10-Q 1 form10-q.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

[X]

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 2017

 

[  ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from to

Commission file number: 000-55918

 

MUSCLE MAKER, INC.

(Exact name of registrant as specified in its charter)

 

 

 

California   47-2555533

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

     

308 East Renfro Street, Suite 101,

Burleson, Texas

  76028
(Address of Principal Executive Offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (832)-632-1386

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

 

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

 

Large accelerated filer [  ]   Accelerated filer [  ]
         
Non-accelerated filer [  ] (Do not check if a smaller reporting company) Smaller reporting company [X]
         
Emerging growth company [  ]      

 

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

 

As of February 25, 2019, there were 7,803,881 shares of common stock outstanding.

 

 

 

   
 

 

MUSCLE MAKER, INC. AND SUBSIDIARIES

 

FORM 10-Q

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2017

 

TABLE OF CONTENTS

 

  Page
   
PART 1 – FINANCIAL INFORMATION  
   
ITEM 1. Financial Statements.  
   

Condensed Consolidated Balance Sheets as of September 30, 2017 (unaudited) and December 31, 2016

1
   

Unaudited Condensed Consolidated Statements of Operations for the Nine Months Ended September 30, 2017 and 2016

2
   

Unaudited Condensed Consolidated Statements of Changes in Stockholders’ (Deficit)/Equity for the Nine Months Ended September 30, 2016

3
   

Unaudited Condensed Consolidated Statements of Changes in Stockholders’ (Deficit)/Equity for the Nine Months Ended September 30, 2017

4
   

Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2017 and 2016

5
   

Notes to Unaudited Condensed Consolidated Financial Statements

7
   
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. 33
   
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk. 46
   
ITEM 4. Controls and Procedures. 46
   
PART II - OTHER INFORMATION  
   
ITEM 1. Legal Proceedings. 48
   
ITEM 1A. Risk Factors. 49
   
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds. 67
   
ITEM 3. Defaults Upon Senior Securities. 68
   
ITEM 4. Mine Safety Disclosures. 68
   
ITEM 5. Other Information. 68
   
ITEM 6. Exhibits. 69
   
SIGNATURES 70

 

   
 

 

MUSCLE MAKER, INC AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   September 30,   December 31, 
   2017   2016 
   (unaudited)     
Assets          
Current Assets:          
Cash  $143,401   $335,724 
Accounts receivable, net of allowance for doubtful accounts
of $4,500 as of September 30, 2017 and December 31, 2016
   317,219    203,100 
Inventory   90,078    64,120 
Receivable from Former Parent, net   177,843    - 
Current portion of loans receivable, net of allowance of
$25,000 at September 30, 2017 and December 31, 2016
   51,665    30,434 
Current portion of loans receivable from related party   21,893    20,000 
Prepaid expenses and other current assets   37,876    50,316 
Total Current Assets   839,975    703,694 
Property and equipment, net   1,617,203    1,072,545 
Goodwill   -    2,521,468 
Intangible assets, net   3,209,743    3,702,649 
Loans receivable - non current   165,602    53,229 
Loans receivables from related parties - non current   36,667    51,667 
Security deposits and other assets   156,796    148,772 
Total Assets  $6,025,986   $8,254,024 
           
Liabilities and Stockholders’ Equity          
Current Liabilities:          
Accounts payable and accrued expenses  $2,253,180   $966,341 
Convertible notes payable   150,000    - 
Deferred revenue   1,416,931    1,302,967 
Deferred rent, current   23,142    - 
Other current liabilities   345,054    158,238 
Total Current Liabilities   4,188,307    2,427,546 
Convertible notes payable to Former Parent, net of debt discount of $0 and $2,699,726 at September 30, 2017 and December 31, 2016, respectively   -    1,004,736 
Convertible notes payable   1,100,000    - 
Convertible notes payable, related parties   300,000    - 
Payable to Former Parent, non-current   -    74,145 
Deferred tax liability   341,989    246,527 
Deferred rent, non-current   273,059    183,638 
Total Liabilities   6,203,355    3,936,592 
           
Commitments and Contingencies          
           
Stockholders’ (Deficit)/Equity:          

Common stock, no par value, 100,000,000 shares authorized,7,629,824 and 4,604,842 shares issued and outstanding as of September 30, 2017 and December 31, 2016, respectively

   13,199,863    5,157,010 
Additional paid-in capital   552,670    2,842,343 
Accumulated deficit   (13,880,663)   (3,841,638)
Total Controlling Interest   (128,130)   4,157,715 
Non-controlling interest   (49,239)   159,717 
Total Stockholders’ (Deficit)/Equity   (177,369)   4,317,432 
Total Liabilities and Stockholders’ Equity  $6,025,986   $8,254,024 

