U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K

þ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
  
 
for the fiscal year ended December 30, 2018
 
or

¨ Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

   
Commission File No. 000-53577
 
DIVERSIFIED RESTAURANT HOLDINGS, INC.
 
  A99A04.JPG
(Exact name of registrant as specified in its charter)
 
Nevada
  
03-0606420
(State or other jurisdiction of incorporation
  
(I.R.S. Employer Identification No.)
or organization)
  
  
 
27680 Franklin Rd., Southfield, MI 48034
(833) 374-7282
 
(Address, including zip code and telephone number, including area code, of Registrant’s principal executive offices)
 
Securities registered pursuant to Section 12(b) of the Exchange Act:
None
Securities registered pursuant to Section 12(g) of the Act:
 
Common Stock, $.0001 par value per share
 
(Title of 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   þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ☐    No  þ
 
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  þ     No  ☐
 



Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  þ     No  ☐
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☐

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ☐    No   þ
 
The aggregate market value of the Registrant’s voting common stock held by non-affiliates was $17.1 million based on the per share closing price of the Company's common stock as reported on the NASDAQ stock market on June 29, 2018 .
 
The number of shares outstanding of the registrant's common stock as of March 29, 2019 was 33,182,875 shares.
 
DOCUMENTS INCORPORATED BY REFERENCE:
 
None.





TABLE OF CONTENTS
 
  
Page
  
  
 
 
 
 
 
 
 
 
 



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PART I

When used in this Form 10-K, the “Company” and “DRH” refers to Diversified Restaurant Holdings, Inc. and, depending on the context, could also be used to refer generally to the Company and its subsidiaries, which are described below.

Cautionary Statement Regarding Forward-Looking Information

Some of the statements in the sections entitled “Business,” and “Risk Factors,” and statements made elsewhere in this Form 10-K may constitute forward-looking statements. These statements reflect the current views of our senior management team with respect to future events, including our financial performance, business, and industry in general. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “forecast,” “estimate,” “may,” “should,” “anticipate” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise.

Forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, the following:
●
the success of our existing and new restaurants;
●
our ability to obtain debt or other financing on favorable terms, or at all;
●
our ability to identify appropriate sites and to finance the development and expansion of our operations;
●
changes in economic conditions;
●
damage to our reputation or lack of acceptance of our brand in existing or new markets;
●
economic and other trends and developments, including adverse weather conditions, in the local or regional areas in which our restaurants are located;
●
the impact of negative economic factors, including the availability of credit, on our landlords and surrounding tenants;
●
changes in food availability and costs;
●
labor shortages and increases in our compensation costs, including, as a result, changes in government regulation;
●
increased competition in the restaurant industry and the segments in which we compete;
●
the impact of legislation and regulations regarding nutritional information, new information or attitudes regarding diet and health, or adverse opinions about the health of consuming our menu offerings;
●
the impact of federal, state, and local beer, liquor, and food service regulations;
●
the success of our and our franchisor's marketing programs;
●
the impact of new restaurant openings, including the effect on our existing restaurants of opening new restaurants in the same markets;
●
the loss of key members of our management team;
●
inability or failure to effectively manage our growth, including without limitation, our need for liquidity and human capital;
●
the impact of litigation;
●
the adequacy of our insurance coverage and fluctuating insurance requirements and costs;
●
the impact of our indebtedness on our ability to invest in the ongoing needs of our business;

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●
the impact of a potential asset impairment charge in the future;
●
the impact of any security breaches of confidential guest information in connection with our electronic processing of credit/debit card transactions;
●
our ability to protect our intellectual property;
●
the impact of any failure of our information technology system or any breach of our network security;
●
the impact of any materially adverse changes in our federal, state, and local taxes;
●
the impact of any food-borne illness outbreak;
●
our ability to maintain our relationship with our franchisor on economically favorable terms;
●
the impact of future sales of our common stock in the public market, the exercise of stock options, and any additional capital raised by us through the sale of our common stock;
●
the effect of changes in accounting principles applicable to us; and
●
the impact on the Company's future results as a result of its guarantees of certain leases of Bagger Dave's Burger Tavern, Inc.

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this Form 10-K. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Any forward-looking statements you read in this Form 10-K reflect our views as of the date of this Form 10-K with respect to future events and are subject to these and other risks, uncertainties, and assumptions relating to our operations, results of operations, growth strategy, and liquidity. You should carefully consider all of the factors identified in this Form 10-K that could cause actual results to differ. Investors are cautioned that all forward-looking statements involve risk and uncertainties and speak only as of the date on which they were made, and we do not undertake any obligation to update any forward-looking statement.

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ITEM 1.     BUSINESS
 
Business Overview
 
DRH is a restaurant company operating a single concept, Buffalo Wild Wings ® (“BWW”). As one of the largest franchisees of BWW, we provide a unique guest experience in a casual and inviting environment. We were incorporated in 2006 and are headquartered in the Detroit metropolitan area. As of December 30, 2018 , we owned 64 restaurants in Florida, Illinois, Indiana, Michigan and Missouri, including the nation’s largest BWW, based on square footage, in downtown Detroit, Michigan.
 
In 2008, DRH became publicly-owned by completing a self-underwritten initial public offering for $735,000 and 140,000 shares. We subsequently completed underwritten, follow-on offerings on April 23, 2013 of 6.9 million shares with net proceeds of $31.9 million and on July 24, 2018 of 5.3 million shares with net proceeds of $4.6 million.
 
DRH and its wholly-owned subsidiaries AMC Group, Inc. (“AMC”), AMC Wings, Inc. ("WINGS”), and AMC Real Estate, Inc. (“REAL ESTATE”and collectively, the "Company") own and operate BWW restaurants.

DRH is continually recognized as a leading franchisee in the BWW system. In 2018, our restaurants claimed 8 out of 15 Grand Prix awards, recognizing the top 15 operators in the franchise system. In 2017 and 2016, three and four of the Company's restaurants, respectively, were recognized as Blazin' 25 restaurants, which rewarded the top performing 25 franchise restaurants in the system. In both 2015 and 2014 we were recognized as Franchisee of the Year. Additionally, in 2016 our Chief Operating Officer was awarded the Franchise Advisory Council Excellence Award and in 2014 he received the Founders' Award.


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The following organizational chart outlines the current corporate structure of DRH. A brief description of the entities follows the organizational chart. DRH is incorporated in Nevada.

DRH10KENTITYGRAPHIC.JPG
AMC was formed on March 28, 2007, and serves as our operational and administrative center. AMC renders management, operational support, and advertising services to WINGS, REAL ESTATE and their subsidiaries. Services rendered by AMC include marketing, restaurant operations, restaurant management consultation, hiring and training of management and staff, and other management services required in the ordinary course of restaurant operations.
 
WINGS was formed on March 12, 2007, and serves as a holding company for our restaurants. We are economically dependent on retaining our franchise rights with BWW. The franchise agreements have specific initial term expiration dates ranging from December 2020 through June 2037 . The franchise agreements are renewable at the option of the franchisor and are generally renewable if the franchisee has complied with the terms of the franchise agreement. When factoring in any applicable renewals, the franchise agreements have specific expiration dates ranging from December 2025 through June 2052 . We believe we are in substantial compliance with the terms of these agreements.

REAL ESTATE was formed on March 18, 2013 and serves as the holding company for any real estate properties owned by DRH. Currently, DRH does not own any real estate.

Our headquarters are located at 27680 Franklin Road, Southfield, Michigan 48034. Our telephone number is (833) 374-7282 . We can also be found on the Internet at www.diversifiedrestaurantholdings.com.

As of December 30, 2018 , we had 2,549 employees of which 1,372 were full-time employees.



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Background

Bagger Dave’s Spin-Off

On December 25, 2016, DRH completed a tax-free spin-off (the “Spin-Off”) of its Bagger Dave's business. Specifically, DRH contributed its 100.0% owned entity, AMC Burgers, LLC and certain real estate entities into Bagger Dave's Burger Tavern, Inc., a newly created Nevada corporation ("Bagger Dave's" or "Bagger"), which was then spun-off into a stand-alone, publicly-traded company on the over-the-counter exchange. In connection with the Spin-Off, DRH contributed to Bagger certain assets, liabilities, and employees related to its Bagger Dave's businesses. Intercompany balances due to/from DRH, which included amounts from sales, were contributed to equity. Additionally, DRH contributed $2 million in cash to Bagger to provide working capital for Bagger’s operations and remains a guarantor for certain of Bagger's lease obligations.

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

Restaurant Concept
 
With 64 BWW restaurants ( 20 in Michigan, 17 in Florida, 15 in Missouri, seven in Illinois and five in Indiana), including the nation’s largest BWW, based on square footage, in downtown Detroit, Michigan, DRH is one of the largest BWW franchisees. As of December 30, 2018 , BWW reported over 1,270 restaurants worldwide that were either directly owned or franchised. The restaurants feature a variety of boldly-flavored, crave-able menu items, including Buffalo, New York-style chicken wings. BWW restaurants create a welcoming neighborhood atmosphere that includes an extensive multi-media system, a full bar and an open layout, which appeals to sports fans and families alike. The social environment created and the connections made with team members, guests and the local community help to differentiate BWW restaurants. Guests have the option of watching sporting events or other popular programs on various projector screens and televisions, competing in Buzztime ® Trivia or playing video games. The open layout of the restaurants offers dining and bar areas that provide distinct seating choices for sports fans and families. BWW restaurants offer flexibility and allow guests to customize their experience to meet their time demands, service preferences or the experience they are seeking for a workday lunch, a dine-in dinner, a take-out meal, an afternoon or evening enjoying a sporting event, or a late-night craving.

BWW restaurants have widespread appeal and have won dozens of “Best Wings” and “Best Sports Bar” awards across the country. The made-to-order menu items are enhanced by the bold flavor profile of 16 signature sauces and 5 signature seasonings, ranging from Sweet BBQ™ to Blazin’®. Restaurants offer 20 to 40 domestic and imported beers on tap, including craft brews, and a wide selection of bottled beers, wines, and liquor. The award-winning food and memorable experience drive guest visits and loyalty. For fiscal year 2018 , our average BWW restaurant derived 83% of its revenue from food, including non-alcoholic beverages, and 17% of its revenue from alcohol sales, primarily draft beer.

Growth Strategy

We are focused on driving sales growth in all of our locations through the execution of local, traffic-driving marketing and advertising strategies, continued support of the community through sponsorship programs and local charities, and delivery of quality food, drinks and service, all in a clean and modern environment. One of our guiding principles is that a happy team member translates to a happy guest. A happy guest drives repeat sales and word-of-mouth referrals, which are two key factors that directly support our local marketing strategy.

We also strive to improve our margins through a number of initiatives, including enhanced methods to manage cost of sales and hourly labor with use of technology and improved application of standards, and working with our service vendors to leverage our scale and obtain higher value at more competitive prices.

We currently own 64 BWW restaurants in five states. We may open a limited number of new BWW locations in our core markets over the long term. However, as capital resources become available, our growth strategy is more likely to consist of disciplined, strategic acquisitions of existing BWW or other franchised restaurants from other operators or franchisors.


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Since 2012 we have acquired 29 restaurants in several transactions and have developed a strong process to identify, evaluate and integrate acquisitions. We have been regularly recognized as one of the best operators in the BWW system, and we believe that we can apply our strong operating disciplines and management culture to acquired locations to achieve financial improvements and growth over the long term. On February 22, 2019 we entered into an Asset Purchase Agreement to acquire 9 BWW restaurants in the Chicago, Illinois market for a cash purchase price of approximately $22.5 million, subject to customary closing conditions. Upon completion of the transaction, since 2012, we will have acquired a total of 38 restaurants and will own and operate a total of 73 BWW restaurants. The transaction remains subject to the franchisor waiving its right of first refusal and franchisor consent, among other things. The transaction also remains contingent upon the Company's completion of satisfactory financing.

Restaurant Operations

We believe retaining talented and passionate restaurant managers and providing our team members with the tools, skills and motivation to deliver our goal of the ultimate social experience, represent two key elements to our success. In order to retain our unique culture, we devote substantial resources to identifying, selecting, and training our restaurant-level team members. We typically have six in-restaurant trainers at each location who provide both front- and back-of-house training on site. We also have a seven-week training program for our restaurant managers, which consists of an average of four weeks of restaurant training and three weeks of cultural training. During this training, managers observe and have the opportunity to participate in our established restaurants’ operations and guest interactions. We believe our focus on guest-centric training is a core strength of our Company and reinforces our mission to delight our guests.

Management and Staffing

The core values that define our culture are to be guest driven, team focused, community connected and dedicated to excellence. Our restaurants are generally staffed with one managing partner and up to five additional managers, depending on the sales volume of the restaurant. The managing partner is responsible for day-to-day operations and for maintaining the standards of quality and performance that define our corporate culture. We use regional directors to oversee our managing partners and supervise the operation of our restaurants, including the continuing development of each restaurant’s management team. Through regular visits to the restaurants and constant communication with the management team, the regional directors ensure adherence to all aspects of our concept, strategy and standards of quality.

Training, Development, and Recruiting

We believe that successful restaurant operations, guest satisfaction, quality, and cleanliness begin with the team member - a key component of our strategy. Our training program, the Hospitality Excellence Academy ("HEA"), is a well-organized, thorough, hands-on training program designed to foster our culture of excellence by cultivating the leaders of tomorrow. We are also in the process of implementing a new learning management system which is expected to represent another step forward by introducing a fully digital platform.

We offer an incentive program that we believe is very competitive in the restaurant industry. In addition to competitive base salaries and benefits, management is incentivized with a performance-based bonus program. Our benefit offerings include group health, dental, and vision insurance, a company-sponsored Safe Harbor 401(k) plan with a non-discretionary company match, a tuition reimbursement program, a referral bonus program and opportunities for career advancement. We emphasize growth from within the organization, giving our team members the opportunity to develop and advance. We believe this philosophy helps build a strong, loyal management team with high team member retention rates, giving us an advantage over our competitors.

Restaurants

Our restaurants range in size from 5,300 to 13,500 square feet, with an average of about 6,400 square feet. We anticipate that future restaurants will range in size from 4,800 to 5,500 square feet with an average cash investment per restaurant ranging from approximately $1.7 million to $2.6 million for a leased site. From time to time, our restaurants may be smaller or larger or cost more or less than our targeted range, depending on the particular circumstances of the selected site. Also, from time to time, we may elect to purchase either the building or the land and the building for certain restaurants, which would require additional capital.
 
We have a continuous capital improvement plan for our restaurants and generally plan major renovations every seven to ten years. For a more detailed discussion of our capital improvement plans, see the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and specifically, the subsection entitled “Liquidity and Capital Resources; Acquisition and Expansion Plans.”


9

Quality Control and Purchasing

We strive to maintain high quality standards, protecting our food supply at all times. Purchasing for our restaurants is primarily through channels established by BWW corporate operations. We do, however, negotiate directly with many of these channels regarding price and delivery terms. When we purchase directly, we seek to obtain the highest quality ingredients, products, and supplies from reliable sources at competitive prices. To maximize our purchasing efficiencies, our corporate staff negotiates, when available, fixed-price contracts (usually for a one-year period) or, where appropriate, contracts based on commodity indexes.

Marketing and Advertising

We are required to pay an advertising fee to BWW equal to 3.00% - 3.15% of total net sales (the "National Ad Fund fee"), which supports national advertising designed to build brand awareness and drive traffic to our restaurants. Some examples include television commercials on major networks, particularly during certain regional and national key games for the NFL, NHL, MLB, NBA, NCAA football, NCAA basketball and the March Madness NCAA basketball tournament. In addition, we invest 0.25% - 0.5% of certain regional net sales in cooperatives of BWW restaurants for two metropolitan areas. We currently have co-ops for the Detroit, MI and Chicago, IL markets where we engage in coordinated local restaurant marketing efforts with other BWW restaurants.

In addition to the National Ad Fund fee, in fiscal year 2018 , we spent approximately 1% of total net sales on local marketing efforts (including co-ops), before rebates. This includes charitable donations and local community sponsorships, which help develop local public relations and are a major component of our marketing efforts. We support programs that build traffic at the grass-roots level. We also participate in numerous local restaurant marketing events throughout the communities we serve.

Information Systems and Technology
 
Enhancing the security of our financial data and other personal information remains a high priority for us. We continue to innovate and modernize our technology infrastructure to provide improved efficiency, control and security. Our ability to accept credit cards as payment in our restaurants and for online orders depends on us remaining compliant with standards set by the Payment Card Industry Security Standards Council (“PCI”). The PCI standards include compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. We maintain security measures that are designed to protect and prevent unauthorized access to such information. We continue to assess new payment standards and have implemented EMV chip enabled devices to ensure the most secure interface available for in-restaurant transactions. We have also implemented a CCV-code requirement for online purchases.

We also believe that technology can provide a competitive advantage and enable our strategy for growth through efficient restaurant operations, information analysis and ease and speed of guest service. We have a standard point-of-sale system in our restaurants that is integrated to our corporate office through a web-based, above-store business intelligence reporting and analysis tool. Our systems are designed to improve operating efficiencies, enable rapid analysis of marketing and financial information and improve administrative productivity. We also integrated the online ordering function and leverage third-party vendors which allow guests to select the music played throughout the restaurant using their mobile devices. In-restaurant tablets have also been introduced to enhance the guest experience through arcade games, some of which are free and some of which are available for purchase. In 2018 we implemented a new operations execution technology platform to enforce compliance and streamline performance across our restaurants. Additionally, in 2017 we completed the roll-out of the BWW loyalty program, Blazin' Rewards®, which is a mobile-based loyalty program.
 
We are constantly assessing new technologies to improve operations, back-office processes and overall guest experience. This includes the implementation of mobile payment options, advanced programming of kitchen display units, tablet-based wait-listing applications, integration with delivery service providers, and server tablet ordering functionality.

Competition
 
The restaurant industry is highly competitive. We believe we compete primarily with local and regional sports bars and national casual dining and quick-casual establishments. Competition is expected to remain intense with respect to price, service, location, concept and type and quality of food. There is also competition for real estate sites, qualified management personnel and hourly restaurant staff. Many of our competitors have been in existence longer than we have and may be better established in markets where we are currently located or may, in the future, be located. Accordingly, we strive to continually improve our restaurants, maintain high quality standards and treat our guests in a manner that encourages them to return. We believe our pricing communicates value to guests in a comfortable, welcoming, full service atmosphere.

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Trademarks, Service Marks, and Trade Secrets

The BWW registered service mark is owned by Buffalo Wild Wings, International, Inc.

Government Regulations

The restaurant industry is subject to numerous federal, state, and local governmental regulations, including those relating to the preparation and sale of food and alcoholic beverages, sanitation, public health, nutrition labeling requirements, fire codes, zoning, and building requirements and to periodic review by state and municipal authorities for areas in which the restaurants are located. Each restaurant requires appropriate licenses from regulatory authorities allowing it to sell beer, wine and liquor and each restaurant requires food service licenses from local health authorities. The majority of our licenses to sell alcoholic beverages must be renewed annually and may be suspended or revoked at any time for cause, including violation by us or our team members of any law or regulation pertaining to alcoholic beverage control, such as those regulating the minimum age of team members or patrons who may serve or be served alcoholic beverages, the serving of alcoholic beverages to visibly intoxicated patrons, advertising, wholesale purchasing and inventory control. In order to reduce this risk, restaurant team members are trained in standardized operating procedures designed to assure compliance with all applicable codes and regulations. We have not encountered any material problems relating to alcoholic beverage licenses or permits to date.

We are also subject to laws governing our relationship with team members. Our failure to comply with federal, state and local employment laws and regulations may subject us to losses and harm our brand. The laws and regulations govern such matters as: workers’ compensation insurance; wage and hour requirements; unemployment and other taxes; working and safety conditions; overtime; and citizenship and immigration status. Significant additional government-imposed regulations under the Fair Labor Standards Act and similar laws related to minimum wages, overtime, rest breaks, paid leaves of absence, and mandated health benefits may also impact the performance of our operations. In addition, team member claims based on, among other things, discrimination, harassment, wrongful termination, wages, hour requirements and payments to team members who receive gratuities, may divert financial and management resources and adversely affect operations. The losses that may be incurred as a result of any violation of such governmental regulations by the Company are difficult to quantify. To our knowledge, we are in compliance in all material respects with all applicable federal, state and local laws affecting our business.

The federal Patient Protection and Affordable Care Act (the "ACA") applies to our business. Under the ACA, we are required to provide full-time employees with medical insurance that meets minimum value and affordability standards. We are also required to provide covered employees and the Internal Revenue Service with specific reportable benefit information. The Company’s medical plans have been offered to all full-time employees and meet the minimum value and affordability requirements of the ACA, and the Company has complied with the informational reporting requirements of the ACA.

Compliance with these laws and regulations may lead to increased costs and operational complexity and may increase our exposure to governmental investigations or litigation. We may also be subject, in certain states, to “dram shop” statutes, which generally allow a person injured by an intoxicated person to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person. We carry liquor liability coverage as part of our existing comprehensive general liability insurance which we believe is consistent with coverage carried by other companies in the restaurant industry of similar size and scope of operations. Even though we carry liquor liability insurance, a judgment against us under a “dram shop” statute in excess of our liability coverage could have a material adverse effect on our business, financial condition and results of operations.

11


ITEM 1A.     RISK FACTORS


Risks Related to Our Business and Industry

Our Independent Auditors Have Expressed Substantial Doubt About Our Ability to Continue as a Going Concern.
 
In the audit opinion for our consolidated financial statements as of and for the year ended December 30, 2018, BDO USA, LLP, our independent auditors, included an explanatory emphasis of matter paragraph expressing substantial doubt about the Company’s ability to continue as a going concern. As further discussed in Note 1 and Note 7 to our consolidated financial statements, the Company has approximately $102.4 million of debt outstanding under its $155.0 million senior secured credit facility with a syndicate of lenders led by Citizens (the “Credit Facility”) with a maturity date of June 29, 2020. The Credit Facility contains various customary financial covenants generally based on the earnings of the Company relative to its debt. The financial covenants consist of a quarterly minimum required debt service coverage ratio (the "DSCR") and a maximum permitted lease adjusted leverage ratio (the "LALR").

As of December 30, 2018 the Company was in compliance with its loan covenants. However, beginning in the third quarter of 2019, the Company is currently forecasting that it may not be in compliance with these financial covenants.

While the Company has successfully negotiated financial covenant amendments in the past and would seek to do so again should it be in default or near a default, there can be no assurance that it will be successful in obtaining a satisfactory amendment.

As a result of this uncertainty coupled with the June 2020 maturity of the Credit Facility, the Company has been in discussions with its current lenders and other sources of capital regarding a possible refinancing and/or replacement of the Credit Facility. The Company is also exploring various other alternatives, including, among other things, possible equity financing. There can be no assurance, however, that any such efforts will be successful.

Until such time as the Company has executed an agreement to amend, refinance or replace the Credit Facility, the Company cannot conclude that it is probable that it will do so, and accordingly, this raises substantial doubt about the Company’s ability to continue as a going concern.

However, our financial statements have been prepared assuming the Company will continue to operate as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Our financial statements do not include adjustments that might result from the outcome of this uncertainty, including any adjustments to reflect the possible future effects of the recoverability and classification of recorded asset amounts or amounts and classifications of liabilities that might be necessary should the Company be unable to continue as a going concern.

Our Financial Results Depend Significantly Upon the Success of Our Existing and New Restaurants

Our ability to maintain and grow our revenue and profits will depend on our ability to successfully drive sales volumes and efficiently manage costs in our existing and new restaurants. Currently, we have 64 BWW restaurants. The results achieved by our current restaurants may not be indicative of longer-term performance or the potential market acceptance of our restaurant concept in other locations.


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The success of our restaurants depends principally upon generating and maintaining guest traffic, loyalty and achieving positive margins. Significant factors that might adversely affect guest traffic, loyalty and profit margins include:
●
economic conditions, including housing market downturns, rising unemployment rates, lower disposable income, adverse credit conditions, rising fuel prices and decreasing consumer confidence and other events or factors that adversely affect consumer spending in the markets we serve;
●
competition in the restaurant industry, particularly in the casual and fast-casual dining segments;
●
changes in consumer preferences;
●
our guests’ failure to accept menu price increases that we may make to offset increases in certain operating costs;
●
our reputation and consumer perception of our concepts’ offerings in terms of quality, price, value, ambiance and service; and
●
our guests’ personal experiences from dining in our restaurants.

Our restaurants are also susceptible to increases in certain key operating expenses that are either wholly or partially beyond our control, including: 
●
food and other raw materials costs, many of which we cannot predict or effectively hedge against;
●
compensation costs, including wage, workers’ compensation, health care and other benefits expenses;
●
rent expenses and construction, remodeling, maintenance and other costs under leases for our new and existing restaurants;
●
compliance costs as a result of changes in regulatory or industry standards;
●
energy, water and other utility costs;
●
costs for insurance (including health, liability and workers’ compensation);
●
information technology and other logistical costs; and
●
expenses due to litigation against us.

Competition in the Restaurant Industry May Affect Our Ability to Compete Effectively

The restaurant industry is intensely competitive. We believe we compete primarily with regional and local sports bars, casual dining concepts, and fast-casual establishments. Many of our direct and indirect competitors are well-established national, regional or local chains with a greater market presence than us. Further, some competitors have substantially greater financial, marketing and other resources than us. In addition, independent owners of local or regional establishments may enter the wing-based restaurant business without significant barriers to entry and such establishments may provide price competition for our restaurants. Competition in the casual dining, fast-casual and quick-service segments of the restaurant industry is expected to remain intense with respect to price, service, location, concept and the type and quality of food. We also face intense competition for real estate sites, qualified management personnel and hourly restaurant staff.

