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EX-32.2 - EXHIBIT 32.2 - Diversified Restaurant Holdings, Inc.ex32210q-6262016.htm
EX-32.1 - EXHIBIT 32.1 - Diversified Restaurant Holdings, Inc.ex32110q-6262016.htm
EX-31.2 - EXHIBIT 31.2 - Diversified Restaurant Holdings, Inc.ex31210q-6262016.htm
EX-31.1 - EXHIBIT 31.1 - Diversified Restaurant Holdings, Inc.ex31110q-6262016.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 June 26, 2016 
 
[_] 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:  26,657,436 shares of $.0001 par value common stock outstanding as of August 3, 2016.
 
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
 
Item 1.  Financial Statements
 
DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
ASSETS
 
June 26, 2016
 
December 27, 2015
 
 
(unaudited)
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
5,537,822

 
$
14,200,528

Accounts receivable
 
508,245

 
620,942

Inventory
 
1,872,057

 
1,934,584

Prepaid assets
 
1,307,165

 
1,618,429

Total current assets
 
9,225,289

 
18,374,483

 
 
 
 
 
Deferred income taxes
 
14,630,653

 
13,320,177

Property and equipment, net
 
81,162,442

 
79,189,661

Intangible assets, net
 
3,388,585

 
3,638,716

Goodwill
 
50,097,081

 
50,097,081

Other long-term assets
 
1,141,900

 
1,152,377

Total assets
 
$
159,645,950

 
$
165,772,495

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
5,601,690

 
$
7,807,552

Accrued compensation
 
2,763,165

 
3,087,883

Other accrued liabilities
 
3,153,133

 
3,663,211

Current portion of long-term debt
 
9,843,746

 
9,891,825

Current portion of deferred rent
 
334,637

 
396,113

Total current liabilities
 
21,696,371

 
24,846,584

 
 
 
 
 
Deferred rent, less current portion
 
3,036,979

 
2,826,210

Unfavorable operating leases
 
631,400

 
671,553

Other long-term liabilities
 
6,186,273

 
4,463,631

Long-term debt, less current portion
 
112,461,267

 
116,364,165

Total liabilities
 
144,012,290

 
149,172,143

 
 
 
 
 
Commitments and contingencies (Notes 9 and 10)
 

 

 
 
 
 
 
Stockholders' equity
 
 
 
 
Common stock - $0.0001 par value; 100,000,000 shares authorized; 26,619,811 and 26,298,725, respectively, issued and outstanding
 
2,586

 
2,584

Additional paid-in capital
 
36,335,496

 
36,136,332

Accumulated other comprehensive loss
 
(2,420,504
)
 
(1,006,667
)
Accumulated deficit
 
(18,283,918
)
 
(18,531,897
)
Total stockholders' equity
 
15,633,660

 
16,600,352

 
 
 
 
 
Total liabilities and stockholders' equity
 
$
159,645,950

 
$
165,772,495

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
 
Six Months Ended
 
 
June 26, 2016
 
June 28, 2015
 
June 26, 2016
 
June 28, 2015
Revenue
 
$
46,391,046

 
$
36,871,838

 
$
94,803,845

 
$
76,312,170

 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
 
 
 
 
 
 
 
 
Food, beverage, and packaging costs
 
13,058,782

 
10,561,270

 
26,754,325

 
22,009,173

Compensation costs
 
12,378,780

 
9,754,171

 
24,890,721

 
19,908,963

Occupancy costs
 
3,051,165

 
2,432,350

 
6,221,920

 
4,804,817

Other operating costs
 
9,684,253

 
7,811,480

 
19,723,097

 
15,772,029

General and administrative expenses
 
2,814,979

 
5,674,963

 
5,477,737

 
8,171,850

Pre-opening costs
 
649,119

 
576,390

 
921,483

 
1,669,890

Depreciation and amortization
 
4,402,183

 
3,250,701

 
8,709,900

 
6,408,023

Impairment and loss (gain) on asset disposal
 
(609,751
)
 
2,320,059

 
(543,623
)
 
2,468,467

Total operating expenses
 
45,429,510

 
42,381,384

 
92,155,560

 
81,213,212

 
 
 
 
 
 
 
 
 
Operating profit (loss)
 
961,536

 
(5,509,546
)
 
2,648,285

 
(4,901,042
)
 
 
 
 
 
 
 
 
 
Interest expense
 
(1,440,562
)
 
(559,035
)
 
(2,885,502
)
 
(991,258
)
Other income, net
 
39,633

 
727,258

 
84,905

 
744,261

 
 
 
 
 
 
 
 
 
Loss before income taxes
 
(439,393
)
 
(5,341,323
)
 
(152,312
)
 
(5,148,039
)
 
 
 
 
 
 
 
 
 
Income tax benefit
 
(256,967
)
 
(2,022,980
)
 
(400,291
)
 
(2,092,338
)
 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(182,426
)
 
$
(3,318,343
)
 
$
247,979

 
$
(3,055,701
)
 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
(0.01
)
 
$
(0.13
)
 
$
0.01

 
$
(0.12
)
Fully diluted earnings per share
 
$
(0.01
)
 
$
(0.13
)
 
$
0.01

 
$
(0.12
)
 
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding
 
 
 
 
 
 
 
 
Basic
 
26,379,065

 
26,151,853

 
26,338,549

 
26,150,518

Diluted
 
26,379,065

 
26,151,853

 
26,338,549

 
26,150,518

 
 











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

3


DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (unaudited)
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 26, 2016
 
