UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2019

OR

Commission file number: 001-36749

 

THE HABIT RESTAURANTS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

17320 Red Hill Avenue, Suite 140, Irvine, CA 92614

(Address of Principal Executive Offices and Zip Code)

(949) 851-8881

(Registrant’s Telephone Number, Including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of Each Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ☐     No  ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ☐     No  ☒

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  ☒     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 during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒     No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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.

 

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 Act).    Yes  ☐     No  ☒

As of June 25, 2019, the last business day of the Registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s common stock held by non-affiliates was approximately $203 million.

As of March 9, 2020, there were 20,792,955 shares of the Registrant’s Class A Common Stock, par value $0.01 per share, outstanding and 5,334,681 shares of the Registrant’s Class B Common Stock, par value $0.01 per share, outstanding.

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DOCUMENTS INCORPORATED BY REFERENCE

None.

 

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THE HABIT RESTAURANTS, INC.

TABLE OF CONTENTS

 

 

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This annual report on Form 10-K (the “Annual Report”) contains forward-looking statements. All statements contained in this Annual Report other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties, and assumptions, including those described in Part I, Item 1A, “Risk Factors” in this Annual Report. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Annual Report may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. If we do update one or more forward-looking statements, no inference should be made that we will make additional updates with respect to those or other forward-looking statements.

 

 

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PART I

The following discussion should be read in conjunction with our audited consolidated financial statements and accompanying notes thereto included elsewhere in this Annual Report. The following discussion includes certain forward-looking statements. For a discussion of important factors, including the continuing development of our business and other factors which could cause actual results to differ materially from the results referred to in the historical information and the forward-looking statements presented herein, see “Item 1A, Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements” contained in this Annual Report.

We operate on a 52- or 53-week fiscal year ending on the last Tuesday of each calendar year for financial reporting purposes. Each quarterly period has 13 weeks, except for a 53-week year when the fourth quarter has 14 weeks. A 53-week year occurs every six or seven years. The 2019 fiscal year contained 53 weeks, while all other years presented in this Annual Report contain 52 weeks. Fiscal years 2015, 2016, 2017, 2018 and 2019 ended on December 29, 2015, December 27, 2016, December 26, 2017, December 25, 2018 and December 31, 2019, respectively.

Unless the context requires otherwise, references to ‘‘The Habit Burger Grill,’’ ‘‘The Habit,’’ the ‘‘Company,’’ ‘‘we,’’ ‘‘our’’ or ‘‘us’’ refer collectively to The Habit Restaurants, Inc. and its consolidated subsidiaries. References to “per customer spend” refer to total restaurant revenue divided by the number of entrées sold.

The Habit Burger Grill is a burger-centric, fast casual restaurant concept that specializes in preparing fresh, made-to-order char-grilled burgers and sandwiches featuring USDA choice tri-tip steak, grilled chicken and sushi-grade tuna cooked over an open flame. In addition, we feature fresh made-to-order salads and an appealing selection of sides, shakes and malts. We were recently named Best Regional Fast Food in USA Today’s 2019 Best Readers’ Choice Awards.

We believe our restaurant concept delivers a highly differentiated customer experience by combining the quality and hospitality that customers commonly associate with our full service and fast casual restaurant competitors with the convenience and value customers generally expect from traditional fast food restaurants. Four pillars form the foundation of our brand:

The first Habit Burger Grill opened in Santa Barbara, California in 1969. Our restaurant concept has been, and continues to be, built around a distinctive and diverse menu, headlined by fresh, char-grilled burgers and sandwiches made-to-order over an open flame and topped with fresh ingredients. Our Chief Executive Officer, Russell W. Bendel, joined The Habit in 2008, and since then we have grown our brand on a disciplined basis. Our highly experienced management team has created and refined our infrastructure to deliver replicable restaurant-level systems, processes and training procedures that can deliver a high-quality experience that is designed to consistently exceed our customers’ expectations.

 

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See Note 1 to our consolidated financial statements for additional information about our business organization, our initial public offering (“IPO”) and transactions completed in connection with our IPO.

Performance Overview

Our disciplined growth strategy has enabled growth across all of our key performance metrics, including the number of new restaurant openings, comparable restaurant sales, average unit volumes (“AUVs”), revenue, net income and Adjusted EBITDA.

AUVs are calculated by dividing revenue for the trailing 52-week period for all company-operated restaurants that have operated for 12 full accounting periods by the total number of restaurants open for such period. For purposes of the AUV calculation in 2019, we used the last 52 of the 53 weeks of the fiscal year. For the definition and reconciliation of Adjusted EBITDA, a non-GAAP term, to net income, see the section entitled “Item 6, Selected Financial Data.’’ Management has determined that we have one reportable segment. Our chief operating decision maker is our Chief Executive Officer, who reviews financial performance and allocates resources at a consolidated level on a recurring basis.

Our Competitive Strengths—“The Habit Difference”

Quality. Quality is a key ingredient in everything we do and our commitment to quality starts with our food. The Habit offers a diverse menu featuring a distinctive char-grilled preparation technique to deliver an appealing variety of burgers, chicken, tuna and steak featured in our sandwiches and salads, which are made-to-order using fresh ingredients. Chargrilling is part of what gives our entrées at the Habit bold flavors and we believe “it’s not the same, without the flame!”

It is our mission to become everyone’s favorite Habit, one burger at a time. We believe that every burger should be made-to-order, char-grilled over an open flame, topped with your choice of lettuce, ripe tomatoes, caramelized onions and melted cheese, wrapped neatly in paper and served alongside hot, crispy fries. Our burger selection ranges from our award-winning original Charburger including your choice of mayonnaise, pickles, ripe tomato, lettuce and caramelized onions served on a toasted bun, to our Santa Barbara style Charburger including all the fixings of the original Charburger plus cheese and avocado served on grilled sourdough. Burgers accounted for approximately 58% of our entrée revenue for the fiscal year ended December 31, 2019. Our sandwich selection offers a variety of choices, featuring sushi-grade tuna, fresh chicken and USDA choice steak and we also offer a variety of salad options, which are key to further diversifying our menu.

Environment. We invest in our restaurant design to deliver a warm and inviting atmosphere enhanced with abundant natural light, polished stone and exposed hardwood accents. Our average restaurant size is between 2,000 and 2,800 square feet and features booth, high-top and community table seating, along with outdoor patios in most of our restaurant locations. Our open kitchen showcases our made-to-order preparation and exemplifies our commitment to freshness. We believe the attractive design of our restaurants and our commitment to delivering superior service makes us a desirable destination at any time of day, which we believe contributed to a balanced day part mix of 50% lunch and 50% dinner for the fiscal year ended December 31, 2019.

Hospitality. We hire and train individuals who share our passion for food and deliver friendly, attentive service by engaging customers the moment they enter our restaurants and maintaining this level of service throughout their visit. We believe our ability to deliver high-quality service is a function of our relationship with our employees, and we therefore focus on fostering an atmosphere of teamwork and support with a clear path toward promotion within

 

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the company. We have developed a proprietary training system for professional development of the entire team, and we believe that by offering our employees great opportunities for ongoing professional development, they in turn remain committed to providing our customers with an experience that exceeds expectations.

Value. We have developed a formula for customer value by delivering high-quality food, a welcoming environment and genuine hospitality, all at an attractive price point. We believe The Habit’s formula brings a highly differentiated experience to the fast casual restaurant segment by combining the quality, convenience and hospitality commonly associated with our casual dining and fast casual competitors at a price point that is below the low end of the average range of the fast casual segment. The price for our char-grilled, made-to-order Charburger combination meal with fries and a regular drink ranges from $7.60 to $8.83 at our company-operated locations, which provides our customers with a meal that is priced below comparable menu options at many competing fast casual restaurant alternatives.

Productive Restaurants

For the fiscal year ended December 31, 2019, our restaurants that had been open for 12 months or more had an AUV of approximately $1.9 million and generated cash-on-cash returns in excess of 37.5%.

Our restaurant model is designed to generate high sales volumes and high cash-on-cash returns.

Cash-on-cash returns are typically defined as the ratio of annual restaurant contribution divided by the total amount of capital expenditures, net of tenant improvement allowances for a new restaurant, expressed as a percentage. High cash-on-cash returns are generally considered 30% or higher. We believe our ability to generate AUVs of approximately $1.9 million for the fiscal year ended December 31, 2019 at our relatively low average per customer spend amount is indicative of our ability to generate traffic and deliver superior restaurant-level execution. Our ability to generate traffic, with an average weekly customer count of approximately 3,800 customers per restaurant location, serves as a benefit to adjacent retail businesses and therefore makes The Habit a desirable tenant for landlords and developers, who seek to find tenants that increase traffic in their retail developments.

Our menu variety and quality offerings contribute to the productivity of our restaurants and positions The Habit as an attractive destination for a range of occasions, including a convenient lunch option, an after-school gathering spot for students, a social venue for seniors or an affordable restaurant for families. We believe our ability to drive traffic across both the lunch and dinner day parts allowed us to deliver an attractive per annum sales per leasable square foot of $777 for the fiscal year ended December 31, 2019.

Broad Customer Appeal

Based on 2019 primary research and a third-party brand usage survey, our customer base is well-balanced with 46% male customers and 54% female customers. We believe our female customers represent a highly desirable customer base with strong influence on a family’s mealtime decision-making process, making them strong brand advocates who appreciate the quality and diversity of our menu offerings. Our customer base extends across age and socioeconomic groups, enabling us to successfully operate restaurants within a variety of communities of varying sizes, ethnic diversity and income ranges. Nearly 60% of our customer base is in the age range of 25 to 54. Families with children under the age of 18 represent a significant segment of this customer base and group occasions. We believe our diversified customer base and menu variety contributed to our balanced day part mix of 50% lunch and 50% dinner for the fiscal year ended December 31, 2019, which in turn contributed to our strong AUVs.

Site Development and Expansion

Site Selection Process

We consider the location of a restaurant to be a critical variable in its long-term success and as such, we devote significant effort to the investigation and evaluation of potential locations. We have developed a targeted site acquisition and qualification process that incorporates our management’s experience as well as extensive data collection, analysis and interpretation. Our restaurant development efforts are led by our highly experienced senior management team and our in-house real estate team. Collectively, they have extensive experience identifying and

 

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qualifying suitable restaurant locations with restaurant concepts such as The Cheesecake Factory, Panda Express, Baja Fresh Mexican Grill, Jack in the Box, El Pollo Loco, Mimi’s Café, Black Bear Diner, Smashburger and Rubio’s Fresh Mexican Grill.

Our site selection process includes extensive data collection, strategic mapping and competitive analysis and we proactively seek new restaurant locations based on specific criteria, such as demographic characteristics, daytime population and residential density thresholds and traffic patterns, along with the potential visibility of, and accessibility to, the restaurant. Our restaurant concept works in a range of location types due to the flexibility of our restaurant design, the balanced sales mix across day parts and guest demographics. Most of our restaurants are located in grocery anchored strip centers, power centers anchored by big box regional retailers and free-standing locations. To assist in our analysis of a potential restaurant location, we focus on locating near traffic generators, such as office buildings, hospitals, movie theaters, recreational parks, high schools and colleges, as well as preferred co-tenants with similar customer demographics to The Habit. While we have typically targeted end-cap locations, we have expanded the number of drive-thru locations in our store openings and we also have the flexibility to operate inline and free-standing locations. We believe there is an opportunity to open more drive-thru locations going forward, which require increased investment costs but generate higher AUVs and generally result in a return on investment similar to our traditional locations. Our ability to succeed in various trade area and real estate types has provided us with flexibility in our market development strategy and has lowered operating risk when selecting new restaurant locations.

Restaurant Design

After securing a restaurant site, we commence our restaurant buildout. Our average restaurant size is between 2,000 and 2,800 square feet and features a comfortable dining room offering booth, high-top and community table seating, along with outdoor patios. Each of our restaurants has a customized layout to optimize the available space with consistent design cues that contribute to our customers’ experiences. The dining area of our typical restaurant can seat approximately 30 to 50 people, and if the location has a patio, the patio will accommodate approximately 25 to 35 additional people.

Our new restaurant model targets an average investment of approximately $1,025,000, net of tenant allowances. We believe our investment in the construction of our restaurant location enables us to provide a differentiated experience for customers due to our focus on the finer details of our restaurant design, which generates broad customer appeal. Our restaurants provide a warm and welcoming atmosphere enhanced with abundant natural light, exposed hardwood accents, polished stone countertops, active California lifestyle watercolor artwork and generally provide ample indoor and patio seating space. The entrance of each of our restaurants is designed to include easy to read menu boards and comfortable waiting benches for to-go orders. Each of our restaurants also includes a designated area for customers to serve their own drink, access the pepper bar or pick one of our flavorful sauces. We believe the atmosphere of our restaurants creates an inviting environment where friends and family can gather throughout the day, encourages repeat visits, inspires brand advocacy and drives increased sales.

The development and construction of our new sites is the responsibility of our real estate, development and construction teams. Our Chief Development Officer oversees the development process that prepares a new restaurant for turnover to operations.

Restaurant Management and Operations

Service

We seek to deliver an experience and atmosphere at The Habit that our customers want to share with family and friends. Our focus on superior restaurant-level execution to enhance our customers’ experiences is instilled within every one of our employees. We make an effort to hire team members who share our passion for food, exhibit a consistently positive attitude and high degree of integrity, approach their jobs with a team mentality and who will operate our restaurants in a way that is consistent with our high standards. We believe that we attract genuine, friendly employees at The Habit, and then reinforce and reward such employees’ dedication to hospitality which helps us to consistently provide high levels of service to our customers and differentiate our dining experience from that of our competitors.

 

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Our team members are empowered to improve the experience of our customers and directly address any customer concerns, which we believe contributes to the success of our business. We encourage our team members to take responsibility for our dining room environment and personally visit tables to ensure our customers’ satisfaction. Our cashiers are extensively trained on the menu items and offer customers thoughtful suggestions to enhance their ordering process. The pepper bar and beverage stations are continuously monitored for cleanliness and an ample supply of products.

A meaningful portion of our customers also visit The Habit for on-the-go meals, where speed and efficiency are of utmost importance. We offer mobile and online ordering supported by a dedicated call center to enhance the ordering experience. In 2018, we added the option of delivery in the majority of our restaurants. We are also using tablets in selected restaurants to expedite drive-thru ordering to facilitate faster customer ordering during peak hours. In 2019, we added self-order kiosks to a number of our stores allowing customers a different and faster way to order in-store and we also launched our mobile app on a nationwide basis as another ordering alternative for our customers. We value our customers’ time and target an average cook time of six to eight minutes to complete the order, allowing our teams to properly execute the made-to-order preparation of our fresh ingredients and still cater to the busy schedules of our customers.

In order to maintain our high level of customer service, we have implemented a Customer Service Evaluation system. We measure team performance using specific metrics, including positive attitude and engagement with our customers. All captured data can be analyzed by category or broad measures, including region or district, and the results are reviewed by our corporate and restaurant-level management on a monthly basis and comprise a portion of each restaurant location’s quarterly bonus plan.

 

Operations

At The Habit, we believe that superior execution leads to superior results. We focus on offering our customers a high-quality and consistent experience every time they visit us and have implemented disciplined operating systems aimed at measuring our ability to deliver this high-quality experience. These systems include restaurant operating reviews, customer service evaluations and speed of service performance standards. Corporate and restaurant-level management utilize the information to identify strengths and opportunities and develop specific plans for continuous performance improvement.

We employ a customer-centered approach to our restaurant operations, which we also believe is fundamental to our success. Each of our restaurants is typically staffed with a restaurant manager, at least two assistant managers and an average of approximately 25 dedicated team members who prepare our food fresh daily and deliver outstanding customer service. We cross-train our employees in an effort to create a depth of competency in our critical restaurant functions. Our District Managers are, on average, responsible for approximately five restaurants, which allows them

 

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to visit each restaurant regularly and maintain a frequent dialogue with our restaurant managers. Similarly, our Directors of Operations are each responsible for between approximately six and nine districts to ensure they are accessible and attentive to the needs and performance of the restaurants in their regions.

Food safety is a top priority, and we dedicate substantial resources, which includes our supply chain and quality assurance teams, to help ensure that our customers enjoy safe, quality food products. We have taken various steps to ensure food quality and mitigate safety risks. Our restaurants undergo internal safety audits and routine health inspections and in the fourth quarter of 2019, we engaged a third party to perform audits of our stores starting in 2020. We also consider food safety and quality assurance when selecting our distributors and suppliers.

Training

We are selective in our hiring processes, aiming to staff our restaurants with team members that are friendly, customer focused, and driven to perform high-quality work. We believe we make employee expectations and accountability clear through our stated commitment to our “daily disciplines,” which are posted in each of our restaurants. We believe that this fosters a culture of excellence and allows us to deliver a consistent customer experience across our restaurant base.

Our management, operations and training philosophy underscore the importance of professional and personal development for every one of our employees. Our professional development procedures include various process calendars and individual milestones which are overseen at the executive level by our Chief Quality Officer. Our restaurant-level managers are incentivized to instill a culture of excellence and drive the development of their employees. A significant component of management’s restaurant-level bonus is based on the ability to properly train and support employees. We often have dozens of managers-in-training at a given time to ensure that we have a pipeline of quality management candidates to support our new restaurants. We have complemented our training and development programs with valuable systems and tools, such as a cloud-based system to deliver proprietary training tools to our employees that also serves as a progress tracking mechanism. Our internal training system, also known as “Flame” training, creates customized progression plans for each restaurant-level employee and is available for review by all members of management. We believe that the hands-on approach we take to provide personal and professional development to every team member contributes to our ability to consistently deliver a high-quality customer experience.

Management Information Systems

We have invested in information systems that provide robust processing and reporting capabilities for our restaurants. All of our company-operated restaurants use MICROS, a leading computerized point-of-sale system, which we believe is scalable to support our long-term growth plans. The point-of-sale system provides a touch screen interface with an integrated kitchen display system and pagers, combined with high speed credit card and gift card processing all specifically designed for the restaurant industry. The point-of-sale system is used to collect daily transaction data, which generates information about daily sales, product mix and average transaction that we actively analyze. Our enterprise-level point-of-sale system allows us to manage all products sold and their corresponding prices in every company-operated restaurant from our corporate office.

Our in-restaurant back office systems are designed to assist in the management of our restaurants by providing quick access to sales information as well as labor and food cost management tools. The systems also provide corporate headquarters and restaurant operations management quick access to detailed business data and reduces restaurant managers’ time spent on administrative needs. The systems also provide sales, bank deposit and variance data to our accounting department on a daily basis. For company-operated restaurants, we use this data to generate daily sales information and weekly consolidated reports regarding sales and other key measures, as well as preliminary weekly reporting on key measures for each location with final reports following the end of each period. Our restaurant managers also have the ability to submit food and operating supply orders electronically to our distribution network. Some of the additional systems that we use include a cloud-based information system, paperless employee files, proprietary on-line Flame training system and a customized labor deployment tool. All of our restaurant systems can be accessed by multi-functional hand-held tablets. Our systems and data are protected by advanced communication and data security systems.

 

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Franchising and Licensing

Although we expect the majority of our expansion to continue to come from company-operated restaurants, we have developed a franchising and licensing strategy that we believe will enable us to expand unit growth in selected new markets. Our franchise and license programs are low cost and high return models that allow us to expand our footprint and build brand awareness in markets that we otherwise do not plan to enter in the short- to medium-term. In addition, licensed locations provide access to non-traditional locations, such as universities, airports and other captive audience venues. At the end of fiscal 2019 we had 23 franchise locations and seven licensed restaurants from which we earn revenue.

We currently have seven license agreements where we typically receive an initial license fee per restaurant that is opened and we are entitled to be paid ongoing monthly royalties based on gross sales at each restaurant opened under the agreements. As of December 31, 2019, we have seven licensed locations opened under these agreements, which operate in California and Arizona.

We have an international franchise agreement for the development of restaurants in the Shanghai area. We received an initial development fee and initial franchise fees under the agreement.  Additionally, we are entitled to be paid ongoing monthly royalties based on gross sales at each restaurant that is opened under the agreement. We currently have seven locations opened under this agreement. We also have an international franchise agreement for the development of restaurants in Cambodia. We received an initial development fee and initial franchise fees under the agreement and we are entitled to be paid ongoing monthly royalties based on the gross sales at each restaurant that is opened under the agreement. We expect to open our first restaurants under this agreement in fiscal year 2020.

We have five domestic franchise agreements where we typically receive an initial franchise fee per restaurant that is opened. Additionally, we are entitled to be paid ongoing monthly royalties based on gross sales at each restaurant opened under the agreements. As of December 31, 2019, we have 16 franchised locations opened under these agreements, which operate in Nevada and Washington.

We intend to expand the number of franchised and licensed restaurants on a disciplined basis as we develop our franchise and license program, and we have a seasoned Chief Global Business Partnership Officer to oversee our strategy to build brand awareness and drive market penetration. We have focused our franchisee and licensee development efforts on experienced, well-capitalized partners that have operating resources, local market knowledge and a capacity to build 10 or more restaurants in their respective markets.

Marketing and Advertising

We believe that our superior execution and high-quality food creates loyal customers who become brand ambassadors. Our focus on genuine hospitality creates a great experience for our customers, motivating them to recommend The Habit to their family and friends. We enhance sales by driving brand awareness and increasing trials by first time customers, because we believe that if we can get new consumers to experience The Habit, they will quickly become regular customers.

Our marketing efforts, headed by our Chief Brand Officer, are centered around two main components:

 

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Purchasing and Distribution

Maintaining a high degree of quality in our restaurants depends in part on our ability to acquire high-quality ingredients and other necessary supplies that meet our specifications from reliable suppliers. We currently have five food distributor agreements, and we contract with them for the majority of our food and supplies. The food and supplies we purchased from our food distributors primarily consist of various proteins, such as fresh ground beef, chicken, sushi-grade tuna and USDA choice tri-tip steak. We also purchase from our food distributors beverages, paper and packaging products, produce, dairy and other grocery items, as well as a variety of kitchen and cleaning supplies needed to support our restaurant operations. We carefully selected our distributors based on their quality, understanding of our brand and ability to support our growth. We will continue to regularly evaluate all of our distributors to ensure that the products we purchase conform to our standards and that the prices they offer are competitive.

We recognize that the safety and consistency of our products begins with our suppliers. Suppliers must meet our criteria and strict quality control standards in the production and delivery of our food and other products. We arrange for delivery of our products to each of our restaurants two to three days a week. Our standard sourcing procedures utilize two or more suppliers per distribution center for each commodity in order to reduce our supplier risk and ensure our ability to secure high-priority ingredients.

Intellectual Property and Trademarks

We own a number of trademarks and service marks registered or pending with the U.S. Patent and Trademark Office (the “PTO”). We have registered several marks with the PTO, including the following: The Habit; The Habit Burger Grill; Respect the Burger; and Custom Built! Quality Food Made to Order & Design. We also have certain trademarks registered or pending in certain foreign countries. In addition, we have registered the Internet domain name www.habitburger.com. The information on, or that can be accessed through, our website is not part of this report.

We plan to license the use of our registered trademarks to franchisees and licensees through franchise and license arrangements. These arrangements will restrict franchisees’ and licensees’ activities with respect to the use of our trademarks and impose quality control standards in connection with goods and services offered in connection with the trademarks.

We believe that our trademarks, service marks and other intellectual property rights have significant value and are important to the marketing of our brand, and it is our policy to protect and defend vigorously our rights to such intellectual property. However, we cannot predict whether steps taken to protect such rights will be adequate. See the section entitled “Item 1A, Risk Factors—Risks Related to Our Business and Industry—We may not be able to

 

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adequately protect our intellectual property, which could harm the value of our brand and have a material adverse effect on our business, financial condition and results of operations.”

Competition

We primarily compete in the fast casual restaurant segment, but we also compete with restaurants in other segments, such as traditional fast food and casual dining. We believe the fast casual restaurant segment is competitive with these other restaurant segments with respect to food quality, price and value relationships, ambience, service and location. Consumers’ dining choices are affected by many factors, including changes in consumer tastes and discretionary spending patterns, macroeconomic conditions, demographic trends, weather conditions, the cost and availability of food products and supplies, labor and government laws and regulations. We also recognize however, that both the fast food and casual dining segments have continued to significantly increase their levels of discounting.

We believe that we have a favorable competitive stance in the fast casual restaurant segment and represent an alternative concept to traditional fast food and casual dining incumbents. Based on a guest segmentation analysis we performed in 2019, we believe our customers make their dining choices among a competitive set that includes large fast casual concepts such as Chipotle Mexican Grill and Panera Bread Company, along with burger-focused competitors that include In-N-Out Burger, Five Guys Burger and Fries, Shake Shack and Smashburger, among others. For additional information regarding the risks we face from competition in our segments, see “Risk Factors— Risks Related to Our Business and Industry—We operate in the highly competitive restaurant industry. If we are not able to compete effectively, it will have a material adverse effect on our business, financial condition and results of operations.”

We believe that our diverse menu, including char-grilled burgers, chicken, tuna and steak featured in our sandwiches and salads, generates broad customer appeal by eliminating the veto vote. We believe that our restaurant design delivers a warm and inviting atmosphere, with consistently delivered genuine hospitality. We believe that our pricing, with the average per customer spend of $9.68 is appealing to our customers when they are choosing among fast casual restaurants. We believe that our focus on quality, environment, hospitality and value differentiate us from our competitors and provides a meaningful foundation for our continued growth.

Seasonality

Seasonal factors and the timing of holidays cause our revenue to fluctuate from quarter to quarter. Our revenue per restaurant is typically slightly lower in the fourth quarter due to holiday closures. Adverse weather conditions may also affect customer traffic, especially in the first and fourth quarters. In addition, we have outdoor seating at many of our restaurants, and the effects of adverse weather may impact the use of these areas and may negatively impact our revenue.

Employees

As of December 31, 2019, we had 6,437 employees, including 181 field supervision/corporate personnel and 6,256 restaurant-level personnel. None of our employees are unionized or covered by a collective bargaining agreement, and we consider our current employee relations to be good.

Government Regulation and Environmental Matters

We are subject to extensive and varied federal, state and local government regulation, including regulations relating to public and occupational health and safety, sanitation and fire prevention. We operate each of our restaurants in accordance with standards and procedures designed to comply with applicable laws, codes and regulations. Although we have not experienced, and do not anticipate, any significant difficulties, delays or failures in obtaining required licenses, permits or approvals, any such problem could delay or prevent the opening of, or adversely impact the viability of, a particular restaurant or group of restaurants.

 

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In addition, in order to develop and construct restaurants, we, and the developers and landlords we work with, need to comply with applicable zoning, land use and environmental regulations. Federal and state environmental regulations have not had a material effect on our operations to date, but more stringent and varied requirements of local governmental bodies with respect to zoning, land use and environmental factors could delay or even prevent construction and increase development costs for new restaurants. We are also required to comply with the accessibility standards mandated by the U.S. Americans with Disabilities Act (the “ADA”), which generally prohibits discrimination in accommodation or employment based on disability. We may in the future have to modify restaurants, for example by adding access ramps or redesigning certain architectural fixtures, to provide service to or make reasonable accommodations for disabled persons. While these expenses could be material, our current expectation is that any such actions will not require us to expend substantial funds.

In addition, we are subject to the U.S. Fair Labor Standards Act, the U.S. Immigration Reform and Control Act of 1986, the Occupational Safety and Health Act and various other federal and state laws governing similar matters including minimum wages, overtime, workplace safety and other working conditions. We are also subject to various laws and regulations relating to our current and any future franchise operations. See the section entitled “Item 1A, Risk Factors—Risks Related to Our Business and Industry—Governmental regulation may adversely affect our ability to open new restaurants or otherwise adversely affect our business, financial condition and results of operations.”

We are subject to federal, state and local environmental laws and regulations concerning waste disposal, pollution, protection of the environment, and the presence, discharge, storage, handling, release and disposal of, or exposure to, hazardous or toxic substances. These environmental laws can provide for significant fines and penalties for non-compliance and liabilities for remediation, sometimes without regard to whether the owner or operator of the property knew of, or was responsible for, the release or presence of the hazardous or toxic substances. Third parties may also make claims against owners or operators of properties for personal injuries and property damage associated with releases of, or actual or alleged exposure to, such substances. We are not aware of any environmental laws that will materially affect our earnings or competitive position, or result in material capital expenditures relating to our restaurants. However, we cannot predict what environmental laws will be enacted in the future, how existing or future environmental laws will be administered, interpreted or enforced, or the amount of future expenditures that we may need to make to comply with, or to satisfy claims relating to, environmental laws. It is possible that we will become subject to environmental liabilities at our properties, and any such liabilities could materially affect our business, financial condition or results of operations. See the section entitled “Item 1A, Risk Factors—Risks Related to Our Business and Industry—Compliance with environmental laws may negatively affect our business.”

Our History and Structure

Holding Company Structure

We are a holding company and our assets principally consist of our ownership (directly or indirectly) in The Habit Restaurants, LLC and its subsidiaries.

The consolidated financial statements of The Habit Restaurants, Inc. include the accounts of The Habit Restaurants, LLC and its subsidiaries (collectively the “Company”). In November 2014, we completed our IPO. In connection with our IPO, The Habit Restaurants, LLC completed a series of recapitalization transactions (the “Recapitalization”), in order to reorganize our capital structure in preparation of the IPO. Each share of The Habit Restaurants, Inc. Class A common stock corresponds to an economic interest held (directly or indirectly) by The Habit Restaurants, Inc. in The Habit Restaurants, LLC. Members of The Habit Restaurants, LLC are entitled to a proportionate share of the distributions and earnings of The Habit Restaurants, LLC, provided that The Habit Restaurants, Inc., as the managing member of The Habit Restaurants, LLC, is entitled to non-pro rata distributions for certain fees and expenses.

The Habit Restaurants, Inc., a Delaware corporation, was formed July 24, 2014 and prior to the IPO had not conducted any activities, other than (i) those incident to its formation, (ii) the merger transactions resulting in it holding interests, indirectly through its wholly-owned subsidiaries, in The Habit Restaurants, LLC (such interests collectively represented a less than 20% interest in The Habit Restaurants, LLC) and (iii) the preparation of the IPO

 

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registration statement. Prior to the completion of our IPO, we had no other material assets and had not engaged in any business or other activities except in connection with our IPO and transactions related to the Recapitalization.

Recent Developments

On January 5, 2020, the Company entered into an Agreement and Plan of Merger with YUM! Brands, Inc., a North Carolina corporation (“Yum! Brands”), and Yum! Brands’ wholly-owned subsidiary, YEB Newco Inc., a Delaware corporation (“Merger Sub”), providing for the merger of Merger Sub with and into the Company, with the Company surviving as a wholly-owned subsidiary of Yum! Brands. The acquisition of The Habit Burger Grill is expected to add an award-winning fast-casual concept with a loyal fan-base to Yum! Brands, the world’s largest restaurant company in terms of units and the parent of the KFC, Pizza Hut and Taco Bell global brands. Yum! Brands intends to fund the transaction using cash on hand and available borrowing capacity under its credit facilities. Under the terms of the agreement, The Habit Restaurants, Inc.’s stockholders will receive $14.00 in cash for each share of Class A common stock they hold on the transaction closing date. The obligation of the parties to consummate the acquisition is subject to customary closing conditions, including the approval of the transaction by the Company’s stockholders at a special meeting of stockholders and the absence of legal restraints and prohibitions against the transaction, among other conditions. For a summary of the transaction, please refer to Note 14—Subsequent Events in our consolidated financial statements of this Annual Report and to our Form 8-K filed with the U.S. Securities and Exchange Commission (the “SEC”) on January 6, 2020.

Available Information

Our Annual Report, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”), are filed with the SEC. Such reports and other information filed by us with the SEC are available free of charge on the SEC website. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of these websites are not incorporated into this Annual Report. Further, our references to the URLs for these websites are intended to be inactive textual references only. We also make the documents listed above available without charge through the Investor Relations Section of our website at www.habitburger.com.

 

 

Our business, operations and financial condition are subject to various risks. The following describes the risks and uncertainties that could cause our actual results to differ materially from those presented in our forward-looking statements. The risks and uncertainties described below are not the only ones we face but do represent those risks and uncertainties that we believe are material to us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also harm our business.

Risks Related to Our Business and Industry

Our future growth depends primarily on our ability to open new restaurants and is subject to many unpredictable factors.

We expect that one of the key means of achieving our growth strategy for the foreseeable future will be through opening new restaurants and operating those restaurants on a profitable basis. We opened 27 restaurants in 2019, consisting of 21 company-operated restaurants and six franchised/licensed locations and we opened 40 restaurants in 2018, consisting of 30 company-operated restaurants and 10 franchised/licensed locations. However, we may not be able to open new restaurants as quickly as planned. In the past, we have experienced delays in opening some restaurants due to construction delays in new developments. Such delays could happen again in future restaurant openings. Delays or failures in opening new restaurants could have a material adverse effect on our growth strategy and our business, financial condition and results of operations. As we operate more restaurants, our rate of expansion relative to the size of our restaurant base will decline.

In addition, one of our biggest challenges is locating and securing an adequate supply of suitable new restaurant sites. Competition for those sites is intense, and other restaurant and retail concepts that compete for those sites may

 

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have economic models that permit them to bid more aggressively for those sites than we can. There is no guarantee that a sufficient number of suitable sites will be available in desirable areas or on terms that are acceptable to us in order to achieve our growth plan. Our ability to open new restaurants also depends on other factors, including:

Our progress in opening new restaurants from quarter to quarter may occur at an uneven rate. If we do not open new restaurants in the future according to our current plans, the delay could have a material adverse effect on our business, financial condition and results of operations.

We operate in the highly competitive restaurant industry. If we are not able to compete effectively, it will have a material adverse effect on our business, financial condition and results of operations.

We face significant competition from restaurants in the fast casual dining and traditional fast food segments of the restaurant industry. These segments are highly competitive with respect to, among other things, taste, price, food quality and presentation, service, location and the ambience and condition of each restaurant. Our competition includes a variety of locally-owned restaurants and national and regional chains offering dine-in, carry-out, delivery and catering services. Many of our competitors have existed longer and have a more established market presence with substantially greater financial, marketing, personnel and other resources than we do. Among our competitors are a number of multi-unit, multi-market, fast casual restaurant concepts, some of which are expanding nationally. As we expand, we will face competition from these restaurant concepts as well as new competitors that strive to compete with our market segments. These competitors may have, among other things, lower operating costs, better locations, better facilities, better management, more effective marketing and more efficient operations. Additionally, we face the risk that new or existing competitors will copy our business model, menu options, presentation or ambience, among other things.

