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EX-32.2 - EXHIBIT 32.2 - Diversified Restaurant Holdings, Inc.ex32210q-9302018.htm
EX-32.1 - EXHIBIT 32.1 - Diversified Restaurant Holdings, Inc.ex32110q-9302018.htm
EX-31.2 - EXHIBIT 31.2 - Diversified Restaurant Holdings, Inc.ex31210q-9302018.htm
EX-31.1 - EXHIBIT 31.1 - Diversified Restaurant Holdings, Inc.ex31110q-9302018.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 30, 2018 
 
[_] 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: (833) 374-7282

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 every Interactive Data File required to be submitted 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 such files).  Yes [X] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
[   ]
Accelerated filer
[  ]
Non-accelerated filer
[ X ]
 
 
 
 
Smaller reporting company
[ X ]
 
 
Emerging growth company
[  ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
[  ]

 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 32,576,887 shares of $.0001 par value common stock outstanding as of November 6, 2018.



INDEX
 






PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements

DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (unaudited)
ASSETS
 
September 30, 2018
 
December 31, 2017
Current assets
 
 
 
 
Cash and cash equivalents
 
$
7,109,781

 
$
4,371,156

Accounts receivable
 
304,339

 
653,102

Inventory
 
1,407,119

 
1,591,363

Prepaid and other assets
 
497,378

 
408,982

Total current assets
 
9,318,617

 
7,024,603

 
 
 
 
 
Property and equipment, net
 
39,160,338

 
48,014,043

Intangible assets, net
 
2,219,698

 
2,438,187

Goodwill
 
50,097,081

 
50,097,081

Other long-term assets
 
967,574

 
185,322

Total assets
 
$
101,763,308

 
$
107,759,236

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' DEFICIT
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
3,727,263

 
$
4,561,939

Accrued compensation
 
2,478,886

 
1,854,127

Other accrued liabilities
 
3,090,820

 
2,404,942

Current portion of long-term debt
 
11,513,280

 
11,440,433

Current portion of deferred rent
 
424,044

 
411,660

Total current liabilities
 
21,234,293

 
20,673,101

 
 
 
 
 
Deferred rent, less current portion
 
2,392,669

 
2,208,238

Deferred income taxes
 
2,017,015

 
2,759,870

Unfavorable operating leases
 
450,712

 
510,941

Other long-term liabilities
 
1,795,725

 
2,346,991

Long-term debt, less current portion
 
93,787,074

 
102,488,730

Total liabilities
 
121,677,488

 
130,987,871

 
 
 
 
 
Commitments and contingencies (Notes 3, 10 and 11)
 

 

 
 
 
 
 
Stockholders’ deficit:
 
 
 
 
Common stock - $0.0001 par value; 100,000,000 shares authorized; 32,577,262 and 26,859,125, respectively, issued and outstanding
 
3,179

 
2,625

Additional paid-in capital
 
26,849,631

 
21,776,402

Accumulated other comprehensive income (loss)
 
667,217

 
(283,208
)
Accumulated deficit
 
(47,434,207
)
 
(44,724,454
)
Total stockholders’ deficit
 
(19,914,180
)
 
(23,228,635
)
 
 
 
 
 
Total liabilities and stockholders’ deficit
 
$
101,763,308

 
$
107,759,236

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 30, 2018
 
September 24, 2017
 
September 30, 2018
 
September 24, 2017
Revenue
 
$
37,491,751

 
$
39,262,940

 
$
114,063,781

 
$
123,535,506

 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
 
 
 
 
 
 
 
 
Food, beverage, and packaging costs
 
10,692,796

 
11,569,925

 
32,388,212

 
36,529,901

Compensation costs
 
10,279,281

 
9,991,381

 
30,611,334

 
31,125,287

Occupancy costs
 
2,912,507

 
2,969,250

 
8,662,717

 
8,701,927

Other operating costs
 
8,461,334

 
8,770,406

 
24,817,359

 
26,188,432

General and administrative expenses
 
2,001,343

 
2,301,061

 
6,361,084

 
6,724,436

Pre-opening costs
 

 
79,605

 

 
405,448

Depreciation and amortization
 
2,908,608

 
3,244,255

 
9,175,853

 
10,149,050

Impairment and loss on asset disposal
 
918,399

 
16,578

 
931,196

 
302,652

Total operating expenses
 
38,174,268

 
38,942,461

 
112,947,755

 
120,127,133

 
 
 
 
 
 
 
 
 
Operating (loss) profit
 
(682,517
)
 
320,479

 
1,116,026

 
3,408,373

 
 
 
 
 
 
 
 
 
Interest expense
 
(1,609,277
)
 
(1,822,876
)
 
(4,865,308
)
 
(5,041,136
)
Other income, net
 
24,778

 
26,000

 
77,994

 
78,307

 
 
 
 
 
 
 
 
 
Loss from continuing operations before income taxes
 
(2,267,016
)
 
(1,476,397
)
 
(3,671,288
)
 
(1,554,456
)
Income tax benefit of continuing operations
 
505,644

 
933,157

 
961,535

 
1,515,453

Loss from continuing operations
 
(1,761,372
)
 
(543,240
)
 
(2,709,753
)
 
(39,003
)
 
 
 
 
 
 
 
 
 
Discontinued operations
 
 
 
 
 
 
 
 
Loss from discontinued operations before income taxes
 

 
(22,960
)
 

 
(155,552
)
Income tax benefit of discontinued operations
 

 
7,806

 

 
58,191

Loss from discontinued operations
 

 
(15,154
)
 

 
(97,361
)
 
 
 
 
 
 
 
 
 
Net loss
 
$
(1,761,372
)
 
$
(558,394
)
 
$
(2,709,753
)
 
$
(136,364
)
 
 
 
 
 
 
 
 
 
Basic earnings per share from:
 
 
 
 
 
 
 
 
Continuing operations
 
$
(0.06
)
 
$
(0.02
)
 
$
(0.10
)
 
$

Discontinued operations
 

 

 

 

Basic net earnings per share
 
$
(0.06
)
 
$
(0.02
)
 
$
(0.10
)
 
$

 
 
 
 
 
 
 
 
 
Diluted earnings per share from:
 
 
 
 
 
 
 
 
Continuing operations
 
$
(0.06
)
 
$
(0.02
)
 
$
(0.10
)
 
$

Discontinued operations
 

 

 

 

Diluted net earnings per share
 
$
(0.06
)
 
$
(0.02
)
 
$
(0.10
)
 
$

 
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding
 
 
 
 
 
 
 
 
Basic
 
30,643,240

 
26,764,776

 
27,990,420

 
26,672,057

Diluted
 
30,643,240

 
26,764,776

 
27,990,420

 
26,672,057

 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 30, 2018
 
September 24, 2017
 
September 30, 2018
 
September 24, 2017
 
 
 
 
 
 
 
 
 
Net loss
 
$
(1,761,372
)
 
$
(558,394
)
 
$
(2,709,753
)
 
$
(136,364
)
 
 
 
 
 
 
 
 
 
Other comprehensive income
 
 
 
 
 
 
 
 
Unrealized changes in fair value of interest rate swaps, net of tax of $166,380, ($150,926), $252,619 and ($71,576), respectively.
 