June 28, 2015
 
June 26, 2016
 
June 28, 2015
 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
(182,426
)
 
$
(3,318,343
)
 
$
247,979

 
$
(3,055,701
)
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss)
 
 
 
 
 
 
 
 
Unrealized changes in fair value of interest rate swaps, net of tax of $188,044, $51,980, $728,340 and $109,713, respectively
 
(365,027
)
 
100,900

 
(1,413,837
)
 
(212,973
)
Unrealized changes in fair value of investments, net of tax of $0, $0 $0 and $1,959, respectively
 

 

 

 
3,804

Total other comprehensive income (loss)
 
(365,027
)
 
100,900

 
(1,413,837
)
 
(209,169
)
 
 
 
 
 
 
 
 
 
Comprehensive loss
 
$
(547,453
)
 
$
(3,217,443
)
 
$
(1,165,858
)
 
$
(3,264,870
)
 
 




































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
 
Retained
Earnings
 
Total
 
Common Stock
 
Paid-in
 
Comprehensive
 
(Accumulated
 
Stockholders'
 
Shares
 
Amount
 
Capital
 
Income (Loss)
 
Deficit)
 
Equity
 Balances - December 28, 2014
26,149,824

 
$
2,582

 
$
35,668,001

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

 
 
 
 
 
 
 
 
 
 
 
 
Issuance of restricted shares
47,502

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
Forfeitures of restricted shares
(3,586
)
 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
Employee stock purchase plan
10,205

 

 
40,360

 

 

 
40,360

 
 
 
 
 
 
 
 
 
 
 
 
Share-based compensation

 

 
162,563

 

 

 
162,563

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

 

 
(98,252
)
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive loss

 

 

 
(209,169
)
 

 
(209,169
)
 
 
 
 
 
 
 
 
 
 
 
 
Net loss

 

 

 

 
(3,055,701
)
 
(3,055,701
)
 
 
 
 
 
 
 
 
 
 
 
 
Balances - June 28, 2015
26,179,445

 
$
2,580

 
$
35,772,674

 
$
(384,325
)
 
$
(5,395,106
)
 
$
29,995,823

 
 
 
 
 
 
 
 
 
 
 
 
Balances - December 27, 2015
26,298,725

 
$
2,584

 
$
36,136,332

 
$
(1,006,667
)
 
$
(18,531,897
)
 
$
16,600,352

 
 
 
 
 
 
 
 
 
 
 
 
Issuance of restricted shares
335,831

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
Forfeitures of restricted shares
(22,351
)
 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
Shares effectively repurchased for required employee withholding taxes
(5,940
)
 

 
(9,326
)
 

 

 
(9,326
)
 
 
 
 
 
 
 
 
 
 
 
 
Employee stock purchase plan
13,546

 
2

 
20,780

 

 

 
20,782

 
 
 
 
 
 
 
 
 
 
 
 
Share-based compensation

 

 
187,710

 

 

 
187,710

 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive loss

 

 

 
(1,413,837
)
 

 
(1,413,837
)
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 
247,979

 
247,979

 
 
 
 
 
 
 
 
 
 
 
 
Balances - June 26, 2016
26,619,811

 
$
2,586

 
$
36,335,496

 
$
(2,420,504
)
 
$
(18,283,918
)
 
$
15,633,660

 
 




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)
 
 
 
Six Months Ended
 
 
June 26, 2016
 
June 28, 2015
Cash flows from operating activities
 
 
 
 
Net income (loss)
 
$
247,979

 
$
(3,055,701
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities
 
 
 
 
Depreciation and amortization
 
8,709,900

 
6,408,023

Amortization of debt discount and loan fees
 
117,238

 
14,214

Amortization of gain on sale-leaseback
 
(78,604
)
 
(78,604
)
Impairment and loss (gain) on asset disposals
 
(543,623
)
 
2,468,467

Share-based compensation, net
 
187,710

 
162,563

Deferred income taxes
 
(582,136
)
 
(1,929,924
)
Changes in operating assets and liabilities that provided (used) cash
 
 
 
 
Accounts receivable
 
112,697

 
1,187,273

Inventory
 
62,527

 
(135,234
)
Prepaid assets
 
311,264

 
(369,353
)
Intangible assets
 
(394,483
)
 
(129,426
)
Other long-term assets
 
10,477

 
(778,071
)
Accounts payable
 
(1,201,271
)
 
(955,715
)
Accrued liabilities
 
(1,175,727
)
 
1,780,743

Deferred rent
 
149,293

 
17,169

Net cash provided by operating activities
 
5,933,241

 
4,606,424

 
 
 
 
 
Cash flows from investing activities
 
 
 
 
Proceeds from sale of investments
 

 
2,952,302

Proceeds from sale of property and equipment, net of fees
 
1,134,717

 

Purchases of property and equipment
 
(11,716,557
)
 
(12,646,471
)
Net cash used in investing activities
 
(10,581,840
)
 
(9,694,169
)
 
 
 
 
 
Cash flows from financing activities
 
 
 
 
Proceeds from issuance of long-term debt
 
7,109,154

 
7,551,319

Repayments of long-term debt
 
(11,134,717
)
 
(4,000,000
)
Repurchase of stock
 

 
(98,252
)
Proceeds from employee stock purchase plan
 
20,782

 
40,360

Tax withholdings for restricted stock units
 
(9,326
)
 

Net cash (used in) provided by financing activities
 
(4,014,107
)
 
3,493,427

 
 
 
 
 
Net decrease in cash and cash equivalents
 
(8,662,706
)
 
(1,594,318
)
 
 
 
 
 
Cash and cash equivalents, beginning of period
 
14,200,528

 
18,688,281

 
 
 
 
 
Cash and cash equivalents, end of period
 
$
5,537,822

 
$
17,093,963

 
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 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 June 26, 2016, we had 83 locations in Florida, Illinois, Indiana, Michigan, Missouri and Ohio.
  