 

See Notes to the Condensed Consolidated Financial Statements

 

 1 
 

 

MUSCLE MAKER, INC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF OPERATION

(unaudited)

 

   For the Three Months Ended   For the Nine Months Ended 
   September 30,   September 30, 
   2017   2016   2017   2016 
                 
Revenues:                    
Company restaurant sales, net of discounts  $1,300,638   $1,017,844   $3,958,653   $1,895,426 
Franchise royalties and fees   791,716    616,916    1,728,933    1,463,521 
Other revenues   262,879    362,530    558,469    557,900 
Total Revenues   2,355,233    1,997,290    6,246,055    3,916,847 
                     
Operating Costs and Expenses:                    
Restaurant operating expenses:                    
Food and beverage costs   639,518    409,692    1,622,316    728,041 
Labor   687,813    458,226    1,920,441    861,994 
Rent   318,831    327,197    915,637    464,132 
Other restaurant operating expenses   351,905    175,797    870,968    387,148 
Total restaurant operating expenses   1,998,067    1,370,912    5,329,362    2,441,315 
Costs of other revenues   97,082    103,009    210,563    256,726 
Depreciation and amortization   140,535    75,848    308,407    160,466 
Impairment of intangible assets   410,225    -    410,225    - 
Impairment of goodwill   2,521,468    -    2,521,468    - 
General and administrative expenses   2,352,007    1,521,416    5,884,594    3,206,501 
Total Costs and Expenses   7,519,384    3,071,185    14,664,619    6,065,008 
Loss from Operations   (5,164,151)   (1,073,895)   (8,418,564)   (2,148,161)
                     
Other (Expense) Income:                    
Other income   2,798    6,261    88,027    6,563 
Interest income, net   6,392    3,997    7,152    4,851 
Amortization of debt discount   (195,702)   (35,351)   (3,956,792)   (102,228)
Total Other Expense, Net   (186,512)   (25,093)   (3,861,613)   (90,814)
                     
Net Loss Before Income Tax   (5,350,663)   (1,098,988)   (12,280,177)   (2,238,975)
Income tax provision   (31,821)   (31,821)   (95,462)   (95,462)
Net Loss   (5,382,484)   (1,130,809)   (12,375,639)   (2,334,437)
Net loss attributable to the non-controlling interest   (518,550)   (296,335)   (2,336,614)   (599,037)
Net Loss Attributable to Controlling Interest  $(4,863,934)  $(834,474)  $(10,039,025)  $(1,735,400)
                     
Net Loss Attributable to Controlling Interest Per Share:                    
Basic and Diluted  $(0.84)  $(0.18)  $(1.81)  $(0.38)
                     
Weighted Average Number of Common Shares Outstanding:                    
Basic and Diluted   5,773,819    4,604,842    5,559,504    4,604,842 

 

See Notes to the Condensed Consolidated Financial Statements

 

 2 
 

 

MUSCLE MAKER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ (DEFICIT)/EQUITY

(unaudited)

 

    No Par
Common Stock
    Additional
Paid-in
    Accumulated     Total
Controlling
    Non-
Controlling
       
    Shares     Amount     Capital     Deficit     Interest     Interest     Total  
Balance - December 31, 2015     4,604,842     $ 5,157,010     $ 216,524     $ (732,057 )   $ 4,641,477     $ 1,269,823     $ 5,911,300  
Net loss     -       -       -       (1,735,400 )     (1,735,400 )     (599,037 )     (2,334,437 )
Balance - September 30, 2016     4,604,842     $ 5,157,010     $ 216,524     $ (2,467,457 )   $ 2,906,077     $ 670,786     $ 3,576,863  

 

See Notes to the Condensed Consolidated Financial Statements

 

 3 
 

 

MUSCLE MAKER, INC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ (DEFICIT)/EQUITY

(unaudited)

 