4,241

 
292,974

 
950,425

 
138,941

Total other comprehensive income
 
4,241

 
292,974

 
950,425

 
138,941

 
 
 
 
 
 
 
 
 
Comprehensive income (loss)
 
$
(1,757,131
)
 
$
(265,420
)
 
$
(1,759,328
)
 
$
2,577

 
 







































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

4


DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT (unaudited)

 
 
 
 
 
Additional
 
Accumulated
Other
 
 
 
Total
 
Common Stock
 
Paid-in
 
Comprehensive
 
Accumulated
 
Stockholders'
 
Shares
 
Amount
 
Capital
 
Loss
 
Deficit
 
Deficit
Balances - December 31, 2017
26,859,125

 
$
2,625

 
$
21,776,402

 
$
(283,208
)
 
$
(44,724,454
)
 
$
(23,228,635
)
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of restricted shares
375,119

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
Forfeitures of restricted shares
(34,921
)
 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 Shares effectively repurchased for required withholding taxes
(50,163
)
 
(5
)
 
(70,346
)
 

 

 
(70,351
)
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of common shares from offering, net of fees and expenses of $.7 million
5,300,000

 
530

 
4,579,251

 

 

 
4,579,781

 
 
 
 
 
 
 
 
 
 
 
 
Employee stock purchase plan
47,078

 
5

 
58,915

 

 

 
58,920

 
 
 
 
 
 
 
 
 
 
 
 
Share-based compensation
81,024

 
24

 
505,409

 

 

 
505,433

 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income

 

 

 
950,425

 

 
950,425

 
 
 
 
 
 
 
 
 
 
 
 
Net loss from continuing operations

 

 

 

 
(2,709,753
)
 
(2,709,753
)
 
 
 
 
 
 
 
 
 
 
 
 
Balances - September 30, 2018
32,577,262

 
$
3,179

 
$
26,849,631

 
$
667,217

 
$
(47,434,207
)
 
$
(19,914,180
)
 


























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 30, 2018
 
September 24, 2017
Cash flows from operating activities
 
 
 
 
Net loss
 
$
(2,709,753
)
 
$
(136,364
)
Net loss from discontinued operations
 

 
(97,361
)
Net loss from continuing operations
 
(2,709,753
)
 
(39,003
)
Adjustments to reconcile net loss from continuing operations to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
9,175,853

 
10,149,050

Amortization of debt discount and loan fees
 
231,392

 
156,951

Amortization of gain on sale-leaseback
 
(156,107
)
 
(99,657
)
Impairment and loss on asset disposals
 
931,196

 
302,652

Share-based compensation
 
505,433

 
284,100

Deferred income taxes
 
(985,393
)
 
(1,573,644
)
Changes in operating assets and liabilities that provided (used) cash
 

 
 
Accounts receivable
 
348,763

 
172,395

Inventory
 
184,244

 
196,987

Prepaid and other assets
 
(88,396
)
 
134,593

Intangible assets
 
(20,000
)
 
(28,729
)
Other long-term assets
 
(8,312
)
 
46,455

Accounts payable
 
(753,767
)
 
1,228,025

Accrued liabilities
 
1,274,271

 
(1,270,506
)
Deferred rent
 
196,815

 
137,342

Net cash provided by operating activities of continuing operations
 
8,126,239

 
9,797,011

Net cash used in operating activities of discontinued operations
 

 
(97,361
)
Net cash provided by operating activities
 
8,126,239

 
9,699,650

 
 

 
 
Cash flows from investing activities
 
 
 
 
Purchases of property and equipment
 
(1,276,122
)
 
(4,453,861
)
Net cash used in investing activities
 
(1,276,122
)
 
(4,453,861
)
 
 

 
 
Cash flows from financing activities
 
 
 
 
Proceeds from issuance of long-term debt
 

 
4,650,965

Repayments of long-term debt
 
(8,679,842
)
 
(9,237,466
)
Issuance of common stock, net of fees and expenses of $.7 million
 
4,579,781

 

Proceeds from employee stock purchase plan
 
58,920

 
45,005

Tax withholdings for restricted stock
 
(70,351
)
 
(59,928
)
Net cash used in financing activities
 
(4,111,492
)
 
(4,601,424
)
 
 
 
 
 
Net increase in cash and cash equivalents
 
2,738,625

 
644,365

 
 
 
 
 
Cash and cash equivalents, beginning of period
 
4,371,156

 
4,021,126

 
 
 
 
 
Cash and cash equivalents, end of period
 
$
7,109,781

 
$
4,665,491

 
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.         NATURE OF BUSINESS, BASIS OF PRESENTATION AND SIGNIFICANT TRANSACTION

Nature of Business

Diversified Restaurant Holdings, Inc. (“DRH” or the "Company") is a restaurant company operating a single concept, Buffalo Wild Wings® (“BWW”). As one of the largest franchisees of BWW, we provide a unique guest experience in a casual and inviting environment.

DRH currently operates 64 BWW restaurants (20 in Michigan, 17 in Florida, 15 in Missouri, 7 in Illinois and 5 in Indiana), including the nation’s largest BWW, based on square footage, in downtown Detroit, Michigan.

On December 25, 2016, the Company completed a spin-off (the "Spin-Off") of 19 Bagger Dave's entities and certain real estate entities which house the respective Bagger Dave's entities previously owned by DRH into a new independent publicly traded company, Bagger Dave's Burger Tavern, Inc. ("Bagger Dave's"). For additional details refer to Note 2 .

Basis of Presentation

The consolidated financial statements as of September 30, 2018 and December 31, 2017, and for the three and nine-month periods ended September 30, 2018 and September 24, 2017, have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the rules and regulations of the Securities and Exchange Commission ("SEC"). The financial information as of September 30, 2018 and for the nine-month periods ended September 30, 2018 and September 24, 2017 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 statements include the accounts of the Company and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated.

The consolidated financial information as of December 31, 2017 is derived from our audited consolidated financial statements and notes thereto for the fiscal year ended December 31, 2017, which is included in Item 8 in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2017, and should be read in conjunction with such consolidated financial statements.

The results of operations for the nine-month periods ended September 30, 2018 and September 24, 2017 are not necessarily indicative of the results of operations that may be achieved for the entire fiscal year ending December 30, 2018.

Our significant accounting policies are disclosed in Part II, Item 8, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

Since December 31, 2017, there has been one significant change in our accounting policies related to revenue recognition, which is presented below.

Revenue Recognition Policy
Revenue is measured based on consideration specified in implied contracts with our customers and excludes amounts collected on behalf of third parties. The Company recognizes revenue when it satisfies a performance obligation (at the time of sale) by transferring control over a product to a customer. Payment is due at the time the food or merchandise is transferred to the customer. The portion of any sale that results in loyalty rewards being issued is deferred, net of estimated breakage, until redemption.
Nature of Goods Sold
DRH earns revenue through sales of food, gift cards and merchandise to our customers. These sales occur through multiple channels, such as in-restaurant, call-in, online (web-based) and via third party delivery services.
Buffalo Wild Wings International, Inc. ("BWLD") offers a system-wide loyalty program (Blazin’ Rewards®) whereby enrolled customers earn points for each qualifying purchase. As a franchisee, DRH is required to participate in the program. DRH estimates the value of loyalty points earned (the value per point) by dividing the menu price of redeemable items by the loyalty reward points required to redeem that menu item. Points issued as part of the loyalty program expire after 6 months of member inactivity. DRH commissioned a study to determine a reasonable estimate of the breakage rate, which was approximately 32%.

7

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


DRH has two types of sales transactions, transactions without loyalty attachment and transactions with loyalty attachment. Transactions without loyalty attachment require no allocation of the transaction price, because the price is observable and fixed based on the menu. Transactions with loyalty attachment have two performance obligations: 1) providing the purchased food and/or merchandise to the customer and, 2) redeeming awarded loyalty points for food or merchandise in the future. In loyalty related transactions the price is allocated to the products sold and the points issued. Revenue related to loyalty points that may be redeemed in the future is deferred, net of estimated breakage, until such loyalty points are redeemed. For additional details refer to Note 6.

The Company offers gift cards for purchase through a BWLD system-wide program. Gift cards sold are recorded as a liability to BWLD. When redeemed, the gift card liability is offset by recording the transaction as revenue. Net gift card activity is settled with BWLD weekly. At times, gift card redemptions may exceed amounts due to BWLD for gift card purchases, resulting in an asset balance. Because this is a system-wide program operated by BWLD, the Company is not impacted by and does not record breakage.

Disaggregation of Revenue
In the following table, revenue is disaggregated by product mix.