Our Ability to Raise Capital in the Future May Be Limited, Which Could Adversely Impact Our Business

Changes in our restaurant operations, lower than anticipated restaurant sales, increased food or compensation costs, increased property expenses, acceleration of our expansion plans or other events, including those described in this Annual Report, may cause us to seek additional debt or equity financing on an accelerated basis. Financing may not be available to us on acceptable terms, and our failure to raise capital when needed could negatively impact our ability to service our debt, our restaurant growth plans as well as our financial condition and the results of our operations. Additional equity financing, if available, may be dilutive to the holders of our common stock. Debt financing may involve significant cash payment obligations, covenants and financial ratios that may restrict our ability to operate and grow our business, if available at all.


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There Can Be No Assurances That, in the Future, We Will Be in Compliance With All Covenants of Our Current or Future Debt Agreements or That Our Lenders Will Waive Any Violations of Such Covenants

Non-compliance with our debt covenants could have a material adverse effect on our business, results of operations, and financial condition. Non-compliance may result in us being in default under our debt agreements, which could cause a substantial financial burden by requiring us to repay our debt earlier than otherwise anticipated.

Actions by Our Franchisor Could Negatively Affect Our Business and Operating Results

We are economically dependent on retaining our franchise rights with BWW. Our restaurant operations depend, in part, on decisions made by our franchisor, including changes of distributors, food menu items and prices, policies and procedures, and advertising programs. Business decisions made by BWW could adversely impact our business, financial condition or results of operations.

Poor Operating Results at Any of Our Restaurants Could Cause us to Cease Operations Regardless of Ongoing Lease and Franchise Agreement Obligations

Factors such as intense competition, difficult labor market conditions and low levels of guest traffic could cause us to cease operations at any of our BWW restaurants. From time to time, we have elected to close underperforming restaurants, and may elect to do so in the future regardless of ongoing lease or franchise agreement terms. In the past we have experienced, and may in the future experience, reduced sales as a result of restaurant closures and could have ongoing liabilities beyond the date of the closure.

Our Success Depends Substantially on the Value of the BWW Brand and Unfavorable Publicity Could Harm Our Business

Multi-unit restaurant businesses such as ours can be adversely affected by publicity resulting from complaints, litigation or general publicity regarding poor food quality, food-borne illness, personal injury, food tampering, adverse health effects of consumption of various food products or high-calorie foods (including obesity) or other concerns. Negative publicity of the BWW brand from traditional media or online social network postings may also result from actual or alleged incidents or events taking place in our restaurants or any BWW restaurant not owned by us.

There has been a marked increase in the use of social media platforms, including weblogs (blogs), social media websites, and other forms of Internet-based communications which allow individuals access to a broad audience of consumers and other interested persons. Consumers value readily available information concerning goods and services that they have or plan to purchase, and may act on such information without further investigation or authentication. The availability of information on social media platforms is virtually immediate, as is its impact. Many social media platforms immediately publish the content their subscribers and participants post, often without filters or checks on accuracy of the content posted. The opportunity for dissemination of any sort of information or media, including inaccurate and prospectively harmful materials, is practically limitless and the technology through which such opportunities are afforded is ubiquitous. Information concerning our Company may be posted on such platforms at any time. Information posted may be adverse to our interests or may be inaccurate, each of which may harm our performance, prospects or business. The harm may be immediate without affording us an opportunity for redress or correction. Such platforms also could be used for dissemination of trade secret information, compromising valuable company assets. In summary, the dissemination of information online could harm our business, prospects, financial condition and results of operations, regardless of the information’s accuracy.

Regardless of whether any public allegations or complaints are valid, unfavorable publicity relating to any BWW restaurant, whether owned by us or not, could adversely affect public perception of the entire brand. Adverse publicity and its effect on overall consumer perceptions of food safety, or our failure to respond effectively to adverse publicity, could have a material adverse effect on our business, financial condition or results of operations. We must protect and grow the value of our brand to continue to be successful in the future. Any incident that erodes consumer trust in or affinity for our brand could significantly reduce the value. If consumers perceive or experience a reduction in food quality, service and ambiance or in any way believe we failed to deliver a consistently positive experience, the value of our brand could suffer.

We May Not Be Able to Attract and Retain Qualified Team Members to Operate and Manage Our Restaurants

The success of our restaurants depends on our ability to attract, motivate, develop and retain a sufficient number of qualified restaurant team members, including managers and hourly team members. The inability to recruit, develop and retain these individuals may delay the planned openings of new restaurants or result in high team member turnover in existing restaurants, thus increasing the cost to efficiently operate our restaurants. This could inhibit our expansion strategy and business performance and negatively impact our operating results.

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Fluctuations in the Cost of Food Could Impact Operating Results

Our primary food products are fresh bone-in chicken wings, frozen boneless chicken and potatoes. Our food, beverage and packaging costs could be significantly affected by increases in the cost of fresh chicken wings, which can result from a number of factors, including but not limited to, seasonality, cost of corn and grain, animal disease, drought and other weather phenomena, increase in demand domestically and internationally, and other factors that may affect availability. Additionally, if there is a significant rise in the price of chicken wings, and we are unable to successfully adjust menu prices or menu mix or otherwise make operational adjustments to account for the higher wing prices, our operating results could be adversely affected. We also depend on our franchisor, BWW, as it relates to chicken wings, to negotiate prices and deliver product to us at a competitive cost. BWW currently sources, negotiates and secures fresh bone-in chicken wings for its franchisees.

Shortages or Interruptions in the Availability and Delivery of Food and Other Supplies May Increase Costs or Reduce Revenue

Possible shortages or interruptions in the supply of food items and other supplies to our restaurants caused by inclement weather, terrorist attacks, natural disasters such as floods, drought, and hurricanes, pandemics, the inability of our vendors to obtain credit in a tightened credit market, food safety warnings or advisories, or the prospect of such pronouncements or other conditions beyond our control, could adversely affect the availability, quality and cost of items we buy and the operations of our restaurants. Our inability to effectively manage supply chain risk could increase our costs and limit the availability of products critical to our restaurant operations.

We May Face Guaranty Obligations or Other Potential Liabilities in Connection With the Spin-Off of Bagger Dave's

Following the Bagger Dave's Spin-Off, we continue to provide lease guaranties and certain transition services to Bagger. We remain as a guarantor on 10 lease agreements as of December 30, 2018 , 3 of which now relate to an unaffiliated party which has taken over the Bagger Dave's lease. In the event Bagger Dave's or the unaffiliated party were unable to meet their lease obligations, we could be required to make the lease payments or suffer other financial liability. The maximum exposure from lease guarantees is approximately $7.3 million . These or other liabilities and costs that may be incurred in connection with the Spin-Off, may exceed our estimates and could have an adverse impact on our business, financial condition and results of operations.

Board Overlap with Bagger Dave's May Give Rise to Conflicts of Interest

Our Executive Chairman currently serves on Bagger Dave's board of directors. Our Executive Chairman is also the Chairman of the Board, Chief Executive Officer and President of Bagger Dave's. We have certain business dealings with Bagger Dave's, including a sublease, a transition services agreement and lease guarantees. We may also have business dealings that extend beyond separation matters. In certain locations, our restaurants are located adjacent to or near a Bagger Dave's restaurant and may compete for guests. While we have procedures in place to consider related party transactions through independent committee members of our board, the overlap in directors with Bagger Dave's may give rise to conflicts of interest.

Increases in Our Compensation Costs, Including as a Result of Changes in Government Regulation, Could Slow Our Growth or Harm Our Business

We are subject to a wide range of compensation costs. Because our compensation costs are, as a percentage of revenue, higher than other industries, we may be significantly harmed by compensation cost increases. Unfavorable fluctuations in market conditions, availability of insurance, or changes in state and/or federal regulations could significantly increase our insurance premiums. In addition, we are subject to the risk of employment-related litigation at both the state and federal levels, including claims styled as class action lawsuits, which are costlier to defend. Also, some employment-related claims in the area of wage and hour disputes are not insurable risks.

Significant increases in health care costs may also continue to occur, and we can provide no assurance that we will be able to effectively contain those costs.

In addition, many of our restaurant personnel are hourly team members subject to various minimum wage requirements or changes to existing tip credit laws. Mandated increases in minimum wage levels and changes to the tip credit laws, which dictate the amounts an employer is permitted to assume a team member receives in tips when calculating the team member’s hourly wage for minimum wage compliance purposes, have recently been and continue to be proposed and implemented at both federal and state government levels. Continued minimum wage increases or changes to allowable tip credits may further increase our compensation costs or effective tax rate.


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Various states in which we operate are considering or have already adopted new immigration laws, and the U.S. Congress and Department of Homeland Security from time to time consider or 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 cumbersome or reduce the availability of potential team members. Although we require all team members to provide us with government-specified documentation evidencing their employment eligibility, some of our team members may, without our knowledge, be unauthorized team members. Unauthorized team members are subject to deportation and may subject us to fines or penalties, and if any of our team members 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 team members. Termination of a significant number of team members that, unbeknownst to us, were unauthorized team members may disrupt our operations, cause temporary increases in our compensation costs as we train new team members and result in additional adverse publicity. Our financial performance could be materially harmed as a result of any of these factors.

Changes in Public Health Concerns and Legislation and Regulations Requiring the Provision of Nutritional Information May Impact Our Performance

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 health effects of consuming our menu offerings. These changes have resulted in, and may continue to result in, the enactment of laws and regulations that impact the ingredients and nutritional content of our menu offerings, or laws and regulations requiring us to disclose the nutritional content of our food offerings. For example, a number of states, counties and cities have enacted menu labeling laws requiring multi-unit restaurant operators to disclose certain nutritional information available to guests or have enacted legislation restricting the use of certain types of ingredients in restaurants. The ACA included nation-wide menu labeling and nutrition disclosure requirements as well, and our restaurants are now covered by these national requirements. The effect of such labeling requirements on consumer choices, if any, is unclear at this time. We cannot make any assurances regarding our ability to effectively respond to changes in consumer health perceptions and to adapt our menu offerings to trends in eating habits. The imposition of menu-labeling laws could have an adverse effect on our business, financial condition and results of operations, as well as the restaurant industry in general.

Multiple jurisdictions in which we operate could adopt recently enacted new requirements that require us to adopt and implement a Hazard Analysis and Critical Control Points (“HACCP”) system for managing food safety and quality. 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. We expect to incur certain costs to comply with these regulations, and these costs may be more than we anticipate. Failure to comply with these laws or regulations could materially adversely affect our business, financial condition and results of operations.
 
Further, growing movements to change laws relating to alcohol may result in a decline in alcohol consumption at our restaurants or increase the number of "dram shop" claims made against us, either of which may negatively impact operations or result in the loss of liquor licenses.

A Regional or Global Health Pandemic Could Severely Affect Our Business

A health pandemic is a disease outbreak that spreads rapidly and widely by infection and affects many individuals in an area or population at the same time. If a regional or global health pandemic were to occur, depending upon its duration and severity, our business could be severely affected. We have positioned our brand as a place where people can gather together. Customers might avoid public gathering places in the event of a health pandemic, and local, regional or national governments might limit or ban public gatherings to halt or delay the spread of disease. A regional or global health pandemic might also adversely impact our business by disrupting or delaying production and delivery of materials and products in our supply chain and by causing staffing shortages in our restaurants. The impact of a health pandemic on us might be disproportionately greater than on other companies that depend less on the gathering of people together for the sale or use of their products and services.


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Changes in Consumer Preferences or Discretionary Consumer Spending Could Harm Our Performance

Our success depends, in part, upon the continued popularity of our chicken wings, other food and beverage items and the appeal of our restaurant concept. We also depend on trends toward consumers eating away from home. Shifts in these consumer preferences could negatively affect our future profitability. Such shifts could be based on health concerns related to the cholesterol, carbohydrate, fat, calorie or salt content of certain food items, including items featured on our menu. Negative publicity over the health aspects of such food items may adversely affect consumer demand for our menu items and could result in a decrease in guest traffic to our restaurants, which could materially harm our business. In addition, our success depends, to a significant extent, on numerous factors affecting discretionary consumer spending, general economic conditions, disposable consumer income, and consumer confidence. A decline in consumer spending or in economic conditions could reduce guest traffic or impose practical limits on pricing, either of which could harm our business, financial condition and results of operations.

Our Operating Results May Fluctuate Due to the Timing of Special Events

Our operating results depend, in part, on special events, such as the Super Bowl ® and other sporting events viewed by our guests in our restaurants, including those sponsored by the National Football League, Major League Baseball, National Basketball Association, National Hockey League and National Collegiate Athletic Association. Interruptions in the viewing of these professional sporting league events due to strikes or lockouts may impact our business, financial condition and results of operations. Additionally, our results are subject to fluctuations based on the dates of sporting events, their availability for viewing through broadcast, satellite, Internet and cable networks, and the level of participation in these events by teams that are relevant to the markets in which we operate. Historically, sales in most of our restaurants have been higher during fall and winter months based on the relative popularity and extent of national, regional and local sporting and other events in the geographic regions in which we currently operate.

We May Not Be Successful When Entering New Markets

When expanding the BWW concept or potentially acquiring other franchise concepts, we may enter new markets in which we may have limited or no operating experience. There can be no assurance that we will be able to achieve success and/or profitability in our new markets or in our new restaurants. The success of these new restaurants will be affected by the different competitive conditions, consumer taste, and discretionary spending patterns within the new markets, as well as by our ability to generate market awareness of the BWW brand, or other brands. New restaurants typically require several months of operation before achieving normal levels of profitability. When we enter highly competitive new markets or territories in which we have not yet established a market presence, the realization of our revenue targets and desired profit margins may be more susceptible to volatility and/or more prolonged than anticipated.

Higher-Than-Anticipated Costs Associated With the Opening of New Restaurants or With the Closing, Relocating, or Remodeling of Existing Restaurants May Adversely Affect Our Business, Financial Condition or Results of Operations

Our revenue and expenses may be significantly impacted by the location, number and timing of the opening of new restaurants and the closing, relocating and remodeling of existing restaurants. We incur substantial pre-opening expenses each time we open a new restaurant and will incur other expenses if we close, relocate or remodel existing restaurants. These expenses are generally higher when we open restaurants in new markets, but the costs of opening, closing, relocating or remodeling any of our restaurants may be higher than anticipated. An increase in such expenses could have an adverse effect on our results of operations.


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Future Acquisitions May Have Unanticipated Consequences That Could Harm Our Business and Our Financial Condition

We may seek to selectively acquire existing BWW or other restaurant concepts as a franchisee, for example, our recent entrance into an Asset Purchase Agreement to acquire 9 BWW restaurants in the Chicago, Illinois market. To do so, we would need to identify suitable acquisition candidates, negotiate acceptable acquisition terms and obtain appropriate financing as needed. Any acquisitions we pursue, whether successfully completed or not, may involve risks, including:
●
material adverse effects on our operating results, particularly in the fiscal quarters immediately following the acquisition as the acquired restaurants are integrated into our operations;
●
customary closing and indemnification risks associated with any acquisition;
●
funds used pursuing acquisitions we are ultimately unable to consummate because the transaction is subject to a right of first refusal in favor of our franchisor, BWW; and
●
diversion of management’s attention from other business concerns.

Future acquisitions of existing restaurants, which may be accomplished through a cash purchase transaction, the issuance of our equity securities, or a combination of both, could result in potentially dilutive issuances of our equity securities, the incurrence of debt and contingent liabilities and impairment charges related to intangible assets, any of which could harm our business, financial condition and results of operations.

Our Inability to Renew Existing Leases or Enter Into New Leases For New or Relocated Restaurants on Favorable Terms May Adversely Affect Our Results of Operations

As of December 30, 2018 , all of our restaurants are located on leased premises and are subject to varying lease-specific arrangements. For example, some of the leases require base rent that is subject to increase based on market factors, and other leases include base rent with specified periodic increases. Some leases are subject to renewals, which could involve substantial increases. Additionally, a few leases require contingent rent based on a percentage of gross sales. When our leases expire, we will evaluate the desirability of renewing such leases. While we currently expect to pursue all renewal options, no guarantee can be given that such leases will be renewed or, if renewed, that rents will not increase substantially. The success of our restaurants depends in large part on their leased locations. As demographic and economic patterns change, current leased locations may or may not continue to be attractive or profitable. Possible declines in trade areas where our restaurants are located or adverse economic conditions in surrounding areas could result in reduced revenue in those locations. In addition, desirable lease locations for new restaurant openings or for the relocation of existing restaurants may not be available at an acceptable cost when we identify a particular opportunity for a new restaurant or relocation.

Economic Conditions Could Have a Material Adverse Impact on Our Landlords in Retail Centers in Which We Are Located

Our landlords may be unable to obtain financing or remain in good standing under their existing financing arrangements, resulting in failures to pay required construction contributions or satisfy other lease covenants to us. If our landlords fail to satisfy required co-tenancies, such failures may result in us terminating leases or delaying openings in these locations. Also, decreases in total tenant occupancy in retail centers in which we are located may affect guest traffic at our restaurants. All of these factors could have a material adverse impact on our business, financial condition or results of operations.

A Decline in Visitors to Any of the Business Districts Near the Locations of Our Restaurants Could Negatively Affect Our Restaurant Sales

Some of our restaurants are located near high-activity areas such as retail centers, big-box shopping centers and entertainment centers. We depend on high visitor rates at these businesses to attract guests to our restaurants. If visitors to these centers decline due to economic conditions, closure of big-box retailers, road construction, changes in consumer preferences or shopping patterns, changes in discretionary consumer spending or otherwise, our restaurant sales in these areas could decline significantly and adversely affect our business, financial condition or results of operations.


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Because Many of Our Restaurants are Concentrated in Local or Regional Areas, We are Susceptible to Economic and Other Trends and Developments, Including Adverse Weather Conditions, in These Areas

Our financial performance is highly dependent on restaurants located in Florida, Illinois, Indiana, Michigan, and Missouri. As a result, adverse economic conditions in any of these areas could have a material adverse effect on our overall results of operations. In addition, other regional occurrences such as local strikes, terrorist attacks, increases in energy prices, adverse weather conditions, hurricanes, droughts or other natural or man-made disasters have occurred. In particular, adverse weather conditions can impact guest traffic at our restaurants, cause the temporary underutilization of certain seating areas, and, in more severe cases, cause temporary restaurant closures, sometimes for prolonged periods. As of December 30, 2018 , approximately 73.4% of our total restaurants are located in Illinois, Indiana, Michigan and Missouri, which are particularly susceptible to snowfall, and approximately 26.6% of our total restaurants are located in Florida, which is particularly susceptible to hurricanes.

Legal Actions Could Have an Adverse Effect on Us

We have faced in the past and could face in the future legal action from government agencies, team members, guests, or other parties. Many state and federal laws govern our industry, and if we fail to comply with these laws, we could be liable for damages or penalties. Further, we may face litigation from guests alleging that we were responsible for an illness or injury they suffered at or after a visit to our restaurants, or alleging that we are not complying with regulations governing our food quality or operations. We may also face employment-related litigation, including claims of age discrimination, sexual harassment, gender discrimination, immigration violations, or other local, state, and federal labor law violations. In light of the potential cost and uncertainty involved in litigation, we may settle matters even when we believe we have a meritorious defense. Litigation and its related costs may have a material adverse effect on our business, financial condition or results of operations.

We May Not Be Able to Obtain and Maintain Licenses and Permits Necessary to Operate Our Restaurants

The restaurant industry is subject to various federal, state and local government licensure and permitting requirements, including those relating to the sale of food and alcoholic beverages. The failure to obtain and maintain these licenses, permits and approvals, including food and liquor licenses, could adversely affect our operating results. Difficulties or failure to obtain any required licenses, permits or other government approvals could delay or result in our decision to cancel the opening of new restaurants. Local authorities may revoke, suspend or deny renewal of our food and liquor licenses if they determine that our conduct violates applicable regulations.

The Sale of Alcoholic Beverages at Our Restaurants Subjects Us to Additional Regulations and Potential Liability

For fiscal year 2018 , approximately 17% of our consolidated restaurant sales were attributable to the sale of alcoholic beverages. We are required to comply with the alcohol licensing requirements of the federal government, states and municipalities where our restaurants are located. Alcoholic beverage control regulations require applications to state authorities and, in certain locations, county and municipal authorities for a license and permit to sell alcoholic beverages on the premises and to provide service for extended hours and on Sundays. Typically, the licenses are renewed annually and may be revoked or suspended for cause at any time. Alcoholic beverage control regulations relate to numerous aspects of the daily operations of our restaurants, including minimum age of guests and team members, hours of operation, advertising, wholesale purchasing, inventory control and handling, storage and dispensing of alcoholic beverages. If we fail to comply with federal, state or local regulations, our licenses may be revoked and we may be forced to terminate the sale of alcoholic beverages at one or more of our restaurants.

In certain states, we are subject to “dram shop” statutes, which generally allow a person injured by an intoxicated person the right to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person. Some dram shop litigation against restaurant companies has resulted in significant judgments, including punitive damages.

We Are Dependent on Information Technology and Any Material Failure or Breach in Security of That Technology Could Impair Our Ability to Efficiently Operate Our Business

We rely on information systems across our operations, including, for example, point-of-sale processing in our restaurants, management of our supply chain, collection of cash, payment of obligations, and various other processes and procedures. Our ability to efficiently manage our business depends significantly on the reliability and capacity of these systems. The failure of these systems to operate effectively, problems with maintenance, upgrading or transitioning to replacement systems, or a breach in security of these systems could cause delays in guest service and reduce efficiency in our operations. There have been a number of recent occurrences of cyber security breaches across many retail industries, and such a breach of our systems could represent a material risk to our operations. Significant capital investments might be required to remediate any problems.


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An Impairment in the Carrying Value of Our Fixed Assets, Intangible Assets or Goodwill Could Adversely Affect Our Financial Condition and Consolidated Results of Operations

Goodwill represents the excess of cost over the fair value of identified net assets of businesses acquired. We review goodwill for impairment annually, or whenever circumstances change in a way which could indicate that impairment may have occurred. Goodwill is tested at the reporting unit level. We identify potential goodwill impairments by comparing the fair value of the reporting unit to its carrying amount, which includes goodwill and other intangible assets. If the carrying amount of the reporting unit exceeds the fair value, an impairment exists. The amount of the impairment is the amount by which the carrying amount exceeds the fair value. A significant amount of judgment is involved in determining if an indication of impairment exists. Factors may include, among others: a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; the testing for recoverability of a significant asset group within a reporting unit; and slower growth rates. Any adverse change in these factors would have a significant impact on the recoverability of these assets and negatively affect our financial condition and consolidated results of operations. We are required to record a non-cash impairment charge if the testing performed indicates that goodwill has been impaired.

We evaluate the useful lives of our fixed assets and intangible assets to determine if they are definite- or indefinite-lived. Reaching a determination on useful life requires significant judgments and assumptions regarding the lease term, future effects of obsolescence, demand, competition, other economic factors (such as the stability of the industry, legislative action that results in an uncertain or changing regulatory environment, and expected changes in distribution channels), the level of required maintenance expenditures and the expected lives of other related groups of assets. We cannot accurately predict the amount and timing of any impairment of assets. Should the value of fixed assets or intangible assets become impaired, there could be an adverse effect on our financial condition and consolidated results of operations.

We May Incur Costs Resulting From Security Risks We Face in Connection With Our Electronic Processing and Transmission of Confidential Guest Information

We accept electronic payment cards from our guests in our restaurants. For the fiscal year ended December 30, 2018 , approximately 73% of our sales were attributable to credit/debit card transactions, and credit/debit card usage could continue to increase. A number of restaurant operators and retailers have experienced actual or potential security breaches in which credit/debit card information may have been stolen. While we carry cyber risk insurance and have taken reasonable steps to prevent the occurrence of security breaches in this respect, we may in the future become subject to claims for purportedly fraudulent transactions arising out of the actual or alleged theft of credit/debit card information, and we may also be subject to lawsuits or other proceedings in the future relating to these types of incidents. Proceedings related to theft of credit/debit card information may be brought by payment card providers, banks, and credit unions that issue cards, cardholders (either individually or as part of a class action lawsuit), and federal and state regulators. Any such proceedings could distract our management team members from running our business and cause us to incur significant unplanned losses and expenses.

We also receive and maintain certain personal information about our guests and team members. The use of this information by us is regulated at the federal and state levels. If our security and information systems are compromised or our team members fail to comply with these laws and regulations and this information is obtained by unauthorized persons or used inappropriately, it could adversely affect our reputation, as well as the results of operations, and could result in litigation against us or the imposition of penalties. In addition, our ability to accept credit/debit cards as payment in our restaurants and online depends on us maintaining our compliance status with standards set by the PCI Security Standards Council. These standards, set by a consortium of the major credit card companies, require certain levels of system security and procedures to protect our guests’ credit/debit card information as well as other personal information. Privacy and information security laws and regulations change over time, and compliance with those changes may result in cost increases due to necessary system and process changes.

Failure to Establish and Maintain Our Internal Control Over Financial Reporting Could Harm Our Business and Financial Results

Our management team members are responsible for establishing and maintaining effective internal control over financial reporting. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of financial reporting for external purposes in accordance with accounting principles generally accepted in the United States. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that we would prevent or detect a misstatement of our financial statements or fraud. Any failure to maintain an effective system of internal control over financial reporting could limit our ability to report our financial results accurately and timely or to detect and prevent fraud. The occurrence of material weaknesses in internal control over financial reporting could cause a loss of investor confidence and decline in the market price of our stock.

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Our Inability or Failure to Effectively Manage Our Marketing Through Social Media Could Materially Adversely Impact Our Business

As part of our marketing efforts, we rely on BWW managed search engine marketing and social media platforms such as Facebook ® and Twitter ® to attract and retain guests. BWW is also initiating a multi-year effort to implement new technology platforms that should allow us to digitally engage with our guests and team members and strengthen our marketing and analytics capabilities. These initiatives may not be successful, resulting in expenses incurred without the benefit of higher revenues or increased employee engagement. In addition, a variety of risks are associated with the use of social media, including the improper disclosure of proprietary information, negative comments about our company, exposure of personally identifiable information, fraud, or out-of-date information. The inappropriate use of social media platforms by our guests or team members could increase our costs, lead to litigation or result in negative publicity that could damage our reputation.