DRH is the largest BWW franchisee and currently operates 64 DRH-owned BWW restaurants (20 in Michigan, 17 in Florida, seven in Illinois, five in Indiana and 15 in Missouri), including the nation’s largest BWW, 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 77 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.  Currently, there are 19 Bagger Dave’s, 16 in Michigan and one in Indiana and two in Ohio.
 
Basis of Presentation
 
The consolidated financial statements as of June 26, 2016 and December 27, 2015, and for the three and six-month periods ended June 26, 2016 and June 28, 2015, 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 June 26, 2016 and for the three and six-month periods ended June 26, 2016 and June 28, 2015 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 27, 2015 is derived from our audited consolidated financial statements and notes thereto for the fiscal year ended December 27, 2015, which is included in Item 8 in the Fiscal 2015 Annual Report on Form 10-K, and should be read in conjunction with such consolidated financial statements.
 
The results of operations for the three and six-month periods ended June 26, 2016 are not necessarily indicative of the results of operations that may be achieved for the entire fiscal year ending December 25, 2016.
 
Segment Reporting
 
During the First Quarter 2016, the Company reorganized segment reporting from one reportable segment to two reportable segments, BWW and Bagger Dave's, due to differences that have developed in the economic characteristics between the two concepts. All prior period information was recast to reflect this change. The Company’s reportable segments are organized based on restaurant concept. Resources are allocated and performance is assessed for the concepts by the Company’s Chief Executive Officer, Chief Financial Officer and Chief Operating Officer whom the Company has determined to be its Chief Operating Decision Makers. See Note 15 for additional information.

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 June 26, 2016 and December 27, 2015, we had goodwill of $50.1 million, that was assigned to our BWW operating segment.
 
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.

7

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

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 December 27, 2015, based on our quantitative analysis, goodwill was considered recoverable. At June 26, 2016, 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. No impairment was recognized for quarter-ended June 26, 2016. During the quarter-ended June 28, 2015, the Company recorded an impairment loss of $1.2 million related to three Bagger Dave's locations. We continue to monitor several other restaurants for potential impairment of long-lived assets while we continue to develop plans to improve operating results. As such, based on our current estimates of the future operating results of these restaurants, we believe that the assets at these restaurants are not impaired. 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. For additional details refer to the 2015 10-K filed on March 11, 2015.

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. During fiscal 2015, the Company decided to close 12 underperforming locations, eight in Indiana, three in Michigan and one in Florida. The Company closed the restaurants during the third and fourth quarters of 2015. In connection with the 2015 closures, the Company recorded a liability of $1.3 million, for the net present value of any remaining lease obligations, net of estimated sublease income. As of June 26, 2016, a liability of $417,599 remains on our Consolidated Balance Sheet and is classified as Other accrued liabilities. For additional details refer to the 2015 10-K filed on March 11, 2015.

Indefinite-Lived Intangible Assets

Liquor licenses, also a component of intangible assets, are deemed to have an indefinite life and, accordingly, are not amortized. Management reviews liquor license assets on an annual basis (at year-end) to determine whether carrying values have been impaired. We identify potential impairments for liquor licenses by comparing the fair value with its carrying amount. If the fair value exceeds the carrying amount, the liquor licenses are not impaired. If the carrying amount exceeds the fair value, an impairment loss is recorded for the difference.  If the fair value of the asset is less than the carrying amount, an impairment is recorded. No impairments were recognized for quarter-ended June 26, 2016 or fiscal year ended December 27, 2015.

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 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 6 and Note 13 for additional information on the interest rate swap agreements.
 
Recent Accounting Pronouncements

In March 2016, the FASB issued Accounting Standards Update ("ASU") 2016-09, Topic 718: Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"). ASU 2016-09 simplifies several aspects of accounting for share-based payment award transactions, including income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. ASU 2016-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, with early adoption permitted. The Company is in the process of assessing the impact of adoption of ASU 2016-09 on its consolidated financial statements.

In February 2016, FASB issued ASU 2016-02, Leases ("ASU 2016-02"). ASU 2016-02 requires that lease arrangements longer than 12 months result in a lessee recognizing a lease asset and liability. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The updated guidance is effective for interim and annual periods beginning after December 15, 2018, and early adoption is permitted. We are currently evaluating the impact of the updated guidance on our consolidated financial statements.
 
In May 2014, the FASB issued ASU 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 is effective for annual periods beginning after December 15, 2017, and interim periods therein.  We are currently evaluating the impact of our pending adoption of ASU 2014-09, although 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.

Recently Adopted Accounting Standards

In November 2015, the FASB issued ASU 2015-17, Topic 740: Balance Sheet Classification of Deferred Taxes (“ASU No. 2015-17”), which simplifies the presentation of deferred income taxes. ASU No. 2015-17 provides presentation requirements to classify deferred tax assets and liabilities as noncurrent in a classified statement of financial position. The Company adopted this standard as of December 27, 2015, with prospective application. The adoption of ASU No. 2015-17 had no impact on the Company’s Consolidated Statements of Operations and Comprehensive Loss.