Disaggregated Revenue
 
 
 
 
Product
Three Months Ended September 30, 2018
 
Three Months Ended September 24, 2017
Food
$
31,394,837

 
$
32,893,804

Alcohol
6,096,914

 
6,369,136

Total
$
37,491,751

 
$
39,262,940

 
 
 
 
Product
Nine Months Ended September 30, 2018
 
Nine Months Ended September 24, 2017
Food
$
95,404,774

 
$
103,521,105

Alcohol
18,659,007

 
20,014,401

Total
$
114,063,781

 
$
123,535,506



Recent Accounting Pronouncements

In August 2017, the Financial Accounting Standards Board (FASB) issued ASU No. 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities (Topic 815) ("ASU 2017-12"). The amendment expands an entity’s ability to hedge accounting to non-financial and financial risk components and requires changes in fair value of hedging instruments to be presented in the same income statement line as the hedged item. The ASU also amends the presentation and disclosure requirements for the effect of hedge accounting. The ASU must be adopted using a modified retrospective approach with a cumulative effect adjustment recorded to the opening balance of retained earnings as of the initial application date. The ASU is effective for fiscal years beginning after December 15, 2018 and interim periods therein. Early adoption is permitted. The Company is in the process of assessing the impact of this ASU on its consolidated results of operations, cash flows, financial position and disclosures.

In February 2016, FASB issued ASU No. 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 have analyzed the impact of the new standard and concluded that the adoption of ASU 2016-02 will materially impact our consolidated financial statements by significantly increasing our non-current assets and liabilities on our consolidated balance sheets in order to record the right of use assets and related lease liabilities for our existing operating leases. We lease all of our restaurant properties, and operating leases comprise the majority of our current lease portfolio. With respect to implementation, we are currently reviewing the accounting standard and expect it to have a material impact on our consolidated financial statements.


8

DIVERSIFIED RESTAURANT HOLDINGS, INC.
NOTES TO INTERIM 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 Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue with Contracts from Customers (Topic 606) ("ASU 2014-09"). ASU 2014-09 supersedes the current revenue recognition guidance, including industry-specific guidance. This ASU and subsequently issued amendments, introduce a five-step model to achieve its core principal of the entity recognizing revenue to depict the transfer of goods or services to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which delayed the effective date of ASU 2014-09 for public companies to January 1, 2018. The FASB also agreed to allow entities to choose to adopt the standard as of the original effective date.

The requirements for these standards relating to Topic 606 are effective for interim and annual periods beginning after December 15, 2017. The Company adopted ASU 2014-09 effective as of January 1, 2018, using the modified retrospective transition method to all existing contracts that were not substantially completed at the adoption date. We finalized our analysis and the adoption of ASU 2014-09 which did not have, and is not expected to have, a material impact on the timing or amount of revenue recognized as compared to the Company's previous revenue recognition practices, or our internal controls over financial reporting.

Significant Transaction

On July 24, 2018 the Company completed an underwritten registered public offering of 6 million shares of common stock at a public offering price of $1.00 per share, which included 700,000 shares offered by a certain selling stockholder, for total Company gross proceeds of $5.3 million. The net proceeds from the Offering were approximately $4.6 million, after deducting the underwriting discounts and commissions and offering expenses payable by us. We intend to use the net proceeds from the offering for working capital and general corporate purposes, which may include repayment of debt.

The offering was made pursuant to a shelf registration statement on Form S-3 (File No. 333-225457) that was filed with the SEC and became effective on July 5, 2018. A prospectus supplement and accompanying prospectus relating to and describing the terms of the offering were filed with the SEC on July 23, 2018.



9

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

2.     DISCONTINUED OPERATIONS

Spin-Off of Bagger Dave's

On August 4, 2016, DRH announced that its Board of Directors unanimously approved a plan to pursue a tax-free spin-off of its Bagger Dave's business. Pursuant to this plan, DRH contributed its 100.0% owned entity, AMC Burgers, LLC and certain real estate entities, into Bagger Dave's Burger Tavern, Inc., a newly created Nevada company, which was then spun-off into a stand-alone company. AMC Burgers, Inc. owned and operated all of the Bagger Dave's Burger Tavern® restaurants and the real estate entities held certain real estate related to the restaurants before the real estate was sold in 2014 and 2015. In connection with the Spin-Off, DRH contributed certain assets, liabilities and employees related to its Bagger Dave's businesses. Intercompany balances due to/from DRH, which included amounts from sales, were contributed to equity of Bagger Dave's. The Spin-Off was effected on December 25, 2016 via a one-for-one distribution of common shares in Bagger Dave's to DRH holders of record on December 19, 2016. As part of the Spin-Off transaction, DRH funded a one-time $2.0 million cash distribution to Bagger Dave's.

Prior to the Spin-Off, Bagger Dave’s was a co-obligor on a joint and several basis with the Company on its $155.0 million senior secured credit facility. The Company’s debt under this facility remained with the Company and Bagger Dave’s was released as a borrower. As a result, this debt was not assigned to discontinued operations. Additionally, DRH retained substantially all of the tax benefits (net operating loss and tax credit carryforwards) generated by Bagger Dave's prior to the date of the transaction.

DRH decided to spin-off Bagger Dave's after considering all reasonable strategic and structural alternatives because of the disparity between the operating models of its two brands, BWW as franchisee, and Bagger Dave's as an owned concept. The management teams of Bagger Dave's and DRH agreed that the nature of the two concepts varied greatly, and that each would be more valuable and operate more effectively independently of one another. Bagger Dave's is a concept developed by the management team of DRH. In contrast to operating a franchised concept like BWW, it has no development restrictions and the flexibility to enhance brand attributes such as logos, trade dress and restaurant design, change its menu offering and improve its operational model in an effort to better align with guest expectations. To manage these functions effectively, specific resources are required that are not necessary for a franchisee. For example, menu development, purchasing and brand marketing are critical to the success of Bagger Dave's but not necessary for a BWW franchisee since these functions are managed by the franchisor. Additionally, as a start-up brand, Bagger Dave's has both higher risk and higher growth potential while BWW, being a mature brand and as a franchisee, has more limited organic growth potential due to the status of its existing market penetration and the need to obtain development rights from the franchisor.

In conjunction with the Spin-Off, DRH entered into a transition services agreement (the "TSA") with Bagger Dave's pursuant to which DRH provided certain information technology and human resources support, limited accounting support, and other minor administrative functions at no charge. The TSA was intended to assist the discontinued component in efficiently and seamlessly transitioning to stand on its own. Certain provisions of the TSA terminated in December 2017 and the First Amendment to TSA (the "Amended TSA") was entered into effective January 1, 2018. Under the Amended TSA, DRH provides ongoing administrative support to Bagger Dave's in certain areas, including information technology, human resources and real estate, in exchange for a fee based on a rate-per-hour of service. The amount charged to Bagger Dave’s was $11,940 and $0, $39,300 and $0 during the three-month periods ended September 30, 2018 and September 24, 2017 and nine-month periods ended September 30, 2018 and September 24, 2017, respectively.

Information related to the Bagger Dave's Spin-Off has been reflected in the accompanying consolidated financial statements as follows:

Consolidated Statements of Operations - Bagger Dave's results of operations for the three and nine month period ended September 24, 2017 have been presented as discontinued operations. There was no activity related to the discontinued operation at the Company for the three and nine month period ended September 30, 2018.

Consolidated Statements of Cash Flows - The Bagger Dave's cash flows from operating and investing activities for the nine-month period ended September 24, 2017 have been presented separately on the face of the cash flow statement. There was no activity related to the discontinued operation at the Company for the three and nine month period ended September 30, 2018.

The operating results of the discontinued operations include only direct expenses incurred by Bagger Dave’s. Discontinued operations exclude certain corporate functions that were previously allocated to Bagger Dave’s. Interest expense was not allocated to discontinued operations because the Company’s debt under the $155 million secured credit facility remained with the Company.

10

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


Prior to the Spin-Off, Bagger Dave's was a reportable segment of the Company. Following the Spin-Off, there were no assets or liabilities remaining from the Bagger Dave's operations as of December 25, 2016. See Note 3 for a discussion of involvement the Company will continue to have with Bagger Dave's after the Spin-Off.

3.     UNCONSOLIDATED VARIABLE INTEREST ENTITIES

After the Spin-Off of Bagger Dave’s and the related discontinuation of its operations described in Note 2, the Company remains involved with certain activities that result in Bagger Dave’s being considered a Variable Interest Entity ("VIE"). This conclusion results primarily from the existence of guarantees by the Company of certain Bagger Dave’s leases as described below under "Lease Guarantees". While the Company holds a variable interest in Bagger Dave’s, it is not considered to be its primary beneficiary because it does not have the power to direct the activities of Bagger Dave’s. Specifically, we considered the fact that, although our Executive Chairman is currently also on Bagger Dave’s board, there are no agreements in place that require him to vote in the interests of the Company, as he does not represent the Company in his capacity as a Bagger Dave’s director.