Any inability to successfully compete with the restaurants in our markets and other restaurant segments will place downward pressure on our customer traffic and may prevent us from increasing or sustaining our revenue and profitability. Consumer tastes, nutritional and dietary trends, methods of ordering, traffic patterns and the type, number and location of competing restaurants often affect the restaurant business, and our competitors may react more efficiently and effectively to those conditions. Several of our competitors compete by offering menu items that are specifically identified as low in carbohydrates, gluten-free or healthier for consumers. In addition, many of our traditional fast food restaurant competitors offer lower-priced menu options or meal packages, or have loyalty programs. Our sales could decline due to changes in popular tastes, “fad” food regimens, such as low carbohydrate diets, and media attention on new restaurants. In addition, both fast food and casual dining segments have implemented deep discounting strategies to attract consumers. If we are unable to continue to compete effectively, our traffic, sales and restaurant contribution could decline which would have a material adverse effect on our business, financial condition and results of operations.

 

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Our expansion into new markets may present increased risks.

We have opened and plan to continue opening restaurants in markets where we have little or no operating experience. Restaurants we open in new markets may take longer to reach expected sales and profit levels on a consistent basis and may have higher construction, product costs, occupancy or operating costs than restaurants we open in existing markets, thereby affecting our overall profitability. New markets may have competitive conditions, consumer tastes and discretionary spending patterns that are more difficult to predict or satisfy than our existing markets. We may need to make greater investments than we originally planned in advertising and promotional activity in new markets to build brand awareness. We may find it more difficult in new markets to hire, motivate and keep qualified employees who share our vision, passion and culture. We may also incur higher costs from entering new markets if, for example, we assign regional managers to manage comparatively fewer restaurants than in more developed markets. As a result, these new restaurants may be less successful or may achieve desired AUVs at a slower rate. We may not be able to successfully develop critical market presence for our brand in new geographical markets, as we may be unable to find and secure attractive locations, build name recognition or attract new customers. Inability to fully implement or failure to successfully execute our plans to enter new markets could have a material adverse effect on our business, financial condition and results of operations.

New restaurants, once opened, may not be profitable, and the increases in average restaurant revenue and comparable restaurant sales that we have experienced in the past may not be indicative of future results.

Some of our restaurants open with an initial start-up period of higher than normal sales volumes, which subsequently decrease to stabilized levels. Typically, our new restaurants have stabilized sales after approximately 13 to 26 weeks of operation, at which time the restaurant’s sales typically begin to grow on a consistent basis. However, we cannot assure you that this will occur for future restaurant openings. In new markets, the length of time before average sales for new restaurants stabilize is less predictable and can be longer as a result of our limited knowledge of these markets and consumers’ limited awareness of our brand. In addition, our average restaurant revenue and comparable restaurant sales may not increase at the rates achieved over the past several years. Our ability to operate new restaurants profitably and increase average restaurant revenue and comparable restaurant sales will depend on many factors, some of which are beyond our control, including:

If our new restaurants do not perform as planned, our business and future prospects could be harmed. In addition, an inability to achieve our expected average restaurant revenue would have a material adverse effect on our business, financial condition and results of operations.

 

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Our sales growth and ability to achieve profitability could be adversely affected if comparable restaurant sales are less than we expect.

The level of comparable restaurant sales, which reflect the change in year-over-year sales for restaurants in the accounting period following their 18th full period of operations, will affect our sales growth and will continue to be a critical factor affecting our ability to generate profits because the profit margin on comparable restaurant sales is generally higher than the profit margin on new restaurant sales. Our past history of positive comparable restaurant sales is not necessarily indicative of future results. Our ability to increase comparable restaurant sales depends in part on our ability to successfully implement our initiatives to build sales. It is possible such initiatives will not be successful, that we will not achieve our target comparable restaurant sales growth or that the change in comparable restaurant sales could be negative, which may cause a decrease in sales growth and ability to achieve profitability that would have a material adverse effect on our business, financial condition and results of operations. See the section entitled “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Measures We Use to Evaluate Our Performance—Comparable Restaurant Sales Growth.”

Our long-term success is highly dependent on our ability to effectively identify and secure appropriate sites for new restaurants.

We intend to develop new restaurants in our existing markets, expand our footprint into adjacent markets and to continue to selectively enter into new markets. In order to build new restaurants, both traditional and drive-thru locations, we must first identify markets where we can enter or expand our footprint, taking into account numerous factors, including the location of our current restaurants, local economic trends, population density, area demographics and geography. Then we must secure appropriate restaurant sites, which is one of our biggest challenges. There are numerous factors involved in identifying and securing an appropriate restaurant site, including:

Given the numerous factors involved, we may not be able to successfully identify and secure attractive restaurant sites in existing, adjacent or new markets, which could have a material adverse effect on our business, financial condition and results of operations.

Changes in food and supply costs or failure to receive frequent deliveries of food ingredients and other supplies could have an adverse effect on our business, financial condition and results of operations.

Our profitability depends in part on our ability to anticipate and react to changes in food and supply costs, and our ability to maintain our menu depends in part on our ability to acquire ingredients that meet our specifications from reliable suppliers. Shortages or interruptions in the availability of certain supplies caused by unanticipated demand, problems in production or distribution, food contamination, inclement weather or other conditions could adversely affect the availability, quality and cost of our ingredients, which could harm our operations. Any increase in the prices of the food products most critical to our menu, such as beef, chicken, fresh produce, soybean oil and other proteins, could have a material adverse effect on our results of operations. Particularly, the cost of ground beef is our

 

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largest commodity expenditure and accounts for approximately 16% of our total food and paper costs, or 5% of our total costs, in the fiscal year ended December 31, 2019. As of December 31, 2019, we did not purchase beef or our produce with fixed pricing or use futures contracts or other financial risk management strategies to reduce our exposure to potential price fluctuations. The market for ground beef and produce is particularly volatile and is subject to extreme price fluctuations due to seasonal shifts, climate conditions, the price of feed, industry demand, energy demand and other factors. Although we try to manage the impact that these fluctuations have on our operating results, we remain susceptible to increases in food costs as a result of factors beyond our control, such as general economic conditions, seasonal fluctuations, weather conditions, demand, food safety concerns, generalized infectious diseases, product recalls and government regulations. Therefore, material increases in the prices of the ingredients most critical to our menu, particularly ground beef, could adversely affect our operating results or cause us to consider changes to our product delivery strategy and adjustments to our menu pricing.

If any of our distributors or suppliers performs inadequately, or our distribution or supply relationships are disrupted for any reason, there could be a material adverse effect on our business, financial condition, results of operations or cash flows. Although we often enter into contracts for the purchase of food products and supplies, we do not have long-term contracts for the purchase of all of such food products and supplies. As a result, we may not be able to anticipate or react to changing food costs by adjusting our purchasing practices or menu prices, which could cause our operating results to deteriorate. If we cannot replace or engage distributors or suppliers who meet our specifications in a short period of time, that could increase our expenses and cause shortages of food and other items at our restaurants, which could cause a restaurant to remove items from its menu. If that were to happen, affected restaurants could experience significant reductions in sales during the shortage or thereafter, if customers change their dining habits as a result. In addition, because we provide moderately priced food, we may choose not to, or may be unable to, pass along commodity price increases to consumers, including price increases with respect to ground beef. These potential changes in food and supply costs could have a material adverse effect on our business, financial condition and results of operations.

Failure to manage our growth effectively could harm our business and operating results.

Our growth plan includes opening a number of new restaurants. Our existing restaurant management systems, financial and management controls and information systems may be inadequate to support our planned expansion. Managing our growth effectively will require us to continue to enhance these systems, procedures and controls and to hire, train and retain managers and team members. We may not respond quickly enough to the changing demands that our expansion will impose on our management, restaurant teams and existing infrastructure, which could harm our business, financial condition and results of operations.

Opening new restaurants in existing markets may negatively impact sales at our existing restaurants.

The consumer target area of our restaurants varies by location, depending on a number of factors, including population density, other local retail and business attractions, area demographics and geography. As a result, the opening of a new restaurant in or near markets in which we already have restaurants could adversely impact sales at these existing restaurants. Existing restaurants could also make it more difficult to build our consumer base for a new restaurant in the same market. Our core business strategy does not entail opening new restaurants that we believe will materially affect sales at our existing restaurants, but we may selectively open new restaurants in and around areas of existing restaurants that are operating at or near capacity to effectively serve our customers.

The planned increase in the number of our restaurants may make our future results unpredictable.

We opened 27 restaurants in 2019, consisting of 21 company-operated restaurants and six franchised/licensed locations. We intend to continue to grow our restaurant base in future years. Our growth strategy and the substantial investment associated with the development of each new traditional or drive-thru restaurant may cause our operating results to fluctuate unpredictably or have an adverse effect on our profits. In addition, we may find that our restaurant concept has limited appeal in new markets or we may experience a decline in the popularity of our restaurant concept in the markets in which we operate. Newly opened restaurants or our future markets and restaurants may not be successful or our system-wide average restaurant revenue may not increase at historical rates, which could have a material adverse effect on our business, financial condition and results of operations.

 

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We have limited control over our franchisees or licensees and our franchisees or licensees could take actions that could harm our business.

A part of our expected growth strategy is to continue partnering with franchisees. As of December 31, 2019, eight franchisees/licensees operated all of our domestic franchised/licensed locations and one franchisee operated all of our international franchised locations. We have limited control over our franchisees and licensees, and they could take actions that could harm our business. Franchisees and licensees are independent contractors and are not our employees, and we will not exercise control over their day-to-day operations. We provide training and support to franchisees and licensees, but the quality of franchised or licensed restaurant operations may be diminished by any number of factors beyond our control. Consequently, franchisees and licensees may not successfully operate restaurants in a manner consistent with our standards and requirements, or may not hire and train qualified managers and other restaurant personnel. If franchisees or licensees do not meet our standards and requirements, our image and reputation, and the image and reputation of other franchisees or licensees, may suffer materially and system-wide sales could decline significantly.

Franchisees and licensees, as independent business operators, may from time to time disagree with us and our strategies regarding the business or our interpretation of our, and their rights and obligations under franchise and development agreements or license agreements, respectively. This may lead to disputes with our franchisees or licensees in the future. These disputes may divert the attention of our management and our franchisees or licensees from operating our restaurants and affect our image and reputation and our ability to attract franchisees or licensees in the future, which could have a material adverse effect on our business, financial condition and results of operations.

There are eight Habit Burger Grill locations in Santa Barbara County, California, operated under a license agreement by our former chief executive officer, for which we receive no royalties or revenue.

Our former chief executive officer, Brent Reichard, and our co-founder, Bruce Reichard, operate eight The Habit Burger Grill restaurants in Santa Barbara County, California through Reichard Bros. Enterprises, Inc., pursuant to license agreements entered into in 2004, as amended and restated in 2007 and as further amended in October 2014 (the “Reichard License”). We do not receive any royalties or other revenue from these locations, and pursuant to the terms of the Reichard License, we are prohibited from opening any company-operated locations in Santa Barbara County, California. Reichard Bros. Enterprises, Inc. is also entitled, pursuant to the terms of the Reichard License, to open additional locations in Santa Barbara County, California. The Reichard License contains quality control provisions, and provides that we may terminate the Reichard License if Reichard Bros. Enterprises, Inc. fails to comply with any material provisions thereof. Nevertheless, if Reichard Bros. Enterprises, Inc. does not successfully operate its licensed restaurants in a manner consistent with our standards and requirements it may have a material adverse effect on our business, financial condition and results of operations.

Negative publicity relating to one of our restaurants, including one of our franchised/licensed restaurants, could reduce sales at some or all of our other restaurants.

Our success is dependent in part upon our ability to maintain and enhance the value of our brand, consumers’ connection to our brand and positive relationships with our franchisees. We may, from time to time, be faced with negative publicity relating to food quality, public health concerns, restaurant facilities, customer complaints or litigation alleging illness or injury, health inspection scores, integrity of our or our suppliers’ food processing, employee relationships or other matters, regardless of whether the allegations are valid or whether we are held to be responsible. The negative impact of adverse publicity relating to one restaurant may extend far beyond the restaurant or franchise involved to affect some or all of our other restaurants. The risk of negative publicity is particularly great with respect to our franchised restaurants because we are limited in the manner in which we can regulate them, especially on a real-time basis. The considerable expansion in the use of social media over recent years can further amplify any negative publicity that could be generated by such incidents. A similar risk exists with respect to unrelated food service businesses, if consumers associate those businesses with our own operations.

Additionally, employee claims against us based on, among other things, wage and hour violations, discrimination, harassment or wrongful termination may also create negative publicity that could adversely affect us and divert our financial and management resources that would otherwise be used to benefit the future performance of our

 

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operations. A significant increase in the number of these claims or an increase in the number of successful claims would have a material adverse effect on our business, financial condition and results of operations. Consumer demand for our products and our brand’s value could diminish significantly if any such incidents or other matters create negative publicity or otherwise erode consumer confidence in us or our products, which would likely result in lower sales and could have a material adverse effect on our business, financial condition and results of operations.

Governmental regulation may adversely affect our ability to open new restaurants or otherwise adversely affect our business, financial condition and results of operations.

We are subject to various federal, state and local regulations, including those relating to building and zoning requirements and those relating to the preparation and sale of food. The development and operation of restaurants depends to a significant extent on the selection and acquisition of suitable sites, which are subject to zoning, land use, environmental, traffic and other regulations and requirements. Our restaurants are also subject to state and local licensing and regulation by health, sanitation, food and occupational safety and other agencies. We may experience material difficulties or failures in obtaining the necessary licenses, approvals or permits for our restaurants, which could delay planned restaurant openings or affect the operations at our existing restaurants. In addition, stringent and varied requirements of local regulators with respect to zoning, land use and environmental factors could delay or prevent development of new restaurants in particular locations.

We are subject to the ADA and similar state laws that give civil rights protections to individuals with disabilities in the context of employment, public accommodations and other areas, including our restaurants. We may in the future have to modify restaurants by adding access ramps or redesigning certain architectural fixtures, for example, to provide service to or make reasonable accommodations for disabled persons. The expenses associated with these modifications could be material.

Our operations are also subject to the U.S. Occupational Safety and Health Act, which governs worker health and safety, the U.S. Fair Labor Standards Act, which governs such matters as minimum wages and overtime, and a variety of similar federal, state and local laws that govern these and other employment law matters. We and our franchisees may also be subject to lawsuits from our employees, the U.S. Equal Employment Opportunity Commission or others alleging violations of federal and state laws regarding workplace and employment matters, discrimination and similar matters, and we have been a party to such matters in the past. Additional, federal, state and local proposals related to paid sick leave or similar matters could, if implemented, have a material adverse effect on our business, financial condition and results of operations.

There is also a potential for increased regulation of certain food establishments in the United States, where compliance with a Hazard Analysis and Critical Control Points (“HACCP”) approach would be required. HACCP refers to a management system in which food safety is addressed through the analysis and control of potential hazards from production, procurement and handling, to manufacturing, distribution and consumption of the finished product. Many states have required restaurants to develop and implement HACCP Systems, and the United States government continues to expand the sectors of the food industry that must adopt and implement HACCP programs. For example, the Food Safety Modernization Act, signed into law in January 2011, granted the U.S. Food and Drug Administration new authority regarding the safety of the entire food system, including through increased inspections and mandatory food recalls. Although restaurants are specifically exempted from or not directly implicated by some of these new requirements, we anticipate that the new requirements may impact our industry. Additionally, our suppliers may initiate or otherwise be subject to food recalls that may impact the availability of certain products, result in adverse publicity or require us to take actions that could be costly for us or otherwise impact our business.

The impact of current laws and regulations, the effect of future changes in laws or regulations that impose additional requirements and the consequences of litigation relating to current or future laws and regulations, or our inability to respond effectively to significant regulatory or public policy issues, could increase our compliance and other costs of doing business and, therefore, have an adverse effect on our results of operations. Failure to comply with the laws and regulatory requirements of federal, state and local authorities could result in, among other things, revocation of required licenses, administrative enforcement actions, fines and civil and criminal liability. In addition, certain laws, including the ADA, could require us to expend significant funds to make modifications to our restaurants if we failed to comply with applicable standards. Compliance with the aforementioned laws and regulations can be costly

 

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and can increase our exposure to litigation or governmental investigations or proceedings, which could have a material adverse effect on our business, financial condition and results of operations.

Food safety and foodborne illness concerns could have an adverse effect on our business.

We cannot guarantee that our internal controls and training will be fully effective in preventing all food safety issues at our restaurants, including any occurrences of foodborne illnesses such as salmonella, E. coli and hepatitis A. Our quality assurance, health and sanitation internal controls and conditions are inspected by an internal team on a quarterly basis. If the internal team fails to report unsafe or unsanitary conditions or insufficient internal controls, we cannot guarantee that our internal controls will be fully effective in preventing all food safety issues. In addition, there is no guarantee that our franchise restaurants will maintain the high levels of internal controls and training we require at our company-operated restaurants. Furthermore, we and our franchisees rely on third-party vendors, making it difficult to monitor food safety compliance and increasing the risk that foodborne illness would affect multiple locations rather than a single restaurant. Some foodborne illness incidents could be caused by third-party vendors and transporters outside of our control. New illnesses resistant to our current precautions may develop in the future, or diseases with long incubation periods could arise, that could give rise to claims or allegations on a retroactive basis. One or more instances of foodborne illness in any of our restaurants or markets or related to food products we sell could negatively affect our restaurant revenue nationwide if highly publicized on national media outlets or through social media. This risk exists even if it were later determined that the illness was wrongly attributed to us or one of our restaurants. A number of other restaurant chains have experienced incidents related to foodborne illnesses that have had a material adverse effect on their operations. The occurrence of a similar incident at one or more of our restaurants, or negative publicity or public speculation about an incident, could have a material adverse effect on our business, financial condition and results of operations.

We could be party to litigation that could distract management, increase our expenses or subject us to material monetary damages or other remedies.

Our customers occasionally file complaints or lawsuits against us alleging we caused an illness or injury they suffered at or after a visit to our restaurants, or that we have problems with food quality or operations. We may also be subject to a variety of other claims arising in the ordinary course of our business, including personal injury claims, contract claims and claims alleging violations of federal and state law regarding workplace and employment matters, equal opportunity, harassment, discrimination and similar matters, and we could become subject to class action or other lawsuits related to these or different matters in the future. In recent years, a number of restaurant companies have been subject to such claims, and some of these lawsuits have resulted in the payment of substantial damages by the defendants. Regardless of whether any claims against us are valid, or whether we are ultimately held liable, claims may be expensive to defend and may divert time and money away from our operations and hurt our performance. A judgment in excess of our insurance coverage for any claims could materially and adversely affect our financial condition and results of operations. Any adverse publicity resulting from these allegations may also materially and adversely affect our reputation, which in turn could have a material adverse effect on our business, financial condition and results of operations.

In addition, the restaurant industry has been subject to a growing number of claims based on the nutritional content of food products sold and disclosure and advertising practices. We may also be subject to this type of proceeding in the future and, even if we are not, publicity about these matters (particularly directed at the fast casual or traditional fast food segments of the industry) may harm our reputation and could have a material adverse effect on our business, financial condition and results of operations.

Additionally, we and the members of our board of directors have been named as defendants in a series of actions related to the Merger (as defined below) and the associated disclosures made in the proxy statement filed with the Securities and Exchange Commission (“SEC”) pursuant to Section 14(a) of the Securities Exchange Act of 1934 (the “Proxy Statement”).  On February 5, 2020, a purported stockholder filed a complaint in the United States District Court for the Southern District of New York, captioned Gottlieb v. The Habit Restaurants, Inc., et al., Civil Action No. 1:20-cv-00966, against the Company and the members of the Company’s board of directors.  On February 11, 2020, a purported stockholder filed a complaint in the United States District Court for the Southern District of New York, captioned Morris v. The Habit Restaurants, Inc., et al., Civil Action No. 1:20-cv-01182, against the Company and the members of the Company’s board of directors.  On February 11, 2020, a purported

 

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stockholder filed a putative class action complaint in the United States District Court for the District of Delaware, captioned Smith v. The Habit Restaurants, Inc., et al., Civil Action No. 1:20-cv-00203, against the Company and the members of the Company’s board of directors.  On February 12, 2020, a purported stockholder filed a complaint in the United States District Court for the Southern District of New York, captioned Avila v. The Habit Restaurants, Inc., et al., Civil Action No. 1:20-cv-01248, against the Company and the members of the Company’s board of directors.  On February 12, 2020, a purported stockholder filed a complaint in the United States District Court for the Southern District of New York, captioned Sterner v. The Habit Restaurants, Inc., et al., Civil Action No. 1:20-cv-01251, against the Company and the members of the Company’s board of directors.  On February 13, 2020, a purported stockholder filed a putative class action complaint in the United States District Court for the Central District of California, captioned Shudic v. The Habit Restaurants, Inc., et al., Civil Action No. 8:20-cv-00294, against the Company and the members of the Company’s board of directors.  On February 20, 2020, a purported stockholder filed a complaint in the United States District Court for the Central District of California, captioned Grijalva v. The Habit Restaurants, Inc., et al., Civil Action No. 2:20-cv-01661, against the Company and the members of the Company’s board of directors.  On February 21, 2020, a purported stockholder filed a complaint in the United States District Court for the District of New Jersey, captioned Restivo v. The Habit Restaurants, Inc., et al., Civil Action No. 2:20-cv-01927, against the Company and the members of the Company’s board of directors.  On February 24, 2020, a purported stockholder filed a putative class action complaint in the Delaware Court of Chancery, captioned Bounds & Co. v. The Habit Restaurants, Inc., et al., C.A. No. 2020-0124 (Del. Ch.), against the Company and the members of the Company’s board of directors.  On February 24, 2020, a purported stockholder filed a putative class action complaint in the United States District Court for the Central District of California, captioned Stein v. The Habit Restaurants, Inc., et al., Civil Action No. 2:20-cv-01763, against the Company and the members of the Company’s board of directors.  On February 26, 2020, a purported stockholder filed a complaint in the United States District Court for the Central District of California, captioned Antalan v. The Habit Restaurants, Inc., et al., Civil Action No. 2:20-cv-01850, against the Company and the members of the Company’s board of directors.

The complaints in these eleven actions (collectively, the “Merger Litigation”) allege, among other things, that the Company and the members of our board of directors violated Sections 14(a) and 20(a) of the Exchange Act, and Rule 14a-9 promulgated under the Exchange Act, and breached their fiduciary duties, by misstating or omitting certain allegedly material information in the Proxy Statement filed with the SEC regarding the Merger.  The complaints seek, among other things, injunctive relief preventing the consummation of the Merger, rescissory damages or rescission in the event of consummation of the Merger, declaratory relief related to the disclosures in the Proxy Statement, and certain fees and expenses.

The Company believes the allegations to be without merit and intends to vigorously defend against them.  Additional lawsuits may be filed in the future related to, among other things, allegations similar to those found in the Merger Litigation, alleged breaches of fiduciary duties, any failure to complete the Merger, or enforcement proceedings commenced against us to attempt to force us to perform our obligations under the Merger Agreement (as defined below).  We cannot predict the outcome of the Merger Litigation or any other proceeding that may be commenced against us.

Compliance with environmental laws may negatively affect our business.

We are subject to federal, state and local laws and regulations concerning waste disposal, pollution, protection of the environment, and the presence, discharge, storage, handling, release and disposal of, and exposure to, hazardous or toxic substances. These environmental laws provide for significant fines and penalties for noncompliance and liabilities for remediation, sometimes without regard to whether the owner or operator of the property knew of, or was responsible for, the release or presence of hazardous toxic substances. Third parties may also make claims against owners or operators of properties for personal injuries and property damage associated with releases of, or actual or alleged exposure to, such hazardous or toxic substances at, on or from our restaurants. Environmental conditions relating to releases of hazardous substances at a prior, existing or future restaurant could have a material adverse effect on our business, financial condition and results of operations. Further, environmental laws, and the administration, interpretation and enforcement thereof, are subject to change and may become more stringent in the future, each of which could have a material adverse effect on our business, financial condition and results of operations.

 

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Changes in economic conditions and adverse weather and other unforeseen conditions, particularly in the markets in which we operate, could have a material adverse effect on our business, financial condition and results of operations.

The restaurant industry depends on consumer discretionary spending. The United States in general or the specific markets in which we operate may suffer from depressed economic activity, recessionary economic cycles, higher fuel or energy costs, low consumer confidence, high levels of unemployment, reduced home values, increases in home foreclosures, investment losses, personal bankruptcies, reduced access to credit or other economic factors that may affect consumer discretionary spending. Traffic in our restaurants could decline if consumers choose to dine out less frequently or reduce the amount they spend on meals while dining out. Negative economic conditions might cause consumers to make long-term changes to their discretionary spending behavior, including dining out less frequently on a permanent basis, which could have a material adverse effect on our business, financial condition and results of operations.

In addition, changes in economic conditions, adverse weather conditions or other unforeseen conditions in states in which we operate, or in the future may operate, could have a disproportionate impact on our overall results of operations. In particular, our business is significantly concentrated in Southern California, and as a result, we could be disproportionately affected by conditions specific to this market.

Specifically, our restaurants in Southern California generated, in the aggregate, approximately 51.1% of our revenue in fiscal year 2019, approximately 52.4% in fiscal year 2018 and approximately 54.4% in fiscal year 2017. Therefore, adverse changes in demographic, unemployment, economic or regulatory conditions in Southern California or the State of California overall, may have a material adverse effect on our business, financial condition and results of operations. As of December 2019, unemployment in California was 3.9% compared to the U.S. unemployment rate of 3.5%. We believe increases in unemployment will have a negative impact on traffic in our restaurants. As a result of our concentration in Southern California, we may be disproportionately affected by these adverse economic conditions compared to other chain restaurants.

Furthermore, regional occurrences in the markets in which we operate, such as local strikes, terrorist attacks, increases in energy prices, adverse weather conditions, tornadoes, earthquakes, hurricanes, floods, droughts, fires or other natural or man-made disasters, could have a material adverse effect on our business, financial condition and results of operations. Adverse weather conditions may also impact customer traffic at our restaurants, and, in more severe cases, cause temporary restaurant closures, sometimes for prolonged periods. Most of our restaurants have outdoor seating, and the effects of adverse weather may impact the use of these areas and may negatively impact our revenue. If restaurant revenue decreases, our profitability could decline as we spread fixed costs across a lower level of sales. Reductions in staff levels, asset impairment charges and potential restaurant closures could result from prolonged negative restaurant revenue, which would have a material adverse effect on our business, financial condition and results of operations.

New information or attitudes regarding diet and health could result in changes in regulations and consumer consumption habits, which could have an adverse effect on our business, financial condition and results of operations.

Regulations and consumer eating habits may change as a result of new information or attitudes regarding diet and health. Such changes may include responses to scientific studies on the health effects of particular food items or federal, state and local regulations that impact the ingredients and nutritional content of the food and beverages we offer. The success of our restaurant operations is dependent, in part, upon our ability to effectively respond to changes in any consumer attitudes or health regulations and our ability to adapt our menu offerings to trends in food consumption, especially fast-moving trends. If consumer health regulations or consumer eating habits change significantly, we may choose or be required to modify or delete certain menu items, which may adversely affect the attractiveness of our restaurants to new or returning customers. While we generally find that changes in consumer eating habits occur slowly, providing us with sufficient time to adapt our restaurant concept accordingly, changes in consumer eating habits can occur rapidly, often in response to published research or study information, which puts additional pressure on us to adapt quickly. To the extent we are unwilling or unable to respond with appropriate changes to our menu offerings in an efficient manner, it could materially affect consumer demand and have an adverse impact on our business, financial condition and results of operations.

 

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Government regulation and consumer eating habits may impact our business as a result of changes in attitudes regarding diet and health or new information regarding the adverse health effects of consuming certain menu offerings. These changes have resulted in, and may continue to result in, laws and regulations requiring us to disclose the nutritional content of our food offerings, and they have resulted, and may continue to result in, laws and regulations affecting permissible ingredients and menu offerings. A number of counties, cities and states, including California, have enacted menu labeling laws requiring multi-unit restaurant operators to disclose to consumers certain nutritional information, or have enacted legislation restricting the use of certain types of ingredients in restaurants, which laws may be different or inconsistent with requirements under the Patient Protection and Affordable Care Act of 2010 (the “PPACA”), which establishes a uniform, federal requirement for certain restaurants to post nutritional information on their menus. Specifically, the PPACA requires chain restaurants with 20 or more locations operating under the same name and offering substantially the same menus to publish the total number of calories of standard menu items on menus and menu boards, along with a statement that puts this calorie information in the context of a total daily calorie intake.

We may not be able to effectively respond to changes in consumer health perceptions, comply with further nutrient content disclosure requirements or adapt our menu offerings to trends in eating habits, which could have a material adverse effect on our business, financial condition and results of operations.

We rely heavily on certain vendors, suppliers and distributors, which could have a material adverse effect on our business, financial condition and results of operations.

Our ability to maintain consistent price and quality throughout our restaurants depends in part upon our ability to acquire specified food products and supplies in sufficient quantities from third-party vendors, suppliers and distributors at a reasonable cost. We use a limited number of suppliers and distributors in various geographical areas, particularly with respect to our fresh food products. Starting in the first fiscal quarter of 2017 we transitioned from one food distributor to four new distributors covering different markets. One of those distributors, Shamrock Foods Company, supplied us with approximately 80.9% of our food supplies in the fiscal year ended December 25, 2018 and 81.2% of our food supplies in the fiscal year ended December 31, 2019. We do not control the businesses of our vendors, suppliers and distributors, and our efforts to specify and monitor the standards under which they perform may not be successful. Furthermore, certain food items are perishable, and we have limited control over whether these items will be delivered to us in appropriate condition for use in our restaurants. If any of our vendors or other suppliers are unable to fulfill their obligations to our standards, or if we are unable to find replacement providers in the event of a supply or service disruption, we could encounter supply shortages and incur higher costs to secure adequate supplies, which would have a material adverse effect on our business, financial condition and results of operations. Furthermore, if our current vendors or other suppliers are unable to support our expansion into new markets, or if we are unable to find vendors to meet our supply specifications or service needs as we expand, we could likewise encounter supply shortages and incur higher costs to secure adequate supplies, which would have a material adverse effect on our business, financial condition and results of operations.

In addition, we use various third-party vendors to provide, support and maintain most of our management information systems. We also outsource certain accounting, payroll and human resource functions to business process service providers. The failure of such vendors to fulfill their obligations could disrupt our operations. Additionally, any changes we may make to the services we obtain from our vendors, or new vendors we employ, may disrupt our operations. These disruptions could have a material adverse effect on our business, financial condition and results of operations.

Failure to maintain our corporate culture and changes in consumer recognition of our brand as we grow could have a material adverse effect on our business, financial condition and results of operations.

We believe that a critical component to our success has been our corporate culture. We have invested substantial time and resources in building our team. As we continue to grow, we may find it difficult to maintain the innovation, teamwork, passion and focus on execution that we believe are important aspects of our corporate culture. Any failure to preserve our culture could negatively affect our future success, including our ability to retain and recruit personnel and to effectively focus on and pursue our corporate objectives. If we cannot maintain our corporate culture as we grow, it could have a material adverse effect on our business, financial condition and results of operations.

 

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In addition, our future results depend on various factors, including local market acceptance of our restaurants and consumer recognition of the quality of our food and operations. Although we have received national and regional recognition for the high-quality of our food and operations, we cannot guarantee that we will continue to receive similar recognition in future periods. Failure to receive continued national and regional recognition may impact consumer recognition of our brand, which could have a material adverse effect on our business, financial condition and results of operations.

The effect of changes to healthcare laws in the United States may increase the number of employees who choose to participate in our healthcare plans, which may significantly increase our healthcare costs and negatively impact our financial results.

In 2010, the PPACA was signed into law in the United States to require health care coverage for many uninsured individuals and expand coverage to those already insured. The PPACA requires us to offer healthcare benefits to all full-time employees (including full-time hourly employees) that meet certain minimum requirements of coverage and affordability, or face penalties. We began offering such benefits in August 2015, and have incurred additional expenses due to organizing and maintaining the plan which is more expensive on a per person basis and for an increased number of employees who have elected to obtain coverage through a healthcare plan we subsidize in part. If we fail to continue to offer such benefits, or the benefits we elect to offer do not meet the applicable requirements, we may incur penalties. It is also possible that by making changes or failing to make changes in the healthcare plans offered by us we will become less competitive in the market for our labor. The future costs and other effects of these new healthcare requirements cannot be determined with certainty, but they may significantly increase our healthcare coverage costs and could have a material adverse effect on our business, financial condition and results of operations.

Additionally, the modifications made under the Tax Cuts and Jobs Act had no impact on the employer mandate. However, we cannot predict the ultimate content, timing or impact of any changes to the PPACA or other federal and state reform efforts. There is no assurance that federal or state health care reform will not adversely affect our business, financial condition and results of operations, and we cannot predict how future federal or state legislative, judicial or administrative changes relating to healthcare reform will affect our business.

We depend on our senior management team and other key employees, and the loss of one or more key personnel or an inability to attract, hire, integrate and retain highly skilled personnel could have an adverse effect on our business, financial condition and results of operations.

Our success depends largely upon the continued services of our key executives. We also rely on our leadership team in setting our strategic direction, operating our business, identifying, recruiting and training key personnel, identifying expansion opportunities, arranging necessary financing and general and administrative functions.

From time to time, there may be changes in our executive management team resulting from the hiring or departure of executives, which could disrupt our business. The loss of one or more of our executive officers or other key employees could have a serious adverse effect on our business. The replacement of one or more of our executive officers or other key employees would involve significant time and expense and may significantly delay or prevent the achievement of our business objectives.

To continue to execute our growth strategy, we also must identify, hire and retain highly skilled personnel. We might not be successful in maintaining our unique culture and continuing to attract and retain qualified personnel. Failure to identify, hire and retain necessary key personnel could have a material adverse effect on our business, financial condition and results of operations.

Labor shortages, unionization activities, labor disputes or increased labor costs could negatively impact our growth and could have a material adverse effect on our business, financial condition and results of operations.

Labor is a primary component in the cost of operating our restaurants. If we face labor shortages or increased labor costs because of increased competition for employees, higher employee turnover rates, increases in the federal, state or local minimum wage or other employee benefits costs (including costs associated with health insurance

 

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coverage), our operating expenses could increase and our growth could be negatively impacted. In addition, our success depends in part upon our ability to attract, motivate and retain a sufficient number of well-qualified restaurant operators and management personnel, as well as a sufficient number of other qualified employees, including customer service and kitchen staff, to align with our expansion schedule. In addition, restaurants have traditionally experienced relatively high employee turnover rates. Although we have not yet experienced significant problems in recruiting or retaining employees, our ability to recruit and retain such individuals may delay the planned openings of new restaurants or result in higher employee turnover in existing restaurants, which could have a material adverse effect on our business, financial condition and results of operations.