   No Par
Common Stock
  

Additional

Paid-in

   Accumulated  

Total

Controlling

   Non-Controlling     
   Shares   Amount   Capital   Deficit   Interest   Interest   Total 
Balance - December 31, 2016   4,604,842   $5,157,010   $2,842,343   $(3,841,638)  $4,157,715   $159,717   $4,317,432 
Issuance of restricted stock   45,352    -    -    -    -    -    - 
Shares issued for cash   56,250    420,000    -    -    420,000    -    420,000 
Exercise of warrants for purchase of
common stock
   5,356    50,000    -    -    50,000    -    50,000 
Restricted stock issued as compensation
for services
   52,307    170,000    -    -    170,000    -    170,000 
Shares issued in connection with merger   1,550,964    1,466,541    (3,594,199)   -    (2,127,658)   2,127,658    - 
Options issued to franchisees   -    -    47,583    -    47,583    -    47,583 
Conversion of convertible notes payable to
Former Parent into common stock
   1,314,753    5,361,177    -    -    5,361,177    -    5,361,177 
Beneficial conversion feature –
First, Second and Third 2017 ARH Notes
   -    -    1,085,985    -    1,085,985    -    1,085,985 
Warrants issued in connection with
convertible debt
   -    -    170,958    -    170,958    -    170,958 
Stock-based compensation:                                   
Amortization of restricted common stock   -    575,135    -    -    575,135    -    575,135 
Net loss   -    -    -    (10,039,025)   (10,039,025)   (2,336,614)   (12,375,639)
                                    
Balance - September 30, 2017   7,629,824   $13,199,863   $552,670   $(13,880,663)  $(128,130)  $(49,239)  $(177,369)

 

See Notes to the Condensed Consolidated Financial Statements

 

 4 
 

 

MUSCLE MAKER, INC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

   For the Nine Months Ended 
   September 30, 
   2017   2016 
         
Cash Flows from Operating Activities          
Net loss  $(12,375,639)  $(2,334,437)
Adjustments to reconcile net loss to net cash used in
operating activities:
          
Depreciation and amortization   308,407    160,466 
Stock-based compensation   575,135    - 
Options issued to franchisees   47,583    - 
Restricted stock issued as compensation for services   170,000    - 
Amortization of debt discount   3,956,792    102,228 
Impairment of intangible asset   410,225    - 
Impairment of Goodwill   2,521,468    - 
Bad debt expense   33,878    11,223 
Deferred rent   112,563    156,551 
Deferred income tax provision   95,462    95,462 
Expenses paid by Former Parent   265,323    - 
Changes in operating assets and liabilities:          
Accounts receivable   (136,774)   (193,233)
Inventory   (25,958)   (38,280)
Prepaid expenses and other current assets   12,440    62,576 
Security deposits and other assets   (8,024)   (43,130)
Accounts payable and accrued expenses   1,096,716    498,091 
Deferred revenue   113,964    597,973 
Other current liabilities   186,816    (76,743)
Total Adjustments   9,736,016    1,333,184 
Net Cash Used in Operating Activities   (2,639,623)   (1,001,253)
           
Cash Flows from Investing Activities          
Purchases of property and equipment   (580,384)   (751,968)
Issuance of loans receivable   (56,250)   (218,750)
Issuance of loans receivable - related parties   (4,389)   - 
Collections from loans receivable   94,031    220,560 
Collections from loans receivable - related parties   17,496    15,000 
Net Cash Used in Investing Activities   (529,496)   (735,158)
           
Cash Flows from Financing Activities          
Proceed from exercise of warrants     50,000    - 
Proceed from sale of restricted stock     420,000    - 
(Repayments) Advances from Former Parent     (182,004)   2,154,750 
Repayments of notes payable   -    (8,100)
Proceeds from convertible notes payable   1,250,000    - 
Proceeds from convertible notes payable - related parties   300,000    - 
Proceeds from convertible notes payable to Former Parent   1,138,800    - 
Net Cash Provided by Financing Activities   2,976,796    2,146,650 
           
Net (Decrease) Increase in Cash   (192,323)   410,239 
Cash - Beginning of Period   335,724    599,278 
Cash - End of Period  $143,401   $1,009,517 

 

See Notes to the Condensed Consolidated Financial Statements

 

 5 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

(unaudited)

 

   For the Nine Months Ended 
   September 30, 
   2017   2016 
         
Supplemental Disclosures of Cash Flow Information:          
Cash paid for interest  $876   $- 
           

Supplemental disclosures of non-cash investing and financing activities

          
Beneficial conversion feature  $1,085,985   $- 
Warrants issued in connection with convertible debt  $170,958   $- 
Payment on note payable by parent in exchange for reduction in receivable from Former Parent  $-   $300,000 
Payable to Parent exchanged for convertible notes  $517,915   $- 
Conversion of convertible notes payable to Former Parent into common stock  $5,361,177   $- 
Loan receivable advanced by Former Parent  $162,500   $- 
Accounts payable associated with purchases of property and equipment  $190,000   $- 

 