Lease Guarantees

At September 30, 2018, the Company is a guarantor for 12 leases, four of which have been re-leased to unaffiliated parties. In the event the respective lessees cannot make their lease payments, the Company may become responsible for the payments under its guarantee.

Upon the Spin-Off of Bagger Dave's, in accordance with ASC 460, Guarantees, the Company evaluated its liability from the lease guarantees first by estimating the non-contingent component representing the estimated fair market value of the guarantees at inception, and recorded a liability. As of September 30, 2018 and December 31, 2017, the liability is $0.3 million, and it is included in other liabilities on the Consolidated Balance Sheet. Prior to December 25, 2017, no liability had been recorded as a result of the affiliate relationship between the Company and Bagger Dave’s.

Secondly, the Company considered the contingent component of the guarantees and concluded that, as of September 30, 2018 and December 31, 2017, no loss under the guarantees was probable because all but one of the Bagger Dave's restaurants subject to the guaranteed leases is either currently operating or the site has been leased to another tenant who is responsible for, and making, the lease payments. With respect to the one Bagger Dave's location that has been closed and not re-leased, Bagger Dave's is continuing to make the lease payments while it either seeks a new tenant for the site or negotiates an exit from the liability with the landlord.

The Company has determined that its maximum exposure resulting from the lease guarantees includes approximately $7.6 million of future minimum lease payments plus potential additional payments to satisfy maintenance, property tax and insurance requirements under the leases as of September 30, 2018. The terms and conditions of the guarantees vary, and each guarantee has an expiration date which may or may not correspond with the end of the underlying lease term. The guarantee expiration dates range from less than 2 months to 12 years as of September 30, 2018. In the event that the Company is required to perform under any of its lease guarantees, we do not believe the liability would be material because we would first seek to minimize the exposure by finding a suitable tenant to lease the space. In many cases, we expect that a replacement tenant would be found. In reaching our conclusion, we also considered the following:

the financial condition of Bagger Dave’s, including its ability to service the lease payments on the locations it continues to operate;
its history of incurring operating losses;
its liquidity position and the actions available to it should its liquidity deteriorate to such a degree that its ability to service required lease payments is threatened; and
the actions available to the Company to avoid or mitigate potential losses should Bagger Dave's become unable to service one or more of the leases that the Company guarantees.


11

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

The following is a detailed listing of all Bagger Dave's leases that include a guarantee by the Company as of September 30, 2018:
Location of lease
Status of location
Guarantee expiry date
Future guaranteed lease payments
Woodhaven, MI
Closed / re-leased
11/30/18
$
12,367

Traverse City, MI
Closed
01/31/19
31,667

Fort Wayne, IN
Open
01/31/19
28,757

Grand Blanc, MI
Open
01/31/20
94,667

Centerville, OH
Open
11/30/20
236,287

Chesterfield Township, MI
Open
12/31/20
146,250

Birch Run, MI
Open
12/31/24
608,508

Berkley, MI
Open
06/08/29
915,120

Cascade Township, MI
Open
06/08/29
839,844

Avon, IN
Closed / re-leased
06/30/29
1,368,744

Greenwood, IN
Closed / re-leased
06/30/29
1,416,960

Canton, MI
Closed / re-leased
06/30/30
1,880,022

Total


$
7,579,193



4.          PROPERTY AND EQUIPMENT, NET

Property and equipment are comprised of the following assets:
 
 
September 30, 2018
 
December 31, 2017
Equipment
 
$
29,944,512

 
$
30,252,867

Furniture and fixtures
 
7,290,884

 
7,444,792

Leasehold improvements
 
63,886,601

 
64,936,413

Restaurant construction in progress
 
202,098

 
161,942

Total
 
101,324,095

 
102,796,014

Less accumulated depreciation
 
(62,163,757
)
 
(54,781,971
)
Property and equipment, net
 
$
39,160,338

 
$
48,014,043


Based on impairment indicators that existed at September 30, 2018, the Company performed an impairment analysis on certain long-lived assets subject to depreciation and recorded a fixed asset impairment of $0.9 million related to one underperforming restaurant located in Missouri. 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, which was recorded in impairment and loss on asset disposals on the Consolidated Statements of Operations.

We are currently monitoring several restaurants with regard to the valuation of the property and equipment. 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.



12

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


5.        INTANGIBLE ASSETS

Intangible assets are comprised of the following:
 
 
September 30, 2018
 
December 31, 2017
Amortized intangible assets
 
 
 
 
Franchise fees
 
$
1,305,642

 
$
1,290,642

Trademark
 
2,500

 
2,500

Non-compete
 
76,560

 
76,560

Favorable operating leases
 
351,344

 
351,344

Loan fees
 

 
368,083

Total
 
1,736,046

 
2,089,129

Less accumulated amortization
 
(772,675
)
 
(907,269
)
Total amortized intangible assets, net
 
963,371

 
1,181,860

 
 
 
 
 
Unamortized intangible assets
 
 
 
 
Liquor licenses
 
1,256,327

 
1,256,327

Total intangible assets, net
 
$
2,219,698

 
$
2,438,187


Amortization expense was $22,212 and $21,067, $63,822 and $63,443 for the three-month periods ended September 30, 2018 and September 24, 2017 and nine-month periods ended September 30, 2018 and September 24, 2017, 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 8.0 years at September 30, 2018.

6.    OTHER ACCRUED LIABILITIES
 
September 30, 2018
 
December 31, 2017
Sales tax payable
$
831,679

 
$
906,410

Accrued interest
427,585

 
481,431

Accrued royalty fees
147,113

 
179,114

Accrued property taxes
620,676

 
69,970

Accrued loyalty rewards
777,524

 
439,106

Other
286,243

 
328,911

Total other accrued liabilities
$
3,090,820

 
$
2,404,942



13

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

7.           LONG-TERM DEBT

Long-term debt consists of the following obligations:
 
 
September 30, 2018
 
December 31, 2017
$120.0 million term loan - the rate at September 30, 2018 and December 31, 2017 was 5.60% and 4.87%, respectively.
 
$
82,198,616

 
$
89,698,616

$30.0 million development line of credit, converted $18.2 million and $3.1 million to a facility term loan in December 2016 and June 2018, respectively. The rate at September 30, 2018 and December 31, 2017 was 5.63% and 4.87%, respectively.
 
18,553,976

 
16,682,853

$5.0 million revolving line of credit - the rate at September 30, 2018 and December 31, 2017 was 5.72% and 5.11%, respectively.
 
5,000,000

 
5,000,000

$5.0 million development line of credit - the rate at December 31, 2017 was 5.00%.
 

 
3,050,965

Unamortized discount and debt issuance costs
 
(452,238
)
 
(503,271
)
Total debt
 
105,300,354

 
113,929,163

 
 
 
 
 
Less current portion
 
(11,513,280
)
 
(11,440,433
)
Long-term debt, net of current portion
 
$
93,787,074

 
$
102,488,730


On June 29, 2015, the Company entered into a five year $155.0 million senior secured credit facility with a syndicate of lenders led by Citizens Bank, N.A. (the “Senior Secured Credit Facility”) with a senior lien on all the Company’s personal property and fixtures. The Senior Secured Credit Facility consists of a $120.0 million term loan (the “Term Loan”), a $30.0 million development line of credit (the “DLOC”) and a $5.0 million revolving line of credit (the “RLOC”).

On December 23, 2016, the Company amended the Senior Secured Credit Facility for purposes of, among other things, releasing the Bagger Dave’s entities as borrowers and releasing all related liens on the Bagger Dave’s assets. In addition, the amendment (a) converted the amounts then outstanding under the DLOC to a development facility term loan (the “DF Term Loan” and, together with the Term Loan, the "Term Loans"), (b) canceled $6.8 million previously available under the DLOC, and (c) extended the maturity date on the remaining $5.0 million under the DLOC to June 29, 2018. Upon the maturity of the DLOC on June 29, 2018, the amount outstanding under the DLOC was added to the existing DF Term Loan.