Although none of our employees are currently covered under collective bargaining agreements, if a significant number of our employees were to become unionized and collective bargaining agreement terms were significantly different from our current compensation arrangements, it could adversely affect our business, financial condition and results of operations. In addition, a labor dispute involving some or all of our employees may harm our reputation, disrupt our operations and reduce our revenue, and resolution of disputes may increase our costs. If we are unable to continue to recruit and retain sufficiently qualified individuals, our business and our growth could be adversely affected. Competition for these employees could require us to pay higher wages, which could result in higher labor costs. In addition, increases in the minimum wage would increase our labor costs. Additionally, costs associated with workers’ compensation are rising, and these costs may continue to rise in the future. Beginning in fiscal year 2018 we moved to a modified self-insurance workers’ compensation program. We are responsible for workers’ compensation insurance claims up to a specified amount. We maintain a reserve for estimated claims both reported and incurred but not reported, based on historical claims experience and other assumptions. Should claims occur in greater amounts than we have expected, our accruals may not be sufficient and we may record additional expenses. We may be unable to increase our menu prices in order to pass these increased labor costs on to consumers, in which case our margins would be negatively affected, which could have a material adverse effect on our business, financial condition and results of operations.

The minimum wage, particularly in California, continues to increase and is subject to factors outside of our control.

We have a substantial number of hourly employees who are paid wage rates based on the applicable federal or state minimum wage, although our pay scale starts in excess of the minimum wage, and increases in the minimum wage may increase our labor costs. On January 1, 2020, the State of California’s (where most of our restaurants are located) minimum wage was raised to $13.00 per hour, after being raised to $12.00 per hour on January 1, 2019. Legislation is currently in place that increases the minimum wage in the State of California gradually over the next two years to $15.00 by January 1, 2022. Moreover, municipalities may set minimum wages above the applicable state standards. The federal minimum wage has been $7.25 per hour since July 24, 2009. Either federally-mandated or state-mandated minimum wages may be raised in the future. We may be unable to increase our menu prices in order to pass future increased labor costs on to our customers, in which case our margins would be negatively affected, which could have a material adverse effect on our business, financial condition and results of operations. In addition, if menu prices are increased by us to cover future increased labor costs, the higher menu prices could adversely affect customer traffic which would reduce sales and thereby reduce our margins.

Changes in employment laws may adversely affect our business.

Various federal and state labor laws govern the relationship with our employees and impact operating costs. These laws include employee classification as exempt or non-exempt for overtime and other purposes, minimum wage requirements, unemployment tax rates, workers’ compensation rates, immigration status and other wage and benefit requirements. Significant additional government-imposed increases in the following areas could have a material adverse effect on our business, financial condition and results of operations:

 

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In addition, various states in which we operate are considering or have already adopted new immigration laws or enforcement programs, and the U.S. Congress and Department of Homeland Security from time to time consider and may implement changes to federal immigration laws, regulations or enforcement programs as well. Some of these changes may increase our obligations for compliance and oversight, which could subject us to additional costs and make our hiring process more cumbersome, or reduce the availability of potential employees. Although we require all workers to provide us with government-specified documentation evidencing their employment eligibility, some of our employees may, without our knowledge, be unauthorized workers. We currently participate in the “E-Verify” program, an Internet-based, free program run by the United States government to verify employment eligibility, in states in which participation is required. However, use of the “E-Verify” program does not guarantee that we will properly identify all applicants who are ineligible for employment. Unauthorized workers are subject to deportation and may subject us to fines or penalties, and if any of our workers are found to be unauthorized, we could experience adverse publicity that negatively impacts our brand and may make it more difficult to hire and keep qualified employees. Termination of a significant number of employees who were unauthorized employees may disrupt our operations, cause temporary increases in our labor costs as we train new employees and result in additional adverse publicity. We could also become subject to fines, penalties and other costs related to claims that we did not fully comply with all recordkeeping obligations of federal and state immigration compliance laws. These factors could have a material adverse effect on our business, financial condition and results of operations.

Furthermore, in recent years immigration laws have been a topic of considerable political focus. The Trump administration has indicated that it intends to re-examine immigration laws and regulations. Further changes in immigration or work authorization laws could increase our compliance and oversight obligations, which could subject us to additional costs and potential liability and make our hiring process more burdensome, and could potentially reduce the availability of prospective employees.

We might require additional capital to support business growth, and this capital might not be available.

We intend to continue to make investments to support our business growth and might require additional funds to respond to business challenges or opportunities, including the need to open additional restaurants, develop new products and menu items or enhance our products and menu items, and enhance our operating infrastructure. Accordingly, we might need to engage in equity or debt financings to secure additional funds. If we raise additional funds through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our Class A common stock. Any debt financing secured by us in the future could involve restrictive covenants relating to our capital-raising activities and other financial and operational matters, which might make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. Moreover, if we issue new debt securities, the debt holders would have rights senior to Class A common stockholders to make claims on our assets. In addition, we might not be able to obtain additional financing on terms favorable to us, if at all. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly limited.

We are subject to all of the risks associated with leasing space subject to long-term non-cancelable leases.

We do not own any real property. Payments under our operating leases account for a significant portion of our operating expenses and we expect the new restaurants we open in the future will also be leased. We are obligated under non-cancelable leases for our restaurants and our corporate headquarters. Our restaurant leases generally have a term of 10 years with two five-year renewal options. Our restaurant leases generally require us to pay a proportionate share of real estate taxes, insurance, common area maintenance charges and other operating costs. Some restaurant leases provide for contingent rental payments based on sales thresholds, although we generally do not expect to pay significant contingent rent on these properties based on the thresholds in those leases. Additional sites that we lease are likely to be subject to similar long-term non-cancelable leases. If an existing or future restaurant is not profitable, and we decide to close it, we may nonetheless be committed to perform our obligations

 

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under the applicable lease including, among other things, paying the base rent for the balance of the lease term. In addition, as each of our leases expires, we may fail to negotiate renewals, either on commercially acceptable terms or at all, which could cause us to pay increased occupancy costs or to close restaurants in desirable locations. These potential increased occupancy costs and closed restaurants could have a material adverse effect on our business, financial condition and results of operations.

We may not be able to adequately protect our intellectual property, which could harm the value of our brand and have a material adverse effect on our business, financial condition and results of operations.

Our intellectual property is material to the conduct of our business. Our ability to implement our business plan successfully depends in part on our ability to further build brand recognition using our trademarks, service marks, trade dress and other proprietary intellectual property, including our name and logos and the unique ambience of our restaurants. While it is our policy to protect and defend vigorously our rights to our intellectual property, we cannot predict whether steps taken by us to protect our intellectual property rights will be adequate to prevent misappropriation of these rights or the use by others of restaurant features based upon, or otherwise similar to, our restaurant concept. It may be difficult for us to prevent others from copying elements of our concept and any litigation to enforce our rights will likely be costly and may not be successful. Although we believe that we have sufficient rights to all of our trademarks and service marks, we may face claims of infringement that could interfere with our ability to market our restaurants and promote our brand. Any such litigation may be costly and could divert resources from our business. Moreover, if we are unable to successfully defend against such claims, we may be prevented from using our trademarks or service marks in the future and may be liable for damages, which in turn could have a material adverse effect on our business, financial condition and results of operations.

In addition, we license certain of our proprietary intellectual property, including our name and logos, to third parties. For example, we grant our franchisees and licensees a right to use certain of our trademarks in connection with their operation of the applicable restaurant. If a franchisee or other licensee fails to maintain the quality of the restaurant operations associated with the licensed trademarks, our rights to, and the value of, our trademarks could potentially be harmed. Negative publicity relating to the franchisee or licensee could also be incorrectly associated with us, which could harm our business. Failure to maintain, control and protect our trademarks and other proprietary intellectual property would likely have a material adverse effect on our business, financial condition and results of operations and on our ability to enter into new franchise agreements.

We may incur costs resulting from breaches of security of confidential consumer information related to our electronic processing of credit and debit card transactions.

The majority of our restaurant sales are by credit or debit cards. Other restaurants and retailers have experienced security breaches in which credit and debit card information has been stolen and some have incurred significant expenses as a result of the security breaches. We may in the future become subject to claims for purportedly fraudulent transactions arising out of the actual or alleged theft of credit or debit card information, and we may also be subject to lawsuits or other proceedings relating to these types of incidents. In addition, most states have enacted legislation requiring notification of security breaches involving personal information, including credit and debit card information. Any such claim or proceeding could cause us to incur significant unplanned expenses, which could have a material adverse effect on our business, financial condition and results of operations. Further, adverse publicity resulting from these allegations may have a material adverse effect on our business and results of operations.

We rely heavily on information technology, and any material failure, weakness, interruption or breach of security could prevent us from effectively operating our business.

We rely heavily on information systems, including point-of-sale processing in our restaurants, for management of our supply chain, payment of obligations, collection of cash, credit and debit card transactions and other processes and procedures. Our ability to efficiently and effectively manage our business depends significantly on the reliability and capacity of these systems. Our operations depend upon our ability to protect our computer equipment and systems against damage from physical theft, fire, power loss, telecommunications failure or other catastrophic events, as well as from internal and external security breaches, viruses and other disruptive problems. The failure of these systems to operate effectively, maintenance problems, upgrading or transitioning to new platforms, or a breach

 

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in security of these systems could result in delays in customer service and reduce efficiency in our operations. Remediation of such problems could result in significant, unplanned capital investments.

Because a component of our strategy is to continue to grow our franchised business internationally, the risks of doing business internationally could lower our revenues, increase our costs, reduce our profits or disrupt our business.

As of December 31, 2019, seven of our 30 franchised/licensed locations were located outside the United States and we expect to continue to expand our franchised/licensed locations internationally. As a result, we are and will be, on an increasing basis, subject to the risks of doing business outside the United States, including:

Any or all of these factors may adversely affect the performance of franchise or licensing revenues we receive from our franchised/licensed restaurants located in international markets. The economy of any region in which our restaurants are located may be adversely affected to a greater degree than that of other areas of the country or the world by certain developments affecting industries concentrated in that region or country. While these factors and the impact of these factors are difficult to predict, any one or more of them could lower our revenues, increase our costs, reduce our profits or disrupt our business, and, as our international franchised/licensed operations increase, these risks will become more pronounced.

 

Our current insurance may not provide adequate levels of coverage against claims.

Our current insurance policies may not be adequate to protect us from liabilities that we incur in our business. Additionally, in the future, our insurance premiums may increase, and we may not be able to obtain similar levels of insurance on reasonable terms, or at all. Any substantial inadequacy of, or inability to obtain insurance coverage could have a material adverse effect on our business, financial condition and results of operations.

There are types of losses we may incur that cannot be insured against or that we believe are not economically reasonable to insure. Such losses could have a material adverse effect on our business, financial condition and results of operations. As a public company, we have enhanced our existing directors’ and officers’ liability

 

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insurance. Although we have obtained such coverage, we may not be able to obtain such coverage at all or at a reasonable cost in the future. Failure to obtain and maintain adequate directors’ and officers’ liability insurance would likely adversely affect our ability to attract and retain qualified officers and directors.

Failure to obtain and maintain required licenses and permits or to comply with food control regulations could lead to the loss of our food service licenses and, thereby, harm our business.

The restaurant industry is subject to various federal, state and local government regulations, including those relating to the sale of food. Such regulations are subject to change from time to time. The failure to obtain and maintain these licenses, permits and approvals could have a material adverse effect on our results of operations. Typically, licenses must be renewed annually and may be revoked, suspended or denied renewal for cause at any time if governmental authorities determine that our conduct violates applicable regulations. Difficulties or failure to maintain or obtain the required licenses and approvals could adversely affect our existing restaurants and delay or result in our decision to cancel the opening of new restaurants, which would have a material adverse effect on our business.

Changes to accounting rules or regulations may adversely affect the reporting of our results of operations.

Changes to existing accounting rules or regulations may impact the reporting of our future results of operations or cause the perception that we are more highly leveraged. Other new accounting rules or regulations and varying interpretations of existing accounting rules or regulations have occurred and may occur in the future. For instance, accounting regulatory authorities issued new regulations which required lessees to capitalize operating leases in their financial statements effective for fiscal years beginning after December 15, 2018. This change required us to record significant right of use assets and lease obligations on our balance sheet and make other changes to our financial statements. Other future changes to accounting rules or regulations could have a material and sometimes adverse effect on the reporting of our business, financial condition and results of operations.

Changes to estimates related to our property, fixtures and equipment or operating results that are lower than our current estimates at certain restaurant locations may cause us to incur impairment charges on certain long-lived assets, which may adversely affect our results of operations.

In accordance with accounting guidance as it relates to the impairment of long-lived assets, we make certain estimates and projections with regard to individual restaurant operations, as well as our overall performance, in connection with our impairment analyses for long-lived assets. When impairment triggers are deemed to exist for any location, the estimated undiscounted future cash flows are compared to its carrying value. If the carrying value exceeds the undiscounted cash flows, an impairment charge equal to the difference between the carrying value and the fair value is recorded. The projections of future cash flows used in these analyses require the use of judgment and a number of estimates and projections of future operating results. If actual results differ from our estimates, additional charges for asset impairments may be required in the future. If future impairment charges are significant, this could have a material adverse effect on our results of operations.

Risks Related to Our Class A Common Stock

KarpReilly and its affiliates have significant influence over us, including control over decisions that require the approval of stockholders, which could limit your ability to influence the outcome of key transactions, including a change of control.

As of December 31, 2019, investment funds affiliated with KarpReilly beneficially owned 1.1% of our outstanding Class A common stock and 47.9% of our outstanding Class B common stock, which aggregates to 10.7% of our voting power. Although their voting power is below 50%, KarpReilly may be able to influence the election of members of our board of directors and our business and affairs, including any determinations with respect to mergers or other business combinations, the acquisition or disposition of assets, the incurrence of indebtedness, the issuance of any additional common stock or other equity securities, the repurchase or redemption of common stock and the payment of dividends, and two of our directors, Christopher K. Reilly and Allan W. Karp, who are affiliated with KarpReilly, will continue to serve on our board of directors.

 

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Additionally, KarpReilly is in the business of making investments in companies and may acquire and hold interests in businesses that compete directly or indirectly with us. KarpReilly may also pursue acquisition opportunities that may be complementary to our business, and, as a result, those acquisition opportunities may not be available to us.

We are required to pay certain of the Continuing LLC Owners for certain tax benefits we may claim, and we expect that the payments we will be required to make will be substantial.

Our acquisitions of interests in The Habit Restaurants, LLC (including transactions treated as “sales or exchanges” for U.S. federal income tax purposes) from the holders of economic, non-voting interests in The Habit Restaurants, LLC (the “Continuing LLC Owners”) for shares of our Class A common stock or cash are expected to provide favorable tax attributes for us. As a result of our acquisitions of interests in The Habit Restaurants, LLC from the Continuing LLC Owners, we anticipate that the resulting tax basis adjustments and other related tax attributes may reduce the amount of tax we would otherwise be required to pay in the future.

In connection with the IPO, we entered into a tax receivable agreement (the “TRA”). Under the TRA, we generally are required to pay to the Continuing LLC Owners 85% of the amount of cash savings, if any, in U.S. federal, state or local tax that we or our subsidiaries actually realize directly or indirectly (or are deemed to realize in certain circumstances) as a result of (i) certain tax attributes that were created as a result of the IPO and any sales or exchanges (as determined for U.S. federal income tax purposes) to or with us of their interests in The Habit Restaurants, LLC for shares of our Class A common stock or cash, including any basis adjustment relating to the assets of The Habit Restaurants, LLC and (ii) tax benefits attributable to payments made under the TRA (including imputed interest). The Habit Restaurants, Inc. and its subsidiaries generally will retain 15% of the applicable tax savings.

The payment obligations under the TRA are obligations of The Habit Restaurants, Inc., not The Habit Restaurants, LLC, and we expect that the payments we will be required to make under the TRA will be substantial. Assuming no material changes in the relevant tax law and that we earn sufficient taxable income to realize all tax benefits that are subject to the TRA, we expect that the tax savings associated with sales or exchanges of interests in The Habit Restaurants, LLC as a result of the IPO, the April 2015 Offering, and the exchanges of economic, non-voting interests in The Habit Restaurants, LLC (the “LLC Units”) for shares of Class A common stock by the Continuing LLC Owners that have occurred through the end of fiscal 2019, would aggregate to approximately $97.4 million. Under such scenario we would be required to pay the other parties to the TRA approximately 85% of such amount, or $82.8 million (and not taking into account any additional liability expected to arise under the TRA as a result of other exchanges). The actual amounts may materially differ from these hypothetical amounts.

The increase in tax basis, as well as the amount and timing of any payments under these agreements, will vary depending upon a number of factors, including the timing of exchanges by the holders of LLC Units, the price of our Class A common stock at the time of the exchange (or the 15 trading days immediately prior to the delivery date of a notice of exchange, where we elect in the future to pay cash consideration for units of The Habit Restaurants, LLC), whether such exchanges are taxable, the amount and timing of the taxable income we generate in the future, the prevailing applicable tax rates and the portion of our payments under the TRA constituting imputed interest. Payments under the TRA are expected to give rise to certain additional tax benefits attributable to either further increases in basis or in the form of deductions for imputed interest, depending on the circumstances. Any such benefits are covered by the TRA and will increase the amounts due thereunder. In addition, the TRA provides for interest, at a rate equal to one year LIBOR, accrued from the due date (without extensions) of the corresponding tax return to the date of payment specified by the TRA. To the extent that we are unable to timely make payments under the TRA for any reason, such payments will be deferred and will accrue interest at a rate equal to one year LIBOR plus 200 basis points until paid (although a rate equal to one year LIBOR will apply if the inability to make payments under the TRA is due to limitations imposed on us or any of our subsidiaries by a debt agreement in effect on the date of the IPO).

There can be no assurance that we will be able to finance our obligations under the TRA in a manner that does not adversely affect our working capital and growth requirements.

 

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Our ability to pay taxes and expenses, including payments under the TRA, may be limited by our structure.

We are a holding company with no direct operations (other than in our capacity as Managing Member of The Habit Restaurants, LLC) that holds as our principal assets an equity interest in The Habit Restaurants, LLC and shares of subsidiaries each of which holds as its principal asset an equity interest in The Habit Restaurants, LLC. We rely on The Habit Restaurants, LLC to provide us with funds necessary to meet any financial obligations. As such, we have no independent means of generating revenue. The Habit Restaurants, LLC is treated by its members as a partnership for federal and applicable state income tax purposes and, as such, generally is not expected to be subject to income tax (except that it may be required to withhold and remit taxes as a withholding agent). Instead, taxable income is allocated to holders of its LLC Units, including us and our subsidiaries. Accordingly, we incur income taxes on our allocable share of any net taxable income of The Habit Restaurants, LLC and we also incur expenses related to our operations. Pursuant to the Limited Liability Company Agreement of The Habit Restaurants, LLC (the “LLC Agreement”) The Habit Restaurants, LLC is obligated to make tax distributions to holders of LLC Units, including us and our subsidiaries, subject to the conditions described below. In addition to tax expenses, we also incur expenses related to our operations, including payments under the TRA, which we expect will be significant. We intend to cause The Habit Restaurants, LLC to make distributions or, in the case of certain expenses, payments in an amount sufficient to allow us to pay our taxes and operating expenses, including distributions to fund any ordinary course payments due under the TRA. However, The Habit Restaurants, LLC’s ability to make such distributions and payments in the future may be subject to various limitations and restrictions, including the operating results of our subsidiaries, our cash requirements and financial condition, the applicable provisions of Delaware law that may limit the amount of funds available for distribution to its members, compliance by The Habit Restaurants, LLC and its subsidiaries with restrictions, covenants and financial ratios related to existing or future indebtedness, and other agreements entered into by The Habit Restaurants, LLC or its subsidiaries with third parties. If we do not have sufficient funds to pay tax or other liabilities or to fund our operations (e.g., as a result of The Habit Restaurants, LLC’s inability to make distributions due to various limitations and restrictions or as a result of the acceleration of our obligations under the TRA), we may have to borrow funds, and thus our liquidity and financial condition could be materially and adversely affected. To the extent that we are unable to make payments under the TRA for any reason, such payments will be deferred and will accrue interest at a rate equal to one year LIBOR plus 200 basis points until paid (although a rate equal to one year LIBOR will apply if the inability to make payments under the TRA is due to limitations imposed on us or any of our subsidiaries by a debt agreement in effect on the date of the IPO).

In certain cases, payments under the TRA to the Continuing LLC Owners may be accelerated or significantly exceed the actual benefits we realize in respect of the tax attributes subject to the TRA.

The TRA provides that (i) in the event that we materially breach the TRA, (ii) if, at any time, we elect an early termination of the TRA, or (iii) upon certain mergers, asset sales, other forms of business combinations or other changes of control, our (or our successor’s) obligations under the TRA (with respect to all LLC Units, whether or not LLC Units have been exchanged or acquired before or after such transaction) would accelerate and become payable in a lump sum amount equal to the present value of the anticipated future tax benefits calculated based on certain assumptions, including that we would have sufficient taxable income to fully utilize the deductions arising from the tax deductions, tax basis and other tax attributes subject to the TRA.

As a result of the foregoing, (i) we could be required to make payments under the TRA that are greater than or less than the specified percentage of the actual tax savings we or our subsidiaries realize in respect of the tax attributes subject to the agreements and (ii) we may be required to make an immediate lump sum payment equal to the present value of the anticipated future tax savings, which payment may be made years in advance of the actual realization of such future benefits, if any such benefits are ever realized. In these situations, our obligations under the TRA could have a substantial negative impact on our liquidity and could have the effect of delaying, deferring or preventing certain mergers, asset sales, other forms of business combinations or other changes of control. There can be no assurance that we will be able to finance our obligations under the TRA in a manner that does not adversely affect our working capital and growth requirements. The TRA was amended January 5, 2020 (the “TRA Amendment”) in connection with the Merger Agreement (as defined below), with the parties agreeing that the consummation of the transactions contemplated by the Merger Agreement will give rise to a Change in Control as defined in the TRA, furthermore, the TRA shall be terminated in its entirety upon payment of the Early Termination Payment, as provided for in the TRA Amendment.

 

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In certain circumstances, The Habit Restaurants, LLC will be required to make distributions to us and the Continuing LLC Owners, and the distributions that The Habit Restaurants, LLC will be required to make may be substantial.

The Habit Restaurants, LLC is treated by its members as a partnership for federal and applicable state income tax purposes and, as such, generally is not expected to be subject to income tax, except that it may be required to withhold and remit taxes as a withholding agent. Instead, taxable income is allocated to holders of its LLC Units, including us. Pursuant to the LLC Agreement, The Habit Restaurants, LLC is obligated to make tax distributions to holders of LLC Units, including us and our subsidiaries, except that The Habit Restaurants, LLC’s ability to make such distributions may be subject to various limitations and restrictions, including the operating results of The Habit Restaurants, LLC, our cash requirements and financial condition, the applicable provisions of Delaware law that may limit the amount of funds available for distribution to its members, compliance by The Habit Restaurants, LLC and its subsidiaries with restrictions, covenants and financial ratios related to existing or future indebtedness, and other agreements entered into by The Habit Restaurants, LLC or its subsidiaries with third parties. We are a holding company with no direct operations (other than in our capacity as Managing Member of The Habit Restaurants, LLC) and will rely on The Habit Restaurants, LLC to provide us with funds necessary to meet any financial obligations.

Funds used by The Habit Restaurants, LLC to satisfy its tax distribution obligations will not be available for reinvestment in our business. Moreover, the tax distributions that The Habit Restaurants, LLC will be required to make may be substantial, and will likely exceed (as a percentage of The Habit Restaurants, LLC’s income) the overall effective tax rate applicable to a similarly situated corporate taxpayer.

As a result of potential differences in the amount of net taxable income allocable to us and to the Continuing LLC Owners, as well as the use of an assumed tax rate in calculating The Habit Restaurants, LLC’s distribution obligations, we may receive distributions significantly in excess of our tax liabilities and obligations to make payments under the TRA. To the extent, as currently expected, we do not distribute such cash balances as dividends on our Class A common stock and instead, for example, hold such cash balances or lend them to The Habit Restaurants, LLC, the Continuing LLC Owners would benefit from any value attributable to such accumulated cash balances as a result of their ownership of Class A common stock following an exchange of their LLC Units.

We will not be reimbursed for any payments made to the Continuing LLC Owners under the TRA in the event that any tax benefits are disallowed.

If the Internal Revenue Service (the “IRS”) or a state or local taxing authority challenges the tax basis adjustments and/or deductions that give rise to payments under the TRA and the tax basis adjustments and/or deductions are subsequently disallowed, the recipients of payments under the agreement will not reimburse us for any payments we previously made to them. Any such disallowance would be taken into account in determining future payments under the TRA and would, therefore, reduce the amount of any such future payments. Nevertheless, if the claimed tax benefits from the tax basis adjustments and/or deductions are disallowed, our payments under the TRA could exceed our actual tax savings, and we may not be able to recoup payments under the TRA that were calculated on the assumption that the disallowed tax savings were available.

The comprehensive tax reform bill could result in The Habit Restaurants, LLC being required to make excess cash distributions to us, which could adversely affect our business and financial condition.

As a result of the Tax Cuts and Jobs Act and other factors, The Habit Restaurants, LLC may make cash distributions to us in excess of our cash needs, and the impact of such excess distributions could be adverse. The Habit Restaurants, LLC operates as a limited liability company that is treated as a partnership for federal and state income tax purposes and is not itself subject to federal and state income tax (except that it may be required to pay an “imputed underpayment” and related interest and penalties in the event of an audit by the IRS, which would adversely affect us). Instead, we, and each other member of The Habit Restaurants, LLC, are required to recognize its allocable share of The Habit Restaurants, LLC’s income, gain, loss, deduction and credit (and each item thereof), as determined for tax purposes, on its U.S. federal income tax return for each taxable year of The Habit Restaurants, LLC ending with or within its taxable year, regardless of whether any distributions of cash or other property are made from The Habit Restaurants, LLC to us. As a result, the LLC Agreement of The Habit Restaurants, LLC contains a “tax distribution” provision that generally obligates The Habit Restaurants, LLC to make cash distributions to its members, including us, in an amount determined by multiplying the highest marginal rate

 

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applicable to any member of The Habit Restaurants, LLC by the amount of net income and/or gain allocable to each member of The Habit Restaurants, LLC. The members of The Habit Restaurants, LLC include individuals.  In light of the fact that (i) the Tax Cuts and Jobs Act has created a significant difference between the income tax rate that generally applies to entities that are treated as corporations for U.S. federal tax purposes, such as us, and the highest marginal tax rate that applies to individuals and (ii) the tax distributions made by The Habit Restaurants, LLC will be based on the higher rate generally applicable to individuals, we expect to receive tax distributions from The Habit Restaurants, LLC in excess of the amount we require to pay our U.S. federal, state and local income taxes. We will need to determine how to deploy such excess cash. In addition, it is possible that the requirement to make excess tax distributions to us will result in The Habit Restaurants, LLC having insufficient cash to meet its cash needs or foregoing otherwise attractive investment opportunities, the consequences of which may be adverse to The Habit Restaurants, LLC, which in turn will result in adverse consequences to us.

Unanticipated changes in effective tax rates or adverse outcomes resulting from examination of our income or other tax returns could adversely affect our financial condition and results of operations.

We are subject to income taxes in the United States, and our domestic tax liabilities will be subject to the allocation of expenses in differing jurisdictions. Our future effective tax rates could be subject to volatility or adversely affected by a number of factors, including:

In addition, we may be subject to audits of our income, sales and other transaction taxes by U.S. federal and state authorities. Outcomes from these audits could have an adverse effect on our financial condition and results of operations.

Our Class A common stock price has been and may continue to be extremely volatile.

The market price and trading volume of our Class A common stock has been and may continue to be volatile for the foreseeable future, and investors in our Class A common stock may experience a decrease, which could be substantial, in the value of their stock, including decreases unrelated to our results of operations or prospects, and could lose part or all of their investment. The high and low share prices for fiscal year 2019 were $13.25 and $7.96, respectively. The price of our Class A common stock could be subject to wide fluctuations in response to a number of factors, including those described elsewhere in this Annual Report and others such as:

 

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In the past, securities class action litigation has often been initiated against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs and divert our management’s attention and resources, and could also require us to make substantial payments to satisfy judgments or to settle litigation.

Our quarterly operating results may fluctuate significantly and could fall below the expectations of securities analysts and investors due to seasonality and other factors, some of which are beyond our control, resulting in a decline in our stock price.

Our quarterly operating results may fluctuate significantly because of several factors, including:

Seasonal factors and the timing of holidays cause our revenue to fluctuate from quarter to quarter. Our revenue per restaurant is typically slightly lower in the fourth quarter due to holiday closures. Adverse weather conditions may also affect customer traffic. In addition, we have outdoor seating at most of our restaurants, and the effects of adverse weather may impact the use of these areas and may negatively impact our revenue.

Regulatory compliance may divert our management’s attention from day-to-day management of our business, which could have a material adverse effect on our business.

Our management team may not successfully or efficiently manage being a public company that is subject to significant regulatory oversight and reporting obligations under the federal securities laws and the regulations imposed by Nasdaq. In particular, these obligations require substantial attention from our senior management and could divert their attention away from the day-to-day management of our business, which could materially and adversely impact our business operations.

 

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Your percentage ownership in us may be diluted by future issuances of capital stock, which could reduce your influence over matters on which stockholders vote.

Our board of directors has the authority, without action or vote of our stockholders, to issue all or any part of our authorized but unissued shares of Class A common stock, including shares issuable upon the exercise of options, or shares of our authorized but unissued preferred stock. Issuances of Class A common stock or voting preferred stock would reduce your influence over matters on which our stockholders vote and, in the case of issuances of preferred stock, would likely result in your interest in us being subject to the prior rights of holders of that preferred stock.

Provisions in our charter documents and Delaware law may deter takeover efforts that could be beneficial to stockholder value.

Our amended and restated certificate of incorporation and by-laws and Delaware law contain provisions that could make it harder for a third party to acquire us, even if doing so might be beneficial to our stockholders. These provisions include a classified board of directors and limitations on actions by our stockholders. In addition, our board of directors has the right to issue preferred stock without stockholder approval that could be used to dilute a potential hostile acquirer. Our amended and restated certificate of incorporation also imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding Class A common stock other than affiliates of KarpReilly. As a result, stockholders may lose their ability to sell their stock for a price in excess of the prevailing market price due to these protective measures, and efforts by stockholders to change the direction or management of the company may be unsuccessful.

If securities or industry analysts do not publish research or reports about our business, or publish inaccurate or unfavorable research or reports about our business, our stock price and trading volume could decline.

The trading market for our Class A common stock depends, to some extent, on the research and reports that securities or industry analysts publish about us and our business. We do not have any control over these analysts. If one or more of the analysts who cover us downgrade our Class A common stock or change their opinion of our Class A common stock, our stock price would likely decline. If one or more of these analysts cease to cover us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which could cause our stock price or trading volume to decline.

Because we have no current plans to pay cash dividends on our Class A common stock for the foreseeable future, you may not receive any return on investment unless you sell your Class A common stock for a price greater than that which you paid for it.

We may retain future earnings, if any, for future operations, expansion and debt repayment and have no current plans to pay any cash dividends for the foreseeable future. Any decision to declare and pay dividends as a public company in the future will be made at the discretion of our board of directors and will depend on, among other things, our results of operations, financial condition, cash requirements, contractual restrictions and other factors that our board of directors may deem relevant. In addition, our ability to pay dividends may be limited by covenants of any existing and future outstanding indebtedness we or our subsidiaries incur, including our credit facility. As a result, you may not receive any return on an investment in our Class A common stock unless you sell our Class A common stock for a price greater than that which you paid for it.

Risks Related to the Merger

The announcement and pendency of the proposed Merger may adversely affect our business, financial condition and results of operations.

On January 5, 2020, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with YUM! Brands, Inc., a North Carolina corporation (“Parent”), and Parent’s wholly-owned subsidiary, YEB Newco Inc., a Delaware corporation (“Merger Sub”), providing for the merger of Merger Sub with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly-owned subsidiary of Parent. Uncertainty about the effect of the proposed Merger on our employees, customers, and other parties may have an adverse effect on our business, financial condition and results of operation regardless of whether the proposed Merger is

 

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completed.  These risks to our business include the following, all of which could be exacerbated by a delay in the completion of the proposed Merger:

Failure to consummate the proposed Merger within the expected timeframe or at all could have a material adverse impact on our business, financial condition and results of operations.

There can be no assurance that the proposed Merger be consummated. The consummation of the proposed Merger is subject to customary closing conditions, including, among other things, the approval of the Merger Agreement and the Merger by the Company’s stockholders at a special meeting of stockholders convened for such purpose and the absence of legal restraints and prohibitions against the Merger and the other transactions contemplated by the Merger Agreement. The obligation of each party to consummate the Merger is also conditioned upon the other party’s representations and warranties being true and correct to the extent specified in the Merger Agreement and the other party having performed in all material respects its obligations under the Merger Agreement. There can be no assurance that these and other conditions to closing will be satisfied in a timely manner or at all.

The Merger Agreement also includes customary termination provision for both the Company and Parent, subject, in certain circumstances, to the payment by the Company of a termination fee of $13,125,000. If we are required to make this payment, doing so may materially adversely affect our business, financial condition and results of operations.

There can be no assurance that a remedy will be available to us in the event of a breach of the Merger Agreement by Yum! Brands, Inc. or its affiliates or that we will wholly or partially recover for any damages incurred by us in connection with the proposed Merger. A failed transaction may result in negative publicity and a negative impression of us among our customers or in the investment community or business community generally. Further, any disruptions to our business resulting from the announcement and pendency of the proposed Merger, including any adverse changes in our relationships with our customers, partners, suppliers and employees, could continue or accelerate in the event of a failed transaction. In addition, if the proposed Merger is not completed, and there are no other parties willing and able to acquire the Company at a price of $14.00 per share or higher, on terms acceptable to us, the share price of our Class A common stock will likely decline to the extent that the current market price of our common stock reflects an assumption that the proposed Merger will be completed.  Also, we have incurred, and will continue to incur, significant costs, expenses and fees for professional services and other transaction costs in connection with the proposed Merger, for which we will have received little or no benefit if the proposed Merger is not completed. Many of these fees and costs will be payable by us even if the proposed Merger is not completed and may relate to activities that we would not have undertaken other than to complete the proposed Merger.

 

 

ITEM 1B. Unresolved Staff Comments

 

 

None.