There is Volatility in Our Stock Price

The market for our stock has, from time to time, experienced extreme price and volume fluctuations. Factors such as announcements of variations in our quarterly financial results and fluctuations in same-store sales could cause the market price of our stock to fluctuate significantly. In addition, the stock market in general, and the market prices for restaurant companies in particular, have experienced volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our stock, regardless of our operating performance.

The market price of our stock can be influenced by shareholders’ expectations about the ability of our business to grow and to achieve certain profitability targets. If our financial performance in a particular quarter does not meet the expectations of our shareholders, it may adversely affect their views concerning our growth potential and future financial performance. In addition, if the securities analysts who regularly follow our stock lower their ratings of our stock, the market price of our stock is likely to drop significantly.

If the Spin-Off Does Not Qualify as a Tax-free Transaction, the Company and its Shareholders Could be Subject to Additional Tax Liabilities

The Company, with the assistance of an opinion obtained from our tax advisors, structured the Spin-Off of Bagger Dave's as a 100% tax-free transaction under the applicable provisions of the U.S. Internal Revenue Code. This opinion is based on assumptions and other representations regarding factual matters made by the Company and Bagger Dave's. In the event these assumptions and representations were found to be inaccurate or incomplete, the tax-free status conclusion reached by our advisors could be in jeopardy. There is a risk that the IRS, upon examination of the facts and circumstances surrounding the transaction, could conclude that the Spin-Off is a taxable event. As a result, the Company and its shareholders could possibly incur additional tax liabilities, including penalties and interest.

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ITEM 1B.     UNRESOLVED STAFF COMMENTS
 
None.  

ITEM 2.        PROPERTIES
 
Our main office is located at 27680 Franklin Road, Southfield, Michigan 48034 and our telephone number is (833) 374-7282 . Our main office has approximately 5,340 square feet of office space. We occupy this facility under a lease that ends June 30, 2019. As of December 30, 2018 , we operated 64 Company-owned restaurants, all of which are leased properties. Typically, our operating leases contain renewal options under which we may extend the renewal lease terms for periods of five to 10 years. Most of our leases include "exclusive use" provisions prohibiting our landlords from leasing space to other restaurants that fall within certain specified criteria and incorporate incremental increases based on time passage and payment of certain occupancy-related expenses.

We own all of the equipment, furnishings, and fixtures in our restaurants. The Company also owns a significant amount of leasehold improvements in the leased facilities.

As of December 30, 2018 , we operated restaurant properties for 20 locations in Michigan, 17 locations in Florida, 15 locations in Missouri, seven locations in Illinois and five locations in Indiana. Our restaurants range in size from approximately 5,300 square feet to 13,500 square feet with the majority of our restaurants located in stand-alone buildings and/or end-cap positions in strip malls, with a few being in strip mall in-line positions.

ITEM 3.        LEGAL PROCEEDINGS

The following information is incorporated by reference: the information set forth under the heading "Legal Proceedings" in Note 11 "Commitments and Contingencies" of the "Notes to the Consolidated Financial Statements" of Part II, Item 8 to this Report on Form 10-K.


ITEM 4.         MINE SAFETY DISCLOSURES
 
Not applicable.

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PART II  

ITEM 5.        MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Market Information
 
The Company's common stock is listed on the NASDAQ Capital Market under the symbol “SAUC”. The development and maintenance of an active public trading market depends upon the existence of willing buyers and sellers, the presence of which is beyond our control. While we are a publicly-traded company, the volume of trading activity in our stock is relatively limited.

Holders
 
As of March 29, 2019 , there were approximately 375 record holders of 33,182,875 shares of the Company's common stock, excluding shareholders whose stock is held either in nominee name and/or street name brokerage accounts. 

Dividends
 
We have not declared or paid any cash dividends on our common stock. It is our policy to preserve cash for development and debt reduction. DRH does not have plans to pay any cash dividends. Our future dividend policy will be determined by our Board of Directors and will depend on various factors, including our results of operations, financial condition, anticipated cash needs, debt levels and plans for expansion.




ITEM 6.        SELECTED FINANCIAL DATA

Not Applicable.

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ITEM 7.        MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition should be read in conjunction with our consolidated financial statements and the related notes to those statements included elsewhere in this document. The following discussion contains, in addition to historical information, forward-looking statements that include risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under the heading “Risk Factors” and elsewhere in this document.

Overview

DRH is a single-concept restaurant company operating 64 BWW franchised restaurants. As one of the largest franchisees of BWW, we provide a unique guest experience in a casual and inviting environment. We are committed to providing value to our guests by offering generous portions of flavorful food in an upbeat and entertaining atmosphere. We believe BWW is a uniquely positioned restaurant brand designed to maximize guest appeal, offering competitive price points and a family-friendly atmosphere, which we believe enables strong long-term performance through varying economic cycles. We were incorporated in Nevada in 2006 and are headquartered in the Detroit metropolitan area. Our current 64 restaurants are located in Florida, Illinois, Indiana, Michigan, and Missouri.

Spin-Off of Bagger Dave’s

On December 25, 2016, DRH completed the Spin-Off of Bagger Dave’s into a new, independent publicly traded company. The Spin-Off was achieved through the distribution of 100 percent of the outstanding capital stock of Bagger Dave’s pro rata to holders of DRH common stock on a one-for-one basis. DRH decided to spin-off Bagger Dave's after considering all reasonable strategic and structural alternatives because of the disparity between the operating models of its two brands, BWW as franchisee, and Bagger Dave's as an owned concept.

As part of the Spin-Off transaction, DRH funded a one-time $2 million cash distribution to Bagger Dave's. The transaction was structured such that Bagger Dave's was released as a borrower under the DRH senior secured credit facility. Additionally, DRH retained substantially all of the tax benefits (net operating loss and tax credit carryforwards) generated prior to the date of the transaction. See “Spinoff of Bagger Dave’s” in Note 2 to the consolidated financial statements for details on the Spin-Off of Bagger Dave’s.
 
Our Growth Strategies and Outlook
 
Our strategy is comprised of the following key growth components:
●
pursue disciplined restaurant growth through a combination of both organic expansion and strategic acquisitions;
●
deliver comparable restaurant sales growth by providing our guest with an exceptional experience and executing effective marketing and promotional strategies; and
●
leverage our infrastructure and operating expertise to grow profit margins.

We have a disciplined strategy for opening new restaurants. We also evaluate the potential for strategic acquisitions of Buffalo Wild Wings restaurants where we have an opportunity to leverage our infrastructure and operational expertise. We believe our historical track record of acquiring and integrating restaurants provides us with additional future growth opportunities and, as our capital resources permit, we will seek to take advantage of strategic acquisitions that may be available in the marketplace.

The Company closed one restaurant in 2018 . Over the next five years, we may consider opening several new restaurants in our markets, but we have no obligation to do so. On February 22, 2019 we entered into an Asset Purchase Agreement to acquire 9 BWW restaurants in the Chicago, Illinois market for a cash purchase price of approximately $22.5 million, subject to customary closing conditions. Upon completion of the transaction, since 2012, we will have acquired a total of 38 restaurants and will own and operate a total of 73 BWW restaurants. The transaction remains subject to the franchisor waiving its right of first refusal and franchisor consent, among other things. (for additional discussion of our growth strategies and outlook, see the section entitled “Business - Growth Strategy”).


24

Performance Indicators

We use several metrics to evaluate and improve each restaurant’s performance that include: sales trends, guest satisfaction, hourly compensation costs and food, beverage and packaging costs. We also use the following key performance indicators in evaluating restaurant performance:
●
Comparable Restaurant Sales . We consider a restaurant to be comparable following the eighteenth month of operation. Changes in comparable restaurant sales reflect changes in sales for the comparable group of restaurants over a specified period of time. Changes in comparable sales can reflect changes in guest count trends, changes in average check size and changes in pricing. We exclude restaurants from comparable sales when they are closed for remodels, or occasionally for other reasons such as impact from significant road construction or other event.
●
Restaurant-Level Contribution. Also referred to as Restaurant-Level EBITDA, this metric presents a restaurant's profit contribution and is defined as net revenue less costs of sales, labor, occupancy and operational expenses. It is representative of a restaurant's cash flow and is often times presented and measured as a percentage of sales in comparison to other restaurants.

Restaurant Openings
 
The following table outlines the restaurant unit information for each fiscal year from 2014 through 2018 , excluding Bagger Dave's restaurants. 
 
 
2018
 
2017
 
2016
 
2015
 
2014
 
 
 
 
 
 
 
 
 
 
 
 
 
Restaurants open at the beginning of fiscal year
 
65

 
64

 
62

 
42

 
36

 
 
 
 
 
 
 
 
 
 
 
 
 
Openings/(Closures):
 
 
 
 
 
 
 
 
 
 
 
New Restaurant Openings
 
—

 
1

 
2

 
3

 
3

 
Restaurant Acquisitions
 
—

 
—

 
—

 
18

 
3

 
Restaurant Closures
 
(1
)
 
—

 
—

 
(1
)
 
—

 
Total restaurants open at the end of fiscal year
 
64

 
65

 
64

 
62

 
42

 

Our Fiscal Year

The Company utilizes a 52- or 53-week accounting period that ends on the last Sunday in December. Fiscal year 2018 , a 52 week year, ended on December 30, 2018 and fiscal year 2017 , a 53 week year, ended on December 31, 2017 .

Key Financial Definitions

Revenue.  Revenue primarily consists of food and beverage sales, and merchandise sales, such as BWW sauce. Revenue is presented net of discounts associated with each sale. Revenue in a given period is directly influenced by the number of operating weeks in such period, the number of restaurants we operate and changes in restaurant sales.

Food, Beverage, Packaging and Merchandise Related Costs. The components of food, beverage, packaging and merchandise related costs are variable in nature, change with sales volume and are subject to increases or decreases based on fluctuations in market prices and commodity costs.

Compensation Costs.  Compensation costs include restaurant management salaries, front- and back-of-house hourly wages, and restaurant-level manager bonuses, team member benefits and payroll taxes.

Occupancy Costs. Occupancy costs include rent charges, both fixed and variable, as well as common area maintenance costs, property insurance and taxes, the amortization of tenant allowances and the adjustment to straight-line rent. These expenses are generally fixed, but a portion may vary with an increase in sales if the lease contains a percentage rent provision.

Other Operating Costs. Other operating costs consist primarily of restaurant-related operating costs, such as supplies, utilities, repairs and maintenance, travel, insurance, credit card fees, recruiting and security. This expense category also includes franchise royalty fees and national advertising fund expenses. These costs generally increase with higher sales volume but, with the exception

25

of certain supplies, royalty fees, national advertising fund expenses and credit card fees, generally decline as a percentage of revenue.

General and Administrative Expenses. General and administrative expenses include costs associated with administrative and operational support functions including senior and supervisory management and staff compensation costs (including share-based compensation) and benefits, marketing and advertising expenses, travel, legal and professional fees, information systems, support office rent and other related support costs.

Pre-Opening Costs.  Restaurant pre-opening costs consist of expenses incurred prior to opening a new restaurant, including manager salaries, relocation costs, supplies, recruiting expenses, initial new market public relations costs, pre-opening activities, team member payroll and related training costs for new team members. Restaurant pre-opening expenses also include rent recorded during the period between date of lease inception and the restaurant opening date. In addition, the Company includes restaurant labor costs that exceed the historical average for the first three months of restaurant operations that are attributable to training and initial staff turnover.

Depreciation and Amortization . Depreciation and amortization includes depreciation on fixed assets, including equipment and leasehold improvements, and amortization of certain intangible assets for restaurants.

Interest Expense . Interest expense consists primarily of interest on our outstanding indebtedness and the amortization of our debt issuance costs, reduced by capitalized interest.

Discontinued Operations. As a result of the Spin-Off of Bagger Dave’s effective December 25, 2016, the results of operations and cash flows from operating and investing activities are presented as discontinued operations in 2017.


26

RESULTS OF OPERATIONS

The following table presents the consolidated statements of operations for the fiscal years ended December 30, 2018 and December 31, 2017 with each line item as a percentage of revenue.
 
 
 
Fiscal Years-Ended
 
 
 
2018
 
2017
Revenue
 
 
100.0
 %
 
100.0
 %
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
 
 
 
 
 
Food, beverage, and packaging
 
 
28.6
 %
 
29.5
 %
Compensation costs
 
 
26.8
 %
 
25.2
 %
Occupancy
 
 
7.6
 %
 
7.1
 %
Other operating costs
 
 
21.8
 %
 
21.2
 %
General and administrative expenses
 
 
5.4
 %
 
5.5
 %
Pre-opening costs
 
 
—
 %
 
0.2
 %
Depreciation and amortization
 
 
7.5
 %
 
7.9
 %
Impairment and loss on asset disposals
 
 
2.5
 %
 
0.2
 %
Total operating expenses
 
 
100.2
 %
 
96.8
 %
 
 
 
 
 
 
Operating (loss)  profit
 
 
(0.2
)%
 
3.2
 %
 
 
 
 
 
 
Interest expense
 
 
(4.2
)%
 
(4.0
)%
Other income, net
 
 
0.1
 %
 
0.1
 %
 
 
 
 
 
 
Loss from continuing operations before income taxes
 
 
(4.3
)%
 
(0.7
)%
Income tax benefit (expense) of continuing operations
 
 
1.1
 %
 
(11.5
)%
Loss from continuing operations
 
 
(3.2
)%
 
(12.2
)%
 
 
 
 
 
 
Discontinued operations
 
 
 
 
 
Loss from discontinued operations before income taxes
 
 
—
 %
 
(0.1
)%
Income tax benefit of discontinued operations
 
 
—
 %
 
—
 %
Loss from discontinued operations
 
 
—
 %
 
(0.1
)%
 
 
 
 
 
 
Net loss
 
 
(3.2
)%
 
(12.3
)%

27


FISCAL YEAR 2018 COMPARED WITH FISCAL YEAR 2017

Revenue

Total revenue for fiscal year 2018 was $153.1 million , a decrease of $12.3 million , or 7.4% , over revenue generated during fiscal year 2017 . The decrease was driven by the 53 rd week in fiscal year 2017, the closure of one restaurant in 2018 and lower traffic in our restaurants, partially offset by sales from a new restaurant opened in Second Quarter 2017 and an increase in delivery sales. Fiscal year 2018 same-store sales decreased by 4.6%.

Operating Expenses

Food, beverage, and packaging related costs decreased by $5.0 million , or 10.3% , to $43.8 million in fiscal year 2018 from $48.8 million in fiscal year 2017 as a result of the 53 rd week in fiscal year 2017 and lower volumes. Food, beverage, and packaging cost as a percentage of sales decreased from 29.5% in fiscal year 2017 to 28.6% in fiscal year 2018 primarily due to lower traditional chicken wing costs, partially offset by promotional activity in Fourth Quarter 2018. Average cost per pound for bone-in chicken wings decreased to $1.76 in fiscal year 2018 from $2.07 in fiscal year 2017 .

Compensation costs decreased by $ 0.6 million , or 1.5% , to $ 41.1 million in fiscal year 2018 from $ 41.7 million in fiscal year 2017 , primarily due to the 53 rd week in fiscal year 2017. Compensation cost as a percentage of sales increased to 26.8% in fiscal year 2018 from 25.2% in fiscal year 2017 primarily due to wage inflation and lower average unit volumes.

Occupancy costs decreased by $0.1 million , or 1.0% , to $ 11.6 million in fiscal year 2018 from $ 11.7 million in fiscal year 2017 , primarily due to the decrease in the number of restaurants operating in 2018 . Occupancy cost as a percentage of sales increased to 7.6% in fiscal year 2018 from 7.1% in fiscal year 2017 primarily due to lower sales.

Other operating costs decreased by $1.6 million , or 4.6% , to $ 33.5 million in fiscal year 2018 from $ 35.1 million in fiscal year 2017 primarily due to cost savings initiatives, reduced royalty and advertising fund contributions as a result of lower sales volumes and the 53 rd week in fiscal year 2017. Other operating costs as a percentage of sales increased to 21.8% in fiscal year 2018 from 21.2% in fiscal year 2017 as a result of lower sales.

General and administrative expenses decreased by $ 0.8 million , or 9.2% , to $ 8.2 million in fiscal year 2018 from $ 9.1 million in fiscal year 2017 . This decrease was primarily due to a decrease in corporate wages and other corporate expenses, partially offset by an increase in marketing expenses. General and administrative costs as a percentage of sales decreased to 5.4% in fiscal year 2018 from 5.5% in fiscal year 2017 as a result of reduced costs, despite lower sales.

Depreciation and amortization decreased by $ 1.6 million , or 12.1% , to $ 11.5 million in fiscal year 2018 from $ 13.1 million in fiscal year 2017 . This decrease was primarily due to fixed asset disposals and fully depreciated assets. Depreciation and amortization as a percentage of sales decreased to 7.5% in fiscal year 2018 from 7.9% in fiscal year 2017 .

Impairment and loss on asset disposal increased by $3.5 million or 1,114.8% to $3.8 million in fiscal year 2018 from $0.3 million in fiscal year 2017 . This increase was due to the impairment of five restaurant locations in Fiscal 2018. Impairment and loss on asset disposal as a percentage of sales increased to 2.5% in Fiscal 2018 from 0.2% in fiscal year 2017 .

Interest and Taxes

Interest expense was $ 6.4 million and $ 6.6 million during the years ended December 30, 2018 and December 31, 2017 , respectively.

In fiscal year 2018 we recorded an income tax benefit of $1.7 million compared with an income tax expense of $19.0 million in fiscal year 2017 . The decrease in the income tax expense is primarily related to the establishment of a full valuation allowance against the Company's deferred tax assets recorded in 2017.

Loss from Operations of the Discontinued Component

Loss from operations of the discontinued component was $0 and $0.2 million in 2018 and 2017 , respectively. The Spin-Off was completed as of December 25, 2016, and as a result, only minor expenses related to Bagger Dave's were incurred in 2017.


28

LIQUIDITY AND CAPITAL RESOURCES; ACQUISITION AND EXPANSION PLANS

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

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

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

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

Going Concern

The Credit Facility contains various customary financial covenants generally based on the performance of the Company. The financial covenants consist of a quarterly minimum required debt service coverage ratio (the "DSCR") and a maximum permitted lease adjusted leverage ratio (the "LALR") which were reset pursuant to an amendment dated February 28, 2018. This amendment also changed the definition of "consolidated EBITDA" used in the calculation of these financial covenants to permit the inclusion of a maximum of $5 million of equity proceeds over the remaining term of the agreement.

On July 24, 2018 the Company completed an underwritten registered public offering of 6 million shares of common stock at a public offering price of $1.00 per share, which included 700,000 shares offered by a certain selling stockholder, for total Company gross proceeds of $5.3 million. The net proceeds from the offering were approximately $4.6 million after deducting the underwriting discounts and commissions and offering expenses payable by us, and were included in "consolidated EBITDA" for purposes of computing financial covenants beginning in the third quarter of 2018. The net proceeds from the offering were intended for working capital and general corporate purposes, including repayment of debt.

As of December 30, 2018 the Company was in compliance with its loan covenants. However, beginning in the third quarter of 2019 the net proceeds from the registered public offering will no longer be included in "consolidated EBITDA" and, as a result, the Company is currently forecasting that it may not be in compliance with these financial covenants in the third quarter.

While the Company has successfully negotiated financial covenant amendments in the past and would seek to do so again should it be in default or near a default, there can be no assurance that it will be successful in obtaining a satisfactory amendment.

As a result of this uncertainty coupled with the June 2020 maturity of the Credit Facility, the Company has been in discussions with its current lenders and other sources of capital regarding a possible refinancing and/or replacement of the Credit Facility. The Company is also exploring various other alternatives, including, among other things, possible equity financing. There can be no assurance, however, that any such efforts will be successful.

Until such time as the Company has executed an agreement to amend, refinance or replace the Credit Facility, the Company cannot conclude that it is probable that it will do so and, accordingly, this raises substantial doubt about the Company’s ability to continue as a going concern.

29


Acquisition and Expansion Plans

Also, on February 22, 2019 we entered in an Asset Purchase Agreement to acquire 9 BWW restaurants in the Chicago, Illinois market for a cash purchase price of approximately $22.5 million, subject to customary closing conditions (the “Acquisition”). The Company's financing discussions referenced above include raising the capital necessary to finance the Acquisition.

Outside of funding our current operations, funding the Acquisition, and servicing our existing debt, our capital requirements are primarily dependent upon our restaurant remodel requirements and the pace of our new restaurant growth plan.

We believe that reinvesting in existing restaurants is an important factor and necessary to maintain the overall positive dining experience for our guests and, as a result, we have historically invested heavily in refreshes and upgrades. Depending on the age of the existing restaurants, upgrades have ranged from $50,000 (for minor interior refreshes or audio/video upgrades) to $1.3 million (for a full extensive remodel of the restaurant with addition of an enclosed patio). While BWW is in the process of developing a new building design standard and testing a variety of remodel options, they have communicated to franchisees that they are targeting a three-tier remodel program with cost ranging from $250,000 to $650,000, depending on the size and revenue profile of the restaurant. We've remodeled or built 27 of our restaurants in the most recent Stadia design standard, and our current plan is to remodel the remaining 37 BWW restaurants to the new design standard over the next 6 years.

We do not currently plan to complete any new restaurant development or any significant facility upgrades in 2019 .

Cash flow from continuing operations for fiscal 2018 and 2017 was $9.6 million and $12.7 million , respectively. Net cash provided by operating activities consisted primarily of net earnings adjusted for non-cash expenses.

For 2018 , our capital expenditures were $1.6 million . Approximately 64% of the capital was used for maintenance type items and the remaining 36% for restaurant refreshes, upgrades and other general corporate purposes.

After the Spin-Off of Bagger Dave’s, the Company retained certain tax benefits (net operating loss and tax credit carryforwards) and, since the Spin-Off, the Company has generated additional tax benefits which, together, will offset pre-tax income totaling over $75 million at current estimated tax rates. We do not expect to incur significant federal and/or state income tax liabilities until our tax benefits have been fully utilized.

Mandatory Upgrades

We did not complete any remodels in 2018 and do not currently expect to complete, nor are we required by the franchisor to complete, any remodels in 2019 . Further, we are currently having discussions with the franchisor regarding requirements for remodels beyond 2019 as the details, specifications and timing of future remodels are being re-evaluated by new ownership after its acquisition of BWW.

Discretionary Upgrades and Relocations

In fiscal year 2018 , the Company invested additional capital to provide minor upgrades and refreshes to a number of its existing locations, funded by cash from operations. These improvements primarily consist of refreshing interior building finishes and audio/visual equipment upgrades. In fiscal 2018 , we did not have any relocations. The decision to relocate is typically driven by timing of our current lease agreements and the availability of real estate that we deem to be a better long-term investment.

2019 Capital Plan

In 2019 , we anticipate our capital expenditures will range between $2.0 million and $2.5 million and will be for minor facility upgrades and general maintenance-type investments in our restaurants. We do not expect to develop any new restaurants or complete any remodels of our existing restaurants.


30

Contractual Obligations

The following table presents a summary of our contractual obligations as of December 30, 2018 :
 
 
Total
 
Less than
one year
 
1 - 3 years
 
3 - 5 years
 
After 5 years
Long-term debt 1
 
$
102,422,630

 
$
11,515,093

 
$
90,907,537

 
$
—

 
$
—

Operating lease obligations
 
72,626,347

 
9,114,525

 
17,558,761

 
14,502,409

 
31,450,652

 
 
$
175,048,977

 
$
20,629,618

 
$
108,466,298

 
$
14,502,409

 
$
31,450,652

1 Amount represents the expected principal cash payments relating to our long-term debt and does not include any fair value adjustments or discounts/premiums or interest rate payments due to the variability of the rates. See Note 7 for additional details.

Impact of Inflation

Our profitability is dependent on, among other things, our ability to anticipate and react to changes in the costs of key operating resources, including food and other raw materials, labor, energy, and other supplies and services. Substantial increases in costs and expenses could impact our operating results to the extent that such increases cannot be passed along to our restaurant guests. The impact of inflation on food, labor, energy and occupancy costs can significantly affect the profitability of our restaurant operations.

All of our restaurant staff members are paid hourly rates related to federal and state minimum wage and, in many cases, the federal or state tipped minimum wage. Certain operating costs, such as taxes, insurance and other outside services continue to increase with the general level of inflation or higher and may also be subject to other cost and supply fluctuations outside of our control.

While we have been able to partially offset inflation and other changes in the costs of key operating resources by gradually increasing prices for our menu items, more efficient purchasing practices, productivity improvements, and greater economies of scale, there can be no assurance that we will be able to continue to do so in the future. From time to time, competitive conditions could limit our menu pricing flexibility. In addition, macroeconomic conditions could make additional menu price increases imprudent. There can be no assurance that all future cost increases can be offset by increased menu prices or that increased menu prices will be fully absorbed by our restaurant guests without any resulting changes in their visit frequencies or purchasing patterns. There can be no assurance that we will continue to generate increases in comparable restaurant sales in amounts sufficient to offset inflationary or other cost pressures.

OFF-BALANCE SHEET ARRANGEMENTS

After the Spin-Off, the Company remains liable for guarantees of certain Bagger Dave’s leases. These guarantees cover 10 separate leases, 3 of which relate to restaurants previously closed by Bagger Dave's and now being operated by a new tenant under either a sub-lease or a new lease.

The Company has determined that its maximum exposure resulting from the lease guarantees includes approximately $7.3 million of future minimum lease payments plus potential additional payments to satisfy maintenance, property tax and insurance requirements under the leases as of December 30, 2018 . The terms and conditions of the guarantees vary, and each guarantee has an expiration date which may or may not correspond with the end of the underlying lease term. These expiration dates range from less than 1 month to 11 years as of December 30, 2018 . In the event that the Company is required to perform under any of its lease guarantees, we do not believe a liability to the Company would be material because it would first seek to minimize its exposure by finding a suitable tenant to sub-lease the space. In many cases, we expect that a replacement tenant would be found and the lessor may agree to release the Company from its future guarantee obligation. Since 2015, 15 Bagger Dave’s locations with DRH lease guarantees were closed. New tenants were found to step into the Company’s lease obligations for 9 of these locations in 3 to 14 months from the date of closure. Over this time, 12 guarantees expired or terminated, and 3 remain obligations of the Company.