In August 2015, the FASB issued ASU 2015-15, Interest - Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements. This ASU adds paragraphs pursuant to the Securities and Exchange Commission's ("SEC") Staff Announcement at the June 18, 2015 Emerging Issues Task Force meeting about the presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements. ASU 2015-15 states that given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to line-of-credit arrangements, the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit. The Company has historically recorded and will continue to record, debt issuance costs associated with the line-of-credit as an asset and subsequently amortize the deferred costs over the term of the line-of-credit, with there being no impact on previously issued financial statements.


9

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

In April 2015, the FASB issued ASU 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. We retrospectively adopted this guidance in First Quarter 2016. This resulted in a reclassification of the December 27, 2015 Consolidated Balance Sheet of $345,317 from Intangible assets, net to Current portion of long-term debt and Long-term debt, $27,002 and $318,315, respectively.
 

2.          PROPERTY AND EQUIPMENT
 
Property and equipment are comprised of the following assets:
 
 
June 26, 2016
 
December 27, 2015
Land
 
$

 
$
37,500

Building
 
3,932,646

 
2,339,219

Equipment
 
35,275,081

 
32,912,992

Furniture and fixtures
 
8,989,084

 
8,194,060

Leasehold improvements
 
77,382,253

 
72,148,545

Restaurant construction in progress
 
700

 
1,768,027

Total
 
125,579,764

 
117,400,343

Less accumulated depreciation
 
(44,417,322
)
 
(38,210,682
)
Property and equipment, net
 
$
81,162,442

 
$
79,189,661

At June 26, 2016 and December 27, 2015, $66,925 and $0.9 million, respectively, of fixed and intangible assets for the closed locations are held for sale, which are recorded in Property and equipment and Intangible assets on the Consolidated Balance Sheets. On June 8, 2016 we sold the Detroit Bagger Dave's building and land net of fees for approximately $1.1 million in proceeds, of which were used to pay down our term loan. We recorded a gain of $884,717, which is recorded in Impairment and loss (gain) on asset disposal on the Consolidated Statements of Operations. We anticipate selling the remaining assets held for sale in Third Quarter 2016.

3.        INTANGIBLE ASSETS
 
Intangible assets are comprised of the following:
 
 
June 26, 2016
 
December 27, 2015
Amortized intangibles:
 
 
 
 
Franchise fees
 
$
1,278,142

 
$
1,278,142

Trademark
 
70,576

 
66,826

Non-compete agreement
 
76,560

 
76,560

Favorable lease
 
351,344

 
351,344

Loan fees - Revolving line of credit and DLOC
 
368,084

 
368,084

Total
 
2,144,706

 
2,140,956

Less accumulated amortization
 
(640,537
)
 
(519,858
)
Amortized intangibles, net
 
1,504,169

 
1,621,098

 
 
 
 
 
Unamortized intangibles:
 
 
 
 
Liquor licenses
 
1,884,416

 
2,017,618

Total intangibles, net
 
$
3,388,585

 
$
3,638,716

 
Amortization expense for the three-month periods ended June 26, 2016 and June 28, 2015 and six-month periods ended June 26, 2016 and June 28, 2015 was $22,831, $17,322, $45,621 and $43,064 respectively. Amortization of favorable leases and loan fees are reflected as part of occupancy and interest expense, respectively.

10

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

 
The aggregate weighted-average amortization period for intangible assets is 10.6 years at June 26, 2016.  

4.           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 June 26, 2016 and June 28, 2015 and six-month periods ended June 26, 2016 and June 28, 2015 were $18,481, $139,270, $60,163 and $277,890, respectively.
 

5.     OTHER ACCRUED LIABILITES
 
June 26, 2016
 
December 27, 2015
Sales tax payable
$
862,795

 
$
987,795

Accrued interest
446,946

 
495,365

Closure liability - current
417,599

 
1,008,707

Accrued property taxes
389,331

 
349,131

Other
1,036,462

 
822,213

Total other accrued liabilities
$
3,153,133

 
$
3,663,211



6.           LONG-TERM DEBT
 
Long-term debt consists of the following obligations:
 
 
June 26, 2016
 
December 27, 2015
Note payable - $120.0 million term loan; payable to Citizens 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 June 26, 2016 was approximately 3.95%.
 
$
104,698,616

 
$
115,833,333

 
 
 
 
 
Note payable - $30.0 million development line of credit; payable to Citizens 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. The rate at June 26, 2016 was approximately 3.95%.
 
18,199,476

 
11,090,323

 
 
 
 
 
Unamortized discount and debt issuance costs
 
(593,079
)
 
(667,666
)
 
 
 
 
 
Total debt
 
122,305,013

 
126,255,990

 
 
 
 
 
Less current portion
 
(9,843,746
)
 
(9,891,825
)
 
 
 
 
 
Long-term debt, net of current portion
 
$
112,461,267

 
$
116,364,165

 
On June 29, 2015, the Company entered into a $155.0 million senior secured credit facility with Citizens (the “June 2015 Senior Secured Credit Facility”).  The June 2015 Senior Secured Credit Facility consists of a $120.0 million term loan (the “June 2015 Term Loan”), a $30.0 million development line of credit (the “June 2015 DLOC”) and a $5.0 million revolving line of credit (the “June 2015 RLOC”). The Company used approximately $65.5 million of the June 2015 Term Loan to refinance existing outstanding debt and used approximately $54.0 million of the June 2015 Term Loan to refinance an acquisition occurring in second quarter 2015.   The remaining balance of the June 2015 Term Loan, approximately $0.5 million, was used to pay the fees, costs, and expenses associated with the closing of the June 2015 Senior Secured Credit Facility.  The June 2015 Term Loan is for a period of five years.  Payments of principal are based upon an 12-month 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%, depending on the lease adjusted leverage ratio defined in the terms of the agreement.  The

11

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

entire remaining outstanding principal and accrued interest on the June 2015 Term Loan is due and payable on the maturity date of 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-month straight-line amortization schedule, plus interest, through maturity on June 29, 2020. The June 2015 RLOC is for a term of two years and no amounts were outstanding as of June 26, 2016.