Payments of principal are based upon a 12-year straight-line amortization schedule, with monthly principal payments of $980,906 on the Term Loans, plus accrued interest. As of September 30, 2018, $5.0 million was outstanding under the RLOC. The entire remaining outstanding principal and accrued interest on the Senior Secured Credit Facility is due and payable on the maturity date of June 29, 2020.

The interest rate for each of the loans, as selected by the borrower, is based upon either a LIBOR or base rate (generally Prime or Fed Funds) plus an applicable margin, which ranges from 2.25% to 3.5% for LIBOR loans and from 1.25% to 2.5% for base rate loans, depending on the lease adjusted leverage ratio as defined in the agreement.

Fees related to the Term Loans are recorded as debt discount and fees related to the DLOC and RLOC are capitalized as intangible assets. Debt issuance costs represent legal, consulting and financial costs associated with debt financing. As a result of the December 2016 Amendment, the Company incurred $197,889 of debt issuance costs recorded as a part of debt discount. Debt discount related to term debt, net of accumulated amortization totaled $452,238 and $503,271 at September 30, 2018 and December 31, 2017, respectively. 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 30, 2018 and September 24, 2017 and nine-month periods ended September 30, 2018 and September 24, 2017 interest expense was $1.6 million and $1.8 million, $4.9 million and $5.0 million, respectively.

The Senior Secured Credit Facility, as amended, 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. On June 30, 2017 and February 28, 2018, the Company further amended the Senior Secured Credit Facility for purposes of revising the maximum lease adjusted leverage ratio and the minimum consolidated debt service coverage ratio and revising certain definitions impacting the calculation of the ratios. As of September 30, 2018, the Company is in compliance with the loan covenants.


14

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

At September 30, 2018, the Company has three 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. 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. The fair value of the derivative assets and liabilities are included in Other long-term assets and Other long-term liabilities on the Consolidated Balance Sheets, respectively. See Note 14 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:

 
 
 
September 30, 2018
 
 
 
Notional amounts
 
Derivative assets
 
Derivative liabilities
Interest rate swaps
Rate
Expires
 
 
 
 
 
April 2012
1.4%
April 2019
$
1,333,333

 
$
3,980

 
$

January 2015
1.8%
December 2019
27,273,809

 
219,434

 

August 2015
2.3%
June 2020
59,301,191

 
550,526

 

Total
 
 
$
87,908,333

 
$
773,940


$


 
 
 
December 31, 2017
 
 
 
Notional amounts
 
Derivative assets
 
Derivative liabilities
Interest rate swaps
Rate
Expires
 
 
 
 
 
April 2012
1.4%
April 2019
$
3,047,619

 
$
6,028

 
$

July 2013
1.4%
April 2018
2,833,333

 
778

 

May 2014
1.5%
April 2018
7,142,857

 

 
408

January 2015
1.8%
December 2019
21,690,476

 
25,953

 

August 2015
2.3%
June 2020
60,412,798

 

 
461,455

Total
 
 
$
95,127,083

 
$
32,759

 
$
461,863


8.            SHARE-BASED COMPENSATION

Restricted share awards

On July 13, 2017, the Company's shareholders approved the Stock Incentive Plan of 2017. The Stock Incentive Plan of 2017 authorized a total of 2,500,000 shares for issuance as incentive awards.

For the nine-months ended September 30, 2018, restricted shares were issued to certain team members under the Stock Incentive Plan of 2017 at a weighted-average grant date fair value of $1.29. For the nine-month period ended September 24, 2017, no restricted shares were issued. Based on the standard form of Stock Award Agreement, shares typically vest ratably over either a one or three year period, or on the third anniversary of the grant date, as determined by the Company's Compensation Committee. Upon vesting, the Company withholds shares to cover the minimum withholding requirement, unless the recipient opts out. Unrecognized share-based compensation expense of $0.6 million at September 30, 2018 will be recognized over the remaining weighted-average vesting period of 1.7 years. The total grant date fair value of shares vested during the nine-month periods ended September 30, 2018 and September 24, 2017, was $0.6 million and $0.4 million, respectively. Under the Stock Incentive Plan of 2017, there were 1.8 million shares available for future awards at September 30, 2018.


15

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

The following table presents the restricted stock transactions during the nine-month period ended September 30, 2018:
 
Number of
Restricted
Stock Shares
Unvested, December 31, 2017
531,000

Granted
375,119

Vested
(165,705
)
Vested shares tax portion
(29,904
)
Expired/Forfeited
(34,921
)
Unvested, September 30, 2018
675,589


The following table presents the restricted stock transactions during the nine-month period ended September 24, 2017:
 
Number of
Restricted
Stock Shares
Unvested, December 25, 2016
473,391

Granted
263,332

Vested
(132,158
)
Vested shares tax portion
(22,716
)
Expired/Forfeited
(48,850
)
Unvested, September 24, 2017
532,999


On July 30, 2010, prior to the adoption of the Stock Incentive Plan of 2011, 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 had an original expiration date six years from the date of issuance. On July 28, 2016, the Stock Option Agreement of 2010 was amended to extend the expiration date of these options to July 31, 2019. The options can be exercised at a price of $2.50 per share. At September 30, 2018, 150,000 shares of authorized common stock are reserved for issuance to provide for the exercise of the remaining options. The intrinsic value of outstanding options was negligible as of both September 30, 2018 and September 24, 2017.

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, each start/end dates coincide with the fiscal quarter and are awarded on the last day of the offering period. During the nine-months ended September 30, 2018 and September 24, 2017, the Company issued 47,078 and 24,519 shares, respectively. Under the ESPP, there were 100,110 shares available for future purchase at September 30, 2018.

Share-based compensation

Share-based compensation of $0.1 million and $0.1 million, $0.5 million and $0.3 million and was recognized during the three-month periods ended September 30, 2018 and September 24, 2017 and nine-month periods ended September 30, 2018 and September 24, 2017, respectively, as compensation costs in the Consolidated Statements of Operations and as additional paid-in capital on the Consolidated Statements of Stockholders' Equity (Deficit) to reflect the grant date fair value of shares vested.

The Company has authorized 10,000,000 shares of preferred stock at a par value of $0.0001No preferred shares are issued or outstanding as of September 30, 2018. 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.

16

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


9.           INCOME TAXES

The effective income tax benefit rate for continuing operations was (22.3)% and (63.2)%, and (26)% and (97)% for the three-month periods ended September 30, 2018 and September 24, 2017 and nine-month periods ended September 30, 2018 and September 24, 2017, respectively. The change in the effective income tax rate for the nine months ended September 30, 2018 compared with the nine months ended September 24, 2017 is primarily attributable to valuation allowance against the deferred tax asset and the reduction of the deferred tax liability caused by the change in certain tax attributes.

In accordance with the provisions of ASC 740, a valuation allowance was established as of December 31, 2017, for the deferred tax assets of the Company, and remains in place as of September 30, 2018. On a quarterly basis, the Company evaluates the recoverability of the deferred tax asset by reviewing current and projected company and restaurant industry trends, and the macro economic environment.

10.           OPERATING LEASES

The Company's lease terms 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 $2.2 million and $2.2 million, $6.7 million and $6.6 million for the three-month periods ended September 30, 2018 and September 24, 2017 and nine-month periods ended September 30, 2018 and September 24, 2017, respectively.

Scheduled future minimum lease payments 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 30, 2018 are summarized as follows:
Year
Amount
Remainder of 2018
$
2,182,708

2019
8,510,133

2020
8,440,957

2021
7,734,279

2022
6,963,903

Thereafter
35,285,924

Total
$
69,117,904


17

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

11.           COMMITMENTS AND CONTINGENCIES

Refer to Note 3 for a discussion of lease guarantees provided by the Company.