 6 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 1 – BUSINESS ORGANIZATION AND NATURE OF OPERATIONS, GOING CONCERN AND MANAGEMENT’S PLANS

 

Muscle Maker, Inc. (“MMI”), a former subsidiary of American Restaurant Holdings (“ARH” or “Former Parent”) was incorporated in California on December 8, 2014 and was a majority owner of Muscle Maker Brands, LLC, (“MMB”). MMB’s subsidiaries include Company owned restaurants as well as Custom Technology, Inc, (“CTI”) a technology and point of sale (“POS”) systems dealer and technology consultant. MMB was formed on December 22, 2014 in the state of California for the purpose of acquiring and operating company owned restaurants, as well as franchising its name and business system to qualified franchisees. Muscle Maker Franchising, LLC (“MMF”) was founded in 1995 in order to develop a brand of healthy-option fast food restaurants.

 

On January 23, 2015 (the “Closing Date”), MMI, MMB and MMF entered into an agreement whereby MMB purchased substantially all of the assets and liabilities of MMF, MMI acquired 74% of the membership units of MMB, and certain members of MMF acquired 26% of the membership units of MMB.

 

On March 23, 2017, ARH authorized and facilitated the distribution of 5,536,308 shares of Common Stock of MMI held by American Restaurants, LLC, the wholly owned subsidiary of ARH, to the shareholders of the Former Parent (the “Spin-Off”). As a result of the Spin-Off on March 23, 2017, ARH is no longer a majority owner of MMI.

 

On June 8, 2017, MMB converted from a limited liability company into a California corporation named Muscle Maker Brands Conversion, Inc. (“MMBC”).

 

On July 18, 2017, MMI formed Muscle Maker Development, LLC (“Muscle Maker Development”) in the state of Nevada for the purpose of running our existing franchise operations and continuing to franchise the Muscle Maker Grill name and business system to qualified franchisees. Muscle Maker Development issued 1,000 membership units to its sole member and manager, MMI. MMB assigned all the existing franchise agreements to Muscle Maker Development (“Assignment and Assumption Agreement”) pursuant to the terms of that certain Assignment and Assumption Agreement, dated August 25, 2017, among MMI, MMB and Muscle Maker Development.

 

On July 18, 2017, MMI formed Muscle Maker Corp., LLC (“Muscle Maker Corp.”) in the state of Nevada for the purpose of developing new corporate stores and operating new and existing corporate stores of MMI. Muscle Maker Corp. issued 1,000 membership units to its sole member and manager, MMI and MMI assigned all the existing corporate stores to Muscle Maker Corp.

 

On September 15, 2017 (“Effective Merger Date”), pursuant to an Agreement of Merger, MMBC was merged (“Merger”) into MMI, with MMI as the surviving corporation, in a tax-free reorganization. Pursuant to the Merger, each share of common stock of MMBC (the “MMBC Common Stock”) owned by the members of MMF was converted into 796 shares of common stock of MMI, resulting in aggregate consideration of 1,550,964 shares of common stock of MMI to the members of MMF. As a result of the Merger, MMI directly owned 70% of the shares of CTI.

 

MMI and its subsidiaries is the “Company”.

 

 7 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 1 – BUSINESS ORGANIZATION AND NATURE OF OPERATIONS, GOING CONCERN AND MANAGEMENT’S PLANS, Continued

 

The Company operates under the name Muscle Maker Grill and is a franchisor and owner operator of Muscle Maker Grill restaurants. As of September 30, 2017, the Company’s restaurant system included thirteen company-owned restaurants, and thirty-nine restaurants. One of the thirteen company-owned restaurants were in the pre-opening phase as of September 30, 2017, and two company-owned restaurants was subsequently open for operation as of the date of the issuance of these consolidated financial statements. A Muscle Maker Grill restaurant offers quality food freshly prepared with the Company’s proprietary recipes created with the guest’s health in mind. The menu is protein based, and features various supplements, health food snacks, along with a nutritious children’s menu.

 

Going Concern and Management’s Plans

 

As of September 30, 2017, the Company had a cash balance, a working capital deficiency and an accumulated deficit of $143,401, $3,348,332, and $13,880,663, respectively. For the nine months ended September 30, 2017, the Company incurred a pre-tax net loss of $12,280,177. These conditions indicate that there is substantial doubt about the Company’s ability to continue as a going concern for at least one year from the date of the issuance of these consolidated financial statements.