 

 

 

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Properties

We believe we are well positioned to continue to grow in our existing markets and leverage our increasing brand awareness to penetrate new markets throughout the United States. As of December 31, 2019, we had 271 locations in 13 states and China, including franchised/licensed locations (excluding eight licensed locations in Santa Barbara County, California). We operate a variety of restaurant formats, including end-cap, free-standing, inline, end-cap drive-thru and traditional stand-alone drive-thru, primarily within suburban shopping centers and retail settings. Our average restaurant size is between 2,000 to 2,800 leasable square feet. The following chart shows the number of company-operated and franchised/licensed restaurants by geographic location as of December 31, 2019.

 

 

We are obligated under non-cancelable leases for our restaurants and our corporate headquarters. Our restaurant leases generally have a term of 10 years with two five-year renewal options. Our restaurant leases generally require us to pay a proportionate share of real estate taxes, insurance, common area maintenance charges and other operating costs. Some restaurant leases provide for contingent rental payments based on sales thresholds, although we generally do not expect to pay significant contingent rent on these properties based on the thresholds in those leases.

We opened 27 restaurants in 2019, consisting of 21 company-operated restaurants and six franchised/licensed locations. We plan to balance our growth between existing markets and new markets, with the majority of new restaurants expected to open in existing markets in 2020.

Our restaurant model is designed to generate high sales volumes, strong restaurant-level financial results and high cash-on-cash returns. Our new restaurant model targets an average cash investment of approximately $1,025,000, net of tenant allowances, AUVs of approximately $1.9 million and cash-on-cash returns of approximately 30% in the third full year of operation.

 

We are currently involved in various claims and legal actions that arise in the ordinary course of business, most of which are covered by insurance. We and our directors have been named as defendants in a series of actions related

 

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to the Merger and the associated disclosures made in the proxy statement filed with the Securities and Exchange Commission (“SEC”) pursuant to Section 14(a) of the Securities Exchange Act of 1934 (the “Proxy Statement”).  On February 5, 2020, a purported stockholder filed a complaint in the United States District Court for the Southern District of New York, captioned Gottlieb v. The Habit Restaurants, Inc., et al., Civil Action No. 1:20-cv-00966, against the Company and the members of the Company’s board of directors.  On February 11, 2020, a purported stockholder filed a complaint in the United States District Court for the Southern District of New York, captioned Morris v. The Habit Restaurants, Inc., et al., Civil Action No. 1:20-cv-01182, against the Company and the members of the Company’s board of directors.  On February 11, 2020, a purported stockholder filed a putative class action complaint in the United States District Court for the District of Delaware, captioned Smith v. The Habit Restaurants, Inc., et al., Civil Action No. 1:20-cv-00203, against the Company and the members of the Company’s board of directors.  On February 12, 2020, a purported stockholder filed a complaint in the United States District Court for the Southern District of New York, captioned Avila v. The Habit Restaurants, Inc., et al., Civil Action No. 1:20-cv-01248, against the Company and the members of the Company’s board of directors.  On February 12, 2020, a purported stockholder filed a complaint in the United States District Court for the Southern District of New York, captioned Sterner v. The Habit Restaurants, Inc., et al., Civil Action No. 1:20-cv-01251, against the Company and the members of the Company’s board of directors.  On February 13, 2020, a purported stockholder filed a putative class action complaint in the United States District Court for the Central District of California, captioned Shudic v. The Habit Restaurants, Inc., et al., Civil Action No. 8:20-cv-00294, against the Company and the members of the Company’s board of directors.  On February 20, 2020, a purported stockholder filed a complaint in the United States District Court for the Central District of California, captioned Grijalva v. The Habit Restaurants, Inc., et al., Civil Action No. 2:20-cv-01661, against the Company and the members of the Company’s board of directors.  On February 21, 2020, a purported stockholder filed a complaint in the United States District Court for the District of New Jersey, captioned Restivo v. The Habit Restaurants, Inc., et al., Civil Action No. 2:20-cv-01927, against the Company and the members of the Company’s board of directors.  On February 24, 2020, a purported stockholder filed a putative class action complaint in the Delaware Court of Chancery, captioned Bounds & Co. v. The Habit Restaurants, Inc., et al., C.A. No. 2020-0124 (Del. Ch.), against the Company and the members of the Company’s board of directors.  On February 24, 2020, a purported stockholder filed a putative class action complaint in the United States District Court for the Central District of California, captioned Stein v. The Habit Restaurants, Inc., et al., Civil Action No. 2:20-cv-01763, against the Company and the members of the Company’s board of directors.  On February 26, 2020, a purported stockholder filed a complaint in the United States District Court for the Central District of California, captioned Antalan v. The Habit Restaurants, Inc., et al., Civil Action No. 2:20-cv-01850, against the Company and the members of the Company’s board of directors.

 

The complaints in these eleven actions (collectively, the “Merger Litigation”) allege, among other things, that the Company and the members of our board of directors violated Sections 14(a) and 20(a) of the Exchange Act, and Rule 14a-9 promulgated under the Exchange Act, and breached their fiduciary duties, by misstating or omitting certain allegedly material information in the Proxy Statement filed with the SEC regarding the Merger.  The complaints seek, among other things, injunctive relief preventing the consummation of the Merger, rescissory damages or rescission in the event of consummation of the Merger, declaratory relief related to the disclosures in the Proxy Statement, and certain fees and expenses. We do not believe that the ultimate resolution of these actions will have a material adverse effect on our business, financial condition, results of operations, liquidity or capital resources nor do we believe that there is a reasonable possibility that we will incur a material loss as a result of such actions. However, a significant increase in the number of these claims or an increase in amounts owing under successful claims could have a material adverse effect on our business, financial condition and results of operations.

 

 

Not applicable.

 

 

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PART II

Our Class A common stock is traded on the Nasdaq Global Market under the symbol “HABT.”

Holders

As of March 9, 2020, there were 76 holders of record of our Class A common stock and 41 holders of record of our Class B common stock. A substantially greater number of holders of our stock are held in “street name” and held of record by banks, brokers and other financial institutions.

Dividends

Our board of directors did not authorize a dividend on our Class A common stock in 2019 and does not currently intend to authorize any cash dividends for the foreseeable future. Any decision to declare and pay dividends in the future will be made at the discretion of our board of directors and will depend on, among other things, our results of operations, financial condition, cash requirements, contractual restrictions and other factors that our board of directors may deem relevant. In addition, our ability to pay dividends may be limited by covenants of any existing and future outstanding indebtedness we or our subsidiaries incur, including our credit facility. Additionally, because we are a holding company, we would depend on distributions from The Habit Restaurants, LLC to fund any dividends we may pay.

Under the Delaware General Corporation Law, we may only pay dividends from legally available surplus or, if there is no such surplus, out of our net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. Surplus is defined as the excess of the fair value of our total assets over the sum of the fair value of our total liabilities plus the par value of our outstanding capital stock. Capital stock is defined as the aggregate of the par value of all issued capital stock. To the extent we do not have sufficient cash to pay dividends, we may decide not to pay dividends.

Recent Sales of Unregistered Securities

None.

 

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Stock Performance Graph

The following graph compares the cumulative total shareholder return on our Class A common stock from December 30, 2014 (using the closing price of our shares of Class A common stock on December 30, 2014) to December 31, 2019 to that of the total return of the Nasdaq Composite and the S&P 600 Restaurants Index, using the same date range. The comparison assumes $100 was invested in our common stock and in each of the forgoing indices on December 30, 2014 and assumes the reinvestment of dividends, if any. This graph is furnished and not “filed” with the SEC or “soliciting material” under the Exchange Act and shall not be incorporated by reference into any such filings, irrespective of any general incorporation contained in such filing.

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

 

 

The following tables summarize consolidated financial information of The Habit Restaurants, Inc. You should read the selected historical financial data set forth below in conjunction with “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8, Financial Statements and Supplementary Data” of Part II to this Annual Report.

We operate on a 52- or 53-week fiscal year ending on the last Tuesday of each calendar year for financial reporting purposes. Each quarterly period has 13 weeks, except for a 53-week year when the fourth quarter has 14 weeks. A 53-week year occurs every six or seven years. The 2019 fiscal year contained 53 weeks, while all other years presented in this Annual Report contain 52 weeks. Fiscal years 2015, 2016, 2017, 2018 and 2019 ended on December 29, 2015, December 27, 2016, December 26, 2017, December 25, 2018 and December 31, 2019 respectively.

 

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A reconciliation of restaurant contribution to company-operated restaurant revenue is provided below:

 

 

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The following table sets forth reconciliations of EBITDA and Adjusted EBITDA to our net income:

 

 

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The Habit Restaurants, Inc. was formed July 24, 2014 and prior to the IPO had not conducted any activities, other than (i) those incident to its formation, (ii) the merger transactions resulting in it holding interests, indirectly through its wholly-owned subsidiaries, in the Habit Restaurants, LLC (such interests collectively represented a less than 20% interest in the Habit Restaurants, LLC) and (iii) the preparation of the IPO registration statement. We conduct our business through The Habit Restaurants, LLC and its subsidiaries. The following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and related notes and other financial information appearing elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risk, uncertainties and assumptions. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of many factors, including those discussed in the section entitled “Item 1A, Risk Factors” and elsewhere in this Annual Report.

Overview

The Habit Burger Grill is a burger-centric, fast casual restaurant concept that specializes in preparing fresh, made-to-order char-grilled burgers and sandwiches featuring USDA choice tri-tip steak, grilled chicken and sushi-grade tuna cooked over an open flame. In addition, we feature fresh made-to-order salads and an appealing selection of sides, shakes and malts. We were recently named Best Regional Fast Food in USA Today’s 2019 Best Readers’ Choice Awards. We operate in the approximately $47 billion fast casual restaurant segment, which we believe has created significant recent disruption in the restaurant industry and has historically gained market share from adjacent restaurant segments, resulting in significant growth opportunities for restaurant concepts such as The Habit.

Recent Developments

On January 5, 2020, the Company entered into an Agreement and Plan of Merger with YUM! Brands, Inc., a North Carolina corporation (“Yum! Brands”), and Yum! Brands’ wholly-owned subsidiary, YEB Newco Inc., a Delaware corporation (“Merger Sub”), providing for the merger of Merger Sub with and into the Company, with the Company surviving as a wholly-owned subsidiary of Yum! Brands. The acquisition of The Habit Burger Grill is expected to add an award-winning fast-casual concept with a loyal fan-base to Yum! Brands, the world’s largest restaurant company in terms of units and the parent of the KFC, Pizza Hut and Taco Bell global brands. Yum! Brands intends to fund the transaction using cash on hand and available borrowing capacity under its credit facilities. Under the terms of the agreement, The Habit Restaurants, Inc.’s stockholders will receive $14.00 in cash for each share of Class A common stock they hold on the transaction closing date. The obligation of the parties to consummate the acquisition is subject to customary closing conditions, including the approval of the transaction by the Company’s stockholders at a special meeting of stockholders and the absence of legal restraints and prohibitions against the transaction, among other conditions. For a summary of the transaction, please refer to Note 14—Subsequent Events in our consolidated financial statements of this Annual Report and to our Form 8-K filed with the U.S. Securities and Exchange Commission (the “SEC”) on January 6, 2020.

History and Operations

The first location opened in Santa Barbara, California in 1969. Our restaurant concept has been, and continues to be built around a distinctive and diverse menu, headlined by fresh, char-grilled burgers and sandwiches made-to-order over an open flame and topped with fresh ingredients. Our Chief Executive Officer, Russell W. Bendel, joined The Habit in 2008, after KarpReilly, a private investment firm based in Greenwich, Connecticut, acquired an equity interest in us in 2007. At the time of KarpReilly’s investment, we had 17 locations. Since then, we have grown our brand on a disciplined basis designed to capitalize on the large market opportunity available to us and, as of December 31, 2019, we had 271 locations, which includes 30 franchised/licensed locations. Our highly experienced management team has created and refined the infrastructure to create replicable restaurant-level systems, processes and training procedures that can deliver a high-quality experience that is designed to consistently exceed our customers’ expectations.

 

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Growth Strategies and Outlook

We plan to continue to expand our business, focus on comparable restaurant sales growth and enhance our competitive positioning by executing on the following strategies:

We had 271 restaurants in 13 states and China as of December 31, 2019, including franchised/licensed locations (excluding eight licensed locations in Santa Barbara County, California). We opened 27 restaurants in 2019, consisting of 21 company-operated and six franchised/licensed locations. To increase comparable restaurant sales, we plan to continue delivering superior execution, focusing on customer frequency, attracting new customers and improving per customer spend. We believe we are well positioned for future growth, with a developed corporate infrastructure capable of supporting our expanding restaurant base. Additionally, we believe we have an opportunity to maintain our profitability as we benefit from increased economies of scale. However, these growth rates cannot be guaranteed.

Exchanges

During fiscal year 2019, 43,082 LLC Units were exchanged by the Continuing LLC Owners for shares of Class A common stock, and a corresponding number of shares of Class B common stock were then cancelled in connection with such exchanges. In addition, during fiscal year 2019, 86,856 restricted stock units vested, of which 18,089 were withheld to satisfy tax withholding obligations, 1,661 LLC Units were forfeited and a corresponding number of shares of Class B common stock were then cancelled in connection with the forfeitures. As a result of these exchanges, vesting of restricted stock units, withholdings for tax obligations and forfeitures, as of December 31, 2019, The Habit Restaurants, Inc. directly or indirectly held 20,779,567 LLC Units, representing a 79.6% economic interest in The Habit Restaurants, LLC, and continues to exercise exclusive control over the Habit Restaurants, LLC, as its sole managing member.

Tax Receivable Agreement

In connection with the IPO, we entered into the TRA. Under the TRA, we generally will be required to pay to the continuing LLC Owners 85% of the amount of cash savings, if any, in U.S. federal, state or local tax that we actually realize directly or indirectly (or are deemed to realize in certain circumstances) as a result of (i) certain tax attributes created as a result of the IPO and any sales or exchanges (as determined for U.S. federal income tax purposes) to or with us of their interests in The Habit Restaurants, LLC for shares of our Class A common stock or cash, including any basis adjustment relating to the assets of The Habit Restaurants, LLC and (ii) tax benefits attributable to payments made under the TRA (including imputed interest). The Habit Restaurants, Inc. and its subsidiaries generally will retain 15% of the applicable tax savings.

The Habit Restaurants, Inc. may accumulate cash balances in future years resulting from distributions from The Habit Restaurants, LLC exceeding our tax or other liabilities. To the extent The Habit Restaurants, Inc. does not use such cash balances to pay a dividend on Class A common stock and instead decides to hold such cash balances, Continuing LLC Owners who exchange LLC Units for shares of Class A common stock in the future could also benefit from any value attributable to such accumulated cash balances.

Key Measures We Use to Evaluate Our Performance

In assessing the performance of our business, we consider a variety of performance and financial measures. The key measures for determining how our business is performing are revenue, comparable restaurant sales growth, AUVs, restaurant contribution and number of new restaurant openings.

 

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Restaurant Revenue

Revenue consists of sales of food and beverages in company-operated restaurants and mobile event-based catering trucks, net of promotional allowances and employee meals. Several factors impact our revenue in any period, including the number of restaurants in operation and per restaurant sales.

Franchise/License Revenue

Franchise/license revenue consists of fees charged to, and royalty revenue collected from, franchise/license owners who enter into a franchise/license agreement with us. We recognize royalty revenue when the sale occurs. Initial franchise/license fees are recognized as revenue as the performance obligations of the contract are satisfied. We have identified separate performance obligations over the term of the contract and recognize revenue as those performance obligations are satisfied. These performance obligations include rights to use trademarks and intellectual property, initial training and other operational support visits. The development fees collected by us upon signing a franchise/license agreement are deferred until operations have commenced. Revenue is also recognized in the event of a termination of a franchise/license agreement.

Comparable Restaurant Sales

Comparable restaurant sales reflect the change in year-over-year sales for the comparable restaurant base. We include restaurants in the comparable restaurant base in the accounting period following its 18th full period of operations. Each of our periods is the applicable four or five-week reporting period, except for the 12th period of a 53-week year, which contains six weeks. As of the end of fiscal years 2015, 2016, 2017, 2018 and 2019 there were 90, 114, 142, 168 and 206 company-operated restaurants, respectively, in our comparable restaurant base. This measure highlights performance of existing restaurants, as the impact of new restaurant openings is excluded.

Comparable restaurant sales growth is generated by increases in customer traffic or increases in per customer spend. Per customer spend can be influenced by changes in menu prices and/or the mix and number of items sold per transaction.

Measuring our comparable restaurant sales growth allows us to evaluate the performance of our existing restaurant base. Various factors impact comparable restaurant sales, including:

 

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The following table shows our quarterly comparable company-operated restaurant sales growth since 2014:

 

 

 

Average Unit Volumes (AUVs)

AUVs are calculated by dividing revenue for the trailing 52-week period for all company-operated restaurants that have operated for 12 full accounting periods by the total number of restaurants open for such period. We operate on a 4-4-5 calendar, each accounting period will consist of either four or five weeks with the exception of a 53-week year, where the last period contains six weeks. For purposes of the AUV calculation in 53-week years, we use the last 52 of the 53 weeks of the fiscal year. This measurement allows management to assess changes in consumer spending patterns at our restaurants and the overall performance of our restaurant base.

 

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Restaurant Contribution

Restaurant contribution is defined as revenue less restaurant operating costs, which are food and paper costs, labor and related expenses, occupancy and other operating expenses. We expect restaurant contribution to increase in proportion to the number of new company-operated restaurants we open and by our comparable restaurant sales growth. Fluctuations in restaurant contribution margin can also be attributed to those factors discussed below for the components of restaurant operating costs.

Restaurant Development

The schedule below reflects the number of restaurants opened or closed during a particular reporting period. Before we open new company-operated restaurants, we incur pre-opening costs. Some of our restaurants open with an initial start-up period of higher than normal sales volumes, which subsequently decrease to stabilized levels. Typically, our new restaurants have stabilized sales after approximately 13 to 26 weeks of operation, at which time the restaurant’s sales typically begin to grow on a consistent basis. In new markets, the length of time before average sales for new restaurants stabilize is less predictable and can be longer as a result of our limited knowledge of these markets and consumers’ limited awareness of our brand. New restaurants may not be profitable, and their sales performance may not follow historical patterns. The number and timing of restaurant openings has had, and is expected to continue to have, an impact on our results of operations. The following table shows the growth in our restaurant base for the fiscal years 2015, 2016, 2017, 2018 and 2019, respectively.

 

 

Key Financial Definitions

Restaurant revenue. Restaurant revenue represents sales of food and beverages in company-operated restaurants and catering trucks, net of promotional allowances and employee meals. Restaurant sales in a given period are directly impacted by the number of operating weeks in the period, the number of restaurants we operate and comparable restaurant sales growth.

 

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Franchise/license revenue. Franchise/license revenue consists of fees charged to, and royalty revenue collected from, franchise/license owners who enter into a franchise/license agreement with us. We recognize royalty revenue when the sale occurs. Initial franchise/license fees are recognized as revenue as the performance obligations of the contract are satisfied. The development fees collected by us upon signing a franchise/license agreement are deferred until operations have commenced. Revenue is also recognized in the event of a termination of a franchise/license agreement.

Food and paper costs. Food and paper costs consist primarily of food, beverage and packaging costs. The components of cost of sales are variable in nature, change with sales volume and are influenced by menu mix and subject to increases or decreases based on fluctuations in commodity costs. Other important factors causing fluctuations in food and paper costs include transportation costs, seasonality, discounting activity and restaurant level management of food waste. Food and paper costs are a substantial expense and can be expected to grow proportionally as our revenue grows.

Labor and related expenses. Labor and related expenses include all restaurant-level management and hourly labor costs, including wages, benefits and bonuses, payroll taxes and other indirect labor costs. Like our other expense items, we expect labor and related expenses to grow proportionally as our revenue grows. Factors that influence fluctuations in our labor and related expenses include minimum wage and payroll tax legislation, the frequency and severity of workers’ compensation claims, health care costs and the performance of our restaurants.

Occupancy and other operating expenses. Occupancy and other operating expenses include all other restaurant-level operating expenses, such as supplies, utilities, repairs and maintenance, travel costs, credit card fees, costs related to delivery orders, recruiting, expenses related to our call center services, restaurant-level marketing costs, security, rent, common area maintenance, property taxes/licenses and insurance.

General and administrative expenses. General and administrative expenses include expenses associated with corporate and regional supervision functions that support the operations of existing restaurants and development of new restaurants, including compensation and benefits, travel expenses, stock-based compensation expenses, legal and professional fees, marketing costs, information systems, corporate office rent and other related corporate costs. General and administrative expenses can be expected to grow as we grow, including incremental legal, accounting, insurance and other expenses incurred as a public company.

Exchange related expenses. Exchange related expenses include costs associated with the exchange of LLC Units to Class A common stock by the Continuing LLC Owners pursuant to the LLC Agreement.

Depreciation and amortization expense. Depreciation and amortization expenses are periodic non-cash charges that consist of depreciation of fixed assets, including equipment and capitalized leasehold improvements. Depreciation is determined using the straight-line method over the assets’ estimated useful lives, ranging from three to twenty years.

Pre-opening costs. Pre-opening costs are incurred in connection with the hiring and training of personnel, as well as other operating expenses during the build-out period of new company-operated restaurant openings. Pre-opening costs also include net occupancy costs incurred between the date of possession and the opening date for our new restaurants. Pre-opening costs are expensed as incurred.

Loss on disposal of assets. Loss on disposal of assets is composed of the loss on retirements and replacements of leasehold improvements, furniture, fixtures and equipment. These losses are related to normal disposals in the ordinary course of business, along with disposals related to selected restaurant remodeling activities.

Tax Receivable Agreement liability adjustment. Tax Receivable Agreement expenses are adjustments associated with revisions to the expected TRA liability as a result of updated estimated future tax savings at the federal, state and local level.

Interest expense, net. Interest expense includes cash and imputed non-cash charges related to our deemed landlord financing, interest expense related to the TRA, and amortization of finance fees related to our outstanding credit facility, net of interest income on our investments.

 

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Provision for income taxes. Provision for income taxes represents federal, state and local current and deferred income tax expense. As a partnership, The Habit Restaurants, LLC generally pays no tax on its net income, and each of its members is required to report such member’s allocable share of The Habit Restaurants, LLC’s net income on such member’s income tax returns. In contrast, The Habit Restaurants, Inc. is a corporation for federal, state and local income tax purposes, and The Habit Restaurants, Inc. and its subsidiaries will pay tax on their allocable share of income of The Habit Restaurants, LLC.

Critical Accounting Policies

Our discussion and analysis of operating results and financial condition are based upon our consolidated financial statements. The preparation of our consolidated financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures of contingent assets and liabilities. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. Our critical accounting policies are those that materially affect our financial statements and involve difficult, subjective or complex judgments by management. Although these estimates are based on management’s best knowledge of current events and actions that may impact us in the future, actual results may be materially different from the estimates. We believe the following critical accounting policies are affected by significant judgments and estimates used in the preparation of our consolidated financial statements and that the judgments and estimates are reasonable.

Leases

In fiscal year 2019 we adopted ASC 842 Leases which required lessees to recognize a lease liability and a right-of-use (“ROU”) asset for all leases, including operating leases, with an expected term greater than 12 months on its balance sheet. Operating lease ROU assets and liabilities are recognized on our consolidated balance sheet at commencement date, which is the date we gain access to the property. The lease liability is determined based on the present value of the minimum rental payments using our incremental borrowing rate in effect at the time of lease commencement. The ROU asset is determined based on the lease liability adjusted for lease incentives received.  Lease expense is recognized on a straight-line bases over the lease term.  Certain leases require contingent rent above the minimum lease payments based on a percentage of sales, these contingent amounts are excluded in determining the lease liability and ROU asset and are accounted for as period expense. The option periods are not included in the determination of the lease liability and ROU asset as we are not reasonably certain if we will extend at the time of lease commencement. Lease expenses for the period prior to the restaurant opening are reported as pre-opening expense in the consolidated statements of operations. Lease expenses for the period after a restaurant opens are reported on the occupancy and other operating expenses line of the consolidated statements of operations. Leases for fiscal year 2018 and prior were reported in accordance with the previous guidance under ASC 840 which also required rent expense to be reported on a straight-line basis over the lease term, beginning when we had the right to control the use of the property. The difference between rent expense and rent paid was recorded as deferred rent in the consolidated balance sheet.

Revenue Recognition

We recognize revenue when products are delivered to the customers or meals are served. Revenue is recognized net of sales taxes. We sell gift cards which do not have an expiration date and do not deduct non-usage fees from outstanding gift card balances. Revenue related to the sale of gift cards is deferred until the gift card is redeemed. A certain amount of gift cards will not be redeemed and may become breakage income or may need to be refunded to the various states. To date, we have not recognized breakage income of gift cards or refunded any amounts to the various states.

Valuation of Goodwill, Long-Lived and Other Intangible Assets

Intangible assets consist primarily of goodwill and tradenames.

Goodwill represents the excess of the purchase price over the fair value of net assets acquired in business combinations and is allocated to the appropriate reporting unit when acquired. In accordance with the provisions of

 

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ASC 350—Intangibles—Goodwill and Other, goodwill and indefinite lived intangible assets are not amortized, but tested for impairment at least annually or more frequently if events occur or circumstances indicate that the carrying amount may be impaired. For purposes of applying ASC 350, we have identified a single reporting unit, as that term is defined in ASC 350, to which goodwill is attributable.

As of September of 2011, the Financial Accounting Standards Board issued an amendment of the FASB Accounting Standards Codification 350 that has been coined the ASC 350 Impairment Analysis – “Step 0.” Step 0 allows for an entity to first assess qualitative factors to determine whether it is necessary to perform further analysis. If determined necessary after the qualitative test, we would assess if the carrying amount exceeds the reporting unit’s fair value and we would recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value.

Tradenames acquired in a business combination and determined to have an indefinite useful life are not amortized because there is no foreseeable limit to the cash flows generated by the intangible asset, and have no legal, contractual, regulatory, economic or competitive limiting factors. Accordingly, tradenames are evaluated for impairment annually and whenever events or changes in circumstances indicate that the value of the asset may be impaired. We also annually evaluate any tradenames that are not being amortized to determine whether events and circumstances continue to support an indefinite useful life. If a tradename that is not being amortized is determined to have a finite useful life, the asset will be amortized prospectively over the estimated remaining useful life and tested for impairment in the same manner as a long-lived asset.

Income Taxes and Tax Receivable Agreement 

We are subject to U.S. federal income taxes, in addition to state and local taxes, with respect to our allocable share of any net taxable income of The Habit Restaurants, LLC.

We account for uncertain tax positions in accordance with ASC 740, Income Taxes. ASC 740 prescribes a recognition threshold and measurement process for accounting for uncertain tax positions and also provides guidance on various related matters such as derecognition, interest, penalties, and required disclosures. We have no uncertain tax liabilities at December 31, 2019. In the future, if an uncertain tax position arises, interest and penalties will be accrued and included on the provision for income taxes line of the Statements of Consolidated Income. We file tax returns in U.S. federal and state jurisdictions. Generally, we are subject to examination by U.S. federal (or state and local) income tax authorities for three to four years from the filing of a tax return.

In connection with the IPO, we entered into the TRA. Under the TRA, we generally are required to pay to the Continuing LLC Owners 85% of the amount of cash savings, if any, in U.S. federal, state or local tax that we actually realize directly or indirectly (or are deemed to realize in certain circumstances) as a result of (i) certain tax attributes created as a result of the IPO and any sales or exchanges (as determined for U.S. federal income tax purposes) to or with us of their interests in The Habit Restaurants, LLC for shares of our Class A common stock or cash, including any basis adjustment relating to the assets of The Habit Restaurants, LLC and (ii) tax benefits attributable to payments made under the TRA (including imputed interest). The Habit Restaurants, Inc. generally will retain 15% of the applicable tax savings. In addition, the TRA provides for interest, at a rate equal to one year LIBOR, accrued from the due date (without extensions) of the corresponding tax return to the date of payment specified by the TRA. To the extent that we are unable to timely make payments under the TRA for any reason, such payments will be deferred and will accrue interest at a rate equal to one year LIBOR plus 200 basis points until paid (although a rate equal to one year LIBOR will apply if the inability to make payments under the TRA is due to limitations imposed on us or any of our subsidiaries by a debt agreement in effect on the date of the IPO). Our ability to make payments under the TRA and to pay our own tax liabilities to taxing authorities generally will depend on our receipt of cash distributions from The Habit Restaurants, LLC. See the section entitled “Item 1A, Risk Factors—Risks Related to Our Business and Industry.”

Pursuant to the LLC Agreement, the Continuing LLC Owners have the right to exchange their LLC Units, together with a corresponding number of shares of Class B common stock (which will be cancelled in connection with any such exchange) for, generally, at the option of The Habit Restaurants, Inc. (such determination to be made by the disinterested members of our board of directors), (i) shares of our Class A common stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications or (ii) cash

 

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consideration (generally calculated based on the volume-weighted average price of the Class A common stock of The Habit Restaurants, Inc., as displayed under the heading Bloomberg VWAP on the Bloomberg page designated for the Class A common stock of The Habit Restaurants, Inc. for the 15 trading days immediately prior to the delivery date of a notice of exchange). At any time that an effective registration statement is on file with the SEC with respect to the shares of Class A Common Stock to be issued upon an exchange, The Habit Restaurants, Inc. may not provide cash consideration upon an exchange to a Continuing LLC Owner without the Continuing LLC Owner’s prior consent. These exchanges are expected to result in increases in the tax basis of the assets of The Habit Restaurants, LLC that otherwise would not have been available. Increases in tax basis resulting from such exchanges may reduce the amount of tax that The Habit Restaurants, Inc. would otherwise be required to pay in the future. This tax basis may also decrease gains (or increase losses) on future dispositions of certain assets to the extent tax basis is allocated to those assets. We amended its LLC Agreement in May 2016, pursuant to which we processed exchange requests every other week, rather than weekly, effective in June 2016. We further amended its LLC Agreement in March 2017, pursuant to which we process exchange requests monthly, effective in May 2017.

If the IRS or a state or local taxing authority challenges the tax basis adjustments that give rise to payments under the TRA and the tax basis adjustments are subsequently disallowed, the recipients of payments under the agreement will not reimburse us for any payments we previously made to them. Any such disallowance would be taken into account in determining future payments under the TRA and would, therefore, reduce the amount of any such future payments. Nevertheless, if the claimed tax benefits from the tax basis adjustments are disallowed, our payments under the TRA could exceed our actual tax savings, and we may not be able to recoup payments under the TRA that were calculated on the assumption that the disallowed tax savings were available.

The TRA provides that (i) in the event that we materially breach the TRA, (ii) if, at any time, we elect an early termination of the TRA, or (iii) upon certain mergers, asset sales, other forms of business combinations or other changes of control, our (or our successor’s) obligations under the TRA (with respect to all LLC Units, whether or not LLC Units have been exchanged or acquired before or after such transaction) would accelerate and become payable in a lump sum amount equal to the present value of the anticipated future tax benefits calculated based on certain assumptions, including that we would have sufficient taxable income to fully utilize the deductions arising from the tax deductions, tax basis and other tax attributes subject to the TRA.

As a result of the foregoing, (i) we could be required to make payments under the TRA that are greater than or less than the specified percentage of the actual tax savings we realize in respect of the tax attributes subject to the agreements and (ii) we may be required to make an immediate lump sum payment equal to the present value of the anticipated future tax savings, which payment may be made years in advance of the actual realization of such future benefits, if any of such benefits are ever realized. In these situations, our obligations under the TRA could have a substantial negative impact on our liquidity and could have the effect of delaying, deferring or preventing certain mergers, asset sales, other forms of business combinations or other changes of control. There can be no assurance that we will be able to finance our obligations under the TRA in a manner that does not adversely affect our working capital and growth requirements.

Payments under the TRA are intended to be treated as additional consideration for the applicable interests in The Habit Restaurants, LLC treated as sold or exchanged (as determined for U.S. federal income tax purposes) to or with us, except with respect to certain actual or imputed interest amounts payable under the TRA. As of December 31, 2019, we recorded a liability of $82.8 million representing the payments due to the Continuing LLC Owners under the TRA.

2014 Omnibus Incentive Plan

Our board of directors adopted The Habit Restaurants, Inc. 2014 Omnibus Incentive Plan (the “2014 Omnibus Incentive Plan”). The 2014 Omnibus Incentive Plan also permits grants of cash bonuses. This plan authorized 2,525,275 total options and restricted stock units. No awards may be granted under the plan after November 19, 2024. In April 2019, our board of directors adopted the Amended and Restated 2014 Omnibus Incentive Plan, which required and received stockholder approval at our 2019 Annual Meeting of Stockholders. This amendment increased the authorized options and restricted stock units by 1,000,000 shares. This amendment also amended the 2014 Omnibus Incentive Plan to provide for an aggregate annual limit on compensation payable to each non-employee director (whether or not pursuant to the Amended and Restated 2014 Omnibus Incentive Plan), require a minimum

 

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vesting period of at least one year for 95% of awards, expressly prohibit automatic “reload” grants of additional awards upon exercise of a stock option or SAR, expand our authority to claw back awards granted under the Amended and Restated 2014 Omnibus Incentive Plan and proceeds on the exercise or disposition of such awards, expressly prohibit “gross-ups” or other payments in respect of any excise taxes assessed on any awards granted under the Amended and Restated 2014 Omnibus Incentive Plan and expressly prohibit the payment of dividends and dividend equivalent on unvested awards.

We follow the provisions of ASC 718, Compensation-Stock Compensation, which requires that we measure and recognize compensation expense for all stock-based payment awards made to employees and directors based on their estimated grant date fair values. ASC 718 requires that stock-based compensation expense be recorded for all equity-classified stock options.

The purpose of the Amended and Restated 2014 Omnibus Incentive Plan is to advance our interests by providing for the grant to eligible individuals of equity-based and other incentive awards.

 

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Results of Operations

Fiscal Year Ended December 31, 2019 Compared to Fiscal Year Ended December 25, 2018

The following table presents selected consolidated comparative results of operations for fiscal year ended December 31, 2019 compared to fiscal year ended December 25, 2018. Our operating results are presented as a percentage of total revenue, with the exception of restaurant operating costs, depreciation and amortization expense, pre-opening costs, asset impairment and loss on disposal of assets, which are presented as a percentage or restaurant revenue. Our financial results for these periods are not necessarily indicative of the financial results that we will achieve in future periods. Certain totals for the table below may not sum to 100% due to rounding.