Fees related to the term debt are recorded as debt discount and fees related to the DLOC and RLOC are capitalized as intangible assets. Debt issuance costs represents legal, consulting and financial costs associated with debt financing. Debt discount and debt issuance cost related to term debt totaled $593,079, net of accumulated amortization at June 26, 2016. Unamortized debt issuance costs related to the DLOC and RLOC totaled $286,987 at June 26, 2016. 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 June 26, 2016 and June 28, 2015 and six-month periods ended June 26, 2016 and June 28, 2015, interest expense was $1.4 million, $0.6 million, $2.9 million and $1.0 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, both of which we are in compliance with as of June 26, 2016.
  
At June 26, 2016, 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 and are included in Other long-term liabilities on the Balance Sheet. Under the swap agreements, the Company receives interest at the one -month LIBOR and pays a fixed rate. 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 13 for additional information pertaining to interest rate swaps.

The following summarizes the fair values of derivative instruments designated as cash flow hedges which were outstanding:

 
 
 
June 26, 2016
 
 
 
Notional amounts
 
Derivative assets
 
Derivative liabilities
Interest rate swaps
Rate
Expires
 
 
 
 
 
April 2012
1.4%
April 2019
$
6,476,191
 
 
$

 
$
82,105

October 2012
0.9%
October 2017
2,785,714
 
 
 
 
11,958
 
July 2013
1.4%
April 2018
9,904,762
 
 
 
 
64,273
 
May 2014
1.5%
April 2018
10,357,143
 
 
 
 
158,834
 
January 2015
1.8%
December 2019
20,833,333
 
 
 
 
942,461
 
August 2015
2.3%
June 2020
49,696,875
 
 
 
 
2,407,801
 
Total
 
 
$
100,054,018

 
 
$

 
$
3,667,432


 
 
 
December 27, 2015
 
 
 
Notional amounts
 
Derivative assets
 
Derivative liabilities
Interest rate swaps
Rate
Expires
 
 
 
 
April 2012
1.4%
April 2019
$
7,619,048
 
 
$

 
$
56,280

October 2012
0.9%
October 2017
3,214,286
 
 
 
 
3,027
 
July 2013
1.4%
April 2018
8,190,476
 
 
 
 
60,164
 
May 2014
1.5%
April 2018
11,428,571
 
 
 
 
122,716
 
January 2015
1.8%
December 2019
20,547,619
 
 
 

 
 
415,459

August 2015
2.3%
June 2020
49,696,875
 
 
 
 
867,609
 
Total
 
 
$
100,696,875

 
 
$

 
$
1,525,255



12

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

7.            STOCK-BASED COMPENSATION

Restricted stock awards

In First and Second Quarter 2016, restricted shares were granted to certain team members and Board members at a weighted-average fair value of $1.52 per share and in Second quarter 2015 restricted shares were granted to certain team members and board members at a weighted-average fair value of $4.21.  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 a three year period, one year period or upon the three year 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 $790,242 at June 26, 2016 will be recognized over the remaining weighted-average vesting period of 2.2 years. The total fair value of shares vested during the six-month periods ended June 26, 2016 and June 28, 2015 was $108,671 and $104,947, respectively.  Under the Stock Incentive Plan, there are 95,775 shares available for future awards at June 26, 2016.

The following table presents the restricted shares transactions during the six-month periods ended June 26, 2016:
 
Number of
Restricted
Stock Shares
Unvested, December 27, 2015
241,124

Granted
335,831

Vested
(63,106
)
Vested shares tax portion
(5,940
)
Expired/Forfeited
(22,351
)
Unvested, June 26, 2016
485,558

 
The following table presents the restricted shares transactions during the six-month periods ended June 28, 2015:
 
Number of
Restricted
Stock Shares
Unvested, December 28, 2014
164,867

Granted
47,502

Vested
(22,751
)
Expired/Forfeited
(3,586
)
Unvested, June 28, 2015
186,032

   
On July 30, 2010, DRH granted options for the purchase of 210,000 shares of common stock to the then-members of its Board of Directors .  These options are fully vested and expire six years from issuance, July 30, 2016.  On July 28, 2016, the Stock Option Agreement of 2010 was amended and extends the expiration date of the agreement to July 31, 2019. 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 June 26, 2016, 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 $0 and $273,000 as of June 26, 2016 and June 28, 2015, respectively.

Employee stock purchase plan

The Company has also 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 ESPP has four offering periods, each start/end dates coincide with the fiscal quarter and are awarded on the last day of the offering period. During the six-month periods ended June 26, 2016 and June 28, 2015, we issued 13,546 and 10,205 shares, respectively. Under the ESPP, there are 199,043 shares available for future awards at June 26, 2016.


13

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

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 $90,284 and $106,770, $187,710 and $162,563 was recognized during the three-month periods ended June 26, 2016 and June 28, 2015 and six-month periods ended June 26, 2016 and June 28, 2015 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.
   