 

The Company’s operations have primarily been funded through proceeds from the issuance of equity and debt. Subsequent to September 30, 2017, the Company received an aggregate of $3,113,105 associated with the issuances of convertible promissory notes payable and warrants to various lenders, of which $1,871,340 was converted into common stock. In addition, the Company received an aggregate of $420,000 in connection with sales of restricted common stock and $50,000 in connection with the exercise of a warrant From September 12, 2018 through the date of this report, the Company entered into Securities Purchase Agreements (“SPA”) with several accredited investors (the “Investors”) providing for the sale by the Company to the Investors of 15% Senior Secured Convertible Promissory Notes (the “SPA Notes”) in the aggregate amount of $2,165,000, in addition $635,000 in existing convertible debt converted was converted into SPA Notes. (See Note 15 – Subsequent Events -15% Senior Secured Convertible Notes).

 

Although management believes that the Company has access to capital resources, there are no commitments, other than aforementioned, in place for new financing as of the date of the issuance of these consolidated financial statements there can be no assurance that the Company will be able to obtain funds on commercially acceptable terms, if at all. The Company expects to have ongoing needs for working capital in order to (a) fund operations; plus (b) expand operations by opening additional corporate-owned restaurants. To that end, the Company may be required to raise additional funds through equity or debt financing. However, there can be no assurance that the Company will be successful in securing additional capital. If the Company is unsuccessful, the Company may need to (a) initiate cost reductions; (b) forego business development opportunities; (c) seek extensions of time to fund its liabilities, or (d) seek protection from creditors.

 

The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”), which contemplate continuation of the Company as a going concern and the realization of assets and the satisfaction of liabilities in the normal course of business. The carrying amounts of assets and liabilities presented in the condensed consolidated financial statements do not necessarily purport to represent realizable or settlement values. The condensed consolidated financial statements do not include any adjustment that might result from the outcome of this uncertainty.

 

 8 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 2 – REVERSE STOCK SPLITS

 

Effective September 20, 2017, pursuant to authority granted by the stockholders of the Company, the Company implemented a 1-for-7 reverse split of the Company’s issued common stock (the “Reverse Split”).

 

Effective January 31, 2018, pursuant to authority granted by the stockholders of the Company, the Company implemented a 3-for-4 reverse split of the Company’s issued common stock (the “Second Reverse Split”).

 

All share and per share information has been retroactively adjusted to reflect the Reverse Split for all periods presented.

 

NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America for annual financial statements. In the opinion of management, such statements include all adjustments (consisting only of normal recurring items) which are considered necessary for a fair presentation of the unaudited condensed consolidated financial statements of the Company as of September 30, 2017, and for the nine months ended September 30, 2017 and 2016. The results of operations for the nine months ended September 30, 2017 are not necessarily indicative of the operating results for the full year. It is suggested that these unaudited condensed consolidated financial statements be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2016, included in this filing. The balance sheet as of December 31, 2016 has been derived from the Company’s audited financial statements.

 

Principles of Consolidation

 

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries and majority-owned subsidiary. Any intercompany transactions and balances have been eliminated in consolidation.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period.

 

 9 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES, continued

 

Use of Estimates, continued

 

Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Significant estimates include:

 

  the fair value of assets acquired and liabilities assumed in a business combination;
  the assessment of recoverability of long-lived assets, including property and equipment, goodwill and intangible assets;
  the estimated useful lives of intangible and depreciable assets;
  the recognition of revenue; and
  the recognition, measurement and valuation of current and deferred income taxes

 

Estimates and assumptions are periodically reviewed, and the effects of any material revisions are reflected in the financial statements in the period that they are determined to be necessary. Actual results could differ from those estimates and assumptions.

 

Cash and Cash Equivalents

 

The Company considers all highly-liquid instruments with an original maturity of three months or less when purchased to be cash equivalents. There were no cash equivalents as of September 30, 2017 and December 31, 2016.

 

Convertible Instruments

 

The Company evaluates its convertible instruments to determine if those contracts or embedded components of those contracts qualify as derivative financial instruments to be separately accounted for in accordance with Topic 815 of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”). The accounting treatment of derivative financial instruments requires that the Company record embedded conversion options and any related freestanding instruments at their fair values as of the inception date of the agreement and at fair value as of each subsequent balance sheet date. Any change in fair value is recorded as non-operating, non-cash income or expense for each reporting period at each balance sheet date. The Company reassesses the classification of its derivative instruments at each balance sheet date. If the classification changes as a result of events during the period, the contract is reclassified as of the date of the event that caused the reclassification. Embedded conversion options and any related freestanding instruments are recorded as a discount to the host instrument.

 

If the instrument is determined not to be a derivative liability, the Company then evaluates for the existence of a beneficial conversion feature by comparing the market price of the Company’s common stock as of the commitment date to the effective conversion price of the instrument.