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


31

Critical Accounting Polices and Estimates

The preparation of financial statements and related disclosures in conformity with generally accepted accounting principles in the United States of America (“GAAP”) and the Company’s discussion and analysis of its financial condition and operating results require the Company’s management to make judgments, assumptions and estimates that affect the amounts reported in its consolidated financial statements and accompanying notes. Note 1, “Nature of Business and Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K describes the significant accounting policies and methods used in the preparation of the Company’s consolidated financial statements. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates, and such differences may be material. We consider an accounting estimate to be critical if it requires assumptions to be made and changes in these assumptions could have a material impact on our consolidated financial condition or results of operations. Management considers these policies critical because they are both important to the portrayal of the Company’s financial condition and operating results, and they require management to make judgments and estimates about inherently uncertain matters. The Company’s management has reviewed these critical accounting policies and related disclosures with the Audit Committee of the Company’s Board of Directors.

Impairment or Disposal of Long-Lived Assets

We review long-lived assets quarterly to determine if triggering events have occurred which would require a test to determine if the carrying amount of these assets is recoverable based on estimated future cash flows. Assets are reviewed at the lowest level for which cash flows can be identified, which is at the individual restaurant level. In the absence of extraordinary circumstances, restaurants are included in the impairment analysis after they have been open for two years. We evaluate the recoverability of a restaurant’s long-lived assets, including intangibles, leasehold improvements, furniture, fixtures and equipment over the remaining life of the primary asset in the asset group, after considering the potential impact of planned operational improvements, marketing programs, and anticipated changes in the trade area. In determining future cash flows, significant estimates are made by management with respect to future operating results for each restaurant over the remaining life of the primary asset in the asset group. If assets are determined to be impaired, the impairment charge is measured by calculating the amount by which the asset carrying amount exceeds its fair value based on our estimate of discounted future cash flows. The determination of asset fair value is also subject to significant judgment. Based on management's quantitative analysis, an impairment of $3.7 million was recorded for five BWW locations for the fiscal year ended December 30, 2018 . For the fiscal year ended December 31, 2017 no impairment losses were recognized in continuing operations.

We account for exit or disposal activities, including restaurant closures, in accordance with Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 420, Exit or Disposal Cost Obligations . Such costs include the cost of disposing of the assets, as well as other facility-related expenses from previously closed restaurants. These costs are generally expensed as incurred.

Indefinite-Lived Intangible Assets

Liquor licenses, also a component of intangible assets, are deemed to have an indefinite life and, accordingly, are not amortized. Management reviews liquor license assets on an annual basis or more frequently if impairment indicators are present to determine whether carrying values have been impaired. We identify potential impairments for liquor licenses by comparing the fair value with its carrying amount. If the fair value exceeds the carrying amount, the liquor licenses are not impaired. If the carrying amount exceeds the fair value, an impairment loss is recorded for the difference. If the fair value of the asset is less than the carrying amount, an impairment is recorded. No impairments were recognized in fiscal 2018 or  2017 in continuing operations.

Goodwill

Goodwill is not amortized and represents the excess of cost over the fair value of identified net assets of businesses acquired. Goodwill is subject to an annual impairment analysis or more frequently if indicators of impairment exist. At both December 30, 2018 and December 31, 2017 , we had goodwill of $50.1 million . The goodwill is assigned to the Company's Buffalo Wild Wings reporting unit, which is the Company's only reporting unit.

The Company assesses goodwill for impairment on an annual basis during the fourth quarter, or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. The Company’s assessment first reviews relevant qualitative factors to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount. In evaluating whether it is

32

more likely than not that the fair value of a reporting unit is less than its carrying amount, we assess relevant events and circumstances. If, after assessing the totality of events and circumstances, we determine that it is more likely than not that the fair value of the reporting unit is less than the carrying amount, the quantitative impairment test would be necessary. Conversely, if it is not more likely than not that the fair value of the reporting unit is less than the carrying amount, further action would not be required.

We adopted Accounting Standards Update ("ASU") 2017-04, Topic 350: Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment ("ASU 2017-04") as of September 25, 2017. ASU 2017-04 requires goodwill impairment to be measured as the excess of the carrying value over the fair value of the reporting unit, not to exceed the carrying amount of goodwill. The carrying value of our reporting unit as of October 1, 2018 and September 25, 2017 was negative, and therefore goodwill was not impaired as of December 30, 2018 and December 31, 2017 .

Income Taxes

Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.

In accordance with the provisions of FASB ASC 740, Income Taxes , (“ASC 740”) a valuation allowance is established when it is more likely than not that some portion of the deferred tax assets will not be realized. Realization is dependent upon the generation of future taxable income or the reversal of deferred tax liabilities during the periods in which those temporary differences become deductible. We consider the reversal of deferred tax liabilities, projected future taxable income and tax planning strategies. Management assesses the available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit use of the existing deferred tax assets. A significant piece of objective negative evidence evaluated was the cumulative loss incurred over the three-year period ended December 31, 2017, which continued through 2018 . Such objective evidence limits the ability to consider other subjective evidence, such as our projections for future growth. As a result of this evaluation, as of December 31, 2017, a valuation allowance of $17.6 million was recorded because the company was unable to assert that realization of the deferred tax asset is more likely than not. As of December 30, 2018 , the valuation allowance is $18.1 million . The amount of the deferred tax asset considered realizable, however, could be adjusted if estimates of future taxable income increase or if objective negative evidence in the form of cumulative losses is no longer present and additional weight is given to subjective evidence such as our projections for growth.

The Company applies the provisions of ASC 740, regarding the accounting for uncertainty in income taxes. The Company classifies all interest and penalties as income tax expense. There are no accrued interest amounts or penalties related to uncertain tax positions as of December 30, 2018 and December 31, 2017 .

Interest Rate Swap Agreements

The Company utilizes interest rate swap agreements with Citizens Bank, N.A. (“Citizens”) and other banks to fix interest rates on a portion of the Company’s variable rate debt, which reduces exposure to interest rate fluctuations. Our derivative financial instruments are recorded at fair value on the balance sheet. The effective portion of changes in the fair value of derivatives which qualify for hedge accounting is recorded in accumulated other comprehensive income (loss) and is recognized in the statement of operations when the hedged item affects earnings. Ineffective portion of the change in fair value of a hedge would be recognized in income immediately. The Company does not use any other types of derivative financial instruments to hedge such exposures, nor does it use derivatives for speculative purposes.

The interest rate swap agreements associated with the Company’s current debt agreements qualify for hedge accounting. As such, the Company records the change in the fair value of its swap agreements as a component of accumulated other comprehensive income (loss), net of tax. The Company records the fair value of its interest swaps on the Consolidated Balance Sheet in other long-term assets or other liabilities depending on the fair value of the swaps. See Note 7 , Note 14 and Note 15 for additional information on the interest rate swap agreements.

Share-based Compensation

The fair value of restricted shares is equal to the number of restricted shares issued times the Company’s stock price on the date of grant and is amortized as compensation expense on a straight-line basis over the service period of the award.

33


ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Not Applicable.

34

ITEM 8.        CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Consolidated Financial Statements, Notes to Consolidated Financial Statements, and the Report of Independent Registered Accounting Firm are included in this Annual Report and are incorporated herein by reference.


DIVERSIFIED RESTAURANT HOLDINGS, INC.
Index to Consolidated Financial Statements



35

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


Shareholders and Board of Directors
Diversified Restaurant Holdings, Inc.
Southfield, Michigan

Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Diversified Restaurant Holdings, Inc. (the “Company”) and subsidiaries as of December 30, 2018 and December 31, 2017, the related consolidated statements of operations and comprehensive loss, stockholders’ deficit, and cash flows for each of the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 30, 2018 and December 31, 2017, and the results of their operations and their cash flows for the years then ended , in conformity with accounting principles generally accepted in the United States of America.
Going Concern Uncertainty
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company is forecasting an insufficient amount of earnings before taxes, depreciation and amortization to meet the financial covenant ratios set forth in their Credit Facility which will result in the Company’s debt becoming due upon demand which raises substantial doubt about its ability to continue as a going concern. Management’s plans in regard to this matter is also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements 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 audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that 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. We believe that our audits provide a reasonable basis for our opinion.



/s/ BDO USA, LLP

We have served as the Company's auditor since 2011.

Troy, Michigan
April 3, 2019
 

36

DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS  

 
 
December 30, 2018
 
December 31, 2017
ASSETS
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
5,364,014

 
$
4,371,156

Accounts receivable
 
654,322

 
653,102

Inventory
 
1,526,779

 
1,591,363

Prepaid and other current assets
 
511,835

 
408,982

Total current assets
 
8,056,950

 
7,024,603

 
 
 
 
 
Property and equipment, net
 
34,423,345

 
48,014,043

Intangible assets, net
 
2,198,685

 
2,438,187

Goodwill
 
50,097,081

 
50,097,081

Other long-term assets
 
408,761

 
185,322

Total assets
 
$
95,184,822

 
$
107,759,236

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' DEFICIT
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
4,273,133

 
$
4,561,939

Accrued compensation
 
1,830,415

 
1,854,127

Other accrued liabilities
 
2,946,738

 
2,404,942

Current portion of long-term debt
 
11,515,093

 
11,440,433

Current portion of deferred rent
 
427,479

 
411,660

Total current liabilities
 
20,992,858

 
20,673,101

 
 
 
 
 
Deferred rent, less current portion
 
2,385,961

 
2,208,238

Deferred income taxes
 
1,220,087

 
2,759,870

Unfavorable operating leases
 
438,944

 
510,941

Other liabilities
 
1,587,821

 
2,346,991

Long-term debt, less current portion
 
90,907,537

 
102,488,730

Total liabilities
 
117,533,208

 
130,987,871

 
 
 
 
 
Commitments and contingencies (Notes 3, 10 and 11)
 

 

 
 
 
 
 
Stockholders’ deficit :
 
 
 
 
Common stock - $0.0001 par value; 100,000,000 shares authorized; 33,200,708 and 26,859,125, respectively, issued and outstanding
 
3,182

 
2,625

Additional paid-in capital
 
27,021,517

 
21,776,402

Accumulated other comprehensive income (loss)
 
355,293

 
(283,208
)
Accumulated deficit
 
(49,728,378
)
 
(44,724,454
)
Total stockholders’ deficit
 
(22,348,386
)
 
(23,228,635
)
 
 
 
 
 
Total liabilities and stockholders’ deficit
 
$
95,184,822

 
$
107,759,236


See accompanying notes to consolidated financial statements.

37

DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
 
 
 
Fiscal Years Ended
 
 
December 30, 2018
 
December 31, 2017
Revenue
 
$
153,138,219

 
$
165,462,612

 
 
 
 
 
Operating expenses
 
 
 
 
Restaurant operating costs (exclusive of depreciation and amortization shown separately below):
 
 
 
 
Food, beverage, and packaging
 
43,795,044

 
48,799,718

Compensation costs
 
41,111,404

 
41,726,264

Occupancy
 
11,607,378

 
11,720,147

Other operating costs
 
33,455,134

 
35,062,833

General and administrative expenses
 
8,246,709

 
9,081,866

Pre-opening costs
 
—

 
405,448

Depreciation and amortization
 
11,532,662

 
13,115,072

Impairment and loss on asset disposals
 
3,772,431

 
310,536

Total operating expenses
 
153,520,762

 
160,221,884

 
 
 
 
 
Operating (loss)  profit
 
(382,543
)
 
5,240,728

 
 
 
 
 
Interest expense
 
(6,416,531
)
 
(6,633,709
)
Other income, net
 
112,155

 
106,586

 
 
 
 
 
Loss from continuing operations before income taxes
 
(6,686,919
)
 
(1,286,395
)
Income tax benefit (expense) of continuing operations
 
1,682,995

 
(18,997,756
)
Loss from continuing operations
 
(5,003,924
)
 
(20,284,151
)
 
 
 
 
 
Discontinued operations
 


 


Loss from discontinued operations before income taxes
 
—

 
(238,253
)
Income tax benefit of discontinued operations
 
—

 
64,328

Loss from discontinued operations
 
—

 
(173,925
)
 
 
 
 
 
Net loss
 
$
(5,003,924
)
 
$
(20,458,076
)
 
 
 
 
 
Basic and diluted loss per share from :
 
 
 
 
Continuing operations
 
$
(0.17
)
 
$
(0.76
)
Discontinued operations
 
—

 
(0.01
)
Basic and diluted loss per share:
 
$
(0.17
)
 
$
(0.77
)
 
 
 
 
 
Weighted average number of common shares outstanding
 
 

 
 

Basic and diluted
 
28,969,221

 
26,717,910

 


See accompanying notes to consolidated financial statements.

38

DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES  
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS  
 
 
 
Fiscal Years Ended
 
 
December 30, 2018
 
December 31, 2017
Net loss
 
$
(5,003,924
)
 
$
(20,458,076
)
 
 
 
 
 
Other comprehensive income
 
 
 
 
Unrealized changes in fair value of interest rate swaps, net of tax of ($169,728) and ($335,371)
 
638,501

 
651,014

 
 
 
 
 
Comprehensive loss
 
$
(4,365,423
)
 
$
(19,807,062
)
 
 






































See accompanying notes to consolidated financial statements.

39

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

 
 
 
 
 
Additional
 
Accumulated
Other
 

 
Total
 
Common Stock
 
Paid-in
 
Comprehensive
 
Accumulated
 
Stockholders'
 
Shares
 
Amount
 
Capital
 
Income (Loss)
 
Deficit
 
Deficit
Balances - December 25, 2016
26,632,222

 
$
2,610

 
$
21,355,270

 
$
(934,222
)
 
$
(24,534,378
)
 
$
(4,110,720
)
Adoption of ASU 2016-09 (Note 1)
—

 
—

 
—

 
—

 
268,000

 
268,000

Issuance of restricted shares
263,332

 
—

 
—

 
—

 
—

 
—

Forfeitures of restricted shares
(50,850
)
 
—

 
—

 
—

 
—

 
—

Shares effectively repurchased for required employee withholding taxes
(22,716
)
 
(2
)
 
(62,147
)
 
—

 
—

 
(62,149
)
Employee stock purchase plan
37,137

 
4

 
65,196

 
—

 
—

 
65,200

Share-based compensation
—

 
13

 
418,083

 
—

 
—

 
418,096

Other comprehensive income
—

 
—

 
—

 
651,014

 
—

 
651,014

Net loss from continuing operations
—

 
—

 
—

 
—

 
(20,284,151
)
 
(20,284,151
)
Net loss from discontinued operations
—

 
—

 
—

 
—

 
(173,925
)
 
(173,925
)
Balances - December 31, 2017
26,859,125

 
$
2,625

 
$
21,776,402

 
$
(283,208
)
 
$
(44,724,454
)
 
$
(23,228,635
)
Issuance of restricted shares
975,119

 
—

 
—

 
—

 
—

 
—

Forfeitures of restricted shares
(35,671
)
 
—

 
—

 
—

 
—

 
—

 Shares effectively repurchased for required withholding taxes
(50,163
)
 
(5
)
 
(70,345
)
 
—

 
—

 
(70,350
)
Issuance of common shares from offering, net of fees and expenses of $0.7 million
5,300,000

 
530

 
4,579,251

 
—

 
—

 
4,579,781

Employee stock purchase plan
71,274

 
7

 
83,115

 
—

 
—

 
83,122

Share-based compensation
81,024

 
25

 
653,094

 
—

 
—

 
653,119

Other comprehensive income
—

 
—

 
—

 
638,501

 
—

 
638,501

Net loss from continuing operations
—

 
—

 
—

 
—

 
(5,003,924
)
 
(5,003,924
)
Balances - December 30, 2018
33,200,708

 
$
3,182

 
$
27,021,517

 
$
355,293

 
$
(49,728,378
)
 
$
(22,348,386
)
 
 
 
 
 
 
 
 
 
 
 
 



See accompanying notes to consolidated financial statements.

40

DIVERSIFIED RESTAURANT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

 
 
Fiscal Years Ended
 
 
December 30, 2018
 
December 31, 2017
Cash flows from operating activities
 
 
 
 
Net loss
 
$
(5,003,924
)
 
$
(20,458,076
)
Loss from discontinued operations
 
—

 
173,925

Net loss from continuing operations
 
(5,003,924
)
 
(20,284,151
)
Adjustments to reconcile net loss from continuing operations to net cash provided by op erating activities:
 
 
 
 
Depreciation and amortization
 
11,532,662

 
13,115,072

Amortization of debt discount and loan fees
 
296,385

 
294,103

Amortization of gain on sale-leaseback
 
(199,834
)
 
(131,617
)
Impairment and loss on asset disposals
 
3,772,431

 
310,536

Share-based compensation
 
653,094

 
418,096

Deferred income taxes
 
(1,706,828
)
 
18,943,427

Changes in operating assets and liabilities that provided (used) cash
 
 
 
 
Accounts receivable
 
(1,220
)
 
(376,864
)
Inventory
 
64,584

 
109,241

Prepaid and other assets
 
50,847

 
896,954

Intangible assets
 
(20,000
)
 
(48,806
)
Other long-term assets
 
1,987

 
48,217

Accounts payable
 
(300,702
)
 
555,089

Accrued liabilities
 
313,195

 
(1,357,970
)
Deferred rent
 
193,542

 
182,477

Net cash provided by operating activities of continuing operations
 
9,646,219

 
12,673,804

Net cash used in operating activities of discontinued operations
 
—

 
(173,925
)
Net cash provided by operating activities
 
9,646,219

 
12,499,879

 
 
 
 
 
Cash flows from investing activities
 
 
 
 
Purchases of property and equipment
 
(1,623,355
)
 
(4,687,242
)
Net cash used in investing activities
 
(1,623,355
)
 
(4,687,242
)
 
 
 
 
 
Cash flows from financing activities
 
 
 
 
Proceeds from issuance of long-term debt
 
—

 
4,650,965

Repayments of long-term debt
 
(11,622,559
)
 
(12,116,623
)
Proceeds from employee stock purchase plan
 
83,122

 
65,200

Proceeds from issuance of common stock, net of fees and expenses of $0.7 million
 
4,579,781

 
—

Tax withholding for restricted stock
 
(70,350
)
 
(62,149
)
Net cash used in financing activities
 
(7,030,006
)
 
(7,462,607
)
 
 
 
 
 
Net increase in cash and cash equivalents
 
992,858

 
350,030

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

 
4,021,126

 
 
 
 
 
Cash and cash equivalents, end of period
 
$
5,364,014

 
$
4,371,156


See accompanying notes to consolidated financial statements.

41
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1 . NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

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

DRH currently operates 64 BWW restaurants ( 20 in Michigan, 17 in Florida, 15 in Missouri, 7 in Illinois and 5 in Indiana).

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

DRH and its wholly-owned subsidiaries AMC Group, Inc. (“AMC”), AMC Wings, Inc. (“WINGS”), and AMC Real Estate, Inc. (“REAL ESTATE” and, collectively, the "Company") own and operate BWW restaurants. DRH is incorporated in Nevada.

We are economically dependent on retaining our franchise rights with BWW. The franchise agreements have specific initial terms with expiration dates ranging from December 2020 through June 2037 . After consideration of renewal options, the franchise agreements have expiration dates ranging from December 2025 through June 2052 . The franchise agreements are renewable upon written request by the franchisee and upon approval of the franchisor. Franchise agreements are generally renewed if the franchisee has complied with the terms of the franchise agreement.

We follow accounting standards set by the Financial Accounting Standards Board ("FASB"). The FASB sets generally accepted accounting principles in the United States of America ("GAAP") that we follow to ensure we consistently report our financial condition, results of operations, and cash flows. References to GAAP issued by the FASB in these footnotes are to the FASB Accounting Standards Codification ("ASC").

Principles of Consolidation

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include the accounts of the Company and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated.

For Variable Interest Entities ("VIE(s)"), we assess whether we are the primary beneficiary as prescribed by the accounting guidance on the consolidation of a VIE. The primary beneficiary of a VIE is the party that has the power to direct the activities that most significantly impact the performance of the entity and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the entity. See Note 3 to the accompanying notes to the consolidated financial statements for more details.

Segment Reporting

As of December 30, 2018 , the Company has one operating and reportable segment.

Fiscal Year

The Company utilizes a 52- or 53-week accounting period that ends on the last Sunday in December. Fiscal year 2018 ended on December 30, 2018 and was comprised of 52 weeks. Fiscal year 2017 ended on December 31, 2017 was comprised of 53 weeks.


42
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Going Concern

As further discussed in Note 7 , the Company has approximately $102.4 million of debt outstanding under its $155.0 million senior secured credit facility with a syndicate of lenders led by Citizens (the “Credit Facility”) with a maturity date of June 29, 2020. The debt agreement contains various customary financial covenants generally based on the earnings of the Company relative to its debt. The financial covenants consist of a quarterly minimum required debt service coverage ratio (the "DSCR") and a maximum permitted lease adjusted leverage ratio (the "LALR") which were reset pursuant an amendment dated February 28, 2018. This amendment also changed the definition of "consolidated EBITDA" used in the calculation of these financial covenants to permit the inclusion of a maximum of $5 million of equity proceeds over the remaining term of the agreement.

On July 24, 2018 the Company completed an underwritten registered public offering of 6 million shares of common stock at a public offering price of $1.00 per share, which included 700,000 shares offered by a certain selling stockholder, for total Company gross proceeds of $5.3 million . The net proceeds from the offering were approximately $4.6 million after deducting the underwriting discounts and commissions and offering expenses payable by us, and were included in "consolidated EBITDA" for purposes of computing financial covenants beginning in the third quarter of 2018.

As of December 30, 2018 , the Company was in compliance with its loan covenants. However, beginning in the third quarter of 2019, the net proceeds from the registered public offering will no longer be included in "consolidated EBITDA" and, as a result, the Company is currently forecasting that it may not be in compliance with these financial covenants in the third quarter.

While the Company has successfully negotiated financial covenant amendments in the past and would seek to do so again should it be in default or near a default, there can be no assurance that it will be successful in obtaining a satisfactory amendment.

As a result of this uncertainty coupled with the June 2020 maturity of the Credit Facility, the Company has been in discussions with its current lenders and other sources of capital regarding a possible refinancing and/or replacement of the Credit Facility. The Company is also exploring various other alternatives, including, among other things, possible equity financing. There can be no assurance, however, that any such efforts will be successful.

Until such time as the Company has executed an agreement to amend, refinance or replace the Credit Facility, the Company cannot conclude that it is probable that it will do so and, accordingly, this raises substantial doubt about the Company’s ability to continue as a going concern.

However, the accompanying financial statements have been prepared assuming the Company will continue to operate as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The accompanying financial statements do not include adjustments that might result from the outcome of this uncertainty, including any adjustments to reflect the possible future effects of the recoverability and classification of recorded asset amounts or amounts and classifications of liabilities that might be necessary should the Company be unable to continue as a going concern.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash on hand and demand deposits in banks. The Company considers all highly-liquid investments purchased with original maturities of three months or less to be cash and cash equivalents. The Company, at times throughout the year, may, in the ordinary course of business, maintain cash balances in excess of federally-insured limits. Management does not believe the Company is exposed to any unusual risks on such deposits.

Accounts Receivable

At December 30, 2018 and December 31, 2017 , accounts receivable primarily consist of contractually determined receivables from BWW for gift card reimbursements. Accounts receivable are stated at the amount management expects to collect. Balances that are outstanding after management has used reasonable collection efforts are written off with a corresponding charge to bad debt expense. There was no allowance for doubtful accounts necessary at December 30, 2018 and December 31, 2017 .


43
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Gift Cards

The Company records gift cards under a BWW system-wide program. Gift cards sold are recorded as a gift card liability. When redeemed, the gift card liability account is offset by recording the transaction as revenue. At times, gift card redemptions can exceed amounts due to BWW for gift card purchases resulting in an asset balance. Under this centralized system the balance due to/from BWW is settled weekly and we are not responsible for breakage. The Company's gift card balance was an asset of $0.4 million and liability of $0.5 million as of December 30, 2018 and December 31, 2017 , respectively.

Inventory

Inventory consists mainly of food and beverage products and is accounted for at the lower of cost or net realizable value using the first in, first out method of inventory valuation. Cash flows related to inventory sales are classified in net cash provided by operating activities in the Consolidated Statements of Cash Flows.

Prepaids and Other Long-Term Assets

Prepaid assets consist principally of prepaid insurance and service contracts and are recognized ratably as operating expense over the period of future benefit. Other assets consist primarily of security deposits for operating leases and utilities.

Property and Equipment

Property and equipment are recorded at cost. Equipment and furniture and fixtures are depreciated using the straight-line method over the estimated useful lives of the assets, which range from three to seven years . Leasehold improvements, which include the cost of improvements funded by landlord incentives or allowances, are amortized using the straight-line method over the lesser of the term of the lease, or the estimated useful lives of the assets, which is typically five to 15 years . Maintenance and repairs are expensed as incurred. Upon retirement or disposal of assets, the cost and accumulated depreciation are eliminated from the respective accounts and the related gains or losses are credited or charged to earnings.

The Company capitalizes items associated with construction but not yet placed into service, known as construction in progress (“CIP”). Items capitalized include fees associated with the design, build out, furnishing of the restaurants, leasehold improvements, construction period interest (when applicable), equipment, and furniture and fixtures. Restaurant CIP is not amortized or depreciated until the related assets are placed into service. Items are placed into service according to their asset category when the restaurant is open for service.

Intangible Assets

Amortizable intangible assets consist of franchise fees, trademarks, non-compete agreements, and favorable and unfavorable operating leases, and are stated at cost, less accumulated amortization. Intangible assets are amortized on a straight-line basis over the estimated useful life, as follows: franchise fees - 10 – 20 years , trademarks - 15 years , non-compete - 3 years , and favorable and unfavorable leases - over the term of the respective leases.