Franchise Related
The Company is required to pay BWLD royalties (5.0% of net sales) and advertising fund contributions (3.00% - 3.15% of net sales). In addition, the Company is required to spend an additional 0.25% - 0.5% of regional net sales related to advertising cooperatives for certain metropolitan markets for the term of the individual franchise agreements. The Company incurred $1.9 million and $2.0 million, $5.7 million and $6.0 million in royalty expense for the three-month periods ended September 30, 2018 and September 24, 2017 and nine-month periods ended September 30, 2018 and September 24, 2017, respectively. Advertising fund contribution expenses were $1.2 million and $1.3 million, $3.7 million and $4.0 million for the three-month periods ended September 30, 2018 and September 24, 2017 and nine-month periods ended September 30, 2018 and September 24, 2017, respectively. Amounts are recorded in Other operating costs on the Consolidated Statement of Operations.

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 have historically ranged from $70,000 to $1,300,000 depending on an individual restaurant's needs.

Legal Proceedings
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.



18

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

12.         EARNINGS PER SHARE

The following is a reconciliation of basic and fully diluted earnings per common share for the three-month periods ended September 30, 2018 and September 24, 2017 and nine-month periods ended September 30, 2018 and September 24, 2017:

 
Three months ended
 
 
September 30, 2018
 
September 24, 2017
Loss from continuing operations
 
$
(1,761,372
)
 
$
(543,240
)
Loss from discontinued operations
 

 
(15,154
)
Net loss
 
$
(1,761,372
)
 
$
(558,394
)

 
 
 
 
Weighted-average shares outstanding
 
30,643,240

 
26,764,776

Effect of dilutive securities
 

 

Weighted-average shares outstanding - assuming dilution
 
30,643,240

 
26,764,776


 
 
 
 
Earnings per common share from continuing operations
 
$
(0.06
)
 
$
(0.02
)
Earnings per common share from discontinued operations
 

 

Earnings per common share
 
$
(0.06
)
 
$
(0.02
)

 
 
 
 
Earnings per common share - assuming dilution - from continuing operations
 
(0.06
)
 
(0.02
)
Earnings per common share - assuming dilution - from discontinued operations
 

 

Earnings per common share - assuming dilution
 
$
(0.06
)
 
$
(0.02
)

 
 
 
 

 
Nine Months Ended
 
 
September 30, 2018
 
September 24, 2017
Loss from continuing operations
 
$
(2,709,753
)
 
$
(39,003
)
Loss from discontinued operations
 

 
(97,361
)
Net Loss
 
$
(2,709,753
)
 
$
(136,364
)

 


 


Weighted-average shares outstanding
 
27,990,420

 
26,672,057

Effect of dilutive securities
 

 

Weighted-average shares outstanding - assuming dilution
 
27,990,420

 
26,672,057


 


 


Earnings per common share from continuing operations
 
$
(0.10
)
 
$

Earnings per common share from discontinued operations
 

 

Earnings per common share
 
$
(0.10
)
 
$


 


 


Earnings per common share - assuming dilution - from continuing operations
 
(0.10
)
 

Earnings per common share - assuming dilution - from discontinued operations
 

 

Earnings per common share - assuming dilution
 
$
(0.10
)
 
$


During the three and nine month periods ended September 30, 2018 and September 24, 2017, 675,589 and 532,999 shares, respectively, of unvested restricted stock were excluded from the calculation of diluted earnings per share because such shares were anti-dilutive.


19

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


13.            SUPPLEMENTAL CASH FLOWS INFORMATION

Other Cash Flows Information

Cash paid for interest was $1.6 million and $1.7 million, $4.7 million and $4.7 million during the three-month periods ended September 30, 2018 and September 24, 2017 and nine-month periods ended September 30, 2018 and September 24, 2017, respectively.

Cash paid for income taxes was $23,662 and $0, $23,857 and $2,819 during the three-month periods ended September 30, 2018 and September 24, 2017 and nine-month periods ended September 30, 2018 and September 24, 2017, respectively.

Supplemental Schedule of Non-Cash Operating, Investing, and Financing Activities

Noncash investing activities for property and equipment not yet paid as of September 30, 2018 and September 24, 2017, was $0.1 million and $0.0 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:

 
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 30, 2018 and December 31, 2017, respectively, our financial instruments consisted of cash and cash equivalents, accounts receivable, accounts payable, interest rate swaps, lease guarantee liability, 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 observable market 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 7 for additional information pertaining to interest rates swaps.

The fair value of our lease guarantee liability was determined by calculating the present value of the difference between the estimated rate at which the Company and Bagger Dave’s could borrow money in a duration similar to the underlying lease guarantees. Our lease guarantees are classified as a Level 2 measurement as there is no actively traded market for such instruments.

As of September 30, 2018 and December 31, 2017, our total debt was approximately $105.3 million and $113.9 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 nine month period ended September 30, 2018 and the fiscal year ended December 31, 2017.


20

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 September 30, 2018:

FAIR VALUE MEASUREMENTS
Description
 
Level 1
 
Level 2
 
Level 3
 
Asset/(Liability)
Total
Interest rate swaps
 
$

 
$
773,940

 
$

 
$
773,940

Lease guarantee liability
 

 
(292,397
)
 

 
(292,397
)
Total
 
$

 
$
481,543

 
$

 
$
481,543


 
The following table presents the fair values for those assets and liabilities measured on a recurring basis as of December 31, 2017:

FAIR VALUE MEASUREMENTS
Description
 
Level 1
 
Level 2
 
Level 3
 
Asset/(Liability)
Total
Interest rate swaps
 
$

 
$
(429,104
)
 
$

 
$
(429,104
)
Lease guarantee liability
 

 
(303,006
)
 

 
(303,006
)
Total
 
$

 
$
(732,110
)
 
$

 
$
(732,110
)

Non-financial assets and liabilities that are measured at fair value on a non-recurring basis 

Our impairment analysis generally estimates long-lived asset fair values, including property, plant and equipment and leasehold improvements, using a discounted cash flow approach. The inputs used to determine fair value relate primarily to future assumptions regarding restaurant sales and profitability and our discount rate assumption. These inputs are categorized as Level 3 inputs. The inputs used represent management’s assumptions about what information market participants would use in pricing the assets and are based upon the best information available at the balance sheet date. During Third Quarter 2018, we recorded an impairment charge of $.9 million, for one underperforming restaurant.
 

21

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


15.    ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes each component of Accumulated Other Comprehensive Income (Loss):
 
 
Three Months Ended September 30, 2018
 
Three Months Ended September 24, 2017
 
 
Interest Rate Swaps
 
Interest Rate Swaps
Beginning balance
 
$
662,976

 
$
(1,088,255
)
 
 
 
 
 
Gain recorded to other comprehensive income (loss)
 
170,621

 
443,900

Tax expense
 
(166,380
)
 
(150,926
)
Other comprehensive income
 
4,241

 
292,974


 
 
 
 
Accumulated other comprehensive income (loss)
 
$
667,217

 
$
(795,281
)
 
 
 
 
 
 
 
Nine Months Ended September 30, 2018
 
Nine Months Ended September 24, 2017
 
 
Interest Rate Swaps
 
Interest Rate Swaps
Beginning balance
 
$
(283,208
)
 
$
(934,222
)
 
 
 
 
 
Gain recorded to other comprehensive loss
 
1,203,044

 
210,517

Tax expense
 
(252,619
)
 
(71,576
)
Other comprehensive income
 
950,425

 
138,941

 
 
 
 
 
Accumulated other comprehensive income (loss)
 
$
667,217

 
$
(795,281
)

22



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 31, 2017. Information included in this discussion and analysis includes commentary on company-owned restaurants, restaurant sales, and same store sales. Management believes such sales information is an important measure of our performance, and is useful in assessing the Buffalo Wild Wings® Grill & Bar (“BWW”) concept. 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

Some of the statements contained in this “Quarterly Report on Form 10-Q” may constitute “forward-looking statements” within the meaning of the Federal Private Securities Litigation Reform Act of 1995. These statements reflect the current views of our senior management team with respect to future events, including our financial performance, business and industry in general. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “forecast,” “estimate,” “may,” “should,” “anticipate,” and variations of such words and similar statements of a future or forward-looking nature are intended to identify such forward-looking statements. We intend for our forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and we set forth this statement in order to comply with such safe harbor provisions.

