to $10.5 million in Third Quarter 2015 from $7.2 million in Third Quarter 2014.  The increase was primarily due to an increased number of restaurants operating in 2015. Other operating costs as a percentage of sales increased to 22.3% in Third Quarter 2015 from 22.0% in Third Quarter 2014, primarily due to expenses associated with the acquisition of the 18 restaurants on June 29, 2015.
 
General and administrative expenses increased by $1.9 million, or 88.8%, to $4.0 million in Third Quarter 2015 from $2.1 million in Third Quarter 2014.  The increase was related to several non-reoccurring expenses including the acquisition of 18 BWW restaurants, execution of the final sale leaseback, and transitioning our accounting duties in house rather than using a third party firm. General and administrative expenses as a percentage of sales increased to 8.6% in Third Quarter 2015 from 6.5% in Third Quarter 2014. These non-recurring investments amounted to approximately 1.8% of sales.
 
Pre-opening costs increased by $0.1 million, or 7.2%, to $0.7 million in Third Quarter 2015 from $0.6 million in Third Quarter 2014. Pre-opening costs as a percentage of sales decreased to 1.4% in Third Quarter 2015 from 1.9% in Third Quarter 2014.
 
Depreciation and amortization increased by $1.6 million, or 55.4%, to $4.5 million in Third Quarter 2015 from $2.9 million in Third Quarter 2014.  This increase was primarily due to an increased number of restaurants operating in 2015.  Depreciation and amortization as a percentage of sales increased to 9.5% in Third Quarter 2015 from 8.7% in Third Quarter 2014.

Loss on asset disposals increased by $0.5 million, or 1,511.9%, to $0.5 million in Third Quarter 2015 from $33,013 in Third Quarter 2014. The $0.5 million was the result of a $0.2 million loss on our most recent sale leaseback and the remaining $0.3 million was a direct result of remodels and refreshes of existing restaurants. Loss on asset disposals as a percentage of sales increased to 1.1% in Third Quarter 2015 from 0.1% in Third Quarter 2014.


23


Results of Operations for the Nine Months Ended September 27, 2015 and September 28, 2014
 
 
 
Nine Months Ended
 
 
September 27, 2015
September 28, 2014
Total revenue
 
100.0
 %
100.0
%
 
 
 
 
Operating expenses
 
 
 
Restaurant operating costs:
 
 
 
Food, beverage, and packaging costs
 
28.8
 %
28.7
%
Compensation costs
 
26.7
 %
25.9
%
Occupancy costs
 
6.8
 %
5.4
%
Other operating costs
 
21.3
 %
21.0
%
General and administrative expenses
 
9.9
 %
6.8
%
Pre-opening costs
 
1.9
 %
2.2
%
Depreciation and amortization
 
8.8
 %
8.2
%
Impairment and loss on asset disposals
 
2.4
 %
0.4
%
Total operating expenses
 
106.6
 %
98.6
%
 
 
 
 
Operating income (loss)
 
(6.6
)%
1.4
%

Revenue for Year to Date 2015 was $123.4 million, an increase of $30.1 million or 32.3% over the $93.3 million of revenue generated during Year to Date 2014. The increase was attributable to increased same store sales, acquisition of 21 BWW locations (three in the Third Quarter 2014 and 18 in the Third Quarter 2015), and the opening of 10 DRH-owned restaurants (four BWW restaurants and six Bagger Dave’s). Of the increase, $3.9 million was attributable to the 4.1% same store sales increase of 57 BWW and 11 Bagger Dave’s restaurants. $3.2 million was attributable to the acquisition of three BWW restaurants on June 30, 2014. $10.2 million was attributable to the acquisition of 18 BWW restaurants on June 29, 2015. The remaining $12.8 million is a result of restaurants operating outside our comparable sales base, including 12 Bagger Dave’s and five BWW restaurants. The Company's 4.1% increase in same store sales is a result of an increase of 4.8% same store sales for Bagger Dave's and 4.0% same store sales for BWW.

Food, beverage, and packaging costs increased by $8.7 million or 32.6% to $35.5 million in Year to Date 2015 from $26.8 million in Year to Date 2014.  The increase was primarily due to the increased number of restaurants operating in 2015.  Food, beverage, and packaging costs as a percentage of sales increased to 28.8% in Year to Date 2015 from 28.7% in Year to Date 2014 due to higher chicken wing prices offset partially by the increase of menu prices. Average cost per pound for bone-in chicken wings was $1.81 in Year to Date 2015 compared to $1.41 in Year to Date 2014.
 