 

As of September 30, 2017 and December 31, 2016, the Company did not have any derivative liabilities on its balance sheets.

 

 10 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES, continued

 

Revenue Recognition

 

In accordance with the Accounting Standard Codification Topic 605 “Revenue Recognition” (“ASC 605”), the Company recognizes revenue when the following four criteria are met: (1) delivery has occurred or services rendered; (2) persuasive evidence of an arrangement exists; (3) there are no continuing obligations to the customer; and (4) the collection of related accounts receivable is probable.

 

Restaurant Sales

 

Retail store revenue at company operated restaurants is recognized when payment is tendered at the point of sale, net of sales tax, discount and other sales related taxes.

 

Franchise Royalties and Fees

 

Franchise royalties and fees principally consists of royalties and franchise fees. Royalties are based on a percentage of franchisee net sales revenue. Initial franchise fees are recognized upon opening of a restaurant or granting of a new franchise term, which is when the Company has performed substantially all material obligations and initial services required by the franchise agreement. The Company recognizes renewal fees as income when a renewal agreement becomes effective.

 

The Company has supply agreements with certain food and beverage vendors. Pursuant to the terms of these agreements, rebates are provided to the Company based upon the dollar volume of purchases for all company-owned and franchised restaurants from these vendors. Rebates earned on purchases by franchise stores are recorded as revenue during the period in which the related food and beverage purchases are made. The Company recorded revenue from rebates of $239,398 and $383,855, respectively, during the three and nine months ended September 30, 2017, which is included in franchise royalties and fees on the accompanying condensed consolidated statements of operations. The Company recorded revenue from rebates of $99,119 and $280,445, respectively, during the three and nine months ended September 30, 2016, which is included in franchise royalties and fees on the accompanying condensed consolidated statements of operations. Rebates earned on purchases by company owned stores are recorded as a reduction of cost of goods sold during the period in which the related food and beverage purchases are made.

 

Other Revenues

 

Through its subsidiary CTI, the Company derives revenue from the sale of POS computer systems, cash registers and camera systems, and from the provision of related consulting and support services, which generally include implementation, installation and training services. We recognize revenue when persuasive evidence of an arrangement exists, delivery of the product or service has occurred, the fee is fixed or determinable and collectability is reasonably assured. The Company recorded $262,879 and $558,469, respectively, of revenues from these technology sales and services during the three and nine months ended September 30, 2017. The Company recorded $362,530 and $557,900, respectively, of revenues from these technology sales and services during the three and nine months ended September 30, 2016.

 

 11 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES, continued

 

Revenue Recognition, continued

 

Deferred Revenue

 

Deferred revenue primarily includes initial franchise fees received by the Company, for which the restaurant has not yet opened, as well as unearned vendor rebates and customer deposits received in connection with technology sales and services by CTI (see Note 9 – Deferred Revenue).

 

The Company collects initial franchise fees when franchise agreements are signed and recognizes the initial franchise fees as revenue when the store is opened, which is when the Company has performed substantially all initial services required by the franchise agreement. Customer deposits received for technology sales or services are recorded as deferred revenue and recognized when the sale is complete, or the service is performed.

 

Advertising

 

Advertising costs are charged to expense as incurred. Advertising costs were approximately $257,149 and $481,897, respectively, for the three and nine months ended September 30, 2017, and are included in general and administrative expenses in the accompanying condensed consolidated statements of operations. Advertising costs were approximately $263,067 and $273,840, respectively, for the three and nine months ended September 30, 2016, and are included in general and administrative expenses in the condensed consolidated statements of operations. Advertising costs incurred related to our national advertising fund are netted with contributions from our Company-owned stores and our franchisees.

 

Net Loss per Share

 

Basic loss per common share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding during the period. Diluted loss per common share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding, plus the impact of potential common shares, if dilutive, resulting from the exercise of warrants, and stock options from the conversion of convertible debt, from the conversion of Muscle Maker Brands, LLC (“MMB”) membership units and the vesting of restricted stock which were obtained by the non-controlling interest in connection with the acquisition of MMB and are convertible into shares of common stock of MMI.

 

The following securities are excluded from the calculation of weighted average diluted common shares at September 30, 2017 and 2016, respectively, because their inclusion would have been anti-dilutive:

 

   September 30, 
   2017   2016 
Warrants   521,045    72,319 
Options   33,750    - 
Convertible debt   953,846    231,990 
MMB membership units   -    1,550,964 
Total potentially dilutive shares   1,508,641    1,855,273 

 

 12 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES, continued

 

Major Vendor

 

The Company engages various vendors to distribute food products to their Company-owned restaurants. Purchases from the Company’s largest supplier totaled 81% and 84% of the Company’s purchases for the nine months ended September 30, 2017 and for the year ended December 31,2016, respectively.