 

 

 

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Restaurant revenue. Restaurant revenue increased $64.2 million, or 16.1%, for fiscal year 2019 as compared to fiscal year 2018, primarily due to a $24.4 million increase in sales from new restaurants which were opened in fiscal year 2019 and a $27.6 million increase in sales from restaurants opened prior to fiscal year 2019 that did not fall into the comparable restaurant base. Comparable restaurant sales increased $12.7 million, or 3.5%, in fiscal year 2019 as compared to fiscal year 2018. The comparable restaurant sales increase was primarily due to an increase in average transaction amount of 6.3% partially offset by a decrease in traffic of 2.8% in fiscal year 2019 as compared to fiscal year 2018. The increase in revenue was also due in part to increased revenue of $0.2 million for catering trucks in fiscal year 2019 as compared to fiscal year 2018. The restaurant revenue increase was partially offset by a decrease in sales of $0.7 million due to the closure of three restaurants in August of fiscal year 2019. Fiscal year 2019 was a 53-week year and included an additional $7.7 million in restaurant revenue compared to fiscal year 2018 due to the additional operating week.

Franchise/license revenue. Franchise/license revenue decreased $0.3 million for fiscal year 2019 compared to fiscal year 2018. The decrease was primarily due to decreased franchise fees of $0.9 million recognized in fiscal year 2019 as compared to fiscal year 2018 primarily related to terminated franchise agreements. The decrease was partially offset due to increased royalty revenue of $0.6 million in fiscal year 2019 as compared to fiscal year 2018, due to the increased number of franchised/licensed locations.

Food and paper costs. Food and paper costs increased $19.3 million, or 16.1%, for fiscal year 2019 as compared to fiscal year 2018, primarily due to the increase in restaurant sales. As a percentage of revenue, food and paper costs remained flat at 30.0% in fiscal year 2019 and fiscal year 2018.

Labor and related expenses. Labor and related expenses increased $20.5 million, or 15.2%, for fiscal year 2019 as compared to fiscal year 2018, primarily due to the increased labor costs needed to support new restaurants and higher restaurant sales. As a percentage of revenue, labor and related expenses decreased slightly to 33.6% in fiscal year 2019 compared to 33.8% in fiscal year 2018 primarily due to increased menu prices, as we had an approximate 4.7% price increase during the fiscal year. The favorable impact of the price increase was partially offset by higher labor costs primarily due to wage rate increases for hourly employees. On January 1, 2019, the State of California’s (where most of our restaurants are located) minimum wage was raised to $12.00 per hour. In addition, regulatory increases to minimum wages for future periods have been passed and therefore we expect to see increased labor costs to continue. We are also experiencing a tight labor market in some areas which is putting pressure on labor rates.

Occupancy and other operating expenses. Occupancy and other operating expenses increased $19.1 million, or 26.3%, for fiscal year 2019 as compared to fiscal year 2018, primarily due to new restaurants. As a percentage of revenue, occupancy and other operating expenses increased to 19.9% in fiscal year 2019 from 18.3% in fiscal year 2018. The increase is primarily due to higher delivery, call center and on-line costs as we have rolled out the option of delivery in the majority of our restaurants during the second half of last year. In addition, there were higher rent and advertising costs in fiscal year 2019. We expect to see higher rent and delivery costs to continue in fiscal 2020.

General and administrative expenses. General and administrative expenses increased $3.5 million, or 9.1%, for fiscal year 2019 as compared to fiscal year 2018, primarily due to costs associated with supporting an increased number of restaurants, including the increasing number of administrative employees and field and corporate supervision. As a percentage of revenue, general and administrative expenses decreased to 9.1% in fiscal year 2019 from 9.7% in fiscal year 2018.

Transaction and exchange related expenses. There were transaction and exchange related expenses of $0.3 million in fiscal year 2019 that were costs associated with the pending merger with Yum! Brands compared to $0.1 million in fiscal year 2018 which were costs associated with the exchange of LLC Units to Class A common stock by the Continuing LLC Owners.

 

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Depreciation and amortization expenses. Depreciation and amortization expense increased $3.4 million, or 13.8%, for fiscal year 2019 as compared to fiscal year 2018, primarily due to the increased number of restaurants. As a percentage of revenue, depreciation and amortization decreased slightly to 6.0% for fiscal year 2019 compared to 6.1% in fiscal year 2018.

Pre-opening costs. Pre-opening costs were $2.1 million for fiscal year 2019 as compared to $2.9 million for fiscal year 2018. We opened 21 new company-operated restaurants in fiscal year 2019 compared to 30 new company-operated restaurants that opened in fiscal year 2018. Pre-opening costs also include expenses incurred for restaurants that are set to open in the near future. As a percentage of revenue, pre-opening costs decreased to 0.5% in fiscal year 2019, from 0.7% in fiscal year 2018.

Asset impairment and restaurant closure charges. We closed three restaurants in the Orlando, Florida market and also decided not to move forward with the development of two restaurants during fiscal year 2019. We recorded restaurant closure charges of $1.0 million during fiscal year 2019, consisting primarily of lease termination costs, rent expense related to the closed restaurants, severance and other direct costs related to the closed restaurants. The three closed restaurants had previously been impaired during fiscal year 2018, as we determined that the carrying value of the three restaurants in the Orlando, Florida market were not recoverable, and as a result, recorded impairment expense of $3.1 million.

Tax Receivable Agreement liability adjustment. Tax Receivable Agreement expenses, which are adjustments associated with revisions to the expected TRA liability as a result of updated estimated future tax savings at the federal, state and local level, were $0.4 million for fiscal year 2019 as compared to $1.6 million for fiscal year 2018.

Interest expense, net. There was interest income of $0.3 million for fiscal year 2019 as compared to interest expense of $1.0 for fiscal year 2018. The decrease in interest expense, net is primarily attributed to the adoption of ASC 842 Leases, in the current fiscal year. Under the previous guidance, we had a number of leases where we were deemed to be the accounting owner of the building that are now treated as operating leases under the new standard, which resulted in a decrease in interest expense.

Provision (benefit) for income taxes. There was income tax expense of $1.0 million for fiscal year 2019 compared to an income tax benefit of $1.1 million for fiscal year 2018.

 

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Fiscal Year Ended December 25, 2018 Compared to Fiscal Year Ended December 26, 2017

The following table presents selected consolidated comparative results of operations for fiscal year ended December 25, 2018 compared to fiscal year ended December 26, 2017. Our operating results are presented as a percentage of total revenue, with the exception of restaurant operating costs, depreciation and amortization expense, pre-opening costs, asset impairment and loss on disposal of assets, which are presented as a percentage or restaurant revenue. Our financial results for these periods are not necessarily indicative of the financial results that we will achieve in future periods. Certain totals for the table below may not sum to 100% due to rounding.

 

 

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Restaurant revenue. Restaurant revenue increased $68.9 million, or 20.9%, for fiscal year 2018 as compared to fiscal year 2017, primarily due to a $31.5 million increase in sales from new restaurants which were opened in fiscal year 2018 and a $31.6 million increase in sales from restaurants opened prior to fiscal year 2018 that did not fall into the comparable restaurant base. Comparable restaurant sales increased $4.4 million, or 1.5%, in fiscal year 2018 as compared to fiscal year 2017. The comparable restaurant sales increase was primarily due to an increase in average transaction amount of 4.5% partially offset by a decrease in traffic of 3.0% in fiscal year 2018 as compared to fiscal year 2017. The increase in revenue was also due in part to increased revenue of $1.9 million for catering trucks in fiscal year 2018 as compared to fiscal year 2017. We had 10 catering trucks operating by the end of fiscal year 2018 compared to nine catering trucks operating at the end of fiscal year 2017. The restaurant revenue increase was partially offset by a decrease in sales of $0.5 million due to the closure of one restaurant in July of fiscal year 2017.

Franchise/license revenue. Franchise/license revenue increased $1.9 million for fiscal year 2018 compared to fiscal year 2017. The change was primarily due to increased franchise fees of $1.3 million recognized in fiscal year 2018 as compared to fiscal year 2017, of which $1.1 million related to two franchise agreements terminated in fiscal year 2018. The change was also partially due to increased royalty revenue of $0.6 million in fiscal year 2018 as compared to fiscal year 2017, due to the increased number of franchised/licensed locations.

Food and paper costs. Food and paper costs increased $17.9 million, or 17.6%, for fiscal year 2018 as compared to fiscal year 2017, primarily due to the increase in restaurant sales. As a percentage of revenue, food and paper costs decreased to 30.0% in fiscal year 2018 from 30.8% in fiscal year 2017. This decrease was primarily driven by increased menu prices as well as decreases in beef, seafood, other proteins, and produce partially offset by increases in the cost of potatoes in fiscal year 2018.

Labor and related expenses. Labor and related expenses increased $24.2 million, or 21.9%, for fiscal year 2018 as compared to fiscal year 2017, primarily due to the increased labor costs needed to support new restaurants and higher restaurant sales. As a percentage of revenue, labor and related expenses increased to 33.8% in fiscal year 2018 compared to 33.5% in fiscal year 2017. Labor costs were higher primarily due to wage rate increases for hourly employees. On January 1, 2018, the State of California’s (where most of our restaurants are located) minimum wage was raised to $11.00 per hour. In addition, regulatory increases to minimum wages for future periods have been passed and therefore we expect to see increased labor costs to continue. We are also experiencing a tight labor market in some areas which is putting pressure on labor rates.

Occupancy and other operating expenses. Occupancy and other operating expenses increased $16.1 million, or 28.3%, for fiscal year 2018 as compared to fiscal year 2017, primarily due to new restaurants. As a percentage of revenue, occupancy and other operating expenses increased to 18.3% in fiscal year 2018 from 17.2% in fiscal year 2017. The increase is primarily due to higher call center, on-line and delivery costs as we have rolled out the option of delivery in the majority of our restaurants this year, and also due to higher rent and common area maintenance costs in fiscal year 2018. We expect to see higher rent and delivery costs to continue in fiscal 2019.

General and administrative expenses. General and administrative expenses increased $6.4 million, or 19.5%, for fiscal year 2018 as compared to fiscal year 2017, primarily due to costs associated with supporting an increased number of restaurants, including the increasing number of administrative employees and field and corporate supervision. As a percentage of revenue, general and administrative expenses decreased slightly to 9.7% in fiscal year 2018 from 9.8% in fiscal year 2017.

Exchange related expenses. Exchange related expenses, which are costs associated with the exchange of LLC Units to Class A common stock by the Continuing LLC Owners, were $0.1 million for fiscal year 2018 as compared to $0.5 million for fiscal year 2017.

 

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Depreciation and amortization expenses. Depreciation and amortization expense increased $5.7 million, or 30.5%, for fiscal year 2018 as compared to fiscal year 2017, primarily due to the increased number of restaurants. As a percentage of revenue, depreciation and amortization increased to 6.1% for fiscal year 2018 compared to 5.7% in fiscal year 2017, primarily due to slightly higher average capital expenditures on our new restaurants.

Pre-opening costs. Pre-opening costs were $2.9 million for fiscal year 2018 as compared to $3.1 million for fiscal year 2017. We opened 30 new company-operated restaurants in fiscal year 2018 compared to 32 new company-operated restaurants that opened in fiscal year 2017. Pre-opening costs also include expenses incurred for restaurants that are set to open in the near future. As a percentage of revenue, pre-opening costs decreased to 0.7% in fiscal year 2018, from 0.9% in fiscal year 2017.

Asset impairment. Asset impairment expense was $3.1 million for fiscal year 2018. There was no impairment expense in fiscal year 2017. The Company determined that the carrying value of three restaurants in the Orlando, Florida market were not recoverable, and as a result, recorded impairment expense of $3.1 million in fiscal year 2018.

Tax Receivable Agreement liability adjustment. Tax Receivable Agreement expenses, which are adjustments associated with revisions to the expected TRA liability as a result of updated estimated future tax savings at the federal, state and local level, were $1.6 million for fiscal year 2018 as compared to a credit of $57.2 million for fiscal year 2017. The adjustment in fiscal year 2017 was primarily due to the new tax legislation, commonly referred to as the Tax Cuts and Jobs Act, which reduced the U.S. corporate income tax rate to 21% starting in 2018.

Interest expense, net. Interest expense, net increased $0.4 million, or 73.1%, for fiscal year 2018 as compared to fiscal year 2017. The increase in interest expense is primarily attributed to higher interest expense from more deemed landlord locations.

Provision (benefit) for income taxes. There was an income tax benefit of $1.1 million for fiscal year 2018 compared to income tax expense of $65.4 million for fiscal year 2017. In fiscal year 2017 we adjusted deferred tax assets in accordance with the new tax legislation which reduced the U.S. corporate income tax rate to 21% effective in 2018.

Selected Quarterly Financial Data

The following table presents select historical quarterly consolidated statements of operations data and other operations data for fiscal years 2019 and 2018. This quarterly information has been prepared using our unaudited consolidated financial statements and includes all adjustments consisting only of normal recurring adjustments necessary for a fair presentation of the results of the interim periods.

(amounts in thousands except per share data)

 

 

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Liquidity and Capital Resources

Our primary uses of cash are for operational expenditures and capital investments, including new stores, store remodels, store maintenance capital, store fixtures and ongoing infrastructure improvements. Historically, our main source of liquidity has been cash flows from operations.

The significant components of our working capital are liquid assets such as cash, cash equivalents, current marketable securities and receivables, reduced by accounts payable and accrued expenses. Our working capital position benefits from the fact that we generally collect cash from sales to customers the same day or within several days of the related sale, while we typically have longer payment terms with our vendors.

As of December 31, 2019, we have commitments totaling $3.0 million for capital expenditures related to new restaurant openings.

Potential Impacts of Market Conditions on Capital Resources

Until recently, we have consistently experienced increases in comparable restaurant sales and operating cash flows. However, the restaurant industry continues to be challenged and uncertainty exists as to the sustainability of these favorable trends as evidenced in our recent results.

We believe that expected cash flow from operations and our existing cash balance at December 31, 2019 are adequate to fund operations for at least the next 12 months. However, our ability to continue to meet these requirements and obligations will depend on, among other things, our ability to achieve anticipated levels of revenue and cash flow and our ability to manage costs and working capital successfully.

Summary of Cash Flows

Our primary sources of liquidity and cash flows are derived from our existing cash balance at December 31, 2019 and our operating cash flows. We use these to fund capital expenditures for new company-operated restaurant openings, reinvest in our existing restaurants, invest in infrastructure and information technology and maintain working capital. Our working capital position benefits from the fact that we generally collect cash from sales to customers the same day, or in the case of credit or debit card transactions, within several days of the related sale, and we typically have 20 to 30 days to pay our vendors.

The material changes in working capital from fiscal year 2018 to fiscal year 2019 were comprised of a $11.5 million increase in current assets and a $31.9 million increase in current liabilities. The increase in current assets was

 

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primarily due to a $9.5 million increase in cash primarily attributed to the timing of payables, accrued expenses and employee-related accruals, and by an increase in prepaid expenses and other current assets of $4.1 million due primarily to the timing of rent payments, partially offset by a $2.2 million decrease in accounts receivable. The increase in current liabilities was primarily attributed to the adoption of ASC 842 and the recognition of the current portion of operating lease liabilities of $22.8 million as of December 31, 2019 and also due to higher employee-related accruals of 7.1 million which is primarily due to the timing of pay dates and increased workers’ compensation liabilities.

 

 

Cash Flows Provided by Operating Activities

Net cash provided by operating activities increased by $3.3 million to $45.4 million for the fiscal year ended December 31, 2019 from $42.1 million for the fiscal year ended December 25, 2018. Cash flows from operating activities reflect net income adjusted for certain non-cash items including depreciation and amortization, changes in deferred tax assets, stock-based compensation and changes in working capital. The majority of the net cash provided increase in fiscal year 2019 was related to a $4.3 million increase in net income adjusted for non-cash items, a $2.2 million change in accrued expenses and a $2.0 million change in employee-related accruals.

This increase in cash provided by operating activities for the fiscal year ended December 31, 2019 compared to the fiscal year ended December 25, 2018 was partially offset due to changes in prepaid expenses of $2.6 million, changes in accounts payable of $1.5 million and changes in accounts receivable of $1.1 million which were primarily attributed to timing.

Net cash provided by operating activities increased by $8.5 million to $42.1 million for the fiscal year ended December 25, 2018 from $33.6 million for the fiscal year ended December 26, 2017. The majority of the net cash provided increase in fiscal year 2018 was related to a $5.6 million increase in net income adjusted for non-cash items and a change in employee related accruals of $4.0 million.

This increase in cash provided by operating activities for the fiscal year ended December 25, 2018 compared to the fiscal year ended December 26, 2017 was partially offset due to changes in accrued expenses and accounts payable of $1.5 million which was primarily attributed to timing.

Cash Flows Used in Investing Activities

Net cash used in investing activities decreased by $9.0 million to $34.4 million for the fiscal year ended December 31, 2019 from $43.4 million for the fiscal year ended December 25, 2018. There were 21 new company-operated restaurants opened during the fiscal year ended December 31, 2019 compared to 30 new company-operated restaurants that opened during the fiscal year ended December 25, 2018. The decrease was primarily due to the lower number of restaurants opened in fiscal year 2019.

Net cash used in investing activities decreased by $2.6 million to $43.4 million for the fiscal year ended December 25, 2018 from $46.0 million for the fiscal year ended December 26, 2017. There were 30 new company-operated restaurants opened during the fiscal year ended December 25, 2018 compared to 32 new company-operated restaurants that opened during the fiscal year ended December 26, 2017. The decrease was primarily due to the slightly lower number of restaurants opened in fiscal year 2018.

 

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Cash Flows Used in Financing Activities

Net cash used in financing activities decreased by $0.5 million to $1.6 million for the fiscal year ended December 31, 2019 from $2.1 million for the fiscal year ended December 25, 2018. This change was primarily due to a decrease in the TRA payment of $1.1 million in the current year, partially offset by higher tax distributions to Continuing LLC Owners of $0.6 million in the current year.

Net cash used in financing activities decreased by $1.4 million to $2.1 million for the fiscal year ended December 25, 2018 from $3.5 million for the fiscal year ended December 26, 2017. This change was primarily due to a decrease in tax distributions to Continuing LLC Owners of $0.6 million in the current year and due to a decrease in the TRA payment of $0.6 million in the current year.

Credit Facility

On August 2, 2017, The Habit Restaurants, LLC executed a $20 million credit facility with Bank of the West (the “Credit Facility”) with a maturity date of August 2, 2019. In October 2018 and September 2019, we extended the maturity date on the Credit Facility to August 1, 2020 and August 1, 2021, respectively. All borrowings under the Credit Facility will bear interest at a variable rate based upon LIBOR plus the applicable margin for LIBOR loans (as defined in the Credit Facility). The Credit Facility has no unused commitment fees. As part of the initial execution of the Credit Facility, we incurred $0.3 million in deferred financing fees that will be amortized over the length of the agreement. That amortization expense is included in interest expense, net on the accompanying consolidated statements of operations.

The Credit Facility is secured by all the assets of The Habit Restaurants, LLC, and we are required to comply with certain financial covenants therein. The Credit Facility contains customary representations, warranties, negative and affirmative covenants, including a maximum lease adjusted leverage ratio of 4.00 to 1.00 and a minimum EBITDA of $21.4 million for the twelve-month period then ended at the end of each fiscal quarter. As of December 31, 2019, we and The Habit Restaurants, LLC were in compliance with all covenants. As of December 31, 2019, The Habit Restaurants, LLC had no outstanding debt under the Credit Facility.

On January 4, 2018 we executed an irrevocable standby letter of credit for $1.5 million related to our self-insured workers’ compensation coverage. In conjunction with the renewal of our self-insured workers’ compensation coverage in October 2018, we increased our irrevocable standby letter of credit to $3.25 million. The increased standby letter of credit expires on January 5, 2021. In conjunction with the renewal of our self-insured workers’ compensation coverage in October 2019, we executed an additional standby letter of credit for $1.4 million which expires on October 31, 2020. These letters of credit are a reduction of the borrowing capacity of our Credit Facility.

Contractual Obligations

The following table presents our commitments and contractual obligations as of December 31, 2019, as well as our long-term obligations:

 

 

 

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Off-Balance Sheet Arrangements

As of December 31, 2019, we did not have any material off-balance sheet arrangements.

 

 

Interest Rate Risk

We are exposed to market risk from changes in interest rates on debt and changes in commodity prices. As of December 31, 2019, we had no outstanding borrowings.

We manage our interest rate risk through normal operating and financing activities and, when determined appropriate, through the use of derivative financial instruments.

Inflation

The primary inflationary factors affecting our operations are food, labor costs, energy costs and materials used in the construction of new restaurants. Increases in the minimum wage directly affect our labor costs. Many of our leases require us to pay taxes, maintenance, repairs, insurance and utilities, all of which are generally subject to inflationary increases. Finally, the cost of constructing our restaurants is subject to inflationary increases in the costs of labor and material. Increases in labor costs has had an impact on fiscal year 2019 and has the potential to do so going forward.

Commodity Price Risk

We purchase certain products that are affected by commodity prices and are, therefore, subject to price volatility caused by weather, market conditions and other factors which are not considered predictable or within our control. Although these products are subject to changes in commodity prices, certain purchasing contracts or pricing arrangements we use contain risk management techniques designed to minimize price volatility. In many cases, we believe we will be able to address material commodity cost increases by adjusting our menu pricing or changing our product delivery strategy. However, increases in commodity prices, without adjustments to our menu prices, could increase restaurant operating costs as a percentage of restaurant sales.

 

 

The financial statements required by this item are set forth starting on page F-1.

 

 

None.

 

 

 

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Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this Annual Report.

There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their control objectives.

Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of December 31, 2019, our disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed by us in the reports we file or submit with the SEC is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and communicated to our management, including the principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Exchange Act Rule 13a-15(f). Our management, with the participation of the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our internal control, as of December 31, 2019, over financial reporting based on the criteria in “Internal Control — Integrated Framework” (2013 Framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2019.

Our independent registered public accounting firm, Moss Adams LLP, has issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2019. The report of Moss Adams LLP is contained in this Annual Report.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

None.

 

 

 

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PART III

Information about our Executive Officers

The following table sets forth certain information about our directors and executive officers as of the date of this Annual Report on Form 10-K:

 

 

Executive Officer Biographies

Russell W. Bendel was appointed Chief Executive Officer and President of The Habit Restaurants, LLC in June 2008 and was appointed Chief Executive Officer and President of The Habit Restaurants, Inc. in August 2014. He has served as a director of The Habit Restaurants, LLC since August 2008, and has served as a director of The Habit Restaurants, Inc. since August 2014. Previously, Mr. Bendel was President and Chief Operating Officer of The Cheesecake Factory. Beginning in June 2001, Mr. Bendel worked at Mimi’s Café as Chief Executive Officer and President. He currently serves as Director Emeritus of the California Restaurant Association, and on the board of advisors for the Collins School of Hospitality Management at California State Polytechnic University. He holds a Bachelor of Science degree in Hotel Administration from Florida International University. Because of his extensive experience in leadership positions in the restaurant industry, we believe Mr. Bendel is qualified to serve on our board of directors.

Ira Fils was appointed Chief Financial Officer and Secretary of The Habit Restaurants, LLC in August 2008 and was appointed Chief Financial Officer and Secretary of The Habit Restaurants, Inc. in August 2014. He has served as a director of The Habit Restaurants, Inc. since August 2014. Previously, Mr. Fils served as Chief Financial Officer of Mimi’s Café from 2005 to 2008, after joining Mimi’s Café as Vice President of Finance in 2003. From 1998 to 2003, he served in various financial capacities with increasing responsibility which led to him becoming Chief Financial Officer at Rubio’s Restaurants, Inc. He currently sits on the board of directors of California Fish Grill. He holds an undergraduate degree in economics and an MBA from the University of California, Irvine. Because of his experience in the restaurant industry and his financial knowledge, we believe Mr. Fils is qualified to serve on our board of directors.

Anthony Serritella joined The Habit Restaurants, LLC in 1997 as Vice President of Operations and was later appointed Chief Operating Officer. Beginning in 1991, Mr. Serritella worked as the Vice President of Operations for McAthco Enterprises, one of the leading Sizzler franchises. He attended the University of California, San Diego where he studied economics and psychology.

Peter Whitwell joined The Habit Restaurants, LLC in 2005 as Vice President and was later appointed Chief Quality Officer. From 2001 to 2004 he was the Senior Vice President of Baja Fresh Mexican Grill, transitioning from the position of Senior Vice President of Franchise Operations and Quality Assurance, a position he held beginning in

 

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1999. Mr. Whitwell attended Moorpark College, where he studied Communications and Business, as well as California State University, Northridge where he studied speech communications.

Iwona Alter joined The Habit Restaurants, LLC in December 2018 as Chief Brand Officer. Prior to joining The Habit, Ms. Alter served as Chief Marketing Officer at Jack in the Box from 2016 until 2018, after joining Jack in the Box in 2005 and serving in various marketing capacities with increasing responsibility. Prior to joining Jack in the Box, Ms. Alter held various marketing roles both domestically and internationally at other major corporations such as Elmer’s Products, Shiseido Company Ltd., Johnson & Johnson, and J. Walter Thompson. She holds a Bachelor of Business Administration degree from Baruch College in New York, and an MBA in Marketing from Fordham University.

Douglas Branigan joined The Habit Restaurants, LLC in April 2017 as Chief Development Officer. Prior to joining The Habit, Mr. Branigan served as Chief Development Officer at Black Bear Diner, Inc. from 2015 until 2017 and as Vice President of Franchise Development and Operations from 2013 until 2015. Prior to joining Black Bear Diner, Mr. Branigan served as the Chief Operating Officer for Sprinkles Cupcakes from 2012 to 2013. Mr. Branigan served as Senior Vice President of Franchise Operations at Smashburger, LLC from 2009 to 2012. He has also worked in various operating roles at Mimi’s Café, Morton’s of Chicago and Chart House Enterprises. Mr. Branigan earned his Bachelor of Arts in history from Colorado State University.

John Phillips joined The Habit Restaurants, LLC in March 2013 as Vice President of Franchising and was appointed as Chief Global Business Partnership Officer in 2018. Prior to joining The Habit, Mr. Phillips served as Director West Division, Franchise Operations for Burger King Corporation from 2011 to 2013. Prior to joining Burger King, Mr. Phillips was in various roles with El Pollo Loco from 2004 to 2013, most recently serving as Vice President of Operations. Mr. Phillips attended the University of California, San Diego where he studied political science and philosophy.

Non-Executive Director Biographies

Christopher Reilly has served as a director of The Habit Restaurants, LLC since July 2007, and as a director of The Habit Restaurants, Inc. since July 2014. He is a founding partner of KarpReilly, LLC. Prior to KarpReilly, Mr. Reilly was a partner at Apax Partners, L.P. Prior to Apax Partners, Mr. Reilly was a Partner at Saunders, Karp & Megrue, LLC. Mr. Reilly currently serves on the boards of directors of a number of privately held companies. He is also Chairman of the board of trustees of Providence College. Mr. Reilly holds a B.S. from Providence College and an M.B.A. from New York University’s Leonard N. Stern School of Business. Because of Mr. Reilly’s substantial experience with portfolio companies and his private equity, financial and investment banking experience, we believe he is qualified to serve on our board of directors.

Allan Karp has served as a director of The Habit Restaurants, LLC since July 2007, and as a director of The Habit Restaurants, Inc. since August 2014. He is a founding partner of KarpReilly, LLC. Prior to KarpReilly, Mr. Karp was the Co-Chief Executive Officer at Apax Partners, L.P. Prior to Apax Partners, Mr. Karp was a Co-Founder of Saunders, Karp & Megrue, LLC. Mr. Karp currently serves on the boards of directors of a number of privately held companies. Mr. Karp holds a B.S. in Chemistry from University of California-Santa Cruz, and a M.S. in Management from M.I.T. Sloan School of Business. Because of Mr. Karp’s extensive experience with portfolio companies and his private equity, financial and investment banking experience, we believe he is qualified to serve on our board of directors.

Ira L. Zecher has served as a director of The Habit Restaurants, Inc. since August 2014. Mr. Zecher is a managing member of ILZ, LLC, and is a director, audit committee chairman and compensation committee member of the board of Chuy’s Holdings, Inc. (Nasdaq: CHUY). He previously served as a director, audit committee chairman and compensation committee member of Norcraft Companies, Inc. (NYSE: NCFT) from October 2013 to May 2015. Prior to joining The Habit, Mr. Zecher was with Ernst & Young LLP, a registered public accounting firm, for over 36 years until his retirement as a partner in 2010. Mr. Zecher gained extensive experience in audits and transactions at Ernst & Young LLP, where he served as a partner in the Audit and Transaction Advisory Services groups in New York and as the director of the Far East Area Private Equity practice, based in Hong Kong. Mr. Zecher is a CPA and holds a B.A. in accounting from Queens College of the City University of New York. He also completed the Executive Program of the Kellogg School of Management at Northwestern University. From 2010 to 2013, he

 

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taught in the Graduate Accounting program at Rutgers, the State University of New Jersey. Because of Mr. Zecher’s broad accounting and financial experience, we believe he is qualified to serve on our board of directors.

A. William Allen III has served as a director of The Habit Restaurants, Inc. since October 2014. Mr. Allen served as the CEO of OSI Restaurant partners (Bloomin’ Brands, Inc.) for five years until November 2009. He served as Chairman of the Bloomin Brands board of directors from November 2009 through December 2011. Since December 2011, Mr. Allen has acted as an investor, advisor and/or board member to a variety of established and early-stage growth companies, including Fleming’s, Il Fornaio/Corner Bakery, Bruxië and Hubworks. Prior to Bloomin’ Brands, Mr. Allen was Co-Founder of Fleming’s Prime Steakhouse & Wine Bar. Because of his extensive experience in the restaurant industry, we believe Mr. Allen is qualified to serve on our board of directors.

Joseph J. Kadow has served on our board of directors since September 2015. Mr. Kadow had served as Executive Vice President, Chief Legal Officer of Bloomin’ Brands, Inc. from 2005 until his retirement in 2019, and joined Bloomin’ Brands in 1994 as Vice President and General Counsel. Prior to that, he served as a partner in the Orlando, Florida office of the national law firm, Baker Hostetler LLP. Mr. Kadow currently sits on the board of directors of BRP Group, Inc. Mr. Kadow is a past Chairman of the board of directors of the National Restaurant Association. Mr. Kadow received his Bachelor’s Degree in Accounting from the University of Scranton and his J.D. from the Dickinson School of Law at Pennsylvania State University. Because of his extensive restaurant industry experience, we believe Mr. Kadow is qualified to serve on our board of directors.

Karin Timpone has served on our board of directors since October 2018. Ms. Timpone was Global Marketing Officer of Marriott International, Inc. until 2019. Prior to joining Marriott in 2013, she was Senior Vice President of Digital Media for The Walt Disney Company. Ms. Timpone has also held leadership roles at other major corporations such as Yahoo!, Universal Studios, Inc., and The Seagram Company, Ltd. She graduated from Bryn Mawr College with a Bachelor of Arts in Political Science. She received her Master of Arts in Media Ecology at New York University. Because of her extensive business and marketing experience, we believe Ms. Timpone is qualified to serve on our board of directors.

Corporate Governance Highlights

We believe that excellence in corporate governance is key to a strong and accountable Board. Therefore, we have adopted practices that we believe will promote the long-term interests of us and our stockholders, including the below examples.

 

Director Independence

 

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Under the applicable listing requirements and rules of the Nasdaq Stock Market LLC, or Nasdaq, independent directors must compose a majority of our Board, subject to certain specified exceptions. In addition, applicable Nasdaq rules require that, subject to specified exceptions, each member of our Audit, Compensation and Nominating and Corporate Governance Committees must be independent within the meaning of applicable Nasdaq rules. Audit Committee members must also satisfy the independence criteria set forth in Rule 10A-3 under the Securities Exchange Act of 1934 (the “Exchange Act”).

The Board has reviewed the independence of our directors under the corporate governance standards of Nasdaq. Based on this review, the Board determined that each of Ms. Timpone and Messrs. Karp, Reilly, Zecher, Kadow and Allen is independent within the meaning of the corporate governance standards of Nasdaq. In making this determination, our Board considered the relationships that each of these non-employee directors has with us and all other facts and circumstances our Board deemed relevant in determining their independence, including the beneficial ownership of our capital stock held by each non-employee director. As required under applicable Nasdaq rules, we anticipate that our independent directors will meet in regularly scheduled executive sessions at which only independent directors are present.

Board of Directors Leadership Structure

It is our current policy that our Chief Executive Officer shall serve as chairman of the Board. The independent members of the Board have periodically reviewed the Board’s leadership structure and have determined that Habit and our stockholders are well served with this structure.

The Board of Directors’ Role in Risk Oversight

The Board plays an important role in risk oversight at Habit through direct decision-making authority with respect to significant matters, as well as through the oversight of management by the Board and its committees. In particular, the Board administers its risk oversight function through (1) the review and discussion of regular periodic reports by the Board and its committees on topics relating to the risks that Habit faces, (2) the required approval by the Board (or a committee of the Board) of significant transactions and other decisions, (3) the direct oversight of specific areas of Habit’s business by the Audit, Compensation and Nominating and Corporate Governance Committees, and (4) regular periodic reports from the auditors and other outside consultants regarding various areas of potential risk, including, among others, those relating to our internal control over financial reporting. The Board also relies on management to bring significant matters impacting Habit to the attention of the Board.

Pursuant to the Audit Committee’s charter, the Audit Committee is responsible for reviewing and discussing with management and Habit’s independent registered public accounting firm, Habit’s system of internal control, its critical accounting practices, and policies relating to risk assessment and management. As part of this process, the Audit Committee discusses Habit’s major financial risk exposures and steps that management has taken to monitor and control such exposure. In addition, the Audit Committee has established procedures for the receipt, retention and treatment of complaints received by the Company regarding accounting, internal accounting controls or auditing matters, and the confidential, anonymous submissions by employees of concerns regarding questionable accounting or accounting matters.

Because of the role of the Board and the Audit Committee in risk oversight, the Board believes that any leadership structure that it adopts must allow it to effectively oversee the management of the risks relating to Habit’s operations. The Board acknowledges that there are different leadership structures that could allow it to effectively oversee the management of the risks relating to the Company’s operations and believes its current leadership structure enables it to effectively provide oversight with respect to such risks.

Board Committees

The Board has a standing Audit, Compensation and Nominating and Corporate Governance Committee. Each committee operates pursuant to a written charter and each reviews and assesses the adequacy of its charter periodically and submits its charter to the Board for approval. The charter for each committee is available on our website (www.habitburger.com) under “Investor Relations” at “Governance.”

The following table describes which directors serve on each of the Board committees.