Liquor licenses, if transferable, are deemed to have an indefinite life and are carried at the lower of fair value or cost. We identify potential impairments for liquor licenses by comparing the fair value with its carrying amount. If the fair value exceeds the carrying amount, the liquor licenses are not impaired. If the fair value of the asset is less than the carrying amount, an impairment charge is recorded. No impairments were recognized in fiscal years ended December 30, 2018 and December 31, 2017 .


44
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Impairment or Disposal of Long-Lived Assets

We review long-lived assets quarterly to determine if triggering events have occurred which would require a test to determine if the carrying amount of these assets may not be recoverable based on estimated future cash flows. Assets are reviewed at the lowest level for which cash flows can be identified, which is at the individual restaurant level. In the absence of extraordinary circumstances, restaurants are included in the impairment analysis after they have been open for two years. We evaluate the recoverability of a restaurant’s long-lived assets, including intangibles, leasehold improvements, furniture, fixtures, and equipment over the remaining life of the primary asset in the asset group, after considering the potential impact of planned operational improvements, marketing programs, and anticipated changes in the trade area. In determining future cash flows, significant estimates are made by management with respect to future operating results for each restaurant over the remaining life of the primary asset in the asset group. If assets are determined to be impaired, the impairment charge is measured by calculating the amount by which the asset carrying amount exceeds its fair value based on our estimate of discounted future cash flows. The determination of asset fair value is also subject to significant judgment. Refer to Note 17 for additional information.

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

Goodwill

Goodwill is not amortized and represents the excess of cost over the fair value of identified net assets of businesses acquired. Goodwill is subject to an annual impairment analysis or more frequently if indicators of impairment exist. At both December 30, 2018 and December 31, 2017 , we had goodwill of $50.1 million . The goodwill is assigned to the Company's Buffalo Wild Wings reporting unit, which, represents the Company's only reporting unit.

The Company assesses goodwill for impairment on an annual basis during the fourth quarter, or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. The Company’s assessment first reviews relevant qualitative factors to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount. In evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we assess relevant events and circumstances. If, after assessing the totality of events and circumstances, we determine that it is more likely than not that the fair value of the reporting unit is less than the carrying amount, the quantitative impairment test would be necessary. Conversely, if it is not more likely than not that the fair value of the reporting unit is less than the carrying amount, further action would not be required.

We adopted Accounting Standards Update ("ASU") 2017-04, Topic 350: Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment ("ASU 2017-04") as of September 25, 2017. ASU 2017-04 requires goodwill impairment to be measured as the excess of the carrying value over the fair value of the reporting unit, not to exceed the carrying amount of goodwill. The carrying value of our reporting unit as of October 1, 2018 and September 25, 2017 was negative, and therefore goodwill was not impaired as of December 30, 2018 and December 31, 2017 .

Deferred Rent

Certain operating leases provide for minimum annual payments that increase over the life of the lease. Typically, our operating leases contain renewal options under which we may extend the initial lease terms for periods of five to  10 years . The aggregate minimum annual payments are expensed on a straight-line basis commencing at the start of our construction period and extending over the term of the related lease. The amount by which straight-line rent exceeds actual lease payment requirements in the early years of the lease is accrued as deferred rent liability and reduced in later years when the actual cash payment requirements exceed the straight-line expense. The Company also accounts, in its straight-line computation, for the effect of any rental holidays, free rent periods, and landlord incentives or tenant improvement allowances.


45
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Deferred Gains

Deferred gains from sale leaseback transactions are recognized into income over the life of the related operating lease agreements.

Revenue Recognition

Revenue is measured based on consideration specified in implied contracts with our customers and excludes amounts collected on behalf of third parties. The Company recognizes revenue when it satisfies a performance obligation (at the time of sale) by transferring control over a product to a customer. Payment is due at the time the food or merchandise is transferred to the customer. The portion of any sale that results in loyalty rewards being issued is deferred, net of estimated breakage, until redemption.
Disaggregation of Revenue
In the following table, revenue is disaggregated by product mix.

Disaggregated Revenue
 
 
 
 
Product
December 30, 2018
 
December 31, 2017
Food
$
127,808,443

 
$
138,112,003

Alcohol
25,329,776

 
27,350,609

Total
$
153,138,219

 
$
165,462,612


Blazin' Rewards® Loyalty Program

In 2017, the Company completed the implementation of a customer loyalty program, Blazin' Rewards®. The program allows members to earn points when they make purchases at our restaurants. The Company developed an estimate for the value of each point based on historical data. We record the fair value, net of estimated breakage, of the points as a reduction of restaurant sales and establish a liability within deferred revenue as the points are earned. Breakage is the percentage of points earned that are not expected to be redeemed. The revenue associated with the points is recognized upon the redemption of the points. Points generally expire after six months of inactivity.

Nature of Goods Sold
DRH earns revenue through sales of food, beverages, and merchandise to our customers. These sales occur through multiple channels, such as in-restaurant, call-in, online (web-based) and via third party delivery services.
BWW offers a system-wide loyalty program (Blazin’ Rewards®) whereby enrolled customers earn points for each qualifying purchase. As a franchisee, DRH is required to participate in the program. DRH estimates the value of loyalty points earned (the value per point) by dividing the menu price of redeemable items by the loyalty reward points required to redeem that menu item. Points issued as part of the loyalty program expire after 6 months of member inactivity. DRH commissioned a study to determine a reasonable estimate of the breakage rate, which was approximately 32% .

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

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

46
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Advertising

Advertising expenses associated with contributions to the BWW advertising fund and regional cooperatives (between 3.15% and 3.50% of total net sales) are recorded as operating expenses as contributed, while all other advertising expenses are recorded in general and administrative expenses as incurred. Advertising and co-op expenses of continuing operations of $5.0 million and $5.4 million are included in other operating costs in the Consolidated Statements of Operations and advertising expense of $1.1 million and $0.8 million are included in general and administrative expenses in the Consolidated Statements of Operations for the fiscal years ended December 30, 2018 and December 31, 2017 , respectively.

Pre-opening Costs

Pre-opening costs are those costs associated with opening new restaurants and will vary based on the number of new locations opening and under construction. Pre-opening costs typically consist of manager salaries, relocation costs, supplies, recruiting expenses, certain marketing costs and costs associated with team member training. The Company also reclassifies labor costs that exceed the historical average for the first three months of restaurant operations that are attributable to training. These costs are expensed as incurred. Pre-opening costs in continuing operations were $0 and $0.4 million for the years ended December 30, 2018 and December 31, 2017 , respectively. Excess labor cost incurred after restaurant opening and included in pre-opening cost were approximately $0 and $0.1 million for the fiscal years ended December 30, 2018 and December 31, 2017 , respectively.

Income Taxes

Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. A reclassification of the prior year deferred tax table was made to conform to the current year presentation.

The Company applies the provisions of ASC Topic 740, Income Taxes , regarding the accounting for uncertainty in income taxes. The Company classifies all interest and penalties as income tax expense. There are no accrued interest amounts or penalties related to uncertain tax positions as of December 30, 2018 and December 31, 2017 .

Earnings Per Common Share

Earnings per share are calculated under the provisions of FASB ASC 260, Earnings per Share, which requires a dual presentation of "basic" and "diluted" earnings per share on the face of the Consolidated Statements of Operations. Basic earnings per common share excludes dilution and is computed by dividing the net earnings available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share include dilutive common stock equivalents consisting of stock options determined by the treasury stock method. Restricted stock awards contain non-forfeitable rights to dividends, making such awards participating securities. The calculation of basic and diluted earnings per share uses an earnings allocation method to consider the impact of restricted stock.

Share-based Compensation

The fair value of restricted shares is equal to the number of restricted shares issued times the Company’s stock price on the date of grant and is amortized as compensation expense on a straight-line basis over the service period of the award.

Concentration Risks

Approximately 76.0% and 76.9% of the Company's continuing revenues for the fiscal years ended December 30, 2018 and December 31, 2017 , respectively, were generated from food and beverage sales from restaurants located in the Midwest region. The remaining 24.0% and 23.1% of the Company's continuing revenues for the years ended December 30, 2018 and December 31, 2017 , respectively, were generated from food and beverage sales from restaurants located in Florida.


47
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.

Interest Rate Swap Agreements

The Company utilizes interest rate swap agreements with Citizens Bank, N.A. (“Citizens”) and other banks to fix interest rates on a portion of the Company’s portfolio of variable rate debt, which reduces exposure to interest rate fluctuations. Our derivative financial instruments are recorded at fair value on the Consolidated Balance Sheets. The effective portion of changes in the fair value of derivatives which qualify for hedge accounting is recorded in other comprehensive income and is recognized in the Consolidated Statements of Operations when the hedged item affects earnings. Ineffective portion of the change in fair value of a hedge would be recognized in income immediately. The Company does not use any other types of derivative financial instruments to hedge such exposures, nor does it use derivatives for speculative purposes.

The interest rate swap agreements associated with the Company’s current debt agreements qualify for hedge accounting. As such, the Company records the change in the fair value of its swap agreements as a component of accumulated other comprehensive income (loss), net of tax. The Company records the fair value of its interest swaps on the Consolidated Balance Sheets in other long-term assets or other liabilities depending on the fair value of the swaps. See Note 7 and Note 14 for additional information on the interest rate swap agreements.

Recent Accounting Pronouncements

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

In February 2016, FASB issued ASU No. 2016-02, Leases ("ASU 2016-02"). ASU 2016-02 requires that lease arrangements longer than 12 months result in a lessee recognizing a lease asset and liability. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The updated guidance is effective for interim and annual periods beginning after December 15, 2018, and early adoption is permitted. We have analyzed the impact of the new standard and concluded that the adoption of ASU 2016-02 will materially impact our consolidated financial statements by significantly increasing our non-current assets and liabilities on our consolidated balance sheets in order to record the right of use assets and related lease liabilities for our operating leases. We lease all of our restaurant properties, and operating leases comprise the majority of our current lease portfolio. With respect to implementation, we have substantially completed our review of the accounting standard, which will have a material impact on our consolidated financial statements and will expand our required disclosures. We will adjust comparative periods and have elected the package of practical expedients to not reassess whether a contract is or contains a lease, lease classification, and initial direct costs. We expect adoption of the standard will have the impact of increasing our consolidated assets and liabilities. The Company expects adoption of the standard will not have a material impact on its Consolidated Statements of Comprehensive Income (Loss) or Consolidated Statements of Cash Flows.

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


48
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Recently Adopted Accounting Pronouncements

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

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

In January 2017, the FASB issued Accounting Standards Update ("ASU") 2017-04, Topic 350: Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). ASU 2017-04 simplified wording and removes step 2 of the goodwill impairment test. A goodwill impairment will now be the amount by which a reporting units carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. ASU 2017-04 is effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2020, with early adoption permitted for interim or annual goodwill impairment tests on testing dates after January 1, 2017. The Company adopted the standard as of September 25, 2017. The Company has one reporting unit with a negative carrying value, and as a result of the adoption of this standard, there has been no goodwill impairment recognized.

In March 2016, the FASB issued ASU 2016-09, Topic 718: Compensation - Stock Compensation: Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"). ASU 2016-09 simplifies several aspects of accounting for share-based payment award transactions, including income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. ASU 2016-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, with early adoption permitted. Beginning in fiscal 2017, the tax effects of awards will be recognized in the statement of operations. In addition, the Company will account for forfeitures as they occur.

Effective December 26, 2016, the Company adopted the accounting guidance contained within ASU 2016-09. As a result, the Company recorded a deferred tax asset and retained earnings increase of $268,000 to recognize the Company's excess tax benefits that existed as of December 25, 2016, on the Consolidated Balance Sheet.

Significant Transaction

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


2 . DISCONTINUED OPERATIONS

Spin-Off of Bagger Dave's

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

49
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

on December 25, 2016 via a one-for-one distribution of common shares in Bagger Dave's to DRH holders of record on December 19, 2016.As part of the Spin-Off transaction, DRH agreed to fund a one-time $2.0 million cash distribution to Bagger Dave's.

Prior to the Spin-Off, Bagger Dave’s was a co-obligor on a joint and several basis with the Company on its Credit Facility. The Company’s debt under this facility remained with the Company and Bagger Dave’s was released as a borrower. As a result, this debt was not assigned to discontinued operations. Additionally, DRH retained substantially all of the tax benefits (net operating loss and tax credit carryforwards) generated by Bagger Dave's prior to the date of the transaction. See Note 9 for additional information related to income taxes.

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

In conjunction with the Spin-Off, DRH entered into a transition services agreement (the "TSA") with Bagger Dave's pursuant to which DRH provided certain information technology and human resources support, limited accounting support, and other minor administrative functions at no charge. The TSA was intended to assist the discontinued component in efficiently and seamlessly transitioning to stand on its own. Certain provisions of the TSA terminated in December 2017 and the First Amendment to TSA (the "Amended TSA") was entered into effective January 1, 2018. Under the Amended TSA, DRH provides ongoing administrative support to Bagger in certain areas, including information technology, human resources and real estate, in exchange for a fee based on a rate-per-hour of service. The amount charged to Bagger Dave’s was $0.1 million during the year ended December 30, 2018 .

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

•
Consolidated Statements of Operations - Bagger Dave's results of operations for the year ended December 31, 2017 have been presented as discontinued operations. There was no gain or loss on the transaction recorded. There was no activity related to the discontinued operation at the Company for the year ended December 30, 2018 .

•
Consolidated Statements of Cash Flows - Bagger Dave's cash flows from operating activities for the year ended December 31, 2017 have been presented separately on the face of the cash flow statements.There was no activity related to the discontinued operation at the Company for the year ended December 30, 2018 .

The following are major classes of line items constituting pre-tax loss from discontinued operations:
 
 
Fiscal Years Ended
 
 
December 30, 2018
 
December 31, 2017
Restaurant operating costs (exclusive of depreciation and amortization)
 
$
—

 
$
95,536

General and administrative expenses
 
—

 
(334,529
)
Depreciation and amortization
 
—

 
740

Loss from discontinued operations before income taxes
 
—

 
(238,253
)
Income tax benefit
 
—

 
64,328

Total loss from discontinued operations
 
$
—

 
$
(173,925
)

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

50
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


The following table summarizes the Company’s accrual activity related to facility closures during the fiscal years ended December 30, 2018 and December 31, 2017 :
 
Fiscal 2018
 
Fiscal 2017
Beginning of the year
$
—

 
$
107,153

Charges
—

 
—

Payments/utilizations/other
—

 
(107,153
)
End of the year
$
—

 
$
—


The closure liability of $0.1 million was retained by the Company after the Spin-Off of Bagger Dave's, as it was responsible for certain ongoing lease payments associated with the closures.

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

3 . UNCONSOLIDATED VARIABLE INTEREST ENTITIES

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

Lease Guarantees

At December 30, 2018 the Company is a guarantor for 10 leases, 3 of which have been re-leased to an unaffiliated party. In the event the respective lessees cannot make their lease payments, the Company may become responsible for the payments under its guarantee.

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

Secondly, the Company considered the contingent component of the guarantees and concluded that, as of December 30, 2018 and December 31, 2017 , no loss under the guarantees was probable because all of the Bagger Dave's restaurants subject to the leases is either currently operating or the site has been leased to another tenant who is responsible for, and making, the lease payments.


51
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company has determined that its maximum exposure resulting from the lease guarantees includes approximately $7.3 million of future minimum lease payments plus potential additional payments to satisfy maintenance, property tax and insurance requirements under the leases as of December 30, 2018 . The terms and conditions of the guarantees vary, and each guarantee has an expiration date which may or may not correspond with the end of the underlying lease term. The guarantee expiration dates range from less than 1 month to 11 years as of December 30, 2018 . In the event that the Company is required to perform under any of its lease guarantees, we do not believe the liability would be material because we would first seek to minimize the exposure by finding a suitable tenant to lease the space. In many cases, we expect that a replacement tenant would be found and the lessor would agree to release the Company from its future guarantee obligation. Since 2015, 15 Bagger Dave’s locations with DRH lease guarantees were closed. New tenants were found to step into the Company’s lease obligations for 9 of these locations in 3 to 14 months from the date of closure. Over this time, 12 guarantees expired or terminated, and 3 remain obligations of the Company. In reaching our conclusion, we also considered the following:

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

The following table discloses the guarantee expiration of all Bagger Dave's leases that include a guarantee by the Company as of December 30, 2018 :
Guarantee Expiration
Future guaranteed lease payments
Less than six years
423,813

Six to ten years
5,034,624

11 to 15 years
1,843,013

Total
7,301,450



4 . PROPERTY AND EQUIPMENT, NET
 
Property and equipment are comprised of the following:
 
 
December 30, 2018
 
December 31, 2017
Equipment
 
$
29,556,728

 
$
30,252,867

Furniture and fixtures
 
7,242,522

 
7,444,792

Leasehold improvements
 
61,044,840

 
64,936,413

Restaurant construction in progress
 
439,321

 
161,942

Total
 
98,283,411

 
102,796,014

Less accumulated depreciation
 
(63,860,066
)
 
(54,781,971
)
Property and equipment, net
 
$
34,423,345

 
$
48,014,043


Depreciation expense for the years ended December 30, 2018 and December 31, 2017 was $11.5 million and $13.0 million , all of which related to continuing operations.

52
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


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

 
$
1,290,642

Trademark
 
2,500

 
2,500

Non-compete
 
76,560

 
76,560

Favorable operating leases
 
148,799

 
351,344

Loan fees
 
—

 
368,083

Total
 
1,533,501

 
2,089,129

 
 
 
 
 
Less accumulated amortization
 
(591,143
)
 
(907,269
)
Amortized intangible assets, net
 
942,358

 
1,181,860

 
 
 
 
 
Unamortized intangible assets
 
 
 
 
Liquor licenses
 
1,256,327

 
1,256,327

Total intangible assets, net
 
$
2,198,685

 
$
2,438,187


Amortization expense for both years ended December 30, 2018 and December 31, 2017 was $ 0.1 million . Amortization of favorable/unfavorable leases and loan fees are reflected as part of occupancy and interest expense, respectively. Loan fees written off to interest expense during both years ended December 30, 2018 and December 31, 2017 was $0.1 million.

Based on the current intangible assets and their estimated useful lives, future intangible-related expense for the next five years and thereafter is projected as follows:
Year
Amount
2019
$
100,869

2020
100,869

2021
89,388

2022
87,042

2023
85,480

Thereafter
478,710

Total
$
942,358


The aggregate weighted-average amortization period for intangible assets is 7.8 years .

6 . OTHER ACCRUED LIABILITES
 
 
December 30, 2018
 
December 31, 2017
Sales tax payable
 
$
940,165

 
$
906,410

Accrued interest
 
484,535

 
481,431

Accrued royalty fees
 
173,189

 
179,114

Accrued property taxes
 
224,865

 
69,970

Accrued loyalty rewards
 
847,434

 
439,106

Other
 
276,550

 
328,911

Total other accrued liabilities
 
$
2,946,738

 
$
2,404,942


53
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


7 . DEBT

Debt consists of the following obligations:
 
 
December 30, 2018
 
December 31, 2017
$120.0 million term loan - the rate at December 30, 2018 and December 31, 2017 was 5.85% and 4.87%, respectively.
 
$
79,698,616

 
$
89,698,616

$30.0 million development line of credit, converted to the DF Term Loan in December 2016 and June 2018. The rate at December 30, 2018 and December 31, 2017 was 5.85% and 4.87%, respectively.
 
18,111,259

 
16,682,853

$5.0 million revolving line of credit - the rate at December 30, 2018 and December 31, 2017 was 6.01% and 5.11%, respectively.
 
5,000,000

 
5,000,000

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

 
3,050,965

Unamortized discount and debt issuance costs
 
(387,245
)
 
(503,271
)
 
 
 
 
 
Total debt
 
102,422,630

 
113,929,163

 
 
 
 
 
Current portion of debt
 
(11,515,093
)
 
(11,440,433
)
 
 
 
 
 
Long-term debt
 
$
90,907,537

 
$
102,488,730


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

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

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

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

Fees related to the term debt are recorded as debt discount and fees related to the DLOC and RLOC are capitalized as intangible assets. Debt issuance costs represent legal, consulting and financial costs associated with debt financing. As a result of the December 2016 Amendment, the Company incurred $197,889 of debt issuance costs recorded as a part of debt discount. Debt discount related to term debt, net of accumulated amortization, totaled $387,245 and $503,271 , at December 30, 2018 and December 31, 2017 , respectively. Debt discount and debt issuance cost are amortized over the life of the debt and are recorded in interest expense using the effective interest method.


54
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Based on the long-term debt terms that existed at December 30, 2018 , the scheduled principal maturities, net of unamortized discount, for the next five years and thereafter are summarized as follows:
 
Amount
2019
$
11,515,093

2020
90,907,537

Thereafter
—

Total
$
102,422,630


Interest expense was $6.4 million and $6.6 million for the years ended December 30, 2018 and December 31, 2017 , respectively.

The debt agreement contains various customary financial covenants generally based on the earnings of the Company relative to its debt. The financial covenants consist of a quarterly minimum required DSCR and a maximum permitted LALR which were reset pursuant to an amendment dated February 28, 2018. This amendment also changed the definition of "consolidated EBITDA" used in the calculation of these financial covenants to permit the inclusion of a maximum of $5 million of equity proceeds over the remaining term of the agreement. As of December 30, 2018 , the Company was in compliance with its loan covenants. However, beginning in the third quarter of 2019, the net proceeds from the registered public offering will no longer be included in "consolidated EBITDA" and, as a result, the Company is currently forecasting that it may not be in compliance with these financial covenants beginning in the third quarter. Unless, at that time, we obtain a waiver for or amendment of the financial covenants, which requires that lenders representing at least 50.1% of the outstanding principal amount are in agreement, failure to comply with the financial covenants would represent an event of default under the Credit Agreement and would allow the lenders to accelerate the debt.

On July 24, 2018, the Company completed an underwritten registered public offering of 6 million shares of common stock at a public offering price of $1.00 per share, which included 700,000 shares offered by a certain selling stockholder, for total Company gross proceeds of $5.3 million. The net proceeds from the offering were approximately $4.6 million after deducting the underwriting discounts and commissions and offering expenses payable by us, and were included in "consolidated EBITDA" for purposes of computing financial covenants beginning in the third quarter of 2018.

At December 30, 2018 , the Company has three interest rate swap agreements to fix a portion of the interest rates on its variable rate debt. The swap agreements all qualify for hedge accounting. Under the swap agreements, the Company receives interest at the one -month LIBOR and pays a fixed rate. Since these swap agreements qualify for hedge accounting, the changes in fair value are recorded in Other comprehensive income , net of tax. See Note 1 and Note 14 for additional information pertaining to interest rate swaps.

The following tables summarize the fair values of derivative instruments designated as cash flow hedges which were outstanding:
 
 
 
December 30, 2018
Interest rate swaps
Rate
Expires
Notional amounts
 
Derivative assets
 
Derivative liabilities
April 2012
1.4%
April 2019
$
761,905

 
$
1,689

 
$
—

January 2015
1.8%
December 2019
25,809,524

 
152,011

 
—

August 2015
2.3%
June 2020
58,930,655

 
225,426

 
—

Total
 
 
$
85,502,084

 
$
379,126

 
$
—

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

 
$
6,028

 
$
—

July 2013
1.4%
April 2018
2,833,333

 
778

 
—

May 2014
1.54%
April 2018
7,142,857

 
—

 
408

January 2015
1.8%
December 2019
21,690,476

 
25,953

 
—

August 2015
2.3%
June 2020
60,412,798

 
—

 
461,455

Total
 
 
$
95,127,083

 
$
32,759

 
$
461,863


55
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


8 . SHARE-BASED COMPENSATION

The Company established a Stock Incentive Plan in 2011, and on July 13, 2017, the Company's shareholders approved a new stock incentive plan - the Stock Incentive Plan of 2017 (“Stock Incentive Plan”) to attract and retain directors, consultants, and team members and to align their interests with the interests of the Company’s shareholders through the opportunity for increased stock ownership. No further grants will be made under the Stock Incentive Plan of 2011.

The Stock Incentive Plan of 2017 authorized a total of 2,500,000 shares for issuance as incentive awards by way of stock options and/or restricted stock. Stock options must be awarded at exercise prices at least equal to or greater than 100.0% of the fair market value of the shares on the date of grant. The options will expire no later than 10 years from the date of grant, with vesting terms to be defined at grant date, ranging from a vesting schedule based on performance to a vesting schedule that extends over a period of time as selected by the Compensation Committee of the Board of Directors (the “Committee”) or another committee as determined by the Board of Directors. The Committee also determines the grant, issuance, retention, and vesting timing and conditions of awards of restricted stock. The Committee may place limitations, such as continued employment, passage of time, and/or performance measures, on restricted stock. Awards of restricted stock may not provide for vesting or settlement in full of restricted stock based on a performance measure for a performance period of less than one year or based on continued employment or the passage of time over a period of less than one year from the date the award is made.

Restricted share awards

During fiscal years ended December 30, 2018 and December 31, 2017 , restricted shares were issued to certain team members at a weighted-average grant date fair value of $1.15 and $2.31 , respectively. Based on the Stock Award Agreement, shares typically vest ratably over either a one or three year period, or on the third anniversary of the grant date, as determined by the Committee. Unrecognized share-based compensation expense of $1.0 million and $0.8 million at December 30, 2018 and December 31, 2017 , respectively, will be recognized over the remaining weighted-average vesting period of 2.6 years . The total fair value of shares vested during years ended December 30, 2018 and  December 31, 2017 was $0.6 million  and $0.4 million , respectively. Under the Stock Incentive Plan of 2017, there are 1.2 million shares available for future awards at December 30, 2018 .