Compensation costs increased by $8.8 million or 36.3% to $32.9 million in Year to Date 2015 from $24.2 million in Year to Date 2014. This increase was primarily due to the increased number of restaurants operating in 2015. Compensation as a percentage of sales increased to 26.7% in Year to Date 2015 compared to 25.9% Year to Date 2014 primarily driven by increased labor to properly execute an extensive menu change at Bagger Dave's in the Third Quarter 2015. The Company's investment in hourly labor related to new menu training and execution results in 0.3% of total sales realized Year to Date 2015, the remaining variance is driven by wage pressures and minimum staffing standards implemented in the Fourth Quarter 2014 for Bagger Dave's to ensure guest satisfaction.
 
Occupancy costs increased by $3.3 million or 65.0% to $8.3 million in Year to Date 2015 from $5.1 million in Year to Date 2014.  This increase was primarily due to the increased number of restaurants operating in 2015. Occupancy cost as a percentage of sales increased to 6.8% in Year to Date 2015 from 5.4% in Year to Date 2014 primarily due to the execution of the sale leaseback of DRH-owned properties in late 2014 and the costs associated with the early lease termination for the three Bagger Dave's locations closed in the Third Quarter 2015. The net effect of the sale leaseback transaction and the write-down of the lease obligations amounted to 0.8% of sales for the Year to Date 2015 period.
 
Other operating costs increased by $6.6 million or 33.8% to $26.3 million in Year to Date 2015 from $19.6 million in Year to Date 2014.  This increase was primarily due to the increased number of restaurants operating in 2015.  Other operating costs as a percentage of sales increased to 21.3% in Year to Date 2015 from 21.0% in Year to Date 2014 due to technology enhancements

24


to drive guest experience, data integrity and efficiency, increased repair and maintenance expenses and higher credit card fees due to increased usage.
 
General and administrative cost increased by $5.9 million or 92.2% to $12.2 million in Year to Date 2015 from $6.3 million in Year to Date 2014.   The increase was primarily due to a loss provision of $1.9 million stemming from estimated settlement costs and expenses related to a wage-claim litigation, as discussed in Note 11 to the financial statements, as well as acquisition related costs, two sale leaseback transactions, and additional staffing for our recent growth and accounting activities. General and administrative cost as a percentage of sales increased to 9.9% in Year to Date 2015 from 6.8% in Year to Date 2014. Non-recurring corporate expenses were approximately 2.4% of sales.
 
Pre-opening cost increased by $0.3 million or 12.6% to $2.3 million in Year to Date 2015 from $2.1 million in Year to Date 2014.  The increase in pre-opening costs was due to the timing and overall cost to open new restaurants during the period, including extended training to ensure a quality guest experience during the opening period.  Pre-opening cost as a percentage of sales decreased to 1.9% in Year to Date 2015 from 2.2% in Year to Date 2014.
 
Depreciation and amortization cost increased by $3.2 million or 42.7% to $10.9 million in Year to Date 2015 from $7.6 million in Year to Date 2014.  This increase was primarily due to the increased number of restaurants operating in 2015.  Depreciation and amortization cost as a percentage of sales increased to 8.8% in Year to Date 2015 from 8.2% in Year to Date 2014
 
Impairment and loss on asset disposals increased by $2.6 million or 749.2% to $3.0 million in Year to Date 2015 from $0.4 million in Year to Date 2014.  $1.8 million of the increase was due to the asset impairment pertaining to the closure of three Bagger Dave's locations, as discussed in Note 1 and 4 to the financial statements. The remaining $0.8 million was due to the sale leaseback transactions and restaurant remodels. Impairment and loss on asset disposals as a percentage of sales increased to 2.4% in Year to Date 2015 from 0.4% in Year to Date 2014.

INTEREST, OTHER INCOME AND TAXES
 
Interest expense was $1.8 million and $0.5 million during Third Quarter 2015 and Third Quarter 2014, respectively. $0.4 million was a result of disposing old loan fees and expensing a portion of the current loan fees, see Note 7 for additional detail. The remaining $0.8 million is a result of increased debt related to the acquisition and building of new restaurants. Interest expense was $2.8 million and $1.4 million during Year to Date 2015 and Year to Date 2014, respectively. 

Other Income was $34,475 and $67,789 during Third Quarter 2015 and Third Quarter 2014, respectively. Other Income was $0.8 million and $86,426 during Year to Date 2015 and Year to Date 2014, respectively. The increase was due to a transaction fee related to a BWW franchise acquisition.
 
For Third Quarter 2015, DRH had an income tax benefit of $1.4 million compared to an income tax benefit