 

 

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Audit Committee

Our Audit Committee consists of Ira L. Zecher, A. William Allen III and Joseph J. Kadow. Mr. Zecher is both an independent director and an “Audit Committee financial expert” within the meaning of Item 407 of Regulation S-K, and serves as Chair of the Audit Committee. A. William Allen III and Joseph J. Kadow are both independent directors. Each of our Audit Committee members satisfies the independence criteria set forth in Rule 10A-3 under the Exchange Act. A copy of our Audit Committee charter is available on our website. The Audit Committee’s responsibilities include:

Our Audit Committee held four meetings during the fiscal year ended December 31, 2019.

Nominating and Corporate Governance Committee

Our Nominating and Corporate Governance Committee is composed of Christopher Reilly, Joseph J. Kadow Ira L. Zecher and Karin Timpone, with Mr. Reilly serving as Chair of the committee. Our Board has determined that each of Messrs. Reilly, Kadow and Zecher and Ms. Timpone is “independent” as defined under the applicable listing standards of Nasdaq. The Nominating and Corporate Governance Committee’s responsibilities include:

 

 

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Our Nominating and Corporate Governance Committee held four meetings during the fiscal year ended December 31, 2019.

Compensation Committee

Our Compensation Committee is composed of A. William Allen III, Allan Karp and Karin Timpone, with Mr. Allen serving as Chair of the committee. Our Board has determined that each member of the Compensation Committee is “independent” as defined under the applicable listing standards of Nasdaq and meets the independence criteria set forth in Rule 10C-1. The Compensation Committee has the authority to delegate to subcommittees of the Compensation Committee any of the responsibilities of the full committee. The Compensation Committee’s responsibilities include:

 

 

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Our Compensation Committee held four meetings during the fiscal year ended December 31, 2019.

Risks Related to Compensation Practices and Policies

The Compensation Committee maintains a pay-for-performance compensation philosophy, but also recognizes that providing certain types of compensation incentives may inadvertently motivate individuals to act in ways that could be detrimental to the Company in order to maximize personal compensation. To minimize such risk, the Compensation Committee reviews at least annually the overall structure and components of our compensation program. The Compensation Committee also performs an annual evaluation to ensure that salary levels, equity awards and other elements of compensation are benchmarked against appropriate standards and that incentives provided for achievement of target goals are balanced between short-term rewards and longer-term enhancement of stockholder value. Our Compensation Committee has reviewed and evaluated the philosophy and standards on which our compensation plans have been developed and implemented across Habit. It is our belief that our compensation program does not encourage inappropriate actions or risk taking by our executive officers. We do not believe that any risks arising from our employee compensation policies and practices are reasonably likely to have a material adverse effect on our business. In addition, we do not believe that the mix and design of the components of our executive compensation program encourage management to assume excessive risks. We believe that our current business process and planning cycle foster the behaviors and controls that would mitigate the potential for adverse risk caused by the action of our executives, including the following:

Code of Business Conduct and Ethics

Our Board has established a Code of Conduct and Business Ethics applicable to our directors and officers. The Code of Conduct and Business Ethics is accessible on our website at www.habitburger.com. If we make any substantive amendments to the Code of Conduct and Business Ethics or grant any waiver, including any implicit waiver, from a provision of the Code of Conduct and Business Ethics to our officers, we will disclose the nature of such amendment or waiver on that website or in a report on Form 8-K.

 

 

Introduction

This compensation discussion provides an overview of our executive compensation program, together with a description of the material factors underlying the decisions made with respect to the compensation of our chief executive officer and our two other highest paid executive officers during fiscal year 2019 (collectively, our “named

 

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executive officers”), as presented in the tables that follow this discussion. This discussion contains statements regarding our performance targets and goals. These targets and goals are disclosed in the limited context of our compensation program and should not be understood to be statements of management’s expectations or estimates of financial results or other guidance. We specifically caution investors not to apply these statements to other contexts.

Summary Compensation Table

The following table sets forth, for the fiscal years ending December 31, 2019 and December 25, 2018, the compensation earned by our named executive officers.

 

 

Overview

Our executive compensation program is designed to attract, retain and reward key employees, to incentivize them based on the achievement of key performance goals, and to align their interests with the interests of our stockholders. Our Compensation Committee is responsible for determining the compensation of our executive officers, and has delegated certain of its responsibilities to Messrs. Bendel and Fils (other than with respect to their own compensation). For fiscal year 2019, Messrs. Bendel and Fils were responsible for determining the base salaries and annual cash bonus opportunities for our executive officers other than themselves and Mr. Serritella. Our Compensation Committee directly retained Semler Brossy as its executive compensation consultant when determining the components and amounts of executive officer compensation for fiscal year 2019.

 

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Base Salaries

The employment agreements for Messrs. Bendel and Fils set forth their respective base salaries, as in effect on the date on which the agreement was entered into between the executive and the Company. Base salaries for Messrs. Bendel and Fils are subject to annual review and approval by our Compensation Committee and for Ms. Alter is subject to annual review and approval by Messrs. Bendel and Fils. In July 2018, the Board amended Mr. Bendel’s, and Mr. Fils’s employment agreements to increase each executive’s base salary, effective July 1, 2018, from $735,000 to $760,000 and $425,000 to $445,000, respectively. The base salary increases for Messrs. Bendel and Fils were based on a review by the Compensation Committee of the compensation of chief executive officers and chief financial officers of companies we consider to be our peers. Messrs. Bendel and Fils approved a base salary of $330,000 for Ms. Alter in connection with the commencement of her employment in 2018, based on a review of compensation of chief brand officers of companies which we consider our peers.

Annual Cash Bonuses

Our annual cash bonus program is administered by our Compensation Committee, which is responsible for establishing annual performance targets under the program and reviewing and determining annual bonus payouts.

Pursuant to Mr. Bendel’s and Mr. Fils’s amended and restated employment agreements, for fiscal year 2019, Mr. Bendel and Mr. Fils were each eligible to receive an annual cash performance bonus at a target of 35% and 30% of base salary, respectively, subject to achievement of performance objectives established by the Board, which included achievement of target EBITDA. For fiscal year 2019, in accordance with the target EBITDA goal applicable to each of Messrs. Bendel and Fils, as well as his individual performance, as determined in the discretion of the Board, each of Messrs. Bendel and Fils received an annual bonus for fiscal year 2019 as follows: Mr. Bendel, 24.5% of base salary; and Mr. Fils, 21.0% of base salary. For fiscal year 2019, Ms. Alter was entitled to receive an annual cash performance bonus at a target of 30% of base salary pursuant to the terms of her offer letter, under which her bonus for fiscal year 2019 was guaranteed at 100% of target.

2019 Equity Grants

On April 23, 2019, Messrs. Bendel and Fils and Ms. Alter were granted 20,000, 15,000 and 10,000 restricted stock units, respectively, and 50,000, 40,000 and 30,000 options to purchase shares of Class A common stock, in each case, with an exercise price of $10.10 per share. The restricted stock units and stock options vest in substantially equal installments over four years commencing on the date of grant, generally subject to continued employment through the applicable vesting date.

Agreements with our Named Executive Officers

Below are written descriptions of the material terms of the employment agreements with Messrs. Bendel and Fils and the offer letter and severance agreement with Ms. Alter.

Employment Agreement with Mr. Bendel. We entered into an amended and restated employment agreement with Mr. Bendel, effective July 1, 2018. Pursuant to this agreement, Mr. Bendel is entitled to an annual base salary of $760,000. Mr. Bendel’s base salary is subject to annual review and potential increase by our Board or Compensation Committee. In addition, Mr. Bendel is eligible to earn an annual performance cash bonus at a target of 35% of base salary, subject to achievement of performance objectives established by the Board. Mr. Bendel is entitled to an automobile allowance of $2,000 per month. Mr. Bendel is also entitled to certain severance benefits, the terms of which are described below in the section entitled “—Potential Payments Upon Termination of Employment.”

Employment Agreement with Mr. Fils. We entered into an amended and restated employment agreement with Mr. Fils, effective July 1, 2018. Pursuant to this agreement, Mr. Fils is entitled to an annual base salary of $445,000. Mr. Fils’s base salary is subject to annual review and potential increase by our Board or Compensation Committee. In addition, Mr. Fils is eligible to earn an annual performance cash bonus at a target of 30% of base salary, subject to achievement of performance objectives established by the Board. Mr. Fils is entitled to an automobile allowance of $1,000 per month. Mr. Fils is also entitled to certain severance benefits, the terms of which are described below in the section entitled “—Potential Payments Upon Termination of Employment.”

 

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Offer Letter and Severance Agreement with Ms. Alter. We entered into an offer letter with Ms. Alter on October 8, 2018. Pursuant to this offer letter, Ms. Alter is entitled to an annual base salary of $330,000. In addition, Ms. Alter is eligible to earn an annual performance cash bonus at a target of 30% of base salary, based on mutually agreed-upon criteria to be determined annually. Ms. Alter’s cash bonus was guaranteed as to 100% of target for 2018, as pro-rated to reflect her service during the year, and was guaranteed as to 100% of target for 2019. Ms. Alter is entitled to an automobile allowance of $1,400 per month and reimbursement for relocation expenses up to $100,000, plus a tax-gross up to cover such reimbursement. Ms. Alter did not receive any relocation expense reimbursement amounts in 2019. On February 5, 2020, we entered into a severance agreement with Ms. Alter, the terms of which are described below in the section entitled “—Potential Payments Upon Termination of Employment.”

Outstanding Equity Awards at Fiscal Year-End

 

 

 

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Messrs. Bendel and Fils also hold vested common units in The Habit Restaurants, LLC as a result of the conversion of their Class C units into common units immediately prior to the completion of our IPO, as described below.

Pursuant to the terms of the Amended & Restated LLC Agreement of The Habit Restaurants, LLC, our named executive officers may exchange all or a portion of their vested common units (along with an equal number of the Class B Shares that they hold) at any time for shares of our Class A common stock (or, at our option, cash) on a one-for-one basis (the “Exchange”).

Potential Payments Upon Termination of Employment

Messrs. Bendel and Fils—Termination of Employment without Cause or for Good Reason. If the executive’s employment is terminated by us without cause or by the executive for good reason (as such terms are defined in the executive’s employment agreement), the executive will be entitled to (i) accrued but unpaid base salary and vacation through the date of termination, and any other payments required by applicable law or Company policy; (ii) continued payment of the executive’s base salary for a period of 12 months following such termination of employment; (iii) payment of the executive’s COBRA premiums for a period of 12 months following such termination of employment (or, if earlier, the date on which the executive ceases to be eligible for COBRA coverage); (iv) a pro-rated bonus for the year of termination (based on the lesser of the executive’s target bonus in the year of termination or the annual bonus that the executive would have earned had he remained employed during the year of termination, and calculated using the full months worked during the year in which termination occurs); (v) acceleration of any unvested Company equity subject solely to time-based vesting conditions that is scheduled to vest in the 12-month period immediately following the date of termination; and (vi) the portion of any bonus earned for the performance year preceding the year of termination that remains unpaid at the time of termination.

Ms. Alter—Termination of Employment other than for Misconduct. If Ms. Alter’s employment is terminated by us for any reason other than misconduct, she will be entitled to continued payment of her base salary for a period of 12 months following such termination of employment, and any other payments required by applicable law or Company policy.

Messrs. Bendel and Fils—Termination of Employment without Cause or for Good Reason in Connection with a Change in Control. If the executive’s employment is terminated by us without cause or by the executive for good reason during the 24-month period following a change in control of the Company (as such term is defined in the executive’s employment agreement), the executive will be entitled to (i) accrued but unpaid base salary and vacation through the date of termination, and any other payments required by applicable law or Company policy; (ii) an amount equal to 18 months of the greater of the executive’s base salary on the date of termination or on the date of the change in control; (iii) payment of the executive’s COBRA premiums for a period of 18 months following such termination of employment (or, if earlier, the date on which the executive ceases to be eligible for COBRA coverage); (iv) a pro-rated target bonus for the year of termination (calculated using the full months worked during the year in which termination occurs); (v) an amount equal to the executive’s target bonus for the year of termination (calculated using the greater of the executive’s base salary on the date of termination or on the date of the change in control); (vi) acceleration of any unvested Company equity; and (vii) the portion of any bonus earned for the performance year preceding the year of termination that remains unpaid at the time of termination.

Ms. Alter—Termination of Employment without Cause in Connection with a Change in Control. If Ms. Alter’s employment is terminated by us without cause (as such term is defined in Ms. Alter’s severance agreement) during the 24-month period following a change in control of the Company (as such term is defined in Ms. Alter’s severance agreement), she will be entitled to (i) continued payment of her base salary at the rate in effect on the date of such termination of employment for a period of 12 months following such termination of employment; (ii) payment of her COBRA premiums for a period of 12 months following such termination of employment (or, if earlier, the date on which the executive becomes covered under another employer’s health plan); and (iii) the portion of any bonus earned for the performance year preceding the year of termination that remains unpaid at the time of termination. Ms. Alter would also be entitled to any other payments required by applicable law or Company policy.

 

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Messrs. Bendel and Fils—Other Termination of Employment. If the executive’s employment is terminated by us for cause or by the executive without good reason, or if the executive’s employment is terminated due to death or disability (as such term is defined in the executive’s employment agreement), the executive (or his beneficiary, as the case may be) will be entitled to the executive’s accrued but unpaid base salary and vacation through the date of termination, and any other payments required by applicable law or Company policy. If employment is terminated due to death or disability, the executive (or his beneficiary, as the case may be) will also be entitled to (i) a pro-rated target bonus for the year of termination (calculated using the number of full months worked during the year in which termination occurs) and (ii) acceleration of any unvested Company equity subject solely to time-based vesting conditions that is scheduled to vest in the 12-month period immediately following the date of termination.

Ms. Alter—Other Termination of Employment. If Ms. Alter’s employment is terminated by us other than in the contexts described above, or by Ms. Alter for any reason, she will be entitled to her accrued but unpaid base salary and vacation through the date of termination, and any other payments required by applicable law or Company policy.

Messrs. Bendel and Fils and Ms. Alter—Severance Subject to Release of Claims. Our obligation to provide our named executive officers with any severance payments or other benefits under their respective employment agreements, offer letter or severance agreement is conditioned on the executive executing an effective release of claims in our favor. Messrs. Bendel and Fils are also subject to non-competition and non-solicitation of employees, independent contractors, or business partners covenants during and for the two-year period following the executive’s status as a member of The Habit Restaurants, LLC, in each case enforceable by its terms to the extent consistent with applicable law.

Retirement Benefits

Our 401(k) plan permits eligible employees to defer a portion of their annual eligible compensation, subject to the limitations imposed by the Internal Revenue Code, and provides for a Company matching contribution equal to 50% of the first 3% of compensation deferred. None of our named executive officers participated in our 401(k) plan during fiscal year 2019.

Effective May 1, 2014, we adopted The Habit Restaurants, LLC Deferred Compensation Plan (the “Deferred Compensation Plan”), a nonqualified deferred compensation plan that covers our named executive officers and other eligible key employees and that is intended to aid in the attraction and retention of key employees by providing them with benefits upon retirement or death. The Deferred Compensation Plan permits eligible employees to defer a portion of their annual eligible base salary and bonus compensation, and provides for a discretionary Company matching credit equal to 50% of the first 3% of compensation so deferred. The Company may also credit additional amounts to a participant’s discretionary contribution account under the Deferred Compensation Plan. Company matching and any additional discretionary credits begin to vest at a rate of 20% per year after a participant has attained two years of service, as such term is defined in our 401(k) plan, and will vest automatically on a participant’s death or a change in control of the Company if the participant is employed on such date. Each of our named executive officers participated in, and received Company matching credits under, the Deferred Compensation Plan during fiscal year 2019.

Distributions of participant elective deferrals and Company matching credits, to the extent vested, under the Deferred Compensation Plan are generally made in a lump sum upon a participant’s separation from service, unless the participant has made an alternative election in accordance with plan terms. Employer discretionary credits, to the extent vested, are paid in five annual installments upon a participant’s separation from service. In the event of an unforeseeable emergency, a participant may petition for an immediate distribution from his or her deferral account under the plan.

Equity and Incentive Plans

Management Incentive Plan

 

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Effective September 28, 2007, the board of managers of The Habit Restaurants, LLC adopted the Management Incentive Plan. The Management Incentive Plan provides for the grant of Class C units to selected employees and other persons providing services for The Habit Restaurants, LLC and its subsidiaries.

Immediately prior to the completion of our IPO, all of the outstanding vested and unvested Class C units in The Habit Restaurants, LLC were converted into an amount of vested and unvested The Habit Restaurants, LLC common units, respectively, in each case, based on our pre-IPO value. All common units of The Habit Restaurants, LLC outstanding under the Management Incentive Plan were vested as of December 31, 2019. The common units of The Habit Restaurants, LLC are entitled to receive distributions, if any, from The Habit Restaurants, LLC.

2014 Omnibus Incentive Plan

Our Board adopted The Habit Restaurants, Inc. 2014 Omnibus Incentive Plan (the “2014 Omnibus Incentive Plan”) in November 2014 and, following its adoption, all equity-based awards have been granted under the 2014 Omnibus Incentive Plan. The 2014 Omnibus Incentive Plan also permits the grant of cash bonuses. On April 23, 2019, our Board adopted The Habit Restaurants, Inc. Amended and Restated 2014 Omnibus Incentive Plan (the “A&R Omnibus Incentive Plan”) which required and received stockholder approval at our 2019 Annual Meeting of Stockholders. On April 23, 2019, our Board granted restricted stock units and options to purchase shares of our Class A common stock to our named executive officers under the A&R Omnibus Incentive Plan, the terms of which are described above under “2019 Equity Grants.”

Director Compensation

Individuals affiliated with KarpReilly who serve as members of our Board are not separately compensated for their services as a director, other than reimbursement of out-of-pocket expenses incurred in connection with rendering such services. Our other non-employee directors, Mr. Ira L. Zecher, Mr. A. William Allen III, Mr. Joseph J. Kadow and Ms. Karin Timpone, receive fees for service on our Board. Each non-employee director who is not affiliated with KarpReilly is entitled to an annual retainer fee of $40,000. Mr. Zecher is entitled to an additional annual fee of $10,000 for serving as Chair of our Audit Committee and an additional fee of $2,500 for serving as a member of our Nominating and Corporate Governance Committee. Mr. Allen is entitled to an additional annual fee of $7,500 for serving as Chair of our Compensation Committee and an additional fee of $5,000 for serving as a member of our Audit Committee. Mr. Kadow is entitled to an additional annual fee of $5,000 for serving as a member of our Audit Committee and an additional annual fee of $2,500 for serving as a member of our Nominating and Corporate Governance Committee. Ms. Timpone is entitled to an additional annual fee of $5,000 for serving as a member of our Compensation Committee and an additional annual fee of $2,500 for serving as a member of our Nominating and Corporate Governance Committee.

In addition, in connection with the pending Merger with Yum! Brands, the Board formed a special committee composed of Messrs. Kadow and Allen and Ms. Timpone for the purpose of reviewing the terms and conditions of the Merger Agreement and the pending Merger. The Board approved additional fees of $45,000 for Mr. Allen and Ms. Timpone, as members of the special committee, and an additional fee of $55,000 for Mr. Kadow, the chair of the special committee.

Each non-employee director who is not affiliated with KarpReilly is also entitled to receive an annual grant of restricted stock units with a grant date value of $50,000. The restricted stock units will vest in substantially equal installments over three years commencing on the date of grant, subject to continued service as a member of our Board through the applicable vesting date. Due to the timing of her commencement of service on our Board, and her initial equity grant in 2018, Ms. Timpone did not receive an annual grant of restricted stock units in 2019.

The following table provides information regarding the compensation of our non-employee directors for fiscal year 2019:

 

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Equity Compensation Plan Information

The following table sets forth, in tabular format, as of December 31, 2019, a summary of certain information related to our equity incentive plans under which our equity securities are authorized for issuance:

 

 

Security Ownership of Certain Beneficial Owners and Management

The following table sets forth certain information as of March 9, 2020 (unless otherwise specified), with respect to the beneficial ownership of our common stock by each person who is known to own beneficially more than 5% of the outstanding shares of common stock, each person currently serving as a director, each named executive officer, and all directors and executive officers as a group.

 

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The amounts and percentages of Class A common stock and Class B common stock (together with the same amount of LLC Units) beneficially owned are reported on the basis of the regulations of the SEC governing the determination of beneficial ownership of securities. Under these rules, a person is deemed to be a beneficial owner of a security if that person has or shares voting power, which includes the power to vote or to direct the voting of such security, or investment power, which includes the power to dispose of or to direct the disposition of such security. A person is also deemed to be a beneficial owner of any securities of which that person has a right to acquire beneficial ownership within 60 days. Under these rules, more than one person may be deemed to be a beneficial owner of the same securities. Unless otherwise indicated, the address for each listed stockholder is: c/o The Habit Restaurants, LLC, 17320 Red Hill Avenue, Suite 140, Irvine, CA 92614.

Because we have disclosed the ownership of shares of our Class B common stock and LLC Units of The Habit Restaurants, LLC (which will be exchangeable for Class A common stock), the shares of our Class A common stock corresponding to the LLC Units of The Habit Restaurants, LLC are not reflected in the table below.

 

 

 

 

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footnotes continued below

 

 

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Change in Control

On January 5, 2020, the Company entered into the Merger Agreement with Parent and Merger Sub, which may give rise to a change in control of the Company if consummated. For further discussion regarding the arrangements of the Merger Agreement, see Notes to Consolidated Financial Statements—Note 14—Subsequent Events in this Annual Report on Form 10-K.

 

 

General

The following is a description of transactions, since December 25, 2018, in which (a) we are a participant, (b) the amount involved exceeds $120,000 and (c) one or more of our executive officers, directors, or 5% stockholders, or their immediate family members, each of whom we refer to as a “related person,” has a direct or indirect material interest. We refer to these as “related person transactions.”

Recapitalization Transactions in Connection with the IPO

These summaries do not purport to be complete descriptions of all of the provisions of the documents relating to the recapitalization transactions and the material exhibits thereto, and they are qualified in their entirety by reference to the complete text of agreements which have been filed with the SEC as exhibits to the registration statement relating to our IPO.

The Habit Restaurants, LLC Limited Liability Company Agreement

In connection with the recapitalization transactions, the LLC Agreement was amended and restated. As a result of the transactions in connection with the recapitalization and the IPO, The Habit Restaurants, Inc. holds interests directly and indirectly through its subsidiaries in The Habit Restaurants, LLC and is the sole managing member of The Habit Restaurants, LLC. Accordingly, The Habit Restaurants, Inc. operates and controls all of the business and affairs of The Habit Restaurants, LLC and, through The Habit Restaurants, LLC, conducts our business. Additionally, The Habit Restaurants, LLC reclassified its outstanding LLC Units as non-voting units. Notwithstanding the foregoing, The Habit Restaurants, LLC bears the costs of or reimburses The Habit Restaurants, Inc. for certain expenses incurred by The Habit Restaurants, Inc.

Pursuant to the LLC Agreement, The Habit Restaurants, Inc. has the right to determine, subject to the discussion of tax distributions below, when distributions will be made to holders of LLC Units and the amount of any such

 

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distributions. If a distribution is authorized, such distribution will be made to the holders of LLC Units (including The Habit Restaurants, Inc. and its subsidiaries) pro rata in accordance with the percentages of their respective LLC Units (other than, for clarity, certain non-pro-rata payments to us to satisfy certain of our obligations).

The holders of LLC Units, including The Habit Restaurants, Inc. and its subsidiaries, will incur U.S. federal, state and local income taxes on their allocable shares (determined under relevant tax rules) of any taxable income of The Habit Restaurants, LLC. Net profits and net losses of The Habit Restaurants, LLC will generally be allocated to holders of LLC Units (including The Habit Restaurants, Inc.) pro rata in accordance with the percentages of their respective limited liability company interests, except to the extent certain rules provide for disproportionate allocations or are otherwise required under applicable tax law. The LLC Agreement provides for cash distributions, which we refer to as “tax distributions,” to the holders of LLC Units. Generally, these tax distributions will be computed based on our estimate of the taxable income of The Habit Restaurants, LLC allocable to the holders of LLC Units multiplied by an assumed tax rate equal to the highest effective marginal combined U.S. federal, state and local income tax rate prescribed for an individual or corporate resident in Irvine, California (taking into account, among other things, the deductibility of certain expenses and certain adjustments relating to the calculation of state taxes). For purposes of determining the taxable income of The Habit Restaurants, LLC, such determination is made by generally disregarding any adjustment to the taxable income of any member of The Habit Restaurants, LLC that arises under the tax basis adjustment rules of the Internal Revenue Code of 1986, as amended (the “Code”), and is attributable to the acquisition by such member of an interest in The Habit Restaurants, LLC in the IPO and future sale or exchange transactions.

As a result of the potential differences in the amount of net taxable income allocable to us and to The Habit Restaurants, LLC’s other equity holders and potential differences in applicable tax rates, we receive tax distributions in excess of our tax liabilities and our payment obligations under the tax receivable agreement. We do not currently expect to pay any cash dividends on shares of our Class A common stock, and, to the extent we do not distribute such cash balances as dividends and instead retain such cash balances, The Habit Restaurants, LLC’s other equity holders would benefit from any value attributable to such accumulated cash balances as a result of their ownership of shares of common stock following an exchange of their LLC Units of The Habit Restaurants, LLC pursuant to the LLC Agreement. See “—Exchange Procedures.”

Exchange Procedures

Pursuant to and subject to the terms of the LLC Agreement, the Continuing LLC Owners have the right to exchange their LLC Units, together with a corresponding number of shares of Class B common stock (which such shares will be cancelled in connection with any such exchange) for, at the option of The Habit Restaurants, Inc. (such determination to be made by the disinterested members of our Board), (i) shares of our Class A common stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications or (ii) cash consideration (generally calculated based on the volume-weighted average price of the Class A common stock of The Habit Restaurants, Inc., as displayed under the heading Bloomberg VWAP on the Bloomberg page designated for the Class A common stock of The Habit Restaurants, Inc. for the 15 trading days immediately prior to the delivery date of a notice of exchange). At any time that an effective registration statement is on file with the SEC with respect to the shares of Class A Common Stock to be issued upon an exchange, The Habit Restaurants, Inc. may not provide cash consideration upon an exchange to a Continuing LLC Owner without the Continuing LLC Owner’s prior consent. As any Continuing LLC Owner exchanges its LLC Units, The Habit Restaurants, Inc.’s interest in The Habit Restaurants, LLC will increase. The LLC Agreement provides that a Continuing LLC Owner will not have the right to exchange LLC Units if, among other things, we determine that such exchange would be prohibited by law or regulation or would violate other agreements with us to which the Continuing LLC Owner may be subject. These exchanges are expected to result in increases in the tax basis of the assets of The Habit Restaurants, LLC that otherwise would not have been available. Increases in tax basis resulting from such exchanges may reduce the amount of tax that The Habit Restaurants, Inc. would otherwise be required to pay in the future. This tax basis may also decrease gains (or increase losses) on future dispositions of certain assets to the extent tax basis is allocated to those assets. The Company amended its LLC Agreement in May 2016 and then again in March 2017, pursuant to which the Company now processes exchange requests once a month. The new exchange processing timeline became effective in May 2017. We may impose additional restrictions on exchange that we determine to be necessary or advisable to prevent The Habit Restaurants, LLC from being treated as a “publicly traded partnership” for U.S. federal income tax purposes. When a holder exchanges LLC Units and an

 

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equal number of shares of Class B common stock for shares of Class A common stock, because The Habit Restaurants, Inc. acquires additional LLC Units in connection with such exchange, the number of LLC Units held by The Habit Restaurants, Inc. will correspondingly increase, and such shares of Class B common stock will be cancelled.

As noted above, each of the Continuing LLC Owners also holds a number of shares of our Class B common stock equal to the number of LLC Units held by such person. Although shares of Class B common stock have no economic rights, they give holders voting power at The Habit Restaurants, Inc., the managing member of The Habit Restaurants, LLC, at a level that is consistent with their overall equity ownership of our business. Under our amended and restated certificate of incorporation, each share of Class B common stock is entitled to one vote. Accordingly, the voting power afforded to the Continuing LLC Owners by their shares of Class B common stock is automatically and correspondingly reduced as they exchange LLC Units and Class B common stock for shares of our Class A common stock pursuant to the LLC Agreement. Additionally, the voting power afforded to such Continuing LLC Owners will correspondingly increase as a result of the issuance of Class A common stock. Therefore, as a result of these transactions (and without taking into account any subsequent sale of shares of Class A common stock issued pursuant to the LLC Agreement), the voting power will effectively remain unchanged. The limited liability company agreement of The Habit Restaurants, LLC also provides that substantially all expenses incurred by or attributable to The Habit Restaurants, Inc., but not including income tax expenses of The Habit Restaurants, Inc., will be borne by The Habit Restaurants, LLC.

License Agreement with Co-Founders

On February 11, 2004 we entered into a Trademark Assignment Agreement with Reichard Bros. Enterprises, Inc., pursuant to which we acquired all rights in and to eight service marks, trademarks, trade names and logotypes, and all rights, title and interest in a distinctive system for operating Habit restaurants and certain other intellectual property, including recipes, products, formulas, cooking techniques and trade secrets (the “Intellectual Property”) from Reichard Bros. Enterprises, Inc. Concurrently, we entered into an Intellectual Property License Agreement, pursuant to which we granted Reichard Bros. Enterprises, Inc. a royalty-free license to use such intellectual property in Santa Barbara County, California. On July 31, 2007, we amended and restated this license agreement when we entered into an Amended and Restated Trademark and Intellectual Property License Agreement with the co-founders of The Habit, Brent and Bruce Reichard, and Reichard Bros. Enterprises, Inc., pursuant to which we granted Reichard Bros. Enterprises, Inc. an exclusive royalty-free license to use the Intellectual Property to operate Habit restaurants in Santa Barbara County, California. We further amended this agreement in October 2014. We do not receive any royalties or fees from the operations of these restaurants, and they are operated solely by Reichard Bros. Enterprises, Inc. If Reichard Bros. Enterprises, Inc. does not successfully operate its licensed restaurants in a manner consistent with our standards and the standards set forth in the Amended and Restated Trademark License Agreement and requirements it may have a material adverse effect on our business, financial condition and results of operations.

Related Person Transactions Policy

We have a formal written policy with respect to the review, approval and ratification of related person transactions. Under the policy, our Audit Committee is responsible for reviewing and approving related person transactions. In the course of its review and approval of related person transactions, our Audit Committee will consider the relevant facts and circumstances to decide whether to approve such transactions, including, whether the transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances. In particular, our policy requires our Audit Committee to consider, among other factors it deems appropriate:

 

 

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The Audit Committee may approve only those transactions that are in, or are not inconsistent with, our best interests and those of our stockholders, as the Audit Committee determines in good faith.

It is our policy for our Board to consider the nature of and business reason for such transactions, how the terms of such transactions compared to those which might be obtained from unaffiliated third parties and whether such transactions were otherwise fair to and in the best interests of, or not contrary to, our best interest. We believe that we have executed all of the transactions set forth under the section entitled “Certain Relationships and Related Transactions and Director Independence” on terms no less favorable to us than we could have obtained from unaffiliated third parties. It is our intention to ensure that all future transactions between us and our officers, directors and principal stockholders and their affiliates, are approved by the Audit Committee, and are on terms no less favorable to us than those that we could obtain from unaffiliated third parties.

Indemnification Agreements

Our bylaws provide that we will indemnify our directors and officers to the fullest extent permitted by applicable law, subject to certain exceptions contained in our bylaws. In addition, our certificate of incorporation, provides that our directors will not be liable for monetary damages for breach of fiduciary duty as a director.

Prior to the completion of our IPO, we entered into indemnification agreements with each of our then-serving directors. We have since entered into indemnification agreements with each new director who has joined our board of directors after completion of our IPO. The indemnification agreements provide the executive officers and directors with contractual rights to indemnification, and expense advancement and reimbursement, to the fullest extent permitted under the General Corporation Law of the State of Delaware, subject to certain exceptions contained in those agreements. There is no pending litigation, other than the Merger Litigation as defined above, or proceeding naming any of our directors or officers to which indemnification is being sought, and we are not aware of any pending litigation that may result in claims for indemnification by any director or officer.

Director Independence

Under the applicable listing requirements and rules of the Nasdaq Stock Market LLC, or Nasdaq, independent directors must compose a majority of our Board, subject to certain specified exceptions. In addition, applicable Nasdaq rules require that, subject to specified exceptions, each member of our Audit, Compensation and Nominating and Corporate Governance Committees must be independent within the meaning of applicable Nasdaq rules. Audit Committee members must also satisfy the independence criteria set forth in Rule 10A-3 under the Securities Exchange Act of 1934 (the “Exchange Act”).

The Board has reviewed the independence of our directors under the corporate governance standards of Nasdaq. Based on this review, the Board determined that each of Ms. Timpone and Messrs. Karp, Reilly, Zecher, Kadow and Allen is independent within the meaning of the corporate governance standards of Nasdaq. In making this determination, our Board considered the relationships that each of these non-employee directors has with us and all other facts and circumstances our Board deemed relevant in determining their independence, including the beneficial ownership of our capital stock held by each non-employee director. As required under applicable Nasdaq rules, we anticipate that our independent directors will meet in regularly scheduled executive sessions at which only independent directors are present.

 

 

Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Registered Public Accounting Firm

The Audit Committee pre-approves all auditing services, internal control related services and permitted non-audit services (including the fees and terms thereof) to be performed by Moss Adams, subject to the de minimis

 

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exception for non-audit services that are approved by the Audit Committee prior to the completion of an audit. The Audit Committee may delegate pre-approval authority to one or more members of the Audit Committee consistent with applicable law and listing standards, provided that the decisions of such Audit Committee member or members must be presented to the full Audit Committee at its next scheduled meeting.

Moss Adams served as our independent registered public accounting firm in 2019 and 2018. The following sets forth fees billed by Moss Adams for the audit of our annual financial statements and other services rendered:

 

Pursuant to the charter of the Audit Committee, adopted in connection with our IPO, the Audit Committee is responsible for the oversight of our accounting, reporting and financial practices. The Audit Committee has the responsibility to select, appoint, engage, oversee, retain, evaluate and terminate our external auditors; pre-approve all audit and non-audit services to be provided, consistent with all applicable laws, to us by our external auditors; and establish the fees and other compensation to be paid to our external auditors.

The Audit Committee pre-approved all services performed in 2019 and 2018.

 

 

 

 

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PART IV

All other financial schedules have been omitted either because they are not applicable or because the required information is provided in our Consolidated Financial Statements and Notes thereto, starting on page F-1 of this Annual Report.