The following table presents the restricted stock transactions for fiscal  2018 :
 
Number of Restricted Stock Shares
Unvested, December 31, 2017
531,000

Granted
1,056,143

Vested
(226,470
)
Vested shares tax portion
(50,163
)
Forfeited
(35,671
)
Unvested, December 30, 2018
1,274,839


The following table presents the restricted stock transactions for fiscal  2017 :
 
Number of Restricted Stock Shares
Unvested, December 25, 2016
473,391

Granted
263,332

Vested
(132,157
)
Vested shares tax portion
(22,716
)
Forfeited
(50,850
)
Unvested, December 31, 2017
531,000


Stock Options


56
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

On July 30, 2010, prior to the Stock Incentive Plan, DRH granted options for the purchase of 210,000 shares of common stock to the directors of the Company. These options are fully vested and originally expired six years from issuance. On August 13, 2015, 30,000 shares were exercised at a price of $2.50 per share. The intrinsic value of the options exercised was $6,300 . On July 28, 2016, the Stock Option Agreement of 2010 was amended to extend the expiration date of these options to July 31, 2019. The options can be exercised at a price of $2.50 per share. On August 30, 2018, 30,000 options were forfeited. At December 30, 2018 , 150,000 shares of authorized common stock are reserved for issuance to provide for the exercise of the remaining options. The intrinsic value of outstanding options was negligible as of both December 30, 2018 and December 31, 2017 .

Employee stock purchase plan

The Company also reserved 250,000 shares of common stock for issuance under the Employee Stock Purchase Plan (“ESPP”). The ESPP is available to team members subject to employment eligibility requirements. Participants may purchase common stock at 85.0% of the lesser of the start or end price for the offering period. The plan has four offering periods, each start/end date approximates the fiscal quarter and are awarded on the last day of the offering period. During the years ended December 30, 2018 and  December 31, 2017 we issued 71,274 and  37,137 shares, respectively. Under the ESPP, there are 75,914 shares available for future purchase at December 30, 2018 .

Share-based compensation

Share-based compensation of $0.7 million and $0.4 million was recognized during the years ended  December 30, 2018 and December 31, 2017 , respectively, as compensation costs in the Consolidated Statements of Operations and as additional paid-in capital on the Consolidated Statements of Stockholders' Equity (Deficit) to reflect the fair value of shares vested.

Preferred stock

The Company has authorized 10,000,000 shares of preferred stock at a par value of $0.0001 .  No preferred shares are issued or outstanding as of December 30, 2018 . Any preferences, rights, voting powers, restrictions, dividend limitations, qualifications, and terms and conditions of redemption shall be set forth and adopted by a Board of Directors' resolution prior to issuance of any series of preferred stock.

9 . INCOME TAXES

The Tax Cuts and Jobs Act (the "Tax Act") was signed into law on December 22, 2017. The Tax Act includes a number of changes to existing U.S. tax laws that impact the Company, most notably a reduction of the U.S. corporate tax rate from 35% to 21% for tax years beginning after December 31, 2017. Additionally, in December 2017, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which addresses how a company recognizes provisional amounts when a company does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete its accounting for the effect of the changes in the Tax Act. The measurement period, as defined in SAB 118, ends when a company has obtained, prepared and analyzed the information necessary to finalize its accounting, but cannot extend beyond one year. As of December 31, 2017, the Company provided a provisional provision of $3.1 million in the re-measurement of U.S. deferred tax assets. During 2018, the Company finalized its provisional amounts related to U.S. deferred tax assets resulting in a tax benefit of $0.3 million .

The income tax provision (benefit) from continuing operations consists of the following components for the fiscal years ended December 30, 2018 and December 31, 2017 :
 
 
Fiscal Years Ended
 
 
December 30, 2018
 
December 31, 2017
Federal:
 
 
 
 
Current
 
$
—

 
$
—

Deferred
 
(1,762,866
)
 
17,346,134

State:
 
 
 
 
Current
 
26,517

 
(10,000
)
Deferred
 
53,354

 
1,661,622

Income tax provision (benefit)
 
$
(1,682,995
)
 
$
18,997,756



57
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The provision (benefit) for income taxes is different from that which would be obtained by applying the statutory federal income tax rate to loss before income taxes. The items causing this difference are as follows:
 
 
Fiscal Years Ended
 
 
December 30, 2018
 
December 31, 2017
Income tax benefit at federal statutory rate
 
$
(1,404,253
)
 
$
(437,374
)
State income tax
 
91,951

 
1,651,622

Permanent differences
 
347,084

 
506,867

Tax credits
 
(1,642,618
)
 
(1,807,523
)
Tax Reform
 
(348,237
)
 
3,135,891

Other
 
477,739

 
—

Change in valuation allowance
 
795,339

 
15,948,273

Income tax provision (benefit)
 
$
(1,682,995
)
 
$
18,997,756


In accordance with the provisions of ASC 740, a valuation allowance is established when it is more likely than not that some portion of the deferred tax assets will not be realized. Realization is dependent upon the generation of future taxable income or the reversal of deferred tax liabilities during the periods in which those temporary differences become deductible. We consider the reversal of deferred tax liabilities, projected future taxable income and tax planning strategies. Management assesses the available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit use of the existing deferred tax assets. A significant piece of objective negative evidence evaluated was the cumulative loss incurred over the three-year period ended December 31, 2017. Such objective evidence limits the ability to consider other subjective evidence, such as our projections for future growth. As a result of this evaluation, as of December 31, 2017, a valuation allowance of $17.6 million was established because the Company was unable to assert that realization of the deferred tax asset is more likely than not. We maintain that assertion as of December 30, 2018 , therefore the valuation allowance remains in place. We recorded an increase to the valuation allowance of $0.5 million for the fiscal year ended December 30, 2018 . The amount of the deferred tax asset considered realizable, however, could be adjusted if estimates of future taxable income increase or if objective negative evidence in the form of cumulative losses is no longer present and additional weight is given to subjective evidence such as our projections for growth.


58
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred income tax assets and liabilities are summarized as follows:
 
 
December 30, 2018
 
December 31, 2017
Deferred tax assets:
 
 
 
 
Net operating loss carry-forwards
 
$
7,578,965

 
$
8,467,300

Deferred rent expense
 
743,778

 
549,540

Start-up costs
 
5,174

 
81,962

Tax credit carry-forwards
 
9,393,552

 
8,366,915

Interest rate swaps
 
—

 
90,112

Sale leaseback deferred gain
 
344,236

 
314,598

Share-based compensation
 
239,016

 
218,853

Tax depreciation in excess of book
 
1,727,234

 
—

Other
 
486,588

 
296,721

Total deferred tax assets
 
20,518,543

 
18,386,001

 
 

 
 
Deferred tax liabilities:
 
 
 
 
Tax depreciation in excess of book
 
—

 
881,810

Interest rate swaps
 
79,616

 
—

Goodwill amortization in excess of book
 
3,524,692

 
2,647,173

Total deferred tax liabilities
 
3,604,308

 
3,528,983

 
 
 
 
 
Net deferred income tax asset, before valuation allowance
 
16,914,235

 
14,857,018

Valuation allowance on net deferred income tax assets
 
(18,134,322
)
 
(17,616.888
)
Net deferred income tax assets (liabilities)
 
$
(1,220,087
)
 
$
(2,759,870
)

As of December 30, 2018 and December 31, 2017 , the Company has available federal net operating loss carryforwards ("NOLs") of approximately $30.8 million and $33.3 million , respectively. These NOLs expire between 2034 and 2036 . As of December 30, 2018 and December 31, 2017 , the Company has available state NOLs of approximately $22.2 million and $24.2 million , respectively. These NOLs expire between 2026 and 2036. General business tax credits of $9.4 million will expire between 2028 and 2037 .

The Company applies the provisions of ASC 740 regarding the accounting for uncertainty in income taxes. There are no amounts recorded on the Company's consolidated financial statements for uncertain positions. The Company classifies all interest and penalties as income tax expense. There are no accrued interest amounts or penalties related to uncertain tax positions as of December 30, 2018 .

The Company files income tax returns in the United States federal jurisdiction and various state jurisdictions, and is subject to U.S. Federal, state, and local income tax examinations for tax years 2015 through 2017. The Company is not currently under IRS exam for the any fiscal year.

10 . OPERATING LEASES

The Company's lease terms generally include renewal options, and frequently require us to pay a proportionate share of real estate taxes, insurance, common area maintenance, and other operating costs. Some restaurant leases provide for contingent rental payments based on sales thresholds.

Total rent expense was $8.9 million and $8.8 million for the fiscal years ended December 30, 2018 and December 31, 2017 , respectively.


59
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Scheduled future minimum lease payments for each of the five years and thereafter for non-cancelable operating leases for existing restaurants with initial or remaining lease terms in excess of one year at December 30, 2018 are summarized as follows:
Year
Amount
2019
$
9,114,525

2020
9,079,957

2021
8,478,804

2022
7,710,003

2023
6,792,406

Thereafter
31,450,652

Total
$
72,626,347


11 . COMMITMENTS AND CONTINGENCIES

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

Franchise Related
The Company is required to pay BWW royalties ( 5.0% of net sales) and advertising fund contributions ( 3.00% - 3.15% of net sales). In addition, the Company is required to contribute an additional 0.25% - 0.5% of regional net sales related to advertising cooperatives for certain metropolitan markets for the term of the individual franchise agreements. The Company incurred $7.7 million and $8.3 million in royalty expense for the fiscal years ended December 30, 2018 and December 31, 2017 , respectively. Advertising fund and co-op contribution expenses were $5.0 million and $5.4 million for the fiscal years ended December 30, 2018 and December 31, 2017 , respectively. Amounts are recorded in other operating costs on the Consolidated Statement of Operations.

The Company is required by its various BWW franchise agreements to modernize the restaurants during the term of the agreements. The individual agreements generally require improvements between the fifth and tenth year to meet the most current design model that BWW has approved. In the past the modernization costs for a restaurant ranged from $0.3 million to $0.8 million depending on an individual restaurant's needs.

401(k) Plan
In 2018 and 2017 , the Company had a defined contribution 401(k) plan whereby eligible team members could contribute wages in accordance with the provisions of the plan. For 2018, the plan was converted to a safe harbor plan and, as a result, the Company will make a safe harbor matching contribution equal to 100% of employee salary deferrals that up to 3% of compensation plus 50% of employee salary deferrals between 3% and 5% of compensation. This safe harbor matching contribution is 100% vested. For fiscal 2018 , the match amount is $0.3 million . In 2017 , the Company determined that no discretionary match would be made.

Legal Proceedings

The Company is subject to ordinary and routine legal proceedings, as well as demands, claims and threatened litigation, which arise in the ordinary course of our business. These claims arise from personal injuries, contract claims, dram shop claims, employment-related claims, and claims from guests or team members alleging injury, illness, or other food quality, health, or operational concerns. The ultimate outcome of any litigation is uncertain. We have insured and continue to insure against most of these types of claims. A judgment on any claim not covered by or in excess of our insurance coverage could materially adversely affect our business, financial condition or results of operations.


60
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12 . EARNINGS PER COMMON SHARE
 
The following is a reconciliation of basic and fully diluted earnings per common share for the fiscal years ended December 30, 2018 and December 31, 2017 :
 
 
December 30, 2018
 
December 31, 2017
Loss from continuing operations
 
$
(5,003,924
)
 
$
(20,284,151
)
Loss from discontinued operations
 
—

 
(173,925
)
Net loss
 
$
(5,003,924
)
 
$
(20,458,076
)
 
 
 
 
 
Weighted-average shares outstanding
 
$
28,969,221

 
$
26,717,910

Effect of dilutive securities
 
—

 
—

Weighted-average shares outstanding - assuming dilution
 
$
28,969,221

 
$
26,717,910

 
 
 
 
 
Basic and diluted earnings per common share from continuing operations
 
$
(0.17
)
 
$
(0.76
)
Basic and diluted earnings per common share from discontinued operations
 
—

 
(0.01
)
Basic and diluted earnings per common share
 
$
(0.17
)
 
$
(0.77
)

For the fiscal years ended December 30, 2018 and December 31, 2017 , 1,274,839 and 531,000 shares, respectively, of unvested restricted stock were excluded from the calculation of diluted earnings per share because such shares were anti-dilutive.

13 . SUPPLEMENTAL CASH FLOWS INFORMATION

Other Cash Flows Information
Cash paid for interest was $6.1 million and $6.3 million during the years ended December 30, 2018 and December 31, 2017 , respectively. Cash paid for income taxes was $0 and $0 during the years ended December 30, 2018 and December 31, 2017 , respectively.

Supplemental Schedule of Non-Cash Operating, Investing, and Financing Activities
Noncash investing activities for property and equipment not yet paid as of  December 30, 2018 and December 31, 2017 , was $0.2 million and  $0.1 million , respectively.

14 . FAIR VALUE OF FINANCIAL INSTRUMENTS

The guidance for fair value measurements, FASB ASC 820, Fair Value Measurements and Disclosures , establishes the authoritative definition of fair value, sets out a framework for measuring fair value, and outlines the required disclosures regarding fair value measurements. Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. We use a three-tier fair value hierarchy based upon observable and non-observable inputs as follows:
●   
Level 1
Quoted market prices in active markets for identical assets and liabilities;
●   
Level 2
Inputs, other than level 1 inputs, either directly or indirectly observable; and
●  
Level 3
Unobservable inputs developed using internal estimates and assumptions (there is little or no market data) which reflect those that market participants would use.

As of December 30, 2018 and December 31, 2017 , respectively, our financial instruments consisted of cash and cash equivalents; including accounts receivable, accounts payable, interest rate swaps, lease guarantee liability, and debt. The fair value of cash and cash equivalents, accounts receivable, and accounts payable approximate carrying value, due to their short-term nature.

The fair value of our interest rate swaps is determined based on valuation models, which utilize quoted interest rate curves to calculate the forward value and then discount the forward values to the present period. The Company measures the fair value using broker quotes which are generally based on market observable inputs including yield curves and the value associated with counterparty credit risk. Our interest rate swaps are classified as a Level 2 measurement as these securities are not actively traded in the market, but are observable based on transactions associated with bank loans with similar terms and maturities. See Note 1 and Note 7 for additional information pertaining to interest rates swaps.

61
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


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

In connection with our impairment review of long-lived assets described in Note  17 , we measured the fair value of our asset groups that were not deemed recoverable, based on Level 2 and Level 3 inputs consisting of the fair market value or discounted future cash flows associated with the use and eventual disposition of the asset group. The discounted cash flow method is based on Level 3 inputs consisting primarily of our restaurant forecasts and utilizes forward-looking assumptions and projections, as well as factors impacting long-range plans such as pricing, discount rates and commodity prices.

As of December 30, 2018 and December 31, 2017 , our total debt was approximately $102.4 million and $113.9 million , respectively, which approximated fair value because the applicable interest rates are adjusted frequently based on short-term market rates (Level 2).

There were no transfers between levels of the fair value hierarchy during the fiscal years ended December 30, 2018 and December 31, 2017 , respectively.

The following table presents the fair values for those assets and liabilities measured on a recurring basis as of December 30, 2018 :
FAIR VALUE MEASUREMENTS
Description
 
Level 1
 
Level 2
 
Level 3
 
Asset/(Liability) Total
Interest rate swaps
 
$
—

 
$
379,126

 
$
—

 
$
379,126

Lease guarantee liability
 
—

 
(282,084
)
 
—

 
(282,084
)
Total
 
$
—

 
$
97,042

 
$
—

 
$
97,042


The following table presents the fair values for those assets and liabilities measured on a recurring basis as of December 31, 2017 :
FAIR VALUE MEASUREMENTS
Description
 
Level 1
 
Level 2
 
Level 3
 
Asset / (Liability) Total
Interest rate swaps
 
$
—

 
$
(429,104
)
 
$
—

 
$
(429,104
)
Lease guarantee liability
 
—

 
(303,006
)
 
—

 
(303,006
)
Total
 
$
—

 
$
(732,110
)
 
$
—

 
$
(732,110
)

62
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


15 . ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes each component of Accumulated Other Comprehensive Income (Loss) ("AOCI"):
Year to Date December 30, 2018
 
 
Interest Rate
Swaps
Beginning balance
 
$
(283,208
)
Gain recorded to other comprehensive income
 
808,250

Tax expense
 
(169,728
)
Other comprehensive income
 
638,522

Accumulated AOCI
 
$
355,314


Year to Date December 31, 2017
 
 
Interest Rate
Swaps
Beginning balance
 
$
(934,222
)
Gain recorded to other comprehensive loss
 
986,385

Tax expense
 
(335,371
)
Other comprehensive income
 
651,014

Accumulated AOCI
 
$
(283,208
)

63
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


16 . SUMMARY QUARTERLY FINANCIAL DATA (unaudited)
 
 
Fiscal Quarters
 
 
 
April 1, 2018
 
July 1, 2018
 
September 30, 2018
 
December 30, 2018
 
Revenue
 
$
39,532,957

 
$
37,039,073

 
$
37,491,751

 
$
39,074,438

 
Operating profit (loss)
 
1,503,810

 
294,733

 
(682,517
)
1  
(1,498,569
)
1  
Loss from continuing operations before income taxes
 
(109,594
)
 
(1,294,678
)
 
(2,267,016
)
 
(3,015,631
)
 
Net income (loss) from continuing operations
 
191,829

 
(1,140,210
)
 
(1,761,372
)
 
(2,294,171
)
 
 
 
 
 
 
 
 
 
 
 
Basic and diluted earnings (lo ss) per share from:
 
 
 
 
 
 
 
 
 
Continuing operations
 
$
0.01

 
$
(0.04
)
 
$
(0.06
)
 
$
(0.07
)
 
 
 
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding
 
 
 
 
 
 
 
Basic and diluted
 
26,853,724

 
26,474,297

 
30,643,240

 
31,905,623

 

1 The results for the third and fourth quarter were impacted by an impairment charge $0.9 million and $2.8 million , respectively. See Note 17 for for additional details.

 
 
Fiscal Quarters
 
 
 
March 26, 2017
 
June 25, 2017
 
September 24, 2017
 
December 31, 2017
 
Revenue
 
$
44,337,964

 
$
39,934,602

 
$
39,262,940

 
$
41,927,106

 
Operating profit
 
2,366,631

 
721,263

 
320,479

 
1,832,355

 
Income (loss) from continuing operations before income taxes
 
817,844

 
(895,903
)
 
(1,476,397
)
 
268,061

 
Income (loss) from continuing operations
 
795,580

 
(291,343
)
 
(543,240
)
 
(20,245,148
)
2  
Income (loss) from discontinued operations
 
35,540

 
(117,747
)
 
(15,154
)
 
(76,564
)
 
Net income (loss)
 
$
831,120

 
$
(409,090
)
 
$
(558,394
)
 
$
(20,321,712
)
 
 
 
 
 
 
 
 
 
 
 
Basic and diluted earnings (loss) per share from:
 
 
 
 
 
 
 
 
 
Continuing operations
 
$
0.03

 
$
(0.01
)
 
$
(0.02
)
 
$
(0.76
)
 
Discontinued operations
 
—

 
(0.01
)
 
—

 
—

 
Basic and diluted earnings (loss) per share
 
$
0.03

 
$
(0.02
)
 
$
(0.02
)
 
$
(0.76
)
 
 
 
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding
 
 
 
 
 
 
 
Basic and diluted
 
26,629,974

 
26,621,421

 
26,764,776

 
26,845,643

 

2 The results for the quarter ended December 31, 2017 were impacted by a charge of $3.1 million as a result of the enactment of the Tax Act and the recording of a valuation allowance of $15.9 million . See Note 9 for for additional details.

17 . IMPAIRMENT

We review the carrying value of our long-lived assets on a restaurant-by-restaurant basis when indicators of potential impairment exist. Such indicators include, but are not limited to, significant underperformance relative to expected, historical or projected future operating results; significant negative industry or economic trends; and significant changes in laws and regulations. Given the continued underperformance of certain restaurants we determined impairment indicators existed at December 30, 2018 . As such, the Company performed an impairment analysis on its long-lived assets subject to amortization and recorded a fixed asset impairment of $2.8 million related to four underperforming locations. The Company also recorded a fixed asset impairment of $0.9 million related to one underperforming location as of September 30, 2018. The impairment charges were recorded to the extent that the carrying amount of the assets were not considered recoverable based on the estimated discounted cash flows and the underlying fair value of the assets. These charges are reflected in Impairment and loss on asset disposals on the Consolidated Statements of Operations for 2018 . The fair values of each of the related assets to determine the impairment were measured using

64
DIVERSIFIED RESTAURANT HOLDINGS AND SUBSIDIARIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Level 2 and Level 3 inputs as described in Note  14 . For the fiscal year ended December 31, 2017 , no impairment losses were recognized.

We have not closed any of these underperforming restaurants at this time, however, we will continue to evaluate each of these restaurants on a case-by-case basis. Additionally, while we believe that our estimates of fair value are appropriate, we will continue to monitor the asset values of each individual restaurant, and should actual values differ materially from our estimates, we may be required to record impairment charges in the future.


18 . SUBSEQUENT EVENTS

On February 22, 2019 we entered in an Asset Purchase Agreement to acquire 9 BWW restaurants in the Chicago, Illinois market for a cash purchase price of approximately $22.5 million . The transaction remains subject to the franchisor waiving its right of first refusal and franchisor consent, among other things. The transaction also remains contingent upon the Company's completion of satisfactory financing.

65


ITEM 9.        CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
None.

ITEM 9A.     CONTROLS AND PROCEDURES
 
REPORT BY DIVERSIFIED RESTAURANT HOLDINGS, INC.'S MANAGEMENT
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
 
Management is responsible for establishing and maintaining an effective system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles. There are inherent limitations in the effectiveness of any system of internal control. Accordingly, even an effective system of internal control can provide only reasonable assurance with respect to financial statement preparation.

Management assessed the Company's system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles as of December 30, 2018 . This assessment was based on criteria for effective internal control over financial reporting described in  Internal Control — Integrated Framework (2013 Framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of December 30, 2018 , Diversified Restaurant Holdings, Inc. maintained an effective system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles based on those criteria.

This Annual Report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. We were not required to have, nor have we engaged our independent registered public accounting firm to perform an audit of our internal control over financial reporting pursuant to the rules of the Securities and Exchange Commission that permit us to provide only management's report in this Annual Report. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to Section 404(c) of the Sarbanes-Oxley Act. 
 
Diversified Restaurant Holdings, Inc.
  
  
  
  
  
/s/ David G. Burke
Dated:
April 3, 2019
David G. Burke
  
  
Chairman of the Board, President, Chief Executive Officer, and Principal Executive Officer
  
  
  
  
  
/s/ Phyllis Knight
Dated:
April 3, 2019
Phyllis Knight
  
  
Chief Financial Officer, Treasurer, Principal Financial Officer, and Principal Accounting Officer
  
  


Evaluation of Disclosure Controls and Procedures

As of December 30, 2018 , an evaluation was performed under the supervision of and with the participation of our management, including our principal executive and principal financial officers, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our management, including our principal executive and principal financial and accounting officers, concluded that our disclosure controls and procedures were effective as of December 30, 2018 .

Evaluation of Internal Control and Procedures

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). There are inherent limitations in the effectiveness of any system of internal control.

66

Accordingly, even an effective system of internal control can provide only reasonable assurance with respect to financial statement preparation.

Under the supervision and with the participation of our management, including our principal executive and principal financial and accounting officers, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 30, 2018 . This evaluation was based on criteria for effective internal control over financial reporting described in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework). Based on our evaluation under the framework in Internal Control — Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 30, 2018 . Refer to the management's report in Item 8 "Consolidated Financial Statements" of this Annual Report.

The Company is not required to have an audit of its internal control over financial reporting. As such, this annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to Section 404(c) of the Sarbanes-Oxley Act.

Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting that occurred during the year ended December 30, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Our process for evaluating controls and procedures is continuous and encompasses constant improvement of the design and effectiveness of established controls and procedures and the remediation of any deficiencies that may be identified during this process.

ITEM 9B.     OTHER INFORMATION

Not applicable.


67

PART III



ITEM 10.     DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table presents information regarding the beneficial ownership of our common stock by each person known to us to own beneficially more than 5.0% of our outstanding shares of common stock as of March 22, 2019. The title of the class of shares for all owners is $0.0001 par value common stock.

Name and Address of
Beneficial Owner
 
Amount and Nature of
Beneficial Ownership
 
Percent of Class Beneficially Owned  (1)
 
T. Michael Ansley
807 W. Front Street
Suite B
Traverse City, MI 49684
 
10,253,557

(2)  
30.9%
 

(1)
The percentages shown are based on the 33,182,875 shares of our common stock outstanding as of March 22, 2019, plus the number of shares that the named person or group has the right to acquire within 60 days of March 22, 2019. For purposes of computing the percentage of outstanding shares of common stock held by each person or group, any shares that the person or group has the right to acquire within 60 days after March 22, 2019 are deemed to be outstanding with respect to such person or group but are not deemed to be outstanding for the purpose of computing the percentage of ownership of any other person or group.

(2)
This includes 2,214,557 shares owned directly by Mr. Ansley, 8,000,000 shares held jointly with his spouse through a family limited liability company, 9,000 shares indirectly owned as custodian for his children’s UGMA accounts (the beneficial ownership of which he disclaims), and options exercisable within 60 days of March 20, 2017 to purchase 30,000 shares at an exercise price of $2.50 per share.

68


The following table presents information regarding the beneficial ownership of our common stock, as of March 22, 2019, by each of our directors, each of whom is also a nominee for re-election as a director, our executive officers named in the Summary Compensation Table, and all of our directors and executive officers as a group.

Name of Beneficial Owner
Amount and Nature of Beneficial Ownership
 
Percent of Class Beneficially Owned (1)
T. Michael Ansley °
10,253,557

(2)  
30.9%
David G. Burke °
656,939

(3)  
2.0%
Jason T. Curtis
1,177,511

(4)  
3.5%
Jay A. Dusenberry °
128,730

(5)  
*
Philip Friedman °
106,862

(6)  
*
Phyllis A. Knight
496,466

(7)  
1.5%
David Ligotti °
342,307

(8)  
1.0%
Joseph M. Nowicki °
122,651

(9)  
*
Roger Lipton°
20,689

(10)  
*
Officers and All Directors As a Group (9 persons)
13,305,712

(11)  
39.9%

* Less than one percent
° Existing member of the Board

(1)
The percentages shown are based on the 33,182,875 shares of our common stock outstanding as of March 22, 2019, plus the number of shares that the named person or group has the right to acquire within 60 days of March 22, 2019. For purposes of computing the percentage of outstanding shares of common stock held by each person or group, any shares that the person or group has the right to acquire within 60 days after March 22, 2019 are deemed to be outstanding with respect to such person or group but are not deemed to be outstanding for the purpose of computing the percentage of ownership of any other person or group.