 

Controlling and Non-Controlling Interest

 

MMI used to own a 74% controlling interest in MMB through the Effective Merger Date and owns a 70% controlling interest in CTI. The profits and losses of CTI are allocated among the controlling interest and the CTI non-controlling interest in the same proportions as their membership interests. All of the profits and losses of MMB and its subsidiaries were allocated among the controlling interest and MMB non-controlling Interest in proportion to the ownership interests through the Effective Merger Date.

 

Subsequent Events

 

The Company evaluated events that have occurred after the balance sheet date but before the financial statements are issued. Based upon the evaluation and transactions, the Company did not identify any subsequent events that would have required adjustment or disclosure in the financial statements, except as disclosed in Note 16 – Subsequent Events.

 

Reclassifications

 

Certain prior year balances have been reclassified in order to conform to current year presentation. These reclassifications have no effect on the previously reported results of operations or loss per share.

 

Recent Accounting Pronouncements

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”). ASU 2016-02 requires an entity to recognize assets and liabilities arising from a lease for both financing and operating leases. ASU 2016-02 will also require new qualitative and quantitative disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating ASU 2016-02 and its impact on its condensed consolidated financial statements and disclosures.

 

In March 2016, the FASB issued ASU No. 2016-08, “Revenue from Contracts with Customers - Principal versus Agent Considerations”, in April 2016, the FASB issued ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606) - Identifying Performance Obligations and Licensing” and in May 9, 2016, the FASB issued ASU No. 2016-12, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2016-12”). This update provides clarifying guidance regarding the application of ASU No. 2014-09 - Revenue From Contracts with Customers which is not yet effective. These new standards provide for a single, principles-based model for revenue recognition that replaces the existing revenue recognition guidance. In July 2015, the FASB deferred the effective date of ASU 2014-09 for private companies and emerging growth public companies until annual and interim periods beginning on or after December 15, 2018. It will replace most existing revenue recognition guidance under U.S. GAAP when it becomes effective. The Company will evaluate the effects, if any, that adoption of this guidance will have on its condensed consolidated financial statements.

 

 13 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES, continued

 

Recent Accounting Pronouncements, continued

 

In March 2016, the FASB issued ASU No. 2016-09,” Compensation – Stock Compensation (Topic 718)” (“ASU 2016-09”). ASU 2016-09 requires an entity to simplify several aspects of the accounting for share-based payment transactions, including the 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 beginning after December 15, 2016, with early adoption permitted. The Company adopted ASU 2016-09 on the required effective date of January 1, 2017. The adoption of ASU 2016-09 did not have a material impact on the Company’s financial position, results of operations or cash flows.

 

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments (Topic 230)” (“ASU 2016-15”). ASU 2016-15 will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017. The ASU requires adoption on a retrospective basis unless it is impracticable to apply, in which case we will be required to apply the amendments prospectively as of the earliest date practicable. The Company is currently evaluating the effect that adopting this new accounting guidance will have on its condensed consolidated cash flows and related disclosures.

 

In December 2016, the FASB issued ASU No. 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers.” ASU No. 2016-20 amends certain aspects of ASU No. 2014-09 and clarifies, rather than changes, the core revenue recognition principles in ASU No. 2014-09. It is effective for annual reporting periods beginning after December 15, 2018. We are currently evaluating the effect that adopting this new accounting guidance will have on its condensed consolidated cash flows and related disclosures.

 

In January 2017, the FASB issued ASU No. 2017-04, “Intangibles - Goodwill and Other (Topic 350)” (“ASU 2017-04”) Simplifying the Test for Goodwill Impairment. The update simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. It affects public entities that have goodwill reported in their financial statements and have not elected the private company alternative for the subsequent measurement of goodwill. A public entity that is a U.S. Securities and Exchange Commission (“SEC”) filer should adopt the amendments in this update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. We are currently reviewing the new standard and assessing the impact of its adoption.

 

In May 2017, the FASB issued ASU No. 2017-09, Compensation - Stock Compensation (Topic 718); Scope of Modification Accounting. The amendments in this ASU provide guidance that clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. If the value, vesting conditions or classification of the award changes, modification accounting will apply. The guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company is currently evaluating the impact of the adoption of this standard on its condensed consolidated financial statements.