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 June 26, 2016.  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 effective income tax rate for the three-month periods ended June 26, 2016 and June 28, 2015 and six-month periods ended June 26, 2016 and June 28, 2015 was (58.5)%, (37.8)%, (262.8)% and (40.6)%, respectively. The change in the effective income tax rate for June 26, 2016 as compared to the six months ended June 28, 2015 is primarily attributable to the decrease in loss before income taxes.

9.           OPERATING LEASES
 
Base 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 $2.4 million, $1.9 million, $4.9 million and $3.8 million for the three-month periods ended June 26, 2016 and June 28, 2015 and six-month periods ended June 26, 2016 and June 28, 2015, respectively.
 
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 June 26, 2016 are summarized as follows: 
Year
Amount
Remainder of 2016
$
5,509,766

2017
11,007,937

2018
10,535,524

2019
9,688,037

2020
9,423,851

2021 and thereafter
49,035,777

Total
$
95,200,892



10.           COMMITMENTS AND CONTINGENCIES
 
The Company’s ADA requires DRH to open 42 BWW restaurants designated "development territory” by April 1, 2021.   As of June 26, 2016 we have opened 29 of the 42 restaurants required by the ADA.  With the remaining 13 restaurants, we expect the Company will operate 77 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 (between 3.15% and 3.25% of net sales globally) for the term of the individual franchise agreements.  The Company incurred royalty fees of $2.0

14

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

million, $1.5 million, $4.2 million and $3.1 million for the three-month periods ended June 26, 2016 and June 28, 2015 and six-month periods ended June 26, 2016 and June 28, 2015, respectively.  Advertising fund contribution expenses were $1.3 million, $1.0 million $2.8 million and $1.9 million for the three-month periods ended June 26, 2016 and June 28, 2015 and six-month periods ended June 26, 2016 and June 28, 2015, 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 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.
On December 18, 2015, a collective action was filed against AMC Wings, Inc., and the Company in the U.S. District Court for the Southern District of Illinois (the "Court") by plaintiffs, David, et. al. A Sure Wing, LLC, the seller of the 18 St. Louis BWW restaurants acquired by the Company on June 29, 2015, was also named as a defendant. Plaintiffs primarily allege that former and current tipped workers at the above-mentioned companies were assigned to perform tasks outside the scope of their tipped positions, in violation of Illinois and federal law.  On July 6, 2016, the parties filed a joint Notice of Settlement, stating that the parties had reached an agreement in principle to resolve plaintiffs’ class and collective action claims through June 29, 2015, for $600,000 and intend to seek Court approval of their settlement.  On July 8, 2016, following a status conference with the parties, the Court gave leave to plaintiffs to file an amended complaint in light of the settlement discussions.  Plaintiffs did so on July 8, 2016.  At this stage in the proceedings, the parties are drafting a joint motion for preliminary Court approval of the terms of their settlement.
The Company has filed an indemnity claim against A Sure Wing, LLC and has received a reciprocal indemnity claim from A Sure Wing, LLC. A Sure Wing, LLC and the Company previously agreed to toll their respective indemnity claims pending resolution of the matter. A Sure Wing has agreed to fund the settlement in return for DRH releasing their indemnity claim.
 
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.  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 an unfavorable outcome of any pending or threatened proceedings is probable or reasonably possible.  Therefore, no separate reserve or disclosure has been established for these types of legal proceedings. 

15



11.          EARNINGS PER SHARE
 
The following is a reconciliation of basic and fully diluted earnings per common share for the three and six month periods ended June 26, 2016 and June 28, 2015:
 
 
Three months ended
 
 
June 26, 2016
 
June 28, 2015
Loss available to common stockholders
 
$
(182,426
)
 
$
(3,318,343
)
 
 
 
 
 
Weighted-average shares outstanding
 
26,379,065

 
26,151,853

Effect of dilutive securities
 

 

Weighted-average shares outstanding - assuming dilution
 
26,379,065

 
26,151,853

 
 
 
 
 
Earnings per share
 
$
(0.01
)
 
$
(0.13
)
Earnings per share - assuming dilution
 
$
(0.01
)
 
$
(0.13
)

 
 
Six months ended
 
 
June 26, 2016
 
June 28, 2015
Income (loss) available to common stockholders
 
$
247,979

 
$
(3,055,701
)
 
 
 
 
 
Weighted-average shares outstanding
 
26,338,549

 
26,150,518

Effect of dilutive securities
 

 

Weighted-average shares outstanding - assuming dilution
 
26,338,549

 
26,150,518

 
 
 
 
 
Earnings per share
 
$
0.01

 
$
(0.12
)
Earnings per share - assuming dilution
 
$
0.01

 
$
(0.12
)

Potentially dilutive securities whose effect would have been antidilutive are excluded from the computation of diluted earnings per share.


12.            SUPPLEMENTAL CASH FLOWS INFORMATION
 
Other Cash Flows Information
 
Cash paid for interest was $1.4 million, $0.5 million, $2.8 million and $1.0 million during the three-month periods ended June 26, 2016 and June 28, 2015 and six-month periods ended June 26, 2016 and June 28, 2015, respectively.
 
Cash paid for income taxes was $10,000, $34,290, $10,000 and $94,290 during the three-month periods ended June 26, 2016 and June 28, 2015 and six-month periods ended June 26, 2016 and June 28, 2015, respectively.

Supplemental Schedule of Non-Cash Operating, Investing, and Financing Activities
 
Noncash investing activities for property and equipment not yet paid during the six months ended June 26, 2016 and June 28, 2015, was $0.9 million and $1.3 million, respectively.  

13.           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

16

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

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 June 26, 2016 and December 27, 2015, respectively, our financial instruments consisted of cash and cash equivalents, accounts receivable, 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 6 for additional information pertaining to interest rates swaps.
 