(2)
This includes 2,214,557 shares owned directly by Mr. Ansley, 8,000,000 shares held jointly with his spouse through a family limited liability company, 9,000 shares indirectly owned as custodian for his children’s UGMA accounts (the beneficial ownership of which he disclaims), and options exercisable within 60 days of March 22, 2019 to purchase 30,000 shares at an exercise price of $2.50 per share.

(3)
This includes 218,071 shares owned directly by Mr. Burke, 366,667 shares of restricted stock, options exercisable within 60 days of March 22, 2019 to purchase 30,000 shares at an exercise price of $2.50 per share, and 42,201 shares held in his IRA. Shares owned directly include shares acquired pursuant to the issuer's Employee Stock Purchase Plan since last report of common stock ownership.

(4)
This includes 888,956 shares owned directly by Mr. Curtis and 288,555 shares of restricted stock.

(5)
This includes 71,144 shares owned directly by Mr. Dusenberry, 27,586 shares of restricted stock and options exercisable within 60 days of March 22, 2019 to purchase 30,000 shares at an exercise price of $2.50 per share.

(6)
This includes 49,276 shares owned directly by Mr. Friedman, 27,586 shares of restricted stock and options exercisable within 60 days of March 22, 2019 to purchase 30,000 shares at an exercise price of $2.50 per share.

(7)
This includes 215,132 shares currently owned directly by Ms. Knight and 281,334 shares of restricted stock.

(8)
This includes 314,721 shares currently owned directly by Mr. Ligotti and 27,586 shares of restricted stock.

(9)
This includes 43,165 shares currently directly owned by Mr. Nowicki, 27,586 shares of restricted stock, 21,900 shares held jointly with his spouse, and options exercisable within 60 days of March 22, 2019 to purchase 30,000 shares at an exercise price of $2.50 per share.

(10)
This includes 20,689 shares of restricted stock currently owned directly by Mr. Lipton.

(11)
This includes 150,000 shares that such persons have the right to acquire within 60 days of March 22, 2019 pursuant to stock options.


69

Audit Committee

Our Audit Committee is solely responsible for appointing and reviewing fee arrangements with our independent accountants and approving any non-audit services by our independent accountants. Our Audit Committee reviews and monitors our internal accounting procedures and reviews the scope and results of the annual audit and other services provided by our independent accountants. The Audit Committee is also responsible for overseeing our compliance with legal and regulatory requirements, including our disclosure controls and procedures. Our Audit Committee currently consists of Messrs. Joseph M. Nowicki, Jay Alan Dusenberry, Philip Friedman and Roger Lipton. Our Board has determined that each of the members of the Audit Committee meets the criteria for independence under the standards of the NASDAQ Stock Market.

We believe that each of the members of the Audit Committee is financially sophisticated and is able to read and understand our consolidated financial statements. The Audit Committee met seven times during 2018 . Our Board has determined that Mr. Nowicki is an audit committee financial expert as defined in Item 401 of Regulation S-K.

Code of Business Conduct and Ethics

We have adopted a corporate code of ethics that applies to all of our employees, directors and executive officers, including our chief executive officer, chief financial officer and principal accounting officer. We believe our code of ethics is reasonably designed to deter wrongdoing and promote honest and ethical conduct; provide full, fair, accurate, timely and understandable disclosure in public reports; comply with applicable laws; ensure prompt internal reporting of code violations; and provide accountability for adherence to the code. A copy of our corporate code of ethics may be obtained, without charge, upon written request to: Secretary, 27680 Franklin Road, Southfield, Michigan 48034. The code of ethics may be reviewed on our website at http://www.diversifiedrestaurantholdings.com/about-us/governance-documents . In addition, we intend to post on our website all disclosures that are required by law or NASDAQ listing standards concerning any amendments to, or waivers from, any provision of the code.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Exchange Act requires our directors, executive officers, and persons who own more than 10.0% of our outstanding common stock to file with the Securities and Exchange Commission reports of changes in ownership of our common stock held by such persons. Executive officers, directors and greater than 10.0% stockholders are also required to furnish us with copies of all forms they file under this section. To our knowledge, based solely on a review of the copies of such reports furnished to us and representations received from our directors and officers, we believe that all reports required to be filed under Section 16(a) for fiscal year 2018 were timely filed.


70


ITEM 11.     EXECUTIVE COMPENSATION

 
COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS


Summary Compensation Table

The following table summarizes compensation earned by our principal executive officer and our other executive officers for our last two completed fiscal years.
Name and Principal
Position
Year
Salary
($)
Bonus
   ($) (1)
Stock Awards
   ($) (2)
 
Option Awards
($)
Non Equity Incentive Plan Compens-ation
($) (4)
Nonqualified Deferred Compensa-tion Earnings
($)
All Other Compens-ation
($)
Total
($)
T. Michael Ansley
2018
250,000
—
—

 
—
—
—
9,000

259,000
Executive Chairman of the Board
2017
250,000
—
—

 
—
—
—
9,000

259,000
 
 
 
 
 
 
 
 
 
 
 
David G. Burke
2018
450,000
—
276,500

 
—
58,500
—
9,100

794,100
Chief Executive Officer
2017
405,000
35,640
202,500

(3)  
—
—
—
9,135

652,275
 
 
 
 
 
 
 
 
 
 
 
Jason T. Curtis
2018
261,000
—
253,550

 
—
23,490
—
9,100

547,140
Chief Operating Officer
2017
261,000
18,792
50,000

 
—
—
—
9,135

338,927
 
 
 
 
 
 
 
 
 
 
 
Phyllis A. Knight
2018
340,000
—
253,550

 
—
34,000
—
9,100

636,650
Chief Financial Officer
2017
340,000
24,480
183,750

 
—
—
—
9,135

557,365

(1)    Bonuses paid for 2017 pursuant to the terms of the Performance Bonus Plan and the 2017 Short Term Plan. Bonuses in 2017 were paid in a combination of cash (50%) and DRH stock (50%) valued based upon the closing share price on March 29, 2018 of $1.35 per share. There was no vesting requirement for the shares granted in connection with the 2017 bonus.
(2)    Refer to Note 8 "Share-Based Compensation", in the Notes to our Consolidated Financial Statements, for the relevant assumptions used to determine the valuation of the stock awards.

(3)    Refer to Treatment of Certain Incentive Grants under the Stock Incentive Plan of 2011 below for further details on Mr. Burke's stock awards for 2017.

(4)    The amounts in this column include cash awards paid for 2018 performance pursuant to the terms of the Performance Bonus Plan and the 2018 Short Term Plan.



71

Employment Agreements

David G. Burke
On May 19, 2016, the Company and Mr. Burke entered into a written employment agreement for an initial three-year term. Pursuant to the employment agreement, Mr. Burke's base salary for the fiscal years ending in 2017 and 2018 was $405,000 and $450,000, respectively. His base salary for the fiscal year ending in 2019 will be determined by the Board of Directors.

During his term of employment, Mr. Burke is eligible to participate in the Company's annual cash bonus plan. In fiscal years 2016, 2017, and 2018, his target bonus opportunity is 40%, 55% and 65% of base salary, respectively. Actual payments will be determined based upon a combination of Company results and individual performance against the applicable performance goals established by the Board.

Mr. Burke was paid a one-time signing bonus in the amount of $100,000 and was granted 100,000 shares of the Company’s common stock within two weeks following the signing date of the employment agreement. The stock award is subject to the terms and conditions of the Company’s Stock Incentive Plan of 2011 and vested and will vest ratably on January 1, 2018, January 1, 2019, and January 1, 2020.

During each year of the initial three-year term of the employment agreement, the Company will recommend to the Compensation Committee that it grant Mr. Burke an equity award of 50,000 shares of restricted stock. The Compensation Committee granted 50,000 shares of restricted stock to Mr. Burke in 2017 and 2018. Each future award will be subject to the terms and conditions of the Company’s Stock Incentive Plan of 2017 or a successor plan, and will vest three years following the date of grant.

Mr. Burke is eligible to participate in the employee benefit plans and programs generally available to the Company's senior executives, including group medical, dental, vision and life insurance, and disability benefits, subject to the terms and conditions of such plans and programs. Mr. Burke is also be entitled to the fringe benefits and perquisites that are made available to other similarly situated executives of the Company, including a car allowance, each in accordance with and subject to the eligibility and other provisions of such plans and programs.

In addition, the employment agreement also provides for certain payments and benefits in the event of a termination of Mr. Burke’s employment under specific circumstances. If, during the term of the employment agreement, his employment is terminated by the Company other than for “cause,” or by Mr. Burke for “good reason” (each as defined in his agreement), he would be entitled to (1) continuation of his base salary at the rate in effect immediately prior to the termination date for 12 months following the termination date, (2) a lump sum payment equal to a pro-rata portion of his annual bonus and (3) continuation of coverage of medical insurance benefits that he would otherwise be eligible to receive as an active employee of the Company for six months following the termination date. In the event of a change in control followed by termination by the Company without “cause” or by Mr. Burke for “good reason” within 12 months of the change of control, Mr. Burke would be entitled to (1) a lump sum payment equal to 1.5 times his annual base salary and target annual bonus for the year in which the termination occurs, and (2) continuation of coverage of medical insurance benefits that he would otherwise be eligible to receive as an active employee of the Company for six months following the termination date.

Mr. Burke’s receipt of the termination payments and benefits described above is contingent upon execution of a general release of any and all claims arising out of or related to his employment with the Company and the termination of his employment, and compliance with the restrictive covenants described below.

Pursuant to his employment agreement, Mr. Burke has also agreed to customary restrictions with respect to the disclosure and use of the Company’s confidential information, and has agreed that work product or inventions developed or conceived by him while employed with the Company relating to its business is the Company’s property. In addition, during the term of his employment and for the 18 month period following his termination of employment for any reason, Mr. Burke has agreed not to (1) compete with the Company, or (2) solicit or induce any of the Company’s employees or independent contractors to terminate their employment with the Company.

72

Phyllis A. Knight
The Company and Ms. Knight entered into a written employment agreement on October 20, 2016, for an initial three-year term. Pursuant to the employment agreement, Ms. Knight receives a base salary of $340,000 per year.

During her term of employment, Ms. Knight is eligible to participate in the Company's annual cash bonus plan. In fiscal years 2017 and 2018, her target bonus opportunity was 45% and 50%, respectively, of base salary. Actual payments will be determined based upon a combination of Company results and individual performance against the applicable performance goals established by the Board.

As a signing bonus, Ms. Knight received a grant of 100,000 shares of the Company’s common stock. The stock award is subject to the terms and conditions of the Company’s Stock Incentive Plan and vested and will vest ratably on January 1, 2018, January 1, 2019, and January 1, 2020.

During each year of the initial three-year term of the employment agreement, Ms. Knight will be eligible to receive an annual long-term incentive award of stock, options, or a combination thereof, as determined by the Compensation Committee. Each such award will be subject to the terms and conditions of the Company’s Stock Incentive Plan of 2017 or a successor plan, and will vest three years following the date of grant.

Ms. Knight will be eligible to participate in the employee benefit plans and programs generally available to the Company's senior executives, including group medical, dental, vision and life insurance, and disability benefits, subject to the terms and conditions of such plans and programs. Ms. Knight will also be entitled to the fringe benefits and perquisites that are made available to other similarly situated executives of the Company, including a car allowance, each in accordance with and subject to the eligibility and other provisions of such plans and programs.

In addition, the employment agreement also provides for certain payments and benefits in the event of a termination of Ms. Knight’s employment under specific circumstances. If, during the term of the employment agreement, her employment is terminated by the Company other than for “cause,” or by Ms. Knight for “good reason” (each as defined in her agreement), she would be entitled to (1) continuation of her base salary at the rate in effect immediately prior to the termination date for 12 months following the termination date, (2) a lump sum payment equal to a pro-rata portion of her annual bonus and (3) continuation of coverage of medical insurance benefits that she would otherwise be eligible to receive as an active employee of the Company for twelve months following the termination date. In the event of a change in control followed by termination by the Company without “cause” or by Ms. Knight for “good reason” within 12 months of the change of control, Ms. Knight would be entitled to (1) a lump sum payment equal to 1.0 times her annual base salary and target annual bonus for the year in which the termination occurs, and (2) continuation of coverage of medical insurance benefits that she would otherwise be eligible to receive as an active employee of the Company for six months following the termination date.

Ms. Knight’s receipt of the termination payments and benefits described above is contingent upon execution of a general release of any and all claims arising out of or related to her employment with the Company and the termination of her employment, and compliance with the restrictive covenants described below.

Pursuant to her employment agreement, Ms. Knight has also agreed to customary restrictions with respect to the disclosure and use of the Company’s confidential information, and has agreed that work product or inventions developed or conceived by her while employed with the Company relating to its business is the Company’s property. In addition, during the term of her employment and for the 24 month period following her termination of employment for any reason, Ms. Knight has agreed not to (1) compete with the Company, or (2) solicit or induce any of the Company’s employees or independent contractors to terminate their employment with the Company.


73

Treatment of Certain Incentive Grants under the Stock Incentive Plan of 2011

The Company's Stock Incentive Plan of 2011 (the "2011 Plan") provides that no participant may be awarded incentive awards with respect to more than 100,000 shares of common stock in any calendar year. The 2011 Plan states that the purpose of this provision is to ensure that the 2011 Plan provides performance-based compensation and the provision is to be interpreted, administered and amended if necessary to achieve that purpose.

During 2016, the Board of Directors, upon recommendation of the Compensation Committee, granted 133,333 shares of restricted stock to Mr. Burke. 33,333 shares were granted to Mr. Burke as an annual long-term incentive grant and 100,000 shares were granted to Mr. Burke pursuant to the terms of his Employment Agreement.

The Board of Directors interpreted the 2011 Plan to mean that the annual limit of 100,000 shares applied only if the applicable grant was intended to qualify as performance-based compensation under Section 162(m) of the Internal Revenue Code. The grant of restricted stock to Mr. Burke was not subject to any performance conditions, but was subject to time-based vesting. The grant of time-vested restricted stock does not qualify as performance-based compensation under Section 162(m) and the Board of Directors understood that grants of time-vested restricted stock could be made in excess of the annual limit of 100,000 shares set forth in the 2011 Plan.

The Board received a demand letter from counsel on behalf of two stockholders alleging that the grants to Mr. Burke in 2016 violated Section 4.2 of the 2011 Plan, among other claims. The Board formed a Special Committee to review the stockholder demand, conduct a thorough investigation into the legal and factual issues implicated by the demand and recommend a course of action. The Special Committee concluded that the demand was without merit. However, solely in the interests of avoiding litigation that the Board determined in its business judgment would not be in the interests of the Company or its shareholders, the Board elected to rescind, and Mr. Burke simultaneously agreed to surrender, the grant of 33,333 shares so that the aggregate number of restricted shares issued to him in 2016 is 100,000.

The Board also determined that the total compensation package approved by the Board, including the stock grant under Mr. Burke’s employment agreement and the 2016 annual stock grant, was appropriate and aligned with stockholders’ interests. Accordingly, based on a recommendation by the Compensation Committee, the Board determined that it was appropriate to return Mr. Burke’s equity compensation to the level it was prior to the action to void and rescind the 33,333 shares of restricted stock and, therefore, effective June 23, 2017, the Board granted Mr. Burke a restricted stock grant with respect to 33,333 shares of restricted stock, which will vest in a single installment on June 23, 2019.

Executive Officer Bonus Compensation

Beginning in 2013, it has been our policy to provide cash bonus awards for eligible executive officers and employees based on predetermined performance goals. We believe that paying such cash awards:

•
promotes the growth, profitability and expense control necessary to accomplish corporate strategic long-term plans;
•
encourages superior results by providing a meaningful incentive; and
•
supports teamwork among employees.

In furtherance of this goal and to provide a structure for awarding cash bonuses, on March 7, 2013, the Board approved a Performance Bonus Plan (the “Bonus Plan”) which is administered by the Compensation Committee. The Bonus Plan is designed to provide an incentive in the form of a cash bonus award to certain key executives of the Company. Under the terms of the Bonus Plan, each calendar year the Compensation Committee (or its designees) will determine within 90 days of January 1 the employees who will participate in the Bonus Plan and the performance goals that those employees must satisfy to earn the target award established by the Compensation Committee.

Performance goals are to be selected by the Compensation Committee based upon one or more of the following performance criteria: (i) financial results for the Company as a whole or as a business unit, such as net earnings or net income (before or after taxes), earnings per share, net revenues, gross revenues, net operating profit (before or after taxes), and earnings before or after taxes, interest, depreciation and/or amortization (EBITDA); and (ii) criteria related to restaurant growth (either in the aggregate or by type of restaurant). The Compensation Committee may also establish individual goals for an employee relating to his or her individual performance or individual/strategic goals for the executive team as a whole. The Compensation Committee has discretion in assessing whether the individual/strategic goals have been met.


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Target awards payable under the Bonus Plan are expressed as either a percentage of base salary or a fixed dollar amount. The Compensation Committee must establish in writing a formula for determining the percentage of the target award that may be payable based upon the level of attainment of the performance goals for the year. In establishing the formula, the Compensation Committee may assign different weights to the various performance criteria, and such weights may also differ from employee to employee.

Bonus Plan for Fiscal 2018

On June 12, 2018, the Board, upon recommendation of the Compensation Committee, adopted a Short-Term Incentive Program for the 2018 fiscal year (the “2018 Short Term Plan”), which set out the performance goals for fiscal 2018 under the Bonus Plan. The 2018 Short Term Plan was designed to pay an annual cash bonus to members of the Company’s executive team, with such bonus to be based upon a combination of corporate financial goals (Adjusted EBITDA) and strategic/individual goals. Three named executive officers participated in the 2018 Short Term Plan: Mr. Burke, Mr. Curtis and Ms. Knight. The 2018 target bonus for each of these named executive officers was: Mr. Burke - $292,500, Mr. Curtis - $117,450 and Ms. Knight - $170,000, representing 60.0%, 45.0% and 50.0%, respectively, of each officer's base salary.

80.0% of the performance metrics under the 2018 Short Term Plan were related to the achievement of corporate financial performance (Adjusted EBITDA) and 20.0% of the performance metrics were related to individual/strategic goals. Any performance below the threshold resulted in a payout of 0.0% for the metric and all amounts were capped at 150.0% of target. On February 14, 2019, the Compensation Committee certified that no portion of the Adjusted EBITDA target was achieved, resulting in no payout for the executive team.

With respect to the remaining 20.0% of the performance metrics, the Committee determined that the executive team substantially satisfied the following individual/strategic goals for fiscal 2018 and this component of the performance metrics would be paid at 100% (for a percentage payout of 20%):

•
corporate cost improvement through cost controls;
•
SEC compliance;
•
control of operations - maintaining effective restaurant operations; and
•
a successful equity raise.

Based on the attainment of the performance metrics established in the 2018 Short Term Plan, bonus amounts were paid to our executive officers as follows: Mr. Burke, $58,500 , Mr. Curtis, $23,490 , and Ms. Knight, $34,000 .


75

Outstanding Equity Awards at Fiscal Year-End

The following table sets forth certain information for our executive officers concerning unexercised options, stock that has not vested, and equity incentive plan awards as of December 30, 2018 .

Name
Number of Securities Underlying Unexercised Options (#) Exercisable (1)
Number of Securities Underlying Unexercised Options (#) Unexercisable
Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options
(#)
Option Exercise Price
($)
Option Expiration Date  
Number of Shares or Units of Stock That Have Not Vested
(#)
Market Value of Shares or Units of Stock That Have Not Vested
($)
Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested
(#)
Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested
($)
T. Michael Ansley 
30,000
—
—
$
2.50

7/31/2019
—

$
—

—
—
 
 
 
 
 
 
 
 
 
 
David G. Burke 
30,000
—
—
$
2.50

7/31/2019
33,333 (3)

$
33,000

—
—
 
—
—
—
 
 
66,667 (4)

$
66,000

—
—
 
—
—
—
 
 
50,000 (5)

$
49,500

—
—
 
—
—
—
 
 
50,000 (2)

$
49,500

—
—
 
—
—
—
 
 
100,000 (6)

$
99,000

—
—
 
—
—
—
 
 
100,000 (9)

$
99,000

—
—
 
 
 
 
 
 
 
 
 
 
Jason Curtis
—
—
—
 
 
33,333 (7)

$
33,000

—
—
 
—
—
—
 
 
22,222 (5)

$
22,000

—
—
 
—
—
—
 
 
33,000 (2)

$
32,670

—
—
 
—
—
—
 
 
100,000 (6)

$
99,000

—
—
 
—
—
—
 
 
100,000 (9)

$
99,000

—
—
 
 
 
 
 
 
 
 
 
 
Phyllis A. Knight
—
—
—
 
 
66,667 (8)

$
66,000

—
—
 
—
—
—
 
 
15,000 (5)

$
14,850

—
—
 
—
—
—
 
 
33,000 (2)

$
32,670

—
—
 
—
—
—
 
 
100,000 (6)

$
99,000

—
—
 
—
—
—
 
 
100,000 (9)

$
99,000

—
—

(1)
These options became fully vested on July 31, 2013. The Company entered into a Second Amendment to the Stock Option Agreement of 2010 on July 28, 2016 which extended the expiration date of the options from July 31, 2016 to July 31, 2019.
(2)
The shares of restricted stock cliff vest on March 30, 2021. The shares are subject to additional restrictions on transferability and conditions of forfeiture in accordance with the Stock Incentive Plan of 2017.
(3)
The shares of restricted stock cliff vest on June 23, 2019. The shares are subject to additional restrictions on transferability and conditions of forfeiture in accordance with the Stock Incentive Plan of 2011.
(4)
The shares of restricted stock vest ratably on January 1, 2019, and January 1, 2020. The shares are subject to additional restrictions on transferability and conditions of forfeiture in accordance with the Stock Incentive Plan of 2011.
(5)
The shares of restricted stock cliff vest on July 28, 2020. The shares are subject to additional restrictions on transferability and conditions of forfeiture in accordance with the Stock Incentive Plan of 2017.
(6)
The shares of restricted stock vested on November 29, 2021 in accordance with the Stock Incentive Plan of 2017.
(7)
The shares of restricted stock cliff vest on June 2, 2019. The shares are subject to additional restrictions on transferability and conditions of forfeiture in accordance with the Stock Incentive Plan of 2011.
(8)
The shares of restricted stock vest ratably on January 1, 2019 and January 1, 2020. The shares are subject to additional restrictions on transferability and conditions of forfeiture in accordance with the Stock Incentive Plan of 2017.
(9)
The shares of restricted stock cliff vest on November 30, 2021. The shares are subject to additional restrictions on transferability and conditions of forfeiture in accordance with the Stock Incentive Plan of 2017.


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Payments in the Event of Termination of Employment or Change in Control

Employment Agreements

For amounts payable to Mr. Burke and Ms. Knight following a termination of employment (including in the event of a change in control), please see "Employment Agreements" above.

Termination of Employment Due to Death or Disability

Rights under the Stock Incentive Plan of 2011

If an executive officer terminates employment due to death or disability, then restricted stock granted to the officer under the Stock Incentive Plan of 2011 will be partially vested. Also, if we terminate an officer's employment other than for cause, then restricted stock granted to the officer under the plan will be partially vested. The number of shares that will be vested is equal to the number of shares granted to the executive officer multiplied by the number of months that have elapsed since the grant date divided by the number of months in the vesting period. Our Compensation Committee also has discretion to accelerate the vesting of restricted stock.

Rights under the Stock Incentive Plan of 2017

If an executive officer terminates employment due to death or disability, then restricted stock granted to the officer under the Stock Incentive Plan of 2017 will be 100% vested. Our Compensation Committee also has discretion to accelerate the vesting of restricted stock.

If an executive officer had terminated employment due to death or disability, or if we had terminated their employment without cause on December 30, 2018 , each officer would have become vested in the following number of shares of restricted stock with a value shown below.

Executive Officer
 
Number of Shares Vested
 
Value
David G. Burke 
 
114,729
 
$
113,581

Jason Curtis
 
44,753
 
44,306

Phyllis A. Knight
 
59,970
 
59,371

Total
 
219,452
 
$
217,258


These amounts assume that the termination occurred on December 30, 2018 , the last business day of our 2018 fiscal year, and is an estimate of the value of restricted stock that would be vested upon a termination. The actual amount would only be determined upon a termination of employment.

Change in Control

According to their terms when awarded, shares of restricted stock awarded under the Stock Incentive Plan of 2011 or the Stock Incentive Plan of 2017 become fully vested upon a change in control. A “change in control” is defined in each of the Stock Incentive Plan of 2011 and the Stock Incentive Plan of 2017 as (a) the failure of the continuing directors to constitute a majority of the Board of Directors; (b) the acquisition by any person of ownership of 50.0% or more of our outstanding common stock; (c) a reorganization, merger or consolidation after which our stockholders do not own at least 50.0% of the value and voting power of the outstanding capital stock of the entity surviving the transaction; (d) a liquidation or dissolution, or a sale of all or substantially all of our assets; or (e) any other change in control transaction that is reportable to the SEC under Item 6(e) of Schedule 14A of Regulation 14A issued under the Securities Exchange Act of 1934.