Forward-looking statements involve known and unknown risks and uncertainties and are not assurances of future performance. Accordingly, actual results may differ materially from anticipated results due to a variety of factors, including the factors identified in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017. Important factors that could cause actual results to differ materially from our expectations include the following:

the success of our existing and new restaurants;
our ability to identify appropriate sites and to finance the development and expansion of our operations;
changes in economic conditions;
damage to our reputation or lack of acceptance of our brand in existing or new markets;
economic and other trends and developments, including adverse weather conditions, in the local or regional areas in which our restaurants are located;
the impact of negative economic factors, including the availability of credit, on our landlords and surrounding tenants;
changes in food availability and costs;
labor shortages and increases in our compensation costs, including those resulting from changes in government regulation;
increased competition in the restaurant industry and the segments in which we compete;
the impact of legislation and regulations regarding nutritional information, new information or attitudes regarding diet and health, or adverse opinions about the health of consuming our menu offerings;
the impact of federal, state, and local beer, liquor, and food service regulations;
the success of our and our franchisor's strategies and marketing programs;
the impact of new restaurant openings, including the effect on our existing restaurants of opening new restaurants in the same markets;
the loss of key members of our management team;
inability or failure to effectively manage our growth, including without limitation, our need for liquidity and human capital;

23


the impact of litigation;
the adequacy of our insurance coverage and fluctuating insurance requirements and costs;
the impact of our indebtedness on our ability to invest in the ongoing needs of our business;
our ability to obtain debt or other financing on favorable terms, or at all;
the impact of a potential asset impairment charge in the future;
the impact of any security breaches of confidential guest information in connection with our electronic processing of credit/debit card transactions;
our ability to protect our intellectual property;
the impact of any failure of our information technology system or any breach of our network security;
the impact of any materially adverse changes in our federal, state, and local taxes;
the impact of any food-borne illness outbreak;
our ability to maintain our relationship with our franchisor on economically favorable terms;
the impact of future sales of our common stock in the public market, the exercise of stock options, and any additional capital raised by us through the sale of our common stock;
the effect of changes in accounting principles applicable to us; and
the impact on the Company's future results as a result of its guarantees of certain leases of Bagger Dave's Burger Tavern, Inc.
 
We caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date they were made. Subsequent written and oral forward-looking statements attributable to us or to persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth above and elsewhere in our reports filed with the Securities and Exchange Commission. We expressly disclaim any intent or obligation to update any forward-looking statements.

OVERVIEW

Diversified Restaurant Holdings, Inc. (“DRH” or the "Company") is a restaurant company operating a single concept, Buffalo Wild Wings® (“BWW”). DRH currently operates 64 BWW restaurants (20 in Michigan, 17 in Florida, 15 in Missouri, 7 in Illinois and 5 in Indiana), including the nation’s largest BWW, based on square footage, in downtown Detroit, Michigan. As one of the largest franchisees of BWLD, we provide a unique guest experience in a casual and inviting environment. We are committed to providing value to our guests by offering generous portions of flavorful food in an upbeat and entertaining atmosphere. We believe BWW is a uniquely positioned restaurant brand, designed to maximize guest appeal, offering competitive price points and a family-friendly atmosphere, which we believe enables strong performance through economic cycles. We were incorporated in 2006 and are headquartered in the Detroit metropolitan area.

RESTAURANT OPENINGS

The following table outlines the restaurant unit information for each fiscal year from 2014 through 2018. The openings/closures and total restaurants open at the end of the year for 2018 are estimates.
 
 
2018
 
2017
 
2016
 
2015
 
2014
Restaurants open at the beginning of year
 
65

 
64

 
62

 
42

 
36

 
 
 
 
 
 
 
 
 
 
 
Openings/closures:
 
 
 
 
 
 
 
 
 
 
New restaurant openings
 

 
1

 
2

 
3

 
3

Restaurant acquisitions
 

 

 

 
18

 
3

Restaurant closures
 
(1
)
 

 

 
(1
)
 

Total restaurants open at the end of the year
 
64

 
65

 
64

 
62

 
42



24


RESULTS OF OPERATIONS

For the three-month periods ended September 30, 2018 ("Third Quarter 2018") and September 24, 2017 ("Third Quarter 2017"), revenue was generated primarily from the operations of 65 restaurants. Quarterly 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 are defined as a restaurant's comparable sales in the first full month after the 18th month of operation. 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 62 restaurants at both September 30, 2018 and September 24, 2017.

Results of Operations for the Three Months Ended September 30, 2018 and September 24, 2017
 
 
Three months ended
 
 
September 30, 2018
 
September 24, 2017
Total revenue
 
100.0
 %
 
100.0
 %
 
 
 
 
 
Operating expenses
 
 
 
 
Food, beverage, and packaging costs
 
28.5
 %
 
29.5
 %
Compensation costs
 
27.4
 %
 
25.4
 %
Occupancy costs
 
7.8
 %
 
7.6
 %
Other operating costs
 
22.6
 %
 
22.3
 %
General and administrative expenses
 
5.3
 %
 
5.9
 %
Pre-opening costs
 
 %
 
0.2
 %
Depreciation and amortization
 
7.8
 %
 
8.3
 %
Impairment and loss on asset disposal
 
2.4
 %
 
 %
Total operating expenses
 
101.8
 %
 
99.2
 %
 
 
 
 
 
Operating (loss) profit
 
(1.8
)%
 
0.8
 %
 
 
 
 
 
Interest expense
 
(4.3
)%
 
(4.6
)%
Other income, net
 
0.1
 %
 
0.1
 %
 
 
 
 
 
Loss from continuing operations before income taxes
 
(6.0
)%
 
(3.7
)%
 
 
 
 
 
Income tax (expense) benefit of continuing operations
 
1.3
 %
 
2.4
 %
 
 
 
 
 
Loss from continuing operations
 
(4.7
)%
 
(1.3
)%
 
 
 
 
 
Loss from discontinued operations before income taxes
 
 %
 
(0.1
)%
Income tax benefit of discontinued operations
 
 %
 
 %
Loss from discontinued operations
 
 %
 
(0.1
)%
 
 
 
 
 
Net Loss
 
(4.7
)%
 
(1.4
)%


Revenue for Third Quarter 2018 was $37.5 million, a decrease of $1.8 million, or 4.5%, compared to $39.3 million of revenue generated during Third Quarter 2017. The decrease in sales was the result of reduced traffic at our restaurants during the quarter, exacerbated by a large UFC fight that drove significant traffic in Third Quarter 2017. Third Quarter 2018 same-store sales decreased by 5.2%, or by 3.6% exclusive of the large UFC fight.

25



Food, beverage, and packaging costs decreased by $0.9 million, or 7.6%, to $10.7 million in Third Quarter 2018 from $11.6 million in Third Quarter 2017 due to lower sales volumes. Food, beverage, and packaging costs as a percentage of revenue decreased to 28.5% in Third Quarter 2018 from 29.5% in Third Quarter 2017 primarily due to lower traditional chicken wing costs. Average cost per pound for traditional bone-in chicken wings, our most significant input cost, decreased to $1.67 in Third Quarter 2018 compared with $2.14 in Third Quarter 2017.

Compensation costs increased by $0.3 million, or 2.9%, to $10.3 million in Third Quarter 2018 from $10.0 million in Third Quarter 2017 due to higher average wages. Compensation costs as a percentage of sales increased to 27.4% in Third Quarter 2018 from 25.4% in Third Quarter 2017 as a result of lower average unit volumes compared to the same period last year and increases in average wages.

Occupancy costs were flat at $2.9 million in Third Quarter 2018 compared to Third Quarter 2017. Occupancy as a percentage of sales increased to 7.8% in Third Quarter 2018 compared with 7.6% in Third Quarter 2017 due to lower sales volumes compared to the same period last year.

Other operating costs decreased $0.3 million, or 3.5%, to $8.5 million in Third Quarter 2018 from $8.8 million in Third Quarter 2017 due to cost saving initiatives as well as reduced royalty and advertising fund contributions as a result of lower sales volume, partially offset by higher delivery fees on increased sales via third party delivery. Other operating costs as a percentage of sales increased to 22.6% in Third Quarter 2018 from 22.3% in Third Quarter 2017, due to lower sales volumes compared to the same period last year.