As of June 26, 2016 and December 27, 2015, our total debt was approximately $122.3 million and $126.3 million, respectively, which approximated fair value because the applicable interest rates are adjusted frequently based on short-term market rates (Level 2).
 
There were no transfers between levels of the fair value hierarchy during the three and six months ended June 26, 2016 and the fiscal year ended December 27, 2015.

The following table presents the fair values for those assets and liabilities measured on a recurring basis as of June 26, 2016:
 
FAIR VALUE MEASUREMENTS
Description
 
Level 1
 
Level 2
 
Level 3
 
Asset/(Liability)
Total
Interest rate swaps
 
$

 
$
(3,667,432
)
 
$

 
$
(3,667,432
)
 
 
The following table presents the fair values for those assets and liabilities measured on a recurring basis as of December 27, 2015:
 
FAIR VALUE MEASUREMENTS
Description
 
Level 1
 
Level 2
 
Level 3
 
Asset/(Liability)
Total
Cash equivalents
 
$
2,000,000

 
$

 
$

 
$
2,000,000

Interest rate swaps
 

 
(1,525,255
)
 

 
(1,525,255
)
Total
 
$
2,000,000

 
$
(1,525,255
)
 
$

 
$
474,745

 


17


14. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
 
The following table summarizes each component of Accumulated Other Comprehensive Income (loss):
 
 
Three Months Ended June 26, 2016
 
Three Months Ended June 28, 2015
 
 
Interest Rate Swaps
 
Investments
 
Total
 
Interest Rate Swaps
 
Investments
 
Total
Beginning balance
 
$
(2,055,477
)
 
$

 
$
(2,055,477
)
 
$
(485,225
)
 
$

 
$
(485,225
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Gain (loss) recorded to other comprehensive income
 
(553,071
)
 

 
(553,071
)
 
152,880

 

 
152,880

Tax benefit (expense)
 
188,044

 

 
188,044

 
(51,980
)
 

 
(51,980
)
Other comprehensive income (loss)
 
(365,027
)
 

 
(365,027
)
 
100,900

 

 
100,900

 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated OCL
 
$
(2,420,504
)
 
$

 
$
(2,420,504
)
 
$
(384,325
)
 
$

 
$
(384,325
)

 
 
Six Months Ended June 26, 2016
 
Six Months Ended June 28, 2015
 
 
Interest Rate Swaps
 
Investments
 
Total
 
Interest Rate Swaps
 
Investments
 
Total
Beginning balance
 
$
(1,006,667
)
 
$

 
$
(1,006,667
)
 
$
(171,352
)
 
$
(3,804
)
 
$
(175,156
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Gain (loss) recorded to other comprehensive income
 
(2,142,177
)
 

 
(2,142,177
)
 
(322,686
)
 
5,763

 
(316,923
)
Tax benefit (expense)
 
728,340

 

 
728,340

 
109,713

 
(1,959
)
 
107,754

Other comprehensive income (loss)
 
(1,413,837
)
 

 
(1,413,837
)
 
(212,973
)
 
3,804

 
(209,169
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated OCL
 
$
(2,420,504
)
 
$

 
$
(2,420,504
)
 
$
(384,325
)
 
$

 
$
(384,325
)

15. SEGMENT REPORTING

During the First Quarter 2016, the Company reorganized segment reporting from one reportable segment to two reportable segments, BWW and Bagger Dave's, due to differences that have developed in the economic characteristics between the two concepts. All prior period information was recast to reflect this change. The Company’s reportable segments are organized based on restaurant concept. Resources are allocated and performance is assessed for the concepts by the Company’s Chief Executive Officer, Chief Financial Officer and Chief Operating Officer whom the Company has determined to be its Chief Operating Decision Makers. See Note 1 for additional information.

Revenues for all segments include only transactions with customers and include no intersegment revenues. Excluded from net income from operations for BWW and Bagger Dave's are certain legal and corporate costs not directly related to the performance of the segments, interest and other expenses related to the Company’s credit agreements and derivative instruments, certain stock-based compensation expenses, certain bonus expense and certain insurance expenses managed centrally.

18


Segment activity is as follows:

 
Three months ended
 
Six months ended
 
June 26, 2016
 
June 28, 2015
 
June 26, 2016
 
June 28, 2015
Revenue from external customers:
 
 
 
 
 
 
 
BWW
$
40,951,181

 
$
29,610,702

 
$
84,094,433

 
$
61,462,790

Bagger Dave's
5,439,865

 
7,261,136

 
10,709,412

 
14,849,380

Total
$
46,391,046

 
$
36,871,838

 
$
94,803,845

 
$
76,312,170

 
 
 
 
 
 
 
 
Segment operating profit (loss):
 
 
 
 
 
 
 
BWW
$
3,849,895

 
$
3,751,902

 
$
9,135,540

 
$
8,358,232

Bagger Dave's
(889,880
)
 
(2,810,306
)
 
(1,502,142
)
 
(4,268,941
)
Total segment operating profit
$
2,960,015

 
$
941,596

 
$
7,633,398

 
$
4,089,291

Closure-related items
928,153

 

 
583,142

 

Corporate expenses
(2,926,632
)
 
(6,451,142
)
 
(5,568,255
)
 
(8,990,333
)
Total consolidated operating profit (loss)
$
961,536

 
$
(5,509,546
)
 
$
2,648,285

 
$
(4,901,042
)
 
 
 
 
 
 
 
 
Interest expense
$
(1,440,562
)
 