EXHIBITS

 

 

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87

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Not applicable.

 

 

 

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Signatures

Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Irvine, State of California, on March 12, 2020.

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.

 

 

 

 

 

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THE HABIT RESTAURANTS, INC

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

F-1

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

The Habit Restaurants, Inc.

Opinions on the Consolidated Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of The Habit Restaurants, Inc. and Subsidiaries (the “Company”) as of December 31, 2019 and December 25, 2018, the related consolidated statements of operations, equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and schedule listed in Item 15 (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2019 and December 25, 2018, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.

Change in Accounting Principle

As disclosed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for leases in 2019.

Basis for Opinions

The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting included in Item 9A. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control Over Financial Reporting

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A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ Moss Adams LLP

San Diego, California

March 12, 2020

We have served as the Company’s auditor since 2007.

 

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THE HABIT RESTAURANTS, INC.

CONSOLIDATED BALANCE SHEETS

 

 

See notes to consolidated financial statements.

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THE HABIT RESTAURANTS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See notes to consolidated financial statements.

 

 

 

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THE HABIT RESTAURANTS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

 

See notes to consolidated financial statements.

 

 

 

F-6

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THE HABIT RESTAURANTS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See notes to consolidated financial statements.

F-7

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THE HABIT RESTAURANTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1—Nature of Operations and Basis of Presentation

The consolidated financial statements of The Habit Restaurants, Inc. include the accounts of The Habit Restaurants, LLC and its subsidiaries (collectively the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation. The Habit Restaurants, Inc. was formed as a Delaware corporation on July 24, 2014, as a holding company for the purposes of facilitating an initial public offering (the “IPO”) of shares of Class A common stock. The Company acquired, by merger, entities that were members of The Habit Restaurants, LLC. The Company accounted for the merger as a non-substantive transaction in a manner similar to a transaction between entities under common control pursuant to Accounting Standards Codification (“ASC”) ASC 805-50 Transactions between Entities under Common Control, and as such, recognized the assets and liabilities transferred at their carrying amounts on the date of transfer. The Habit Restaurants, Inc. is a holding company with no direct operations that holds as its principal assets an equity interest in The Habit Restaurants, LLC and shares of subsidiaries, each of which in turn holds as its principal asset an equity interest in The Habit Restaurants, LLC, and relies on The Habit Restaurants, LLC to provide the Company with funds necessary to meet any financial obligations. As such, the Company has no independent means of generating revenue. In February 2013, HBG Franchise, LLC (“Franchise”), a wholly-owned subsidiary of The Habit Restaurants, LLC and a Delaware limited liability company, was formed to be able to franchise the Company’s restaurant concept.

During fiscal year 2019, 43,082 common units in The Habit Restaurants, LLC (“LLC Units”) were exchanged by the existing owners of The Habit Restaurants, LLC (the “Continuing LLC Owners”), for shares of Class A common stock, and a corresponding number of shares of Class B common stock were then cancelled in connection with such exchanges. In addition, during fiscal year 2019, 86,856 restricted stock units vested, of which 18,089 were withheld to satisfy tax withholding obligations, 1,661 LLC Units were forfeited; and a corresponding number of shares of Class B common stock were then cancelled in connection with the forfeitures. As a result of these exchanges, vesting of restricted stock units, withholdings for tax obligations and forfeitures, as of December 31, 2019, The Habit Restaurants, Inc. directly or indirectly held 20,779,567 LLC Units, representing a 79.6% economic interest in The Habit Restaurants, LLC, and continues to exercise exclusive control over the Habit Restaurants, LLC, as its sole managing member.

In connection with the recapitalization and the Company’s IPO, The Habit Restaurants, LLC limited liability company agreement (the “LLC Agreement”) was amended and restated to, among other things, create a single new class of non-voting LLC Units. The existing owners of The Habit Restaurants, LLC continue to hold LLC Units, and such existing owners (other than The Habit Restaurants, Inc. and its wholly-owned subsidiaries) were issued a number of shares of our Class B common stock equal to the number of LLC Units held by them. These LLC Units continue to be subject to any vesting, forfeiture, repurchase or similar provisions pursuant to the Pre-IPO agreement. Each share of Class B common stock provides its holder with no economic rights but entitles the holder to one vote on matters presented to The Habit Restaurants, Inc.’s stockholders. Holders of Class A common stock and Class B common stock generally vote together as a single class on all matters presented to our stockholders for their vote or approval, except as otherwise required by applicable law. The Class B common stock is not publicly traded and does not entitle its holders to receive dividends or distributions upon a liquidation, dissolution or winding up of The Habit Restaurants, Inc.

As the sole managing member of The Habit Restaurants, LLC, the Company has the right to determine when distributions will be made to the unit holders of The Habit Restaurants, LLC, and the amount of any such distributions (in each case subject to the requirements with respect to the tax distributions described below). If The Habit Restaurants, Inc. authorizes a distribution, such distribution will be made to the unit holders of The Habit Restaurants, LLC, including The Habit Restaurants, Inc., pro rata in accordance with their respective ownership of the LLC Units (other than, for clarity, certain non-pro rata distributions to the Company to satisfy certain of the Company’s obligations). Notwithstanding the foregoing, The Habit Restaurants, LLC bears the cost of or reimburses The Habit Restaurants, Inc. for certain expenses incurred by The Habit Restaurants, Inc. The Company also entered into a tax receivable agreement (“TRA”).

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The Habit Restaurants, LLC is treated by its members as a partnership for federal and applicable state income tax purposes and, as such, generally is not expected to be subject to income tax (except that it may be required to withhold and remit tax as a withholding agent). Instead, taxable income is allocated to holders of LLC Units, including the Company. Accordingly, the Company incurs income taxes on its allocable share of any net taxable income of The Habit Restaurants, LLC and also incurs expenses related to its operations. Pursuant to the LLC Agreement, The Habit Restaurants, LLC is required to make tax distributions to the holders of LLC Units, except that The Habit Restaurants, LLC’s ability to make such distributions may be subject to various limitations and restrictions, including the operating results of its subsidiaries, its cash requirements and financial condition, the applicable provisions of Delaware law that may limit the amount of funds available for distribution to its members, compliance by The Habit Restaurants, LLC and its subsidiaries with restrictions, covenants and financial ratios related to existing or future indebtedness, and other agreements entered into by The Habit Restaurants, LLC or its subsidiaries with third parties. In addition to tax expenses, The Habit Restaurants, Inc. incurs expenses related to its operations, plus payments under the TRA, which the Company expects will be significant. The Company intends to cause The Habit Restaurants, LLC to make distributions or, in the case of certain expenses, payments in an amount sufficient to allow The Habit Restaurants, Inc. to pay its taxes and operating expenses, including distributions to fund any ordinary course payments due under the TRA. Under the terms of the Company’s LLC Agreement, no member shall be obligated personally for any debt, obligation, or liability of the Company.

The Company is headquartered in Irvine, California, and managed and operated 241 fast casual restaurants as “The Habit Burger Grill” in California, Arizona, Utah, New Jersey, Florida, Maryland, Idaho, Virginia, North Carolina, South Carolina, Pennsylvania and Nevada and had a total workforce of 6,437 employees as of December 31, 2019. The restaurant’s menu includes charbroiled hamburgers, specialty sandwiches, fresh salads, shakes and malts.

Additionally, with the formation of Franchise, the Company began franchising its restaurant concept. Franchise’s future operations are dependent upon the success of the Company’s restaurant concept. The Company had seven licensing and seven franchise agreements as of the period ended December 31, 2019. The Company has seven licensed locations and 23 franchise locations as of December 31, 2019.

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The Company uses a 52- or 53-week fiscal year ending on the last Tuesday of the calendar year. In a 52-week fiscal year, each quarter includes 13 weeks of operations. In a 53-week fiscal year, the first, second and third quarters each include 13 weeks of operations and the fourth quarter includes 14 weeks of operations. The 2019 fiscal year contained 53 weeks, while all other years presented contain 52 weeks. Fiscal years 2019, 2018 and 2017 ended on December 31, 2019, December 25, 2018 and December 26, 2017.

 

 

Note 2—Summary of Significant Accounting Policies

Principles of Consolidation—The accompanying consolidated financial statements include the accounts of the Company, The Habit Restaurants, LLC and Franchise. All significant intercompany balances and transactions have been eliminated in consolidation. The Company had no operations prior to the IPO, other than (i) those incident to its formation, (ii) the merger transactions resulting in it holding interests, indirectly through its wholly-owned subsidiaries, the principal assets of which are equity interests in The Habit Restaurants, LLC (such interests collectively representing, as of December 31, 2019, a less than 20% interest in The Habit Restaurants, LLC) and (iii) the preparation of the IPO registration statement.

Use of Estimates—The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. The Company’s significant estimates include estimates for impairment of property and equipment, workers’ compensation insurance reserves, stock-based compensation expense, income tax receivable liabilities and lease liabilities which are determined based on the present value of the minimum rental payments using the Company’s incremental borrowing rate in effect at the time of lease commencement.

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Reclassifications—Certain comparative prior year amounts in the consolidated financial statements have been reclassified to conform to the current year presentation. These reclassifications have no effect on previously reported net income or earnings per share.

Segment Information—Management has determined that the Company has one reportable segment. Our chief operating decision maker (“CODM”) is our Chief Executive Officer; our CODM reviews financial performance and allocates resources at a consolidated level on a recurring basis.

Cash and Cash Equivalents—For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of ninety days or less to be cash equivalents.

Accounts Receivable—Accounts receivable consist of credit card receivables, amounts due from vendors and landlords, catering events and franchisees/licensees. Amounts are stated at the amounts management expects to collect from balances outstanding at fiscal year-end; accordingly, no allowance for doubtful accounts is required. If amounts become uncollectible, they will be charged to operations when that determination is made.

Inventory—Inventory consists of food, beverage, and paper goods and is stated at the lower of average cost or net realizable value.

Concentration of Credit Risk—Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of cash and cash equivalents. At December 31, 2019 and December 25, 2018, the Company maintained approximately $9.7 million and $9.5 million, respectively, of its day-to-day operating cash balances with a major financial institution, of which $0.3 million and $0.4 million, respectively, represents restricted cash in an impound account for franchisees developing in states that require segregation of fees paid for stores not opened. At December 31, 2019 and December 25, 2018, the Company maintained approximately $0.4 million and $0.3 million, respectively, at the restaurant level for operating purposes. The remaining $24.3 million and $15.1 million at December 31, 2019 and December 25, 2018, respectively, was invested with a major financial institution and consisted entirely of U.S. Treasury instruments with a maturity of two months or less at the date of purchase. At December 31, 2019 and December 25, 2018 and at various times during the periods then ended, cash and cash equivalents balances were in excess of Federal Depository Insurance Corporation insured limits. While the Company monitors the cash balances in its operating accounts on a daily basis and adjusts the cash balances as appropriate, these cash balances could be impacted if the underlying financial institutions fail or are subject to other adverse conditions in the financial markets. To date, the Company has experienced no loss or lack of access to cash in its operating accounts.

Purchasing Concentration—The Company had four distributors covering different markets in fiscal year 2019. One of those distributors accounted for 45% of purchases for the fiscal year 2019. This vendor represented approximately 60% of accounts payable at December 31, 2019. That vendor accounted for 39% of purchases and 59% of accounts payable for the year ended December 25, 2018.

The Company believes there are other available alternatives to the current vendors; however, the philosophy of the Company is to concentrate its purchases over a limited number of distributors in order to maintain quality, consistency, delivery requirements and cost controls and to increase the distributor’s commitment to the Company. The Company relies upon, and expects to continue to rely upon, several single source suppliers; however, management believes sufficient alternative suppliers exist in the marketplace.

Fair Value Measurements— The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and all other current liabilities approximate fair values due to the short maturities of these instruments.

Property and Equipment—Property and equipment is generally carried at cost, less accumulated depreciation. Upon sale, retirement, or other disposition of these assets, the costs and related accumulated depreciation are removed from the respective accounts and any gain or loss on the disposition is included in our consolidated statement of operations. Depreciation on property and equipment is determined using the straight-line method over the assets’ estimated useful lives, ranging from three to 10 years. Leasehold improvements are amortized using the straight-line method over the shorter of the term of the lease, including reasonably assured extensions, or their estimated useful lives.

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Maintenance and repairs are charged against income as incurred and additions, renewals, and improvements are capitalized.

Smallwares which consist of pots, pans and other cooking utensils are carried at cost and any replacements are expensed when acquired.

Goodwill—Goodwill represents the excess of the purchase price over the fair value of net assets acquired in business combinations and is allocated to the appropriate reporting unit when acquired. Under Accounting Standards Codification (“ASC”) 350, Intangibles—Goodwill and Other, goodwill and indefinite lived intangible assets are not amortized but tested for impairment at least annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. For purposes of applying ASC 350, management has determined that the Company has one reporting unit for the analysis. As of September of 2011, the Financial Accounting Standards Board issued an amendment of the FASB Accounting Standards Codification 350 that has been coined the ASC 350 Impairment Analysis – “Step 0.” Step 0 allows for an entity to first assess qualitative factors to determine whether it is necessary to perform further analysis. If determined necessary after the qualitative test, the Company would assess if the carrying amount exceeds the reporting unit’s fair value and the Company would recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. Accordingly, the Company has not recorded any impairment charges related to goodwill.

Tradenames—Tradenames acquired in a business combination and determined to have an indefinite useful life are not amortized because there is no foreseeable limit to the cash flows generated by the intangible asset, and have no legal, contractual, regulatory, economic or competitive limiting factors. Tradenames are evaluated for impairment annually and whenever events or changes in circumstances indicate that the value of the asset may be impaired. The Company also annually evaluates any tradenames that are not being amortized to determine whether events and circumstances continue to support an indefinite useful life. If a tradename that is not being amortized is determined to have a finite useful life, the asset will be amortized prospectively over the estimated remaining useful life and tested for impairment in the same manner as a long-lived asset. Accordingly, the Company has not recorded any impairment charges related to tradenames.

Impairment of Long-lived Assets—The Company evaluates long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. If the estimated future cash flows (undiscounted and without interest charges) from the use of an asset are less than the carrying value, a write-down would be recorded to reduce the related assets to its estimated fair value. Fair value is generally based on a discounted cash flow analysis. Based on its review for fiscal year 2019, the Company does not believe that any indicators of impairment of its long-lived assets has occurred and accordingly no such write-downs have been recorded. The Company recorded a non-cash impairment charge of $3.1 million in fiscal year 2018 for three restaurants in the Orlando, Florida market.

Restaurant Closure Charges—During fiscal year 2019, the Company closed three restaurants in the Orlando, Florida market, all of which were previously impaired during fiscal year 2018, and also decided not to move forward with the development of two restaurants. The Company recorded restaurant closure charges of $1.0 million during fiscal year 2019. Restaurant closure charges consist primarily of lease termination costs, rent expense related to closed restaurants, severance and other direct costs related to closed restaurants.

Leases and Tenant Improvement Allowances— In fiscal year 2019 we adopted ASC 842 Leases which required lessees to recognize a lease liability and a right-of-use (“ROU”) asset for all leases, including operating leases, with an expected term greater than 12 months on its balance sheet. Operating lease ROU assets and liabilities are recognized on our consolidated balance sheet at commencement date, which is the date we gain access to the property. The lease liability is determined based on the present value of the minimum rental payments using our incremental borrowing rate in effect at the time of lease commencement. The ROU asset is determined based on the lease liability adjusted for lease incentives received.  Lease expense is recognized on a straight-line bases over the lease term.  Certain leases require contingent rent above the minimum lease payments based on a percentage of sales, these contingent amounts are excluded in determining the lease liability and ROU asset and are accounted for as period expense. The option periods are not included in the determination of the lease liability and ROU asset as we are not reasonably certain if we will extend at the time of lease commencement. Lease expenses for the period prior to the restaurant opening are reported as pre-opening expense in the consolidated statements of operations.

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Lease expenses for the period after a restaurant opens are reported on the occupancy and other operating expenses line of the consolidated statements of operations.

Asset Retirement Obligations (AROs)—The Company has AROs arising from contractual obligations under certain leases to perform certain asset retirement activities at the time that certain leasehold improvements are disposed of. At the inception of a lease with such conditions, the Company records an AROs liability and a corresponding capital asset in an amount equal to the estimated fair value of the obligation. The liability was initially measured at fair value and subsequently is adjusted for accretion expense and changes in the amount or timing of the estimated cash flows. The corresponding asset retirement costs are capitalized as part of the carrying amount of the related long-lived asset and depreciated over the asset’s remaining useful life. The Company’s AROs is $0.2 million and $0.2 million at December 31, 2019 and December 25, 2018, respectively.

Self-insurance Program—Beginning in fiscal year 2018, the Company began a modified self-insurance workers’ compensation program. In order to minimize the exposure under the self-insurance program, the Company purchased stop-loss coverage both on a per-occurrence and on an aggregate basis. The self-insured losses under the program are accrued based on the Company’s estimate of the expected liability for both claims incurred and incurred but not reported basis. The accruals for the modified self-insurance program involve certain management judgments and assumptions regarding the frequency and severity of claims, recent historical patterns of claim development, independent actuarial assessments, and the Company’s experience with claim-reserve management and settlement practices. These accruals are included in employee-related accruals in the accompanying condensed consolidated balance sheet. As of December 31, 2019 and December 25, 2018, the accruals related to the self-insurance workers’ compensation program were $5.5 million and $3.1 million, respectively. The Company’s actual losses may be significantly different than the estimates currently recorded.

Revenue Recognition—The Company recognizes revenue when products are delivered to the customers or meals are served. Revenue recognized excludes sales taxes.

Franchise/License Fee Revenue—Franchise/license fee revenue consists of fees charged to franchise/license owners who enter into a franchise/license agreement with the Company. Initial franchise/license fees are recognized as revenue as the performance obligations of the contract are satisfied. The Company has identified separate performance obligations over the term of the contract and recognizes revenue as those performance obligations are satisfied. These performance obligations include rights to use trademarks and intellectual property, initial training and other operational support visits. There was franchise/license fee revenue of $0.1 million, $0.2 million and $0.1 million recognized in fiscal years 2019, 2018 and 2017, respectively.

Royalty Revenue—Royalty revenue represents royalties earned from each of the franchisees in accordance with the financial disclosure document and the franchise agreement for use of the “The Habit Burger Grill” name, menus, processes, and procedures. The royalty rate in the franchise agreement is typically 5% of the gross sales of each restaurant operated by each franchisee. Such revenue is recognized when earned and is payable to the Company monthly before the sixth business day of the subsequent month. There was royalty revenue of $2.0 million, $1.5 million and $0.9 million recognized in fiscal years 2019, 2018 and 2017, respectively.

Franchise Area Development Fees—The Company receives area development fees from franchisees and licensees when they execute multi-unit area development agreements. The Company does not recognize revenue from the agreements until the related restaurants open or, in certain circumstances, the fees are applied to satisfy other obligations of the franchisee or licensee. In the event of a termination of a franchise/license agreement these fees may be recognized as revenue at the time of termination. There were franchise area development fees of $0.4 million, $1.2 million and $0.1 million recognized in fiscal years 2019, 2018 and 2017, respectively. Included in fiscal year 2019 is $0.3 million related to the termination of two agreements in fiscal year 2019 and included in fiscal year 2018 amount is $1.1 million related to the termination of two franchise agreements in fiscal year 2018.

Sales Tax—Sales tax collected from customers and remitted to governmental authorities is accounted for on a net basis and therefore is excluded from net revenue in the consolidated statements of operations. This obligation is included in sales taxes payable until the taxes are remitted to the appropriate taxing authorities.

Gift Cards—Revenue related to the sale of gift cards is deferred until the gift card is redeemed. Outstanding gift cards are tracked by a third-party administrator. The balance of unredeemed gift cards was $2.2 million and $2.1 million at December 31, 2019 and December 25, 2018, respectively, and is included in accrued expenses in the

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accompanying consolidated balance sheets. Gift cards do not carry an expiration date; therefore, customers can redeem their gift cards for products indefinitely and the Company does not deduct non-usage fees from outstanding gift card balances. A certain amount of gift cards will not be redeemed and may become breakage income or may need to be remitted to the various states. To date, the Company has not recognized breakage income of gift cards or remitted any amounts to the various states.

Advertising Costs—Advertising and promotional costs are expensed as incurred. Advertising and promotions expense totaled $4.7 million, $3.6 million and $3.2 million for the fiscal years ended December 31, 2019, December 25, 2018 and December 26, 2017, respectively, and is included in occupancy and other operating expenses, pre-opening costs and general and administrative expenses in the consolidated statements of operations.

Pre-opening Costs—Pre-opening costs are costs incurred in connection with the hiring and training of personnel, as well as occupancy, which can include the amortization of lease expenses, and other operating expenses during the build-out period of new restaurant openings. Pre-opening costs are expensed as incurred.

Income Taxes—The Company records a tax provision for the anticipated tax consequences of the reported results of operations. The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. The Company may record a valuation allowance, if conditions are applicable, to reduce deferred tax assets to the amount that is believed more likely than not to be realized.

The Company accounts for uncertain tax positions in accordance with ASC 740, Income Taxes. ASC 740 prescribes a recognition threshold and measurement process for accounting for uncertain tax positions and also provides guidance on various related matters such as derecognition, interest, penalties, and required disclosures. The Company has no uncertain tax liabilities at December 31, 2019. In the future, if an uncertain tax position arises, interest and penalties will be accrued and included on the provision for income taxes line of the Statements of Consolidated Income. The Company files tax returns in the U.S. federal and state jurisdictions. Generally, the Company is subject to examination by U.S. federal (or state and local) income tax authorities for three to four years from the filing of a tax return.

Non-controlling Interest—The non-controlling interest on the consolidated statement of operations represents the portion of earnings or loss before income taxes attributable to the economic interest in the Company’s subsidiary, The Habit Restaurants, LLC, held by the non-controlling Continuing LLC Owners. Non-controlling interest on the consolidated balance sheet represents the portion of net assets of the Company attributable to the non-controlling Continuing LLC Owners, based on the portion of the LLC Units owned by such unit holders. As of December 31, 2019 and December 25, 2018, the non-controlling interest was 20.4% and  20.7%, respectively.

Management Incentive Plans—Prior to the completion of the Company’s IPO, the board of directors adopted The Habit Restaurants, Inc. 2014 Omnibus Incentive Plan which was amended and restated in April 2019. The provisions to this plan are detailed in Note 11-Management Incentive Plans. The Habit Restaurants, LLC maintained a management incentive plan that provided for the grant of Class C units. Class C units were intended to be “profits interests” for U.S. federal income tax purposes. The Class C units participated in distributions and, if vested, could have been converted to Class A units. Because of the ability of the Class C Unit-holder to convert his or her Class C units to Class A units, the Class C units were accounted for as equity classified awards.

In conjunction with the Company’s IPO, all vested and unvested units issued under this plan were exchanged for Common Units of The Habit Restaurants, LLC.

The Company measures stock-based compensation cost at the grant date based on the fair value of the award and recognizes it as expense, net of estimated forfeitures, over the vesting or service period, as applicable, of the award using the straight-line method.

Comprehensive Income—Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Comprehensive income is

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the same as net income for all periods presented. Therefore, a separate statement of comprehensive income is not included in the accompanying consolidated financial statements.

Earnings Per Share—Basic earnings per share (“basic EPS”) is computed by dividing net income attributable to the Habit Restaurants, Inc. by the weighted average number of shares outstanding for the reporting period. Diluted earnings per share (“diluted EPS”) gives effect during the reporting period to all dilutive potential shares outstanding resulting from employee stock-based awards. The following table sets forth the calculation of basic and diluted earnings per share for fiscal years 2019, 2018 and 2017:

 

Diluted earnings per share of Class A common stock is computed similarly to basic earnings per share except the weighted average shares outstanding are increased to include additional shares from the assumed exercise of any common stock equivalents using the treasury method, if dilutive. The Company’s Class B common stock represent voting interests and do not participate in the earnings of the Company. Accordingly, there is no earnings per share related to the Company’s Class B common stock. The Company’s LLC Units are considered common stock equivalents for this purpose. The number of additional shares of Class A common stock related to these common stock equivalents is calculated using the if-converted method. The potential impact of the exchange of the 5,336,807 LLC Units on the diluted EPS had no impact and were therefore excluded from the calculation.

As of December 31, 2019, there were 3,525,275 options authorized under our Amended and Restated 2014 Omnibus Incentive Plan of which 2,536,077, 1,950,726, and 1,296,513 had been granted as of December 31, 2019, December 25, 2018 and December 26, 2017, respectively. The number of dilutive shares of Class A common stock related to these options was calculated using the treasury stock method and 1,689,884, 5,576 and 56,782 shares have been excluded from the diluted EPS for fiscal years 2019, 2018 and 2017, respectively, because they were anti-dilutive.

 

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Recent Accounting Pronouncements— In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which clarifies the accounting for implementation costs in cloud computing arrangements. These amendments align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. ASU 2018-15 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company will adopt the standard on January 1, 2020.

We do not expect the adoption of ASU 2018-15 to result in a material change to our consolidated financial statements.

 

The Company has reviewed all other recently issued accounting pronouncements and concluded that they were either not applicable or not expected to have a significant impact to its consolidated financial statements.

Recently Adopted Accounting Pronouncements— In February 2016, the FASB issued ASU No. 2016-02 Leases, which supersedes ASC 840 Leases and creates a new topic, ASC 842 Leases. This update requires lessees to recognize a lease liability and a right-of-use asset for all leases, including operating leases, with an expected term greater than 12 months on its balance sheet. The update also expands the required quantitative and qualitative disclosures surrounding leases. This update is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, with early adoption permitted. In July 2018, the FASB issued ASU 2018-11, which provides an alternative transition method that allows entities to apply the new leases standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. This transition method option is in addition to the existing transition method of using a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company adopted this ASU in the beginning of the first quarter of fiscal year 2019 and used the cumulative-effect transition method. The Company elected the available practical expedient options which allows an entity to not reassess whether any existing or expired contracts contain leases, not reassess lease classifications for existing or expired leases, and an entity does not need to reassess initial direct costs for any existing leases.

Upon transition, the Company recorded an increase to opening equity of $1.0 million, net of tax, of which $0.7 million was recognized in retained earnings and $0.3 million in non-controlling interests, with a corresponding decrease of $18.6 million in property and equipment, net, a decrease in deemed landlord financing of $19.8 million and a decrease of $0.2 million in deferred tax assets, related to the derecognition of the buildings that the Company had determined that it was the accounting owner of under build to suit lease guidance contained in ASC 840 Leases. The leases where the Company had previously determined that it was the accounting owner are now accounted for as operating leases under the new standard which will result in an increase in occupancy and other operating expenses and a decrease in depreciation and amortization expense and interest expense, net on its consolidated statement of operations. The new standard will not have a material impact on the Company’s consolidated statement of operations for its existing operating leases. In addition, upon transition, the Company also recognized $174.4 million for operating lease liabilities based on the present value of the remaining minimum rental payments using discount rates based on the Company’s borrowing rate as of the effective date and $149.8 million for right-of-use assets based upon the lease liabilities adjusted for deferred rent and lease incentives balances of $24.6 million at adoption. See Note 8—Leases for additional information.

 

 

Note 3—Non-controlling Interests

Pursuant to the LLC Agreement, the Continuing LLC Owners have the right to exchange their LLC Units, together with a corresponding number of shares of Class B common stock (which will be cancelled in connection with any such exchange) for, generally, at the option of the Company (such determination to be made by the disinterested members of our board of directors), (i) shares of our Class A common stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications or (ii) cash consideration. At any time that an effective registration statement is on file with the SEC with respect to the shares of Class A Common Stock to be issued upon an exchange, The Habit Restaurants, Inc. may not provide cash consideration upon an exchange to a Continuing LLC Owner without the Continuing LLC Owner’s prior consent.

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The Company amended its LLC Agreement in May 2016, pursuant to which the Company processed exchange requests every other week, rather than weekly, effective in June 2016. The Company further amended its LLC Agreement in March 2017, pursuant to which the Company processes exchange request monthly, effective in May 2017.

The non-controlling interests represents the portion of earnings or loss attributable to the economic interest held by the non-controlling Continuing LLC Owners. Prior to the completion of the IPO, all earnings or losses were attributed to the Continuing LLC Owners. The non-controlling interests upon the completion of the IPO was 65.5%. Upon completion of the follow-on offering in April 2015, the non-controlling interests portion was 47.1%. The non-controlling interests portion changes as Continuing LLC Owners exchange their LLC Units, together with a corresponding number of shares of Class B common stock, for Class A common stock. The non-controlling interests on the consolidated balance sheet were adjusted to reflect the non-controlling interests portion as of December 31, 2019 and December 25, 2018, which was 20.4% and 20.7%, respectively. The amounts of these changes are reflected in the consolidated statements of stockholders’ equity. The amount recorded in equity for fiscal years 2019 2018 was $0.5 million and $1.5 million, respectively. Net income attributable to non-controlling interests is calculated based on the non-controlling interests ownership percentage in effect at that time.  The table below represents the weighted average non-controlling interests for the periods presented (dollar amounts in thousands):

 

 

 

Note 4—Fair Value Measurements

Fair value measurements enable the reader of the financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values. The Company classifies and discloses assets and liabilities carried at fair value in one of the following three categories:

 

Level 1: Quoted market prices in active markets for identical assets or liabilities.

 

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

 

Level 3: Unobservable inputs that are not corroborated by market data.

The fair values of the Company’s investments in marketable securities are based on quoted prices in active markets for identical assets. The fair value of the investments in marketable securities at December 31, 2019 and December 25, 2018 was approximately $24.3 million and $15.1 million, respectively, and the Company classified such investments as Level 1. These investments consist entirely of U.S. Treasury instruments with a maturity of two months or less at the date of purchase and the interest income received from these instruments is included in interest expense, net in the consolidated statements of operations. These amounts are included in cash and cash equivalents in the accompanying consolidated balance sheets.

 

 

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Note 5—Property and Equipment, net

Property and equipment consists of the following: (amounts in thousands)

 

 

Depreciation and amortization expenses were $27.9 million, $24.5 million and $18.8 million for the years ended December 31, 2019, December 25, 2018 and December 26, 2017, respectively.

As a result of the application of build-to-suit lease guidance contained in ASC 840-40-55, the Company had determined that it is the accounting owner of a total of 31 buildings under deemed landlord financing as of December 25, 2018, and they are included in the Company’s property and equipment. Included in the buildings under deemed landlord financing is the estimated construction costs of the landlord for the shell building. The Company has determined that these locations will be accounted for as operating leases under ASC 842 Leases, and these amounts were derecognized with the adoption of ASC 842 at the beginning of the first quarter of fiscal year 2019. See Note 8—Leases for additional information.

We capitalize internal payroll, payroll related and other costs directly related to the successful development, design and construction of our new restaurants. Capitalized internal payroll and other costs related to the new restaurants were $1.5 million, $1.9 million and $2.0 million for the years ended December 31, 2019, December 25, 2018 and December 26, 2017, respectively.

 

 

Note 6—Income Taxes

The Habit Restaurants, Inc. is subject to U.S. federal and state income taxation on its allocable portion of the income of The Habit Restaurants, LLC. The “Provision for income taxes” in the accompanying consolidated statements of operations for fiscal years ended December 31, 2019, December 25, 2018, and December 26, 2017 is based on an estimate of the Company’s annualized effective income tax rate. The Habit Restaurants, LLC operates as a limited liability company which is not itself subject to federal income tax. Accordingly, the portion of the Company’s subsidiary earnings attributable to the non-controlling interests are subject to tax when reported as a component of the non-controlling interests’ taxable income.

As a result of the recapitalization and the IPO that occurred in fiscal year 2014, the portion of The Habit Restaurants, LLC’s income attributable to The Habit Restaurants Inc. is now subject to U.S. federal, state and local income taxes and is taxed at the prevailing corporate tax rates. The income tax provision reflects a tax rate of 17.0%, (40.9)% and 102.5% for fiscal years ended December 31, 2019, December 25, 2018 and December 26, 2017, respectively. The effective tax rate varies significantly from the federal statutory rate due to the income attributable to the non-controlling interests which is not taxed at the entity level. The change in tax rate for fiscal years ended December 31, 2019, December 25, 2018 and December 26, 2017 is a result of the changes in annual taxable income and related state income taxes (and forecasts thereof which are used to calculate the tax provision during interim periods), and the deferred remeasurement for tax reform rate change in 2017. The income tax provision would reflect an effective tax rate of 28.8%, 28.8% and 42.5% for fiscal years ended December 31, 2019, December 25,

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2018 and December 26, 2017, respectively, if all of the income was taxed at Habit Restaurants, Inc. and the impact of non-recurring and discrete items and the non-controlling interests was disregarded.

Income before the provision for income taxes as shown in the accompanying consolidated statements of operations is all domestic and is as follows (in thousands):

 

 

Components of the provision for income taxes consist of the following (in thousands):

 

 

Prior to July 24, 2014, The Habit Restaurants, LLC had not been subject to U.S federal income taxes as it is organized as a limited liability company, and is treated as a partnership for federal and state income tax purposes. As a result of the recapitalization, IPO, April follow-on offering and exchanges, the portion of The Habit Restaurants, LLC’s income attributable to The Habit Restaurants Inc. is subject to U.S federal, state and local income taxes and is taxed at the prevailing corporate tax rates. The Habit Restaurants, Inc. and its corporate subsidiaries will file its federal income tax return on a consolidated basis.

A reconciliation of the U.S. statutory income tax rate to The Habit Restaurants, Inc. effective tax rate is as follows:

 

 

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The effective tax rate includes a rate benefit attributable to the fact that The Habit Restaurants, LLC operates as a limited liability company that is treated as a partnership for federal and state income tax purposes and is not itself subject to federal and state income tax. Accordingly, the portion of The Habit Restaurants, LLC earnings attributable to the non-controlling interest are subject to tax when reported as a component of the non-controlling interests’ taxable income.

Deferred income taxes are provided for the effects of temporary differences between the tax basis of an asset or liability and its reported amount in the accompanying consolidated balance sheets.