Retirement Benefits

We do not provide a defined benefit pension plan or post-retirement health insurance coverage for our executive officers or other employees. Our executive officers and many of our other employees are eligible to participate in our 401(k) plan. Effective January 1, 2018, to comply with the IRS Safe Harbor Rules, we implemented a matching contribution to our 401(k) plan. For fiscal 2017 , there was no discretionary match. For fiscal 2018 , the Company will make a safe harbor matching contribution equal to 100% of employee salary deferrals that do not exceed 3% of compensation plus 50% of employee salary deferrals between 3% and 5% of

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compensation. Mr. Burke participated in our 401(k) plan during 2017 and 2018 . Ms. Knight participated in our 401(k) plan during 2018 .
Director Compensation for Fiscal 2018

The table below provides information regarding the compensation of our directors for our fiscal year ending December 30, 2018 .

Name (1)(2)
Fees Earned or Paid in Cash
($)
Stock Awards
  ($) (3)
Option Awards
($)
Non-Equity Incentive Plan Compensation
($)
Nonqualified Deferred Compensation Earnings
($)
All Other Compensation
($)
Total
($)
Jay Alan Dusenberry
$
42,000

$
32,000

—
—
—
—
$
74,000

Philip Friedman
$
32,000

$
32,000

—
—
—
—
$
64,000

David Ligotti
$
32,000

$
32,000

—
—
—
—
$
64,000

Joseph M. Nowicki
$
47,000

$
32,000

—
—
—
—
$
79,000

Roger Lipton
$
10,667

$
28,344

—
—
—
—
$
39,011

Gregory J. Stevens
$
21,333

$
—

—
—
—
—
$
21,333


(1)
Compensation information for T. Michael Ansley and David G. Burke is fully reflected in the Summary Compensation Table above and, as such, is not repeated here.
(2)
As of December 30, 2018 , each of Messrs. Dusenberry, Friedman, and Nowicki had outstanding options to purchase 30,000 shares of the Company’s common stock.
(3)
Each non-employee director received a restricted stock award of 27,586 shares (prorated for Mr. Lipton) in 2018 following the annual election of directors, to assist the directors in meeting stock ownership guidelines for non-employee directors. The shares will vest on May 24, 2019. Mr. Stevens forfeited his award upon resignation from the board.

On July 31, 2010, each member of the Board then serving was granted options to purchase up to 30,000 shares of our common stock in return for their services as directors at an exercise price of $2.50 per share. The options are fully vested and expire on July 31, 2019. On March 10, 2011, in connection with his appointment to the Board, Philip Friedman was granted options to purchase 30,000 shares on the same terms as the options issued in July 2010.

We review the compensation of our non-employee directors annually and may engage an independent compensation consultant to advise us on appropriate levels of cash and non-cash compensation for our directors. Our Compensation Committee engaged Lockton in 2015 to perform benchmarking of our director compensation program and to provide us with recommendations for cash compensation to be paid to our directors and to the Chairs of our Audit and Compensation Committees, for appropriate levels and types of stock-based compensation and as to appropriate stock ownership guidelines.

The material provisions of the Board's compensation program are as follows:
•
Cash retainer fee of $32,000, paid in quarterly amounts of $8,000 on the last business day of each calendar quarter;
•
A grant of restricted stock with a value of $32,000, to be granted on the date of the annual election of directors, with a one-year vesting period such that the director would be 100% vested on the first anniversary of the grant date;
•
Additional cash payment to the Chair of the Audit Committee in the amount of $15,000, payable in equal quarterly installments on the last business day of each calendar quarter; and
•
Additional cash payment to the Chair of the Compensation Committee in the amount of $10,000, to be payable in equal quarterly installments on the last business day of each calendar quarter.

The Board, has adopted stock ownership guidelines for non-employee directors, equal to three times the amount of the annual cash retainer, which is intended to be met by three annual restricted stock grants.


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ITEM 12.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS


Information About Director Nominees and Executive Officers

Information about our director nominees and executive officers is set forth below. There are no family relationships among any of our directors, nominees for director and executive officers.

Name, Age, and Position with the Company
Has Served As Director Since
Directors Who Are Both Currently Serving and Nominees for Election
T. Michael Ansley , 48, Director, Executive Chairman of the Board
2006
David G. Burke , 47, Director, President and Chief Executive Officer
2006
Jay Alan Dusenberry , 47, Director
2006
Philip Friedman ,   72 , Director
2011
David Ligotti , 61, Director
2006
Joseph M. Nowicki ,   57, Director
2010
Roger Lipton,  78, Director
2018
Executive Officers (Who Are Not Also Directors)
Jason Curtis , 38, Chief Operating Officer, Secretary
 
Phyllis A. Knight , 56, Chief Financial Officer, Treasurer
 

Our executive officers are generally appointed each year at the annual meeting of our Board. Their terms of office are at the discretion of our Board.

The factual information below for each director, nominee for election as a director and for each executive officer has been provided by that person. The particular experience, qualifications, attributes or skills that led our Board to conclude that each should serve on our Board, in light of our business and structure, was determined by our Board or independent members of the Board.

T. Michael Ansley currently serves as the Executive Chairman of our Board of Directors. He served as our President, Chief Executive Officer, and Chairman of the Board since our inception in 2006 through October of 2016. The Company's roots can be traced back to 1999 when Mr. Ansley opened his first Buffalo Wild Wings ("BWW") franchise in Sterling Heights, Michigan. Mr. Ansley received a Bachelor of Science degree in business administration from the University of Dayton and currently serves on the Board of Directors of the Michigan Restaurant Association. Mr. Ansley also serves as Chairman, President and Chief Executive Officer of Bagger Dave’s Burger Tavern, Inc.

We believe Mr. Ansley is qualified to serve as a director of the Company due to his extensive experience in restaurant management, operations and development as well as his demonstrated business leadership abilities and long history with the Company as its founder.

David G. Burke currently serves as our President and Chief Executive Officer, positions he assumed in October of 2016. Mr. Burke had previously served as Chief Financial Officer and Treasurer of the Company since March 22, 2010, and has been a member of the Board since our inception. Prior to joining the Company, Mr. Burke was employed by Federal-Mogul Corporation, a leading global supplier of powertrain and safety technologies serving the world's foremost original equipment manufacturers and the worldwide aftermarket, where he held roles of increasing responsibility in finance, marketing, and corporate development. Mr. Burke earned a Bachelor of Science degree in mechanical engineering from the University of Dayton and a Master of Business Administration, with a concentration in finance, from the University of Michigan - Ross School of Business.

We believe Mr. Burke is qualified to serve as a director due to his leadership position as President and Chief Executive Officer of the Company, business acumen, and analytical skills, including a unique proficiency with regard to financial modeling and market analysis.

Jay Alan Dusenberry has been a member of the Board since our inception. Mr. Dusenberry served as our Treasurer from our inception to March 22, 2010. Currently, Mr. Dusenberry is a Vice President of Michigan Metal Coatings. From 2013 to 2017, he

79

served as Vice President of KAMAX, a fastener technology company for the automotive industry. From 2009 to 2013, he served as a Vice President at Cold Heading Company, a manufacturer of cold-formed fasteners. He received a Bachelor of Science degree in finance from the University of Dayton and a Master of Business Administration degree from the University of Detroit Mercy.
We believe Mr. Dusenberry is qualified to serve as a director due to his 20 years of experience in business leadership positions, including experience as a financial analyst for a health care system and senior administrative roles as a plant manager, director, and vice president in the automotive manufacturing industry.
 
Philip Friedman was appointed to the Board on March 10, 2011. Mr. Friedman served as Chairman, Chief Executive Officer, and President of McAlister's Corporation, a quick-casual restaurant concept, from 1999 through July 2010. Currently, Mr. Friedman is Chief Executive Officer of Salsarita's Fresh Cantina restaurant chain. Mr. Friedman is also President of P Friedman & Associates Inc., a strategic planning and management consulting company he founded in 1986. Mr. Friedman formerly served on the Boards of the National Restaurant Association and the Mississippi Restaurant Association. He is currently a member of the North Carolina Restaurant and Lodging Association and a former member of the International Franchise Association, the Culinary Institute of America's Society of Fellows and the National Association of Corporate Directors.

We believe Mr. Friedman is qualified to serve as a director because of his extensive franchise and chain restaurant expertise. This expertise is particularly relevant to our business as a franchisee of BWW.

David Ligotti has been a member of the Board since our inception. Mr. Ligotti owns and operates Oakwood Business Services, LLC ("Oakwood"), an accounting, tax, and consulting firm located in Ann Arbor, Michigan. Mr. Ligotti received a Bachelor of Arts degree in political science from Kalamazoo College, a Masters of Business Administration degree, with a major in accounting, from the University of Michigan, and a Master of Science in Taxation degree from Walsh College.

We believe Mr. Ligotti is qualified to serve as a director, as he has been a CPA for more than 30 years and has nearly 30 years of experience in restaurant finance, technology, operation, administration, and accounting.

Joseph M. Nowicki was elected to the Board at the 2010 annual meeting of stockholders. Mr. Nowicki is the Executive Vice President and Chief Financial Officer of Beacon Roofing Supply ("BECN"), a NASDAQ-listed company, a position he assumed on March 25, 2013. At BECN, Mr. Nowicki is responsible for the oversight of finance, credit and investor relations. Mr. Nowicki served as the Chief Financial Officer of Spartan Motors, Inc. (“SPAR”), a NASDAQ-listed specialty vehicle manufacturer based in Charlotte, Michigan from June 30, 2009 to March 22, 2013. Previously, Mr. Nowicki spent approximately 17 years with the Michigan-based furniture manufacturer, Herman Miller, Inc., where he held progressive financial roles, lastly as Vice President, Investor Relations and Treasurer. Before joining Herman Miller, he held several operations and finance positions, including working for IBM and General Motors, and spent several years in public accounting. Mr. Nowicki received a Master of Business Administration from the University of Michigan - Ross School of Business.

We believe Mr. Nowicki is qualified to serve as a director of the Company due to his extensive public company experience and specialized accounting, finance and capital markets expertise.

Roger Lipton joined the Board in September 2018. Mr. Lipton is an investment professional with more than four decades of experience specializing in restaurants and retailers. He earned a B.S. in Mechanical Engineering at Rensselaer Polytechnic Institute and an MBA at Harvard. After working as an auditor with PricewaterhouseCoopers for two years, he began a career on Wall Street, where he focused on the restaurant and franchising industries. He then moved on to build and operate a chain of fast casual restaurants in Canada. He subsequently spent 13 years at Ladenburg, Thalmann & Co., Inc., where he managed the Lipton Research Division, specializing in the restaurant industry. While at Ladenburg, he sponsored an annual restaurant conference for investment professionals. He formed his own firm, Lipton Financial Services, Inc. in 1993 to invest in restaurant and retail companies. Mr. Lipton also serves on the board of Barfly Ventures, operator of the HopCat chain of casual dining restaurants.

We believe Mr. Lipton is qualified to serve as a director of the Company due to his extensive financial and restaurant industry experience.

Executive Officers Who Are Not Also Directors

Mr. Ansley and Mr. Burke are also members of our Board of Directors, and information regarding their business experience is described above. The business experience for Mr. Curtis and Ms. Knight for at least the past five years is summarized below. Our executive officers are generally elected each year at the annual meeting of our Board of Directors that follows the annual meeting of the shareholders. Their terms of office are at the discretion of our Board of Directors.

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Jason Curtis is our Chief Operating Officer, a position he assumed at our inception in 2006. Mr. Curtis also serves as our Corporate Secretary. Beginning in 2000, Mr. Curtis worked in positions of increasing responsibility in the restaurant industry, starting at the ground level in the kitchen of a BWW restaurant that is now owned by the Company. In 2002, he became Chief Operating Officer of AMC Group, LLC, the predecessor to AMC Group, Inc. AMC Group, Inc. is now a wholly-owned subsidiary of DRH. Mr. Curtis provides leadership in all aspects of our sports bars and oversees the day to day operations, training and restaurant support. He aligns our operations team on company strategy and continuous improvement initiatives. He also works with support office department heads to foster a culture of community and excellence.

Phyllis A. Knight was appointed Chief Financial Officer and Treasurer in October 2016. Ms. Knight brings more than 30 years of finance, accounting and leadership experience. She has served in several senior executive positions in the manufacturing, home building and mortgage services industries. Ms. Knight most recently served as EVP and CFO of Polar Corporation, the largest tank trailer manufacturing, parts, and service organization in North America. Prior to that Ms. Knight spent eleven years at Champion Enterprises, Inc. and Champion Enterprises Holdings, LLC, the bulk of which as EVP and CFO. At Champion, she directed all finance functions, including strategic planning, Securities and Exchange Commission reporting, treasury, capital markets, investor relations, cash management, risk management, mergers and acquisitions, and IT. A Certified Public Accountant (inactive license), Ms. Knight began her career at KPMG after earning a Bachelor of Arts degree in Accounting from Michigan State University.

Equity Compensation Plan Information

The following table sets forth information, as of December 30, 2018 , with respect to compensation plans (including individual compensation arrangements) under which our equity securities are authorized for issuance, aggregated as follows:

Plan Category
 
Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
 
Weighted-average exercise
price of outstanding
options, warrants and
rights
 
Number of securities
remaining available for
future issuance
under equity
compensation plans
(excluding securities
reflected in column (a))
Equity compensation plans approved by security holders 1
 
—

 
N/A

 
1,241,444

Equity compensation plans not approved by security holders 2
 
150,000

 
$
2.50

 
N/A

 
1 In 2011, our Board of Directors and Stockholders approved the Stock Incentive Plan of 2011 (the “2011 Incentive Plan”) authorizing the grant of equity-based incentives to employees. On July 13, 2017, the Company's shareholders approved a new stock incentive plan - the Stock Incentive Plan of 2017 (“Stock Incentive Plan”). No further grants will be made under the 2011 Incentive Plan. The Stock Incentive Plan of 2017 authorized a total of 2,500,000 shares for issuance as incentive awards by way of stock options and/or restricted stock.

2 On July 31, 2010, the Company granted options for the purchase of 210,000 shares of common stock to the directors of the Company. These options vested ratably over a three-year period and were originally for a term of six years from issuance. On July 28, 2016, the agreement was amended to extend the expiration date of the remaining 180,000 shares to July 31, 2019. During 2018, 30,000 options were forfeited. The options can be exercised at a price of $2.50 per share.

ITEM 13.     CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

TRANSACTIONS WITH RELATED PERSONS

Certain Transactions

We have a written policy requiring that our Audit Committee review and approve related person transactions that involve us and are of the type that are required to be disclosed in our proxy statement by SEC rules. A transaction may be a related person transaction if any of our directors, executive officers, owners of more than 5.0% of our common stock, or their immediate family have a material interest in the transaction and the amount involved exceeds $120,000. The policy authorizes the Audit Committee

81

to approve a related person transaction if it determines that the transaction is at least as favorable to us as would have been expected if the transaction had been with a person who is not related to us, or is in our best interest.

On December 25, 2016, DRH completed a tax-free spin-off (the “Spin-Off”) of its Bagger Dave's business. Specifically, DRH contributed its 100.0% owned entity, AMC Burgers, LLC and certain real estate entities into Bagger Dave's Burger Tavern, Inc., a newly created Nevada corporation ("Bagger Dave's" or "Bagger"), which was then spun-off into a stand-alone, publicly- traded company on the over-the-counter exchange. In connection with the Spin-Off, DRH contributed to Bagger certain assets, liabilities, and employees related to its Bagger Dave's businesses. Intercompany balances due to/from DRH, which included amounts from sales, were contributed to equity. Additionally, DRH contributed $2 million in cash to Bagger to provide working capital for Bagger’s operations and is a guarantor for certain of Bagger's lease obligations.

Further, in conjunction with the Spin-Off, DRH entered into a transition services agreement (the "TSA") with Bagger Dave's pursuant to which DRH provided certain information technology and human resources support, limited accounting support, and other minor administrative functions at no charge. The TSA was intended to assist the discontinued component in efficiently and seamlessly transitioning to stand on its own. Certain provisions of the TSA terminated in December 2017 and the First Amendment to TSA (the "Amended TSA") was entered into effective January 1, 2018. Under the Amended TSA, DRH provides ongoing administrative support to Bagger Dave's in certain areas, including information technology, human resources and real estate, in exchange for a fee based on a rate-per-hour of service. From January 1, 2018 through March 22, 2019 , the total amount billed by DRH to Bagger Dave's for administrative services under the TSA was $58,965 and the total payments received and credits applied from Bagger by DRH were $0.

Our Executive Chairman (who is also a member of our board of directors) is also the Chairman of the Board, Chief Executive Officer and President of Bagger Dave's.

Indemnification Agreements

We expect to enter into indemnification agreements with each of our directors and executive officers. Each indemnification agreement will provide that, subject to limited exceptions, and among other things, we will indemnify the director or executive officer to the fullest extent permitted by law for claims arising in his or her capacity as our director or officer.

Director Independence

We employ the NASDAQ Stock Market’s standards for determining the independence of directors. Under these standards, an independent director means a person other than an executive officer or one of our team members or any other individual having a relationship which, in the opinion of the Board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.

For purposes of the NASDAQ Stock Market’s independence standards, the term “family member” means a person’s spouse, parents, children, and siblings, whether by blood, marriage, or adoption, or anyone residing in such person’s home.

The Board has assessed the independence of each non-employee director under the NASDAQ Stock Market’s independence standards set forth above and believes that Messrs. Jay Alan Dusenberry, Philip Friedman, Joseph M. Nowicki and Roger Lipton qualify as independent directors. In making this determination, our Board has concluded that none of the independent directors has a relationship that, in the opinion of our Board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The other directors would not qualify as independent due to their employment by us or due to their receipt of certain fees or compensation from us.

Disclosure Controls, Governance, and Nominating Functions

The Board has determined that the governance and disclosure control functions are best suited to participation of the full Board. These functions are to: (i) ensure that all disclosures made by the Company to its stockholders or the investment community fairly present the Company’s financial condition and the results of operations in all material respects and such disclosures are accurate, complete, and timely made as required by applicable laws and any applicable stock exchange requirements; and (ii) advise and make recommendations to the Board with respect to corporate governance principles and practices.

The Board has also adopted resolutions authorizing and directing the independent members of the Board, to recommend qualified candidates to the Board for election as directors of the Company, including the slate of directors that the Board proposes for election by stockholders at the annual meetings and candidates to fill vacancies occurring between annual meetings.

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The independent directors use an informal process to identify potential candidates for nomination as directors. Candidates for nomination have been recommended by an executive officer or director and considered by the independent directors and the Board. Generally, candidates have been persons who have been known to one or more of our Board members. The independent directors have not adopted specific minimum qualifications that they believe must be met by a person they recommend for nomination as a director. In evaluating candidates for nomination, the independent directors will consider the factors they believe to be appropriate. These factors would generally include the candidate’s personal and professional integrity, business judgment, relevant experience and skills, and potential to be an effective director in conjunction with the rest of our Board in collectively serving the long-term interests of our stockholders. We do not have a specific policy relating to the consideration of diversity in identifying director candidates. However, the independent directors consider the diversity of our Board when identifying director candidates. The amount of consideration given to diversity varies with the independent directors’ determination of whether we would benefit from expanding the Board’s diversity in a particular area. We believe this policy has been effective in identifying candidates with the diverse business experience necessary to lead our Company.

Although the independent directors have the authority to retain a search firm to assist it in identifying director candidates, there has, to date, been no need to employ a search firm. The Board does not evaluate potential nominees for director differently based on whether they are recommended by a stockholder.

To nominate a candidate for election to the Board of Directors, a stockholder of record must (i) provide a written notice of nomination to the Secretary of the Company, not less than 90 days nor more than 120 days prior to the first anniversary of the date of the prior year’s annual meeting of stockholders, or (ii) in the case of the nomination of a person for election to the Board of Directors at a special meeting of stockholders, no earlier than 120 days prior to and no less than the later of (a) 90 days prior to such special meeting or (b) the tenth day following the day on which the notice of such special meeting, with certain limited exceptions spelled out in the bylaws. The notice of nomination must set forth (i) the name and record address of the stockholder proposing to make nominations, as they appear on the Company’s books, (ii) the class and number of shares of stock held of record and beneficially owned by such stockholder and/or such beneficial owner, (iii) a representation that the stockholder is a holder of record of stock of the Company entitled to vote at the meeting and intends to appear in person or by proxy at the meeting to propose such nomination, (iv) all information regarding each stockholder nominee that would be required to be set forth in a definitive proxy statement filed with the Securities and Exchange Commission pursuant to Section 14 of the Exchange Act, and the written consent of each stockholder nominee to being named in a proxy statement as a nominee and to serve if elected, and (v) all other information that would be required to be filed with the Securities and Exchange Commission if the person proposing such nominations were a participant in a solicitation subject to Section 14 of the Exchange Act. The Company may require any stockholder nominee to furnish such other information as it may reasonably require in order to determine the eligibility of the stockholder nominee to serve as a director of the Company. The person presiding over the meeting may, if the facts warrant, disregard any proposed nomination of a stockholder nominee that was not made in accordance with the foregoing procedures.


83


ITEM 14.     PRINCIPAL ACCOUNTANT FEES AND SERVICES

Principal Accountant Fees and Services

The following table shows the fees for audit and other professional services provided to us by BDO in 2018 and 2017 .

Services
 
 
December 30, 2018
 
December 31, 2017
Audit Fees (1)
$
265,000

 
$
228,000

Audit-Related Fees (2)
—

 
—

Tax Fees (3)
78,870

 
139,630

All Other Fees (4)
—

 
—

Total audit and non-audit fees
$
343,870

 
$
367,630


(1)
“Audit Fees” include the aggregate fees billed for professional services rendered for the audit of our annual financial statements and for review of financial statements included in our quarterly reports on Form 10-Q. These fees also cover other services that are normally provided by the independent accountants in connection with documents to be filed with the SEC.
(2)
“Audit-Related Fees” consist of fees billed for professional services rendered related to the performance of the audit or review that are not otherwise reported under Audit Fees.
(3)
“Tax Fees” consist of fees billed for professional services rendered in connection with tax compliance, tax advice and tax planning.
(4)
“All Other Fees” consist of fees billed for professional services rendered that are not otherwise reported above.

Policy on Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditors

The Company’s Audit Committee pre-approves all audit and non-audit services provided by the independent auditor prior to the engagement of the independent auditor with respect to such services. The Company’s independent auditor may be engaged to provide non-audit services only after the appointed auditor has first considered the proposed engagement and has determined, in each instance, that the proposed services are not prohibited by applicable regulations and that the auditor’s independence will not be materially impaired as a result of having provided these services. In making this determination, the Audit Committee takes into consideration whether a reasonable investor, knowing all relevant facts and circumstances, would conclude that the auditor’s exercise of objective and impartial judgment on all issues encompassed within the auditor’s engagement would be materially impaired. All services provided by the Company’s independent auditor in 2018 and 2017 were pre-approved by the Audit Committee or its Chairman in accordance with the Company’s policy.


84

PART IV
 

ITEM 15.     EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
(a) (1) Financial Statements. The following financial statements and reports of independent registered public accounting firms of Diversified Restaurant Holdings and its subsidiaries are filed as part of this report:
 
•
Report of Independent Registered Public Accounting Firm — BDO USA, LLP
•
Report by Diversified Restaurant Holdings, Inc.’s Management on Internal Control Over Financial Reporting
•
Consolidated Balance Sheets as of December 30, 2018 and December 31, 2017
•
Consolidated Statements of Operations for the Fiscal Years Ended December 30, 2018 and December 31, 2017
•
Consolidated Statements of Comprehensive Loss for the Fiscal Years Ended  December 30, 2018 and December 31, 2017
•
Consolidated Statements of Stockholders' Equity (Deficit) for the Fiscal Years Ended  December 30, 2018 , and December 31, 2017
•
Consolidated Statements of Cash Flows for the Fiscal Years Ended December 30, 2018 and December 31, 2017
•
Notes to Consolidated Financial Statements

The consolidated financial statements, the notes to the consolidated financial statements, and the report of independent registered public accounting firm listed above are contained in Item 8 of this report.
 
(2) Financial Statement Schedules
 
Not applicable
 
(b) Index to Exhibits required by Item 601 of Regulation S-K:
 
The Exhibit Index preceding the Signatures Page hereto is incorporated by reference under this item.

85

ITEM 16.     SUMMARY

None.

86



EXHIBIT
NO.
EXHIBIT DESCRIPTION
3.1
3.2
3.3
3.4
4.1
4.2
4.3
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10

87

10.11
10.12
10.13
10.14
10.15
10.16
10.17
10.18
21.0
23
31.1
31.2
32.1
32.2
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Document
101.DEF
XBRL Taxonomy Extension Definition Document
101.LAB
XBRL Taxonomy Extension Labels Document
101.PRE
XBRL Taxonomy Extension Presentation Document
*
Management contract or compensatory plan

88

Signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: April 3, 2019

  
DIVERSIFIED RESTAURANT HOLDINGS, INC.
  
  
  
  
  
  
  
  
By:  
/s/ David G. Burke
  
  
  
David G. Burke
  
  
  
President, Chief Executive Officer, Director
  
  
  
(Principal Executive Officer)
  

89

In accordance with 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 dates indicated.
 
  
  
  
  
  
/s/ David G. Burke
Dated:
April 3, 2019
David G. Burke
President, Chief Executive Officer, Director (Principal Executive Officer)
  
  
 
 
 
/s/ Phyllis A. Knight
Dated:
April 3, 2019
Phyllis A. Knight
Treasurer, Chief Financial Officer
(Principal Financial and Accounting Officer)
  
  
  
  
  
/s/ T. Michael Ansley
Dated:
April 3, 2019
T. Michael Ansley
Executive Chairman of the Board of Directors
 
 
 
 
 
/s/ Jay Alan Dusenberry
Dated:
April 3, 2019
Jay Alan Dusenberry
Director
  
  
  
  
  
/s/ David Ligotti
Dated:
April 3, 2019
David Ligotti
Director
  
  
  
  
  
/s/ Roger Lipton
Dated:
April 3, 2019
Roger Lipton
Director
  
  
  
  
  
/s/ Joseph M. Nowicki
Dated:
April 3, 2019
Joseph M. Nowicki
Director
  
  
  
  
  
/s/ Philip Friedman
Dated:
April 3, 2019
Philip Friedman
Director
  
  


90
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