$
(559,035
)
 
$
(2,885,502
)
 
$
(991,258
)
Other income
39,633

 
727,258

 
84,905

 
744,261

Net loss before income taxes
$
(439,393
)
 
$
(5,341,323
)
 
$
(152,312
)
 
$
(5,148,039
)
 
 
 
 
 
 
 
 
 
 
 
 
 
June 26, 2016
 
December 27, 2015
Total assets
 
 
 
 
 
 
 
BWW

 

 
$
116,669,017

 
$
115,044,166

Bagger Dave's

 

 
21,588,976

 
21,886,470

Corporate

 

 
21,387,957

 
28,841,859

Total assets

 

 
$
159,645,950

 
$
165,772,495


16.           SUBSEQUENT EVENTS


On July 28, 2016, the Board of Directors approved the tax-free spinoff of AMC Burgers, which includes all 19 of the Bagger Dave's entities. The company will be formed as an independent, publicly-traded company on the over the counter market. DRH will continue to own and operate its 64 franchised BWW restaurants. DRH is currently developing a comprehensive separation plan for the spinoff. The separation plan, including transaction structure, timing, composition of senior management and the Boards of Directors, capital structure and other matters, will be subject to approval by the DRH Board of Directors, customary regulatory and other approvals. The Company expects to complete the spinoff in the fourth quarter of 2016.


19




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 27, 2015. 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 Buffalo Wild Wings® Grill & Bar (“BWW”) concept and consumer acceptance of the Bagger Dave’s Tavern® (“Bagger Dave’s”) 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 restaurant company operating two complementary concepts:   BWW and Bagger Dave’s.  As the largest franchisees 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 June 26, 2016, we had 83 locations in Florida, Illinois, Indiana, Michigan, Missouri and Ohio.
  
DRH is the largest BWW franchisee and currently operates 64 DRH-owned BWW restaurants (20 in Michigan, 17 in Florida, seven in Illinois, five in Indiana and 15 in Missouri), including the nation’s largest BWW, 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 77 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.  Currently, there are 19 Bagger Dave’s, 16 in Michigan and one in Indiana and two in Ohio.


20


RESTAURANT OPENINGS
 
The following table outlines the restaurant unit information for each fiscal year from 2012 through 2016.
 
 
2016 (estimate)
 
2015
 
2014
 
2013
 
2012
Summary of restaurants open at the beginning of year
 
 
 
 
 
 
 
 
 
 
DRH-owned BWW
 
62

 
42

 
36

 
33

 
22

Bagger Dave’s
 
18

 
24

 
18

 
11

 
6

Total
 
80

 
66

 
54

 
44

 
28

 
 
 
 
 
 
 
 
 
 
 
Openings:
 
 
 
 
 
 
 
 
 
 
DRH-owned BWW
 
2

 
3

 
3

 
3

 
3

Bagger Dave’s
 
1

 
5

 
6

 
7

 
5

BWW Acquisitions
 

 
18

 
3

 

 
8

Closures - DRH-owned BWW
 

 
(1
)
 

 

 

Closures - Bagger Dave's
 

 
(11
)
 

 

 

Total restaurants
 
83

 
80

 
66

 
54

 
44


RESULTS OF OPERATIONS
 
For the three-month period ended June 26, 2016 ("Second Quarter 2016") and six-month period ended June 26, 2016 ("Year to Date 2016") , revenue was generated from the operations of 64 BWW restaurants and 19 Bagger Dave’s restaurants. For the three-month period ended June 28, 2015 ("Second Quarter 2015") and six-month period ended June 28, 2015 ("Year to Date 2015), revenue was generated from the operations of 42 BWW restaurants and 26 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 restaurants comparable sales in the first full month after the 18th month of operations. 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 70 and 50 restaurants at June 26, 2016 and June 28, 2015, respectively.
 

21


Results of Operations for the Three Months Ended June 26, 2016 and June 28, 2015
 
 
Three Months Ended
 
 
June 26, 2016
 
Percent of sales
 
June 28, 2015
 
Percent of sales
BWW
 
$
40,951,181

 
88.3
 %
 
$
29,610,702

 
80.3
 %
Bagger Dave's
 
5,439,865

 
11.7
 %
 
7,261,136

 
19.7
 %
Total revenue
 
46,391,046

 
100.0
 %
 
36,871,838

 
100.0
 %
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Food, beverage, and packaging costs
 
 
 
 
 
 
 
 
BWW
 
11,419,464

 
27.9
 %
 
8,324,900

 
28.1
 %
Bagger Dave's
 
1,639,318

 
30.1
 %
 
2,236,370

 
30.8
 %
Food, beverage, and packaging costs
 
13,058,782

 
28.1
 %
 
10,561,270

 
28.6
 %
 
 
 
 
 
 
 
 
 
Compensation costs
 
 
 
 
 
 
 
 
BWW
 
10,283,942

 
25.1
 %
 
7,064,960

 
23.9
 %
Bagger Dave's
 
2,094,838

 
38.5
 %
 
2,689,211

 
37.0
 %
Compensation costs
 
12,378,780

 
26.7
 %
 
9,754,171

 
26.5
 %
 
 
 
 
 
 
 
 
 
Occupancy costs
 
 
 
 
 
 
 
 
BWW
 
2,774,108

 
6.8
 %
 
1,728,997

 
5.8
 %
Bagger Dave's
 
277,057

 
5.1
 %
 
703,353

 
9.7
 %
Occupancy costs
 
3,051,165

 
6.6
 %
 
2,432,350