These temporary differences result in taxable or deductible amounts in future years. Details of The Habit Restaurants, Inc. deferred tax assets and liabilities are summarized as follows (in thousands):

 

 

The net decrease in deferred tax assets was primarily due to an increase in the tax basis of certain assets resulting from The Habit Restaurants, Inc.’s investment in The Habit Restaurants, LLC. The Habit Restaurants, Inc.’s acquisitions of interests in The Habit Restaurants, LLC (including transactions treated as “sales or exchanges” for U.S. federal income tax purposes) from the Continuing LLC Owners for shares of our Class A common stock or cash resulted in favorable tax attributes for The Habit Restaurants, Inc. In connection with the IPO, we entered into a TRA. Under the TRA, we generally will be required to pay to the Continuing LLC Owners 85% of the amount of cash savings, if any, in U.S. federal, state or local tax that we actually realize directly or indirectly (or are deemed to realize in certain circumstances) as a result of (i) certain tax attributes created as a result of the IPO and any sales or exchanges (as determined for U.S. federal income tax purposes) to or with us of their interests in The Habit Restaurants, LLC for shares of our Class A common stock or cash, including any basis adjustment relating to the assets of The Habit Restaurants, LLC and (ii) tax benefits attributable to payments made under the TRA (including imputed interest). The Habit Restaurants, Inc. generally will retain 15% of the applicable tax savings. The tax effects of the increase in tax attributes that were created as a result of the secondary offering and the exchanges are included in the table of deferred tax assets and liabilities. The amount payable to the Continuing LLC Owners under the TRA is disclosed on the accompanying consolidated balance sheets. Net deferred tax assets are also recorded related to differences between the financial reporting basis and the tax basis of The Habit Restaurants, Inc.’s proportionate share of the net assets of The Habit Restaurants, LLC. Based on the Company’s historical taxable income and its expected future earnings, management evaluates the uncertainty associated with booking tax benefits and determined that the deferred tax assets are more likely than not to be realized, including evaluation of deferred tax liabilities and the expectation of future taxable income.

As of December 31, 2019, the Company had federal, California and other state net operating loss carry forwards of $61.2 million, $26.6 million, and $8.7 million, respectively. The federal net operating loss carry forwards will begin to expire in 2032 and the California and other states net operating loss carry forwards will begin to expire in 2036.

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Included in the balance of unrecognized tax benefits as of December 31, 2019 and December 25, 2018 are $0 and $103,000, respectively, of tax benefits, which if recognized, would affect the effective tax rate. The change in the balance of unrecognized tax benefits for fiscal year 2019 was due to statute expiration. The Habit Restaurants, Inc. recognizes interest and penalties, if any, related to unrecognized tax positions in the provision for income taxes in the accompanying consolidated statement of operations. No interest or penalties were accrued as of December 31, 2019 and December 25, 2018 as the Company believes the amounts would be immaterial.

The Habit Restaurants, Inc. does not anticipate that the unrecognized tax benefits will significantly increase or decrease within the next twelve months of the reporting date.

The Company and its subsidiaries file, or will file, income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Habit Restaurants, Inc. will file its Federal income tax return by October 15, 2020. The Habit Restaurants, LLC is not subject to federal income taxes as it is a flow-through entity. With respect to U.S. federal and state and local jurisdictions, the Company and its subsidiaries are typically subject to examination for three to four years after filing of a tax return.

Effects of the Tax Cuts and Jobs Act

Tax legislation, commonly referred to as the Tax Cuts and Jobs Act (the “Act”), was enacted on December 22, 2017. ASC 740, Accounting for Income Taxes, requires companies to recognize the effect of tax law changes in the period of enactment even though the effective date for most provisions was for tax years beginning after December 31, 2017. Given the significance of the legislation, the SEC staff issued Staff Accounting Bulletin No. 118 (SAB 118), which allows registrants to record provisional amounts during a one year “measurement period” similar to that used when accounting for business combinations. However, the measurement period is deemed to have ended earlier when the registrant has obtained, prepared and analyzed the information necessary to finalize its accounting. During the measurement period, impacts of the law are expected to be recorded at the time a reasonable estimate for all or a portion of the effects can be made, and provisional amounts can be recognized and adjusted as information becomes available, prepared or analyzed. SAB 118 summarizes a three-step process to be applied at each reporting period to account for and qualitatively disclose: (1) the effects of the change in tax law for which accounting is complete; (2) provisional amounts (or adjustments to provisional amounts) for the effects of the tax law where accounting is not complete, but that a reasonable estimate has been determined; and (3) a reasonable estimate cannot yet be made and therefore taxes are reflected in accordance with law prior to the enactment of the Act. 

As of September 25, 2018, the Company’s accounting for the Act was complete. As noted at the fiscal year ended December 26, 2017, the Company was able to reasonably estimate certain effects related to the reduction in the U.S. corporate income tax rate to 21%, including the impact of the Company’s assessment of 100% bonus depreciation for qualified assets placed in service after September 27, 2017 and the inclusion of performance based compensation in determining the excessive compensation limitation. Therefore, the Company recorded provisional adjustments associated with these items during the fiscal year ended December 26, 2017. The Company updated its provision adjustments as related to the bonus depreciation for qualified assets and the impact related to the TRA payments during the first quarter of fiscal 2018, within the prescribed measurement period. The Company finalized the impacts of the Act in 2018 and there were no further changes to the estimates recorded in the second and third quarters of 2018 income tax provision within the prescribed measurement period of SAB 118.  The Company finalized the tax returns related to tax year 2018 by its extended due date of October 15, 2019.

Tax Receivable Agreement

In connection with the IPO that occurred in fiscal year 2014, the Company entered into a TRA. Under the TRA, the Company generally will be required to pay to the Continuing LLC Owners 85% of the amount of cash savings, if any, in U.S. federal, state or local tax that the Company actually realizes directly or indirectly (or are deemed to realize in certain circumstances) as a result of (i) certain tax attributes created as a result of the IPO and any sales or exchanges (as determined for U.S. federal income tax purposes) to or with the Company of their interests in The Habit Restaurants, LLC for shares of our Class A common stock or cash, including any basis adjustment relating to the assets of The Habit Restaurants, LLC and (ii) tax benefits attributable to payments made under the TRA (including imputed interest). The Habit Restaurants, Inc. generally will retain 15% of the applicable tax savings. The

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amount payable to the Continuing LLC Owners under the TRA is disclosed in the accompanying consolidated balance sheets. In addition, the TRA provides for interest, at a rate equal to one year LIBOR, accrued from the due date (without extensions) of the corresponding tax return to the date of payment specified by the TRA. To the extent that the Company is unable to timely make payments under the TRA for any reason, such payments will be deferred and will accrue interest at a rate equal to one year LIBOR plus 200 basis points until paid (although a rate equal to one year LIBOR will apply if the inability to make payments under the TRA is due to limitations imposed on the Company or any of our subsidiaries by a debt agreement in effect on the date of the IPO). The Company’s ability to make payments under the TRA and to pay its tax liabilities to taxing authorities generally will depend on our receipt of cash distributions from The Habit Restaurants, LLC.

Pursuant to the LLC Agreement, the Continuing LLC Owners have the right to exchange their LLC Units, together with a corresponding number of shares of Class B common stock (which will be cancelled in connection with any such exchange) for, at the option of The Habit Restaurants, Inc. (such determination to be made by the disinterested members of our board of directors), (i) shares of our Class A common stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications or (ii) cash consideration (generally calculated based on the volume-weighted average price of the Class A common stock of The Habit Restaurants, Inc., as displayed under the heading Bloomberg VWAP on the Bloomberg page designated for the Class A common stock of The Habit Restaurants, Inc. for the 15 trading days immediately prior to the delivery date of a notice of exchange). At any time that an effective registration statement is on file with the SEC with respect to the shares of Class A common stock to be issued upon an exchange, The Habit Restaurants, Inc. may not provide cash consideration upon an exchange to a Continuing LLC Owner without the Continuing LLC Owner’s prior consent. These exchanges are expected to result in increases in the tax basis of the assets of The Habit Restaurants, LLC that otherwise would not have been available. Increases in tax basis resulting from such exchanges may reduce the amount of tax that The Habit Restaurants, Inc. would otherwise be required to pay in the future. This tax basis may also decrease gains (or increase losses) on future dispositions of certain assets to the extent tax basis is allocated to those assets.

If the IRS or a state or local taxing authority challenges the tax basis adjustments that give rise to payments under the TRA and the tax basis adjustments are subsequently disallowed, the recipients of payments under the agreement will not reimburse any payments the Company previously made to them. Any such disallowance would be taken into account in determining future payments under the TRA and would, therefore, reduce the amount of any such future payments. Nevertheless, if the claimed tax benefits from the tax basis adjustments are disallowed, the Company’s payments under the TRA could exceed its actual tax savings, and the Company may not be able to recoup payments under the TRA that were calculated on the assumption that the disallowed tax savings were available.

The TRA provides that (i) in the event that the Company materially breaches the TRA, (ii) if, at any time, the Company elects an early termination of the TRA, or (iii) upon certain mergers, asset sales, other forms of business combinations or other changes of control, the Company’s (or our successor’s) obligations under the TRA (with respect to all LLC Units, whether or not LLC Units have been exchanged or acquired before or after such transaction) would accelerate and become payable in a lump sum amount equal to the present value of the anticipated future tax benefits calculated based on certain assumptions, including that the Company would have sufficient taxable income to fully utilize the deductions arising from the tax deductions, tax basis and other tax attributes subject to the TRA. The Company’s payment obligations under the TRA with respect to interests in The Habit Restaurants, LLC treated as sold for U.S. federal income tax purposes to the Company in connection with the IPO are calculated based on the IPO price of our Class A common stock net of underwriting discounts. The TRA was amended January 5, 2020 in connection with the Merger Agreement (as defined below), with the parties agreeing that the consummation of the transactions contemplated by the Merger Agreement will give rise to a Change in Control as defined in the TRA, furthermore, the TRA shall be terminated in its entirety upon payment of the Early Termination Payment.

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As a result of the foregoing, (i) the Company could be required to make payments under the TRA that are greater than or less than the specified percentage of the actual tax savings the Company realizes in respect of the tax attributes subject to the agreements and (ii) the Company may be required to make an immediate lump sum payment equal to the present value of the anticipated future tax savings, which payment may be made years in advance of the actual realization of such future benefits, if any of such benefits are ever realized. In these situations, the Company’s obligations under the TRA could have a substantial negative impact on its liquidity and could have the effect of delaying, deferring or preventing certain mergers, asset sales, other forms of business combinations or other changes of control. There can be no assurance that the Company will be able to finance its obligations under the TRA in a manner that does not adversely affect its working capital and growth requirements.

Payments under the TRA are intended to be treated as additional consideration for the applicable interests in The Habit Restaurants, LLC treated as sold or exchanged (as determined for U.S. federal income tax purposes) to or with the Company, except with respect to certain actual or imputed interest amounts payable under the TRA. In December 2019, the Company made TRA payments, including accrued interest, of $0.4 million to related parties.

As of December 31, 2019, the Company recorded a liability of $82.8 million, representing the payments due to the Continuing LLC Owners under the TRA. As of December 31, 2019, $1.2 million of the liability is classified as a current liability.

As part of the TRA, there are adjustments associated with revisions to the expected TRA liability as a result of updated estimated future tax savings at the federal, state and local level. The amounts of these adjustments were $0.4 million in fiscal year 2019 and $1.6 million in fiscal year 2018 and are reflected in the consolidated statements of operations. The amounts of these adjustments resulted in other income of $57.2 million for fiscal year 2017 and are reflected in the consolidated statements of operations. This adjustment was primarily attributed to the U.S. corporate income tax rate effective in 2018 under the Tax Cuts and Jobs Act.

In addition, from time to time we may have adjustments to deferred tax assets as a result of changes in the tax basis associated with the TRA. The amounts of these changes are reflected in the consolidated statements of stockholders’ equity. The amount recorded in equity for fiscal year 2019 due to changes of the deferred tax assets associated with the tax basis increase was $0.1 million.

Payments are due under the TRA for a given year if the Company has a net realized tax benefit. The realized tax benefit is intended to measure the decrease or increase in the actual tax liability of the Company attributable to the tax benefits defined in the TRA (i.e., basis adjustments and imputed interest), using a “with and without” methodology. Payments are anticipated to be made under the TRA for approximately 20-25 years, with a payment due after the filing of the Company’s federal income tax return, which is due on October 15th of any given year (including extensions). The payments are to be made in accordance with the terms of the TRA. The Company shall pay or cause to be paid within five business days after the obligations became due (i.e. payable within 95-125 calendar days after the due date of the federal income tax return (taking into account valid extensions) dependent upon the type of holder of the TRA). The timing of the payments are subject to certain contingencies including whether the Company will have sufficient taxable income to utilize all of the tax benefits defined in the TRA.

Obligations pursuant to the TRA are obligations of the Company. They do not impact the non-controlling interest. These obligations are not income tax obligations and have no impact on the tax provision or the allocation of taxes.

 

Note 7—Long-Term Debt

On August 2, 2017, The Habit Restaurants, LLC executed a $20 million credit facility with Bank of the West (the “Credit Facility”) with a maturity date of August 2, 2019. In October 2018 and September 2019, the Company extended the maturity date on the Credit Facility to August 1, 2020 and August 1, 2021, respectively. All borrowings under the Credit Facility will bear interest at a variable rate based upon LIBOR plus the applicable margin for LIBOR loans (as defined in the Credit Facility). The Credit Facility has no unused commitment fees. As part of the initial execution of the Credit Facility, the Company incurred $0.3 million in deferred financing fees that will be amortized over the length of the agreement. That amortization expense is included in interest expense, net on the accompanying consolidated statements of operations. As of December 31, 2019, The Habit Restaurants, LLC

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had no borrowings outstanding against the Credit Facility. Interest related to the Credit Facility, if applicable, is due monthly. 

The Credit Facility is secured by substantially all the assets of The Habit Restaurants, LLC, and the Company is required to comply with certain financial covenants therein. The Credit Facility contains customary representations, warranties, negative and affirmative covenants, including a maximum lease adjusted leverage ratio of 4.00 to 1.00 and a minimum EBITDA of $21.4 million for the twelve-month period then ended at the end of each fiscal quarter. As of December 31, 2019, The Company and The Habit Restaurants, LLC were in compliance with all covenants.

Interest expense for the Credit Facility and prior credit facilities amounted to $0.1 million, $0.2 million and $0.1 million for fiscal year ended December 31, 2019, December 25, 2018 and December 26, 2017, respectively, and consisted of amortization of deferred financing fees and unused commitment fees from the prior credit facility.

On January 4, 2018 the Company executed an irrevocable standby letter of credit for $1.5 million related to the Company’s self-insured workers’ compensation coverage. In conjunction with the renewal of the Company’s self-insured workers’ compensation coverage in October 2018, the Company increased its irrevocable standby letter of credit to $3.25 million. The increased standby letter of credit expires on January 5, 2021. In conjunction with the renewal of the Company’s self-insured workers’ compensation coverage in October 2019, the Company executed an additional standby letter of credit for $1.4 million which expires on October 31, 2020. These letters of credit are a reduction of the borrowing capacity or our Credit Facility.

 

Note 8—Leases

The Company leases its restaurant facilities and corporate offices under non-cancelable operating leases. Our restaurant leases generally have terms ranging from 10 to 20 years with renewal options ranging from five to 20 years. The Company currently has no finance leases. The Company determines if an agreement is a lease at inception. Right-of-use (“ROU”) assets represent the right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized on our condensed consolidated balance sheet at commencement date, which is the date the Company gains access to the property. The lease liability is determined based on the present value of the minimum rental payments. Since most of the Company’s leases do not provide an implicit rate of return, the Company uses its incremental borrowing rate in effect at the time of lease commencement. The ROU asset is determined based on the lease liability adjusted for lease incentives received. Lease expense is recognized on a straight-line basis over the lease term. The restaurants’ leases generally include land and buildings and require various expenses incidental to the use of the property, such as common area maintenance, property taxes and insurance. These costs are separate from the minimum rent payment and are not considered in the determination of the lease liability and ROU asset. The Company has not noted any material instances in its leases where these costs were combined with the minimum rent payment, and has therefore elected the policy to not separate lease from non-lease components if they are combined with the minimum rent payment. Certain leases require contingent rent above the minimum lease payments based on a percentage of sales, these contingent amounts are excluded in determining the lease liability and right-of-use asset and are accounted for as period expenses. The option periods are not included in the determination of the lease liability and right-of-use asset as the Company is not reasonably certain if it will extend at the time of lease commencement.

The following table represents the lease costs for fiscal year 2019 (amounts in thousands):

Supplemental cash flow information related to leases (amounts in thousands):

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Supplemental balance sheet information related to leases:

Maturities of lease liabilities (amounts in thousands):

As of December 31, 2019, we have additional leases that have not yet commenced of $34.1 million that are expected to commence during fiscal year 2020 and fiscal year 2021 with lease terms ranging from 10 to 15 years

 

Note 9—Commitments and Contingencies

Future commitments—The Company’s growth strategy includes new restaurant openings during fiscal year 2020 and beyond. In connection with the build out of the restaurants, the Company may be obligated for a portion of the start-up and/or construction costs. As of December 31, 2019, the Company had approximately $3.0 million in such commitments related to new restaurants.

Litigation—The Company is involved in various claims and legal actions that arise in the ordinary course of business. The Company and its directors have been named as defendants in a complaint filed in the United States District Court for the Southern District of New York alleging violations of federal securities laws in connection with the Merger. Management does not believe that the ultimate resolution of these actions will have a material adverse effect on the Company’s consolidated financial position, results of operations, liquidity and capital resources. A significant increase in the number of litigated claims or an increase in amounts owing under successfully litigated claims could materially adversely affect the Company’s business, financial condition, results of operations, and cash flows.

 

 

Note 10—Employee Benefit Plan

The Company maintains a qualified 401(k) retirement plan (the “401k Plan”). Certain employees are eligible to participate in the 401k Plan after completing one year of service and reaching the age of 21. The 401k Plan permits eligible employees to make contributions up to specified percentages of their compensation. The Company made discretionary matching contributions totaling approximately $0.2 million, $0.1 million and $0.1 million for the fiscal years ended December 31, 2019, December 25, 2018 and December 26, 2017, respectively.

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The Company also maintains a nonqualified deferred compensation plan. It allows eligible employees, including our executive officers, to defer a portion of their compensation. The Company made discretionary matching contributions totaling approximately $0.1 million, $0.1 million and $0.1 million for the fiscal years ended December 31, 2019, December 25, 2018 and December 26, 2017, respectively.

 

Note 11—Management Incentive Plans

Stock-based compensation is included in general and administrative expenses on the accompanying consolidated statements of operations. The stock-based compensation expense related to the Amended and Restated 2014 Omnibus Incentive Plan and to units issued under The Habit Restaurants, LLC Management Incentive Plan is summarized in the table below for the periods indicated: (in thousands)

 

 

2014 Omnibus Incentive Plan

Prior to the completion of the Company’s IPO, the board of directors adopted The Habit Restaurants, Inc. 2014 Omnibus Incentive Plan (the “2014 Omnibus Incentive Plan”) and, subsequent to the IPO, all equity-based awards have been granted under the 2014 Omnibus Incentive Plan. The 2014 Omnibus Incentive Plan also permits grants of cash bonuses. This plan authorized 2,525,275 total options and restricted stock units. No awards may be granted under the plan after November 19, 2024. In April 2019, our board of directors adopted the Amended and Restated 2014 Omnibus Incentive Plan, which required and received stockholder approval at our 2019 Annual Meeting of Stockholders. This amendment increased the authorized options and restricted stock units by 1,000,000 shares. This amendment also amended the 2014 Omnibus Incentive Plan to provide for an aggregate annual limit on compensation payable to each non-employee director (whether or not pursuant to the Amended and Restated 2014 Omnibus Incentive Plan), require a minimum vesting period of at least one year for 95% of awards, expressly prohibit automatic “reload” grants of additional awards upon exercise of a stock option or SAR, expand our authority to claw back awards granted under the Amended and Restated 2014 Omnibus Incentive Plan and proceeds on the exercise or disposition of such awards, expressly prohibit “gross-ups” or other payments in respect of any excise taxes assessed on any awards granted under the Amended and Restated 2014 Omnibus Incentive Plan and expressly prohibit the payment of dividends and dividend equivalents on unvested awards.

The purpose of the 2014 Omnibus Incentive Plan is to advance the Company’s interests by providing for the grant to eligible individuals of equity-based and other incentive awards.

The Amended and Restated 2014 Omnibus Incentive Plan is administered by our board of directors or a committee of our board of directors (the “Administrator”). The Administrator has the authority to, among other things, interpret the Amended and Restated 2014 Omnibus Incentive Plan, determine eligibility for, grant and determine the terms of awards under the Amended and Restated 2014 Omnibus Incentive Plan and to do all things necessary to carry out the purposes of the Amended and Restated 2014 Omnibus Incentive Plan. The Administrator’s determinations under the Amended and Restated 2014 Omnibus Incentive Plan are conclusive and binding. The Administrator will determine the time or times at which an award will vest or become exercisable. The maximum term of an award will not exceed ten years from the date of grant.

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Non-Qualified Stock Options:

The following table sets forth information about the fair value of the non-qualified stock option grants on the date of grant using the Black-Scholes option-pricing model and the weighted average assumptions used for such a grant:

 

 

The assumptions above represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. The expected term of options granted during 2019 was based on a representative peer group within the industry. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury constant maturities rate in effect at the time of grant. The Company utilized a weighted rate for expected volatility based on a representative peer group within the industry.

The aggregate intrinsic value in the table above is obtained by subtracting the weighted average exercise price from the fair value of the underlying common stock as of December 31, 2019, December 25, 2018 and December 26, 2017 and multiplying this result by the related number of options outstanding and expected to vest at December 31, 2019, December 25, 2018 and December 26, 2017 and exercisable at December 31, 2019. The fair values of the common stock used in the above calculations were $10.43 per share, $10.09 per share and $9.50 per share, the closing prices of the Company’s common stock on December 31, 2019, December 24, 2018 and December 26, 2017, respectively, the last trading day of each fiscal year.

There was approximately $2.9 million of total unrecognized compensation costs related to options granted under the Plan as of December 31, 2019. That cost is expected to be recognized over a weighted average period of 2.8 years.

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Restricted Stock Units:

A summary of stock-based compensation activity related to restricted stock units for fiscal years 2019, 2018 and 2017 is as follows:

 

 

The aggregate intrinsic value in the table above is obtained by multiplying the related number of units outstanding and expected to vest at December 31, 2019, December 25, 2018 and December 26, 2017, by the estimated fair value of the common stock as of December 31, 2019, December 25, 2018 and December 26, 2017. The estimated fair value of the common stock as of December 31, 2019, December 25, 2018 and December 26, 2017 used in the above calculation was $10.43, $10.09 and $9.50, the closing prices of the Company’s common stock on December 31, 2019, December 24, 2018 and December 26, 2017, respectively, the last trading day of the fiscal year.

As of December 31, 2019, total unrecognized stock-based compensation expense related to non-vested restricted stock units was approximately $3.3 million. That cost is expected to be recognized over a weighted average period of 2.8 years.

The Habit Restaurants, LLC Management Incentive Plan

In connection with the IPO, the Company converted all of the outstanding vested and unvested Class C units into an equivalent amount of vested and unvested LLC Units of The Habit Restaurants, LLC, respectively. As of December 31, 2019, there was no unrecognized stock-based compensation expense related to these units.

 

 

Note 12—Membership Units

The Habit Restaurants, LLC’s ownership structure prior to our recapitalization allowed for four classes of members: Class A members, Class B members, Class C members, and Class D members. Class C units could only have been issued under The Habit Restaurants, LLC’s management incentive plan discussed in Note 11—Management Incentive Plans. All classes of members were entitled to receive distributions, if any, in accordance with the provisions of the Company’s LLC operating agreement. In accordance with the provisions of the Company’s LLC operating agreement, if distributions were declared, Class D members had priority over distributions prior to Class B, Class A, and Class C members in that order. Class C member distributions were restricted based on whether the units were vested or unvested at the time of the distribution and cash was paid out only on vested units. Distributions of $1.0 million, $0.4 million and $1.1 million were declared and paid for the fiscal years ended December 31,

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2019, December 25, 2018 and December 26, 2017, respectively. Members of The Habit Restaurants, LLC who held unvested units did not receive their portion of the 2014 distribution until the units vested. Distributions of $0.1 million, $0.1 million and $0.2 million on such amounts were paid as of December 31, 2019, December 25, 2018 and December 26, 2017, respectively, and are included in the distributions above. There were no unpaid distributions as of December 31, 2019. As part of the Recapitalization, these membership units have been exchanged for common units. All units that were previously unvested continued to vest based on the vesting schedule of the outstanding unvested Class C unit from which it was converted. The Company has the right to determine, subject to certain tax distributions, when distributions will be made to holders of common units of The Habit Restaurants, LLC and the amount of any such distributions. If a distribution is authorized, such distribution will be made to the holders of common units (including the Company and its subsidiaries) pro rata in accordance with the percentages of their respective common units (other than, for clarity, certain non-pro-rata payments to the Company to satisfy certain of its obligations). Additionally, the new vested and unvested common units of The Habit Restaurants, LLC received upon the conversion of vested and unvested Class C units were entitled to receive distributions, if any, from The Habit Restaurants, LLC, provided, however, that distributions (other than tax distributions) in respect of unvested common units of The Habit Restaurants, LLC were only delivered to the holder thereof when, such common units ultimately vested. Pursuant to and subject to the terms of the LLC Agreement of The Habit Restaurants, LLC, the Continuing LLC Owners have the right to exchange their common units, together with a corresponding number of shares of Class B common stock (which such shares will be cancelled in connection with any such exchange) for, at the option of the Company, (i) cash consideration (calculated based on the volume-weighted average price of the Class A common stock of the Company, as displayed under the heading Bloomberg VWAP on the Bloomberg page designated for the Class A common stock of the Company for the 15 trading days immediately prior to the delivery date of a notice of exchange) or (ii) shares of the Company’s Class A common stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications. At any time that an effective registration statement is on file with the Securities and Exchange Commission (“SEC”) with respect to the shares of Class A Common Stock to be issued upon an exchange, The Habit Restaurants, Inc. may not provide cash consideration upon an exchange to a Continuing LLC Owner without the Continuing LLC Owner’s prior consent.

 

 

Note 13—Stockholders’ Equity

The Company is authorized to issue 140,000,000 shares of capital stock, consisting of 70,000,000 shares of Class A common stock, par value $0.01 per share, and 70,000,000 shares of Class B common stock, par value $0.01 per share.

In November 2014, the Company completed its IPO of 5,750,000 shares of its Class A common stock at a price to the public of $18.00 per share. As discussed in Note 12, the existing owners of The Habit Restaurants, LLC continue to hold common units in The Habit Restaurants, LLC, and such existing owners (other than The Habit Restaurants, Inc. and its wholly-owned subsidiaries) were issued a number of shares of our Class B common stock equal to the number of common units held by them in connection with the completion of the IPO. Each such share of Class B common stock provides its holder with no economic rights but entitles the holder to one vote on matters presented to The Habit Restaurants, Inc.’s stockholders. The Company’s Class A and Class B common stock generally vote together as a single class on all matters submitted to a vote of stockholders, except as otherwise required by applicable law. However, the Class B common stock is not publicly traded and does not entitle its holders to receive dividends or distributions upon a liquidation, dissolution or winding up of the Company. When a member of The Habit Restaurants, LLC exchanges common units for shares of Class A common stock, such corresponding shares of Class B common stock will be cancelled.

Dividend Rights. Subject to preferences that may apply to shares of preferred stock outstanding at the time, holders of outstanding shares of Class A common stock are entitled to receive dividends out of assets legally available at the times and in the amounts as the board of directors may from time to time determine. Holders of our Class B Common Stock do not have any right to receive dividends.

Voting Rights. Holders of our Class A common stock and our Class B common stock have voting power over The Habit Restaurants, Inc., the sole managing member of The Habit Restaurants, LLC, at a level that is consistent with their overall equity ownership of our business. Pursuant to our amended and restated certificate of incorporation and amended and restated bylaws, each share of Class A common stock entitles the holder to one vote with respect to

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each matter presented to our stockholders on which the holders of Class A common stock are entitled to vote. Each holder of Class B common stock shall be entitled to the number of votes equal to the total number of LLC Units held by such holder multiplied by the exchange rate specified in the LLC Agreement with respect to each matter presented to our stockholders on which the holders of Class B common stock are entitled to vote. Accordingly, the holders of LLC Units collectively have a number of votes that is equal to the aggregate number of LLC Units that they hold. Subject to any rights that may be applicable to any then outstanding preferred stock, our Class A and Class B common stock vote as a single class on all matters presented to our stockholders for their vote or approval, except as otherwise provided in our amended and restated certificate of incorporation or amended and restated bylaws or required by applicable law. Holders of our Class A and Class B common stock do not have cumulative voting rights. Except in respect of matters relating to the election and removal of directors on our board of directors and as otherwise provided in our amended and restated certificate of incorporation, our amended and restated bylaws, or as required by law, all matters to be voted on by our stockholders must be approved by a majority of the shares present in person or by proxy at the meeting and entitled to vote on the subject matter.

Preemptive Rights. Neither the Class A common stock, nor the Class B common stock is entitled to preemptive or other similar subscription rights to purchase any of our securities.

Conversion or Redemption Rights. Neither the Class A common stock, nor the Class B common stock is convertible or redeemable.

Liquidation Rights. Upon our liquidation, the holders of our Class A common stock will be entitled to receive pro rata our assets which are legally available for distribution, after payment of all debts and other liabilities and subject to the prior rights of any holders of preferred stock then outstanding. Holders of our Class B common stock do not have any right to receive a distribution upon a voluntary or involuntary liquidation, dissolution or winding up of our affairs. Notwithstanding the foregoing, The Habit Restaurants, LLC will bear the cost of or reimburse The Habit Restaurants, Inc. for certain expenses incurred by The Habit Restaurants, Inc.

 

Note 14—Subsequent Events

On January 5, 2020, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with YUM! Brands, Inc., a North Carolina corporation (“Parent”), and Parent’s wholly-owned subsidiary, YEB Newco Inc., a Delaware corporation (“Merger Sub”), providing for the merger of Merger Sub with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly-owned subsidiary of Parent.

At the effective time of the Merger (the “Effective Time”), each:

 

 

 

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Consideration payable to holders of Company Stock Options and Company RSUs will be made no later than three business days after the Effective Time, net of any required withholding of taxes.

Concurrently with the Effective Time, each LLC Unit not held by the Company or one of its subsidiaries, whether vested or unvested, together with one share of or Class B common stock, par value $0.01 per share, of the Company (“Class B Common Stock,” and collectively with Class A Common Stock, “Company Common Stock”), will be exchanged for one share of Class A Common Stock (the “Exchange”), as is more particularly described in the Merger Agreement, and each share of Class B Common Stock will automatically be cancelled immediately upon consummation of the Exchange.

The Merger Agreement includes customary representations, warranties and covenants of the Company, Parent and Merger Sub. The Company has agreed to operate its business in the ordinary course until the Effective Time. The Company has also agreed not to, and to cause its subsidiaries and instruct its representatives not to, solicit or initiate discussions with third parties regarding other proposals for a strategic transaction involving the Company. Parent and the Company have agreed to use their reasonable best efforts to take all actions necessary to consummate the Merger, subject to certain limitations, and as is more particularly described in the Merger Agreement.

The obligation of the parties to consummate the Merger is subject to the expiration of the waiting period (and any extension thereof) under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and other customary conditions. The Merger Agreement includes no financing contingency of any kind, and the Company has the ability to seek specific performance of enforce Parent’s obligation to close the Merger, as is more particularly described in the Merger Agreement.

Note 15—Quarterly Financial Reporting

(Unaudited)

(amounts in thousands except per share data)

 

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THE HABIT RESTAURANTS, INC.

CONDENSED BALANCE SHEETS

(PARENT COMPANY ONLY)

 

See notes to condensed financial statements.

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THE HABIT RESTAURANTS, INC.

CONDENSED STATEMENTS OF OPERATIONS

(PARENT COMPANY ONLY)

 

See notes to condensed financial statements.

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THE HABIT RESTAURANTS, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(PARENT COMPANY ONLY)

 

See notes to condensed financial statements.

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THE HABIT RESTAURANTS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(PARENT COMPANY ONLY)

Note 1—Organization

The Habit Restaurants, Inc. (the "Company") was formed as a Delaware corporation on July 24, 2014, as a holding company for the purposes of facilitating an initial public offering (the “IPO”) of shares of Class A common stock. The Company acquired, by merger, entities that were members of The Habit Restaurants, LLC. On November 25, 2014, the Company completed the IPO of 5,750,000 shares of Class A common stock at a price to the public of $18.00 per share, raising net proceeds of $96.3 million after underwriting discounts and commissions but before expenses. The net proceeds were used to purchase, directly and indirectly, economic, non-voting interest in The Habit Restaurants, LLC (the "LLC Units") from The Habit Restaurants, LLC. On April 15, 2015, the Company completed a follow-on offering of 5,750,000 shares of Class A common stock at a price to the public of $30.96 per share (the “April 2015 Offering”). All of these shares were offered by the selling stockholders. The Company did not receive any proceeds from the offering. The Habit Restaurants, Inc. is a holding company with no direct operations that holds as its principal assets an equity interest in The Habit Restaurants, LLC and shares of subsidiaries, each of which in turn holds as its principal asset an equity interest in The Habit Restaurants, LLC, and relies on The Habit Restaurants, LLC to provide the Company with funds necessary to meet any financial obligations. As such, the Company has no independent means of generating revenue.

Note 2—Basis of Presentation

These condensed financial statements should be read in conjunction with the consolidated financial statements of The Habit Restaurants Inc. and the accompanying notes thereto, included in this annual report on Form 10-K. The Company is the sole managing member of The Habit Restaurants, LLC. The Company receives compensation from The Habit Restaurants, LLC for all costs associated with being a public company and maintaining its existence. These amounts are recorded in intercompany revenue on the condensed statements of operations.

Note 3—Commitments and Contingencies

In connection with the IPO that occurred in fiscal year 2014, the Company entered into a tax receivable agreement (the “TRA”). Under the TRA, the Company generally will be required to pay to the holders of economic, non-voting interest in The Habit Restaurants, LLC (the "Continuing LLC Owners") 85% of the amount of cash savings, if any, in U.S. federal, state or local tax that the Company actually realizes directly or indirectly (or are deemed to realize in certain circumstances) as a result of (i) certain tax attributes that were created as a result of the IPO and any sales or exchanges (as determined for U.S. federal income tax purposes) to or with the Company of their interests in The Habit Restaurants, LLC for shares of our Class A common stock or cash, including any basis adjustment relating to the assets of The Habit Restaurants, LLC and (ii) tax benefits attributable to payments made under the TRA (including imputed interest). The Habit Restaurants, Inc. generally will retain 15% of the applicable tax savings. See Note 6 to the consolidated financial statements for more information regarding the TRA. As of December 31, 2019 and December 25, 2018, the Company recorded a liability of $82.8 million and $82.7 million, respectively, representing the payments due to the Continuing LLC Owners under the TRA.

 

 

 

 

 

 

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