General and administrative expenses decreased by $0.3 million, or 13.0%, to $2.0 million in Third Quarter 2018 from $2.3 million in Third Quarter 2017. This decrease was was primarily due to a decrease in corporate wages and other corporate expenses, partially offset by an increase in marketing expense. General and administrative expenses as a percentage of sales decreased to 5.3% in Third Quarter 2018 from 5.9% in Third Quarter 2017.

Depreciation and amortization decreased by $0.3 million, or 10.3%, to $2.9 million in Third Quarter 2018 from $3.2 million in Third Quarter 2017. This decrease was primarily due to fixed asset disposals and fully depreciated assets. Depreciation and amortization as a percentage of sales decreased to 7.8% in Third Quarter 2018 from 8.3% in Third Quarter 2017.

Impairment and loss on asset disposal increased by $0.9 million to $0.9 million in Third Quarter 2018 from $0 million in Third Quarter 2017. This increase was due to the impairment of fixed assets at one Missouri location in Third Quarter 2018. Impairment and loss on asset disposal as a percentage of sales increased to 2.4% in Third Quarter 2018.

26


Results of Operations for the Nine Months Ended September 30, 2018 and September 24, 2017
 
 
Nine months ended
 
 
September 30, 2018
 
September 24, 2017
Total revenue
 
100.0
 %
 
100.0
 %
 
 
 
 
 
Operating expenses
 
 
 
 
Food, beverage, and packaging costs
 
28.4
 %
 
29.6
 %
Compensation costs
 
26.8
 %
 
25.2
 %
Occupancy costs
 
7.6
 %
 
7.0
 %
Other operating costs
 
21.8
 %
 
21.2
 %
General and administrative expenses
 
5.6
 %
 
5.4
 %
Pre-opening costs
 
 %
 
0.3
 %
Depreciation and amortization
 
8.0
 %
 
8.2
 %
Impairment and loss on asset disposal
 
0.8
 %
 
0.2
 %
Total operating expenses
 
99.0
 %
 
97.1
 %
 
 
 
 
 
Operating (loss) profit
 
1.0
 %
 
2.9
 %
 
 
 
 
 
Interest expense
 
(4.3
)%
 
(4.1
)%
Other income, net
 
0.1
 %
 
0.1
 %
 
 
 
 
 
Loss from continuing operations before income taxes
 
(3.2
)%
 
(1.1
)%
 
 
 
 
 
Income tax benefit of continuing operations
 
0.8
 %
 
1.2
 %
 
 
 
 
 
Income (loss) from continuing operations
 
(2.4
)%
 
0.1
 %
 
 
 
 
 
Loss from discontinued operations before income taxes
 
 %
 
(0.1
)%
Income tax benefit of discontinued operations
 
 %
 
 %
Loss from discontinued operations
 
 %
 
(0.1
)%
 
 
 
 
 
Net loss
 
(2.4
)%
 
 %


Revenue for the nine months ended September 30, 2018 ("Year to Date 2018") was $114.1 million, a decrease of $9.5 million, or 7.7%, compared to $123.5 million of revenue generated during the nine months ended September 24, 2017 ("Year to Date 2017"). The decrease was driven by lower traffic in our restaurants in Year to Date 2018, including traffic from a large UFC fight occurring in Third Quarter 2017, partially offset by sales from a new restaurant opened in June of 2017.

Food, beverage, and packaging costs decreased by $4.1 million, or 11.3%, to $32.4 million in Year to Date 2018 from $36.5 million in Year to Date 2017 due to lower volumes. Food, beverage, and packaging costs as a percentage of revenue decreased to 28.4% in Year to Date 2018 from 29.6% in Year to Date 2017 primarily due to lower traditional chicken wing costs. Average cost per pound for traditional bone-in chicken wings, our most significant input cost, decreased to $1.74 in Year to Date 2018 compared with $2.06 in Year to Date 2017.

Compensation costs decreased by $0.5 million, or 1.7%, to $30.6 million in Year to Date 2018 from $31.1 million in Year to Date 2017 due to lower hourly wages on lower average unit volumes partially offset by higher average wages. Compensation costs as a percentage of sales increased to 26.8% in Year to Date 2018 from 25.2% in Year to Date 2017 due to lower average unit volumes coupled with higher average wages.

Occupancy costs were flat at $8.7 million in Year to Date 2018 compared to Year to Date 2017. Occupancy as a percentage of sales increased to 7.6% in Year to Date 2018 compared with 7.0% in Year to Date 2017 as a result of lower sales volumes.

27



Other operating costs decreased $1.4 million, or 5.2%, to $24.8 million in Year to Date 2018 from $26.2 million in Year to Date 2017 due to cost saving initiatives as well as reduced royalty and advertising fund contributions as a result of lower sales volume. Other operating costs as a percentage of sales increased to 21.8% in Year to Date 2018 from 21.2% in Year to Date 2017, primarily due to lower average unit volumes.

General and administrative expenses decreased $0.3 million, or 5.4% to $6.4 million in Year to Date 2018 from $6.7 million in Year to Date 2017. Lower wage and other corporate expenses in Year to Date 2018 were offset by higher marketing expense. General and administrative expenses as a percentage of sales increased to 5.6% in Year to Date 2018 from 5.4% in Year to Date 2017 as a result of lower sales volumes.

Pre-opening costs decreased $0.4 million, or 100.0%, to $0 in Year to Date 2018 from $0.4 million in Year to Date 2017. We haven't opened any new restaurants in 2018 and opened one new restaurants in the Second Quarter 2017. Pre-opening costs as a percentage of sales decreased to 0.0% in Year to Date 2018 from 0.3% in Year to Date 2017.

Depreciation and amortization decreased by $1.0 million, or 9.6%, to $9.2 million in Year to Date 2018 from $10.1 million in Year to Date 2017. This decrease was primarily due to fixed asset disposals and fully depreciated assets. Depreciation and amortization as a percentage of sales decreased to 8.0% in Year to Date 2018 from 8.2% in Year to Date 2017.

Impairment and loss on asset disposal increased by $0.6 million, or 207.7% to $0.9 million in Year to Date 2018 from $0.3 million in Year to Date 2017. This increase was primarily due to the impairment of fixed assets at one Missouri location in Third Quarter 2018. Impairment and loss on asset disposal as a percentage of sales increased to 0.8% in Year to Date 2018 from 0.2% in Year to Date 2017.

INTEREST AND TAXES

Interest expense decreased $0.2 million to $1.6 million or 11.7% in the Third Quarter 2018 from $1.8 million during the Third Quarter 2017. Interest expense was $4.9 million and $5.0 million in Year to Date 2018 and in Year to Date 2017, respectively.

For Third Quarter 2018, DRH had an income tax benefit of $0.5 million compared to Third Quarter 2017 income tax benefit of $0.9 million. For Year to Date 2018, DRH had an income tax benefit of $1.0 million compared to Year to Date 2017 income tax benefit of $1.5 million. The decrease in the income tax benefit is primarily attributable to valuation allowance against the deferred tax asset and the reduction of the deferred tax liability caused by the change in certain tax attributes.


LIQUIDITY AND CAPITAL RESOURCES

On June 29, 2015, the Company entered into a five-year $155.0 million senior secured credit facility with a syndicate of lenders led by Citizens Bank, N.A. (the “Senior Secured Credit Facility”) with a senior lien on all the Company’s personal property and fixtures. The Senior Secured Credit Facility consists of a $120.0 million term loan (the “Term Loan”), a $30.0 million development line of credit (the “DLOC”) and a $5.0 million revolving line of credit (the “RLOC”).

On December 23, 2016, the Company amended the Senior Secured Credit Facility for purposes of, among other things, releasing the Bagger Dave’s entities as borrowers and releasing all related liens on the Bagger Dave’s assets. In addition, the amendment (a) converted the amounts then outstanding under the DLOC to a development facility term loan (the “DF Term Loan” and, together with the Term Loan, the "Term Loans"), (b) canceled $6.8 million previously available under the DLOC, and (c) extended the maturity date on the remaining $5.0 million under the DLOC to June 29, 2018. Upon the maturity of the DLOC on June 29, 2018, the amount outstanding under the DLOC was added to the existing DF Term Loan.