 

 14 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES, continued

 

Recent Accounting Pronouncements, continued

 

In July 2017, the FASB issued ASU No. 2017-11, “Earnings Per Share (Topic 260) Distinguishing Liabilities from Equity (Topic 480) Derivatives and Hedging (Topic 815),” which addresses the complexity of accounting for certain financial instruments with down round features. Down round features are features of certain equity-linked instruments (or embedded features) that result in the strike price being reduced on the basis of the pricing of future equity offerings. Current accounting guidance creates cost and complexity for entities that issue financial instruments (such as warrants and convertible instruments) with down round features that require fair value measurement of the entire instrument or conversion option. The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in any interim period. The Company is currently evaluating the impact of the adoption of this standard on its condensed consolidated financial statements.

 

In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. This guidance is effective for all entities for fiscal years, and interim periods within those years, beginning after December 15, 2018, with early adoption permitted. The amendments in ASU 2018-02 should be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. The adoption of this guidance is not expected to have a material impact on the Company’s condensed consolidated financial statements and related disclosures.

 

In June 2018, the FASB issued ASU No. 2018-07, “Compensation — Stock Compensation (Topic 718),” (“ASU 2018-07”). ASU 2018-07 is intended to reduce cost and complexity and to improve financial reporting for nonemployee share-based payments. Currently, the accounting requirements for nonemployee and employee share-based payment transactions are significantly different. ASU 2018-07 expands the scope of Topic 718, Compensation — Stock Compensation (which currently only includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. This ASU supersedes Subtopic 505-50, Equity — Equity-Based Payments to Nonemployees. The amendments in this ASU are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted, but no earlier than a company’s adoption date of Topic 606, Revenue from Contracts with Customers. The Company is currently evaluating ASU 2018-07 and its impact on the condensed consolidated financial statements.

 

 15 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 3 – SIGNIFICANT ACCOUNTING POLICIES, continued

 

Recent Accounting Pronouncements, continued

 

In July 2018, the FASB issued ASU No. 2018-09, “Codification Improvements” (“ASU 2018-09”). These amendments provide clarifications and corrections to certain ASC subtopics including the following: Income Statement - Reporting Comprehensive Income – Overall (Topic 220-10), Debt - Modifications and Extinguishments (Topic 470-50), Distinguishing Liabilities from Equity – Overall (Topic 480-10), Compensation - Stock Compensation - Income Taxes (Topic 718-740), Business Combinations - Income Taxes (Topic 805-740), Derivatives and Hedging – Overall (Topic 815-10), and Fair Value Measurement – Overall (Topic 820-10). The majority of the amendments in ASU 2018-09 will be effective in annual periods beginning after December 15, 2018. The Company is currently evaluating and assessing the impact this guidance will have on its condensed consolidated financial statements.

 

In July 2018, the FASB issued ASU No. 2018-10, “Codification Improvements to Topic 842, Leases” (“ASU 2018-10”). The amendments in ASU 2018-10 provide additional clarification and implementation guidance on certain aspects of the previously issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”) and have the same effective and transition requirements as ASU 2016-02. Upon the effective date, ASU 2018-10 will supersede the current lease guidance in ASC Topic 840, Leases. Under the new guidance, lessees will be required to recognize for all leases, with the exception of short-term leases, a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis. Concurrently, lessees will be required to recognize a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU 2018-10 is effective for emerging growth companies for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted. The guidance is required to be applied using a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative periods presented in the financial statements. The Company is currently assessing the impact this guidance will have on its condensed consolidated financial statements.

 

In July 2018, the FASB issued ASU No. 2018-11, “Leases (Topic 842): Targeted Improvements,” (“ASU 2018-11”). The amendments in ASU 2018-11 related to transition relief on comparative reporting at adoption affect all entities with lease contracts that choose the additional transition method and separating components of a contract affect only lessors whose lease contracts qualify for the practical expedient. The amendments in ASU 2018-11 are effective for emerging growth companies for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The Company is currently assessing the impact this guidance will have on its condensed consolidated financial statements.

 

NOTE 4 – ACQUISITIONS

 

On September 30, 2016, MMB acquired a business in Winston-Salem, North Carolina (the “Winston Acquisition”). The purchase price of the store was $124,117, of which $120,000 relates to leasehold improvements and equipment purchases and the remaining $4,117 relates to security deposits. The Winston-Salem store commenced operations on January 11, 2017.

 

 16 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 5 - LOANS RECEIVABLE

 

At September 30, 2017 and December 31, 2016, the Company’s loans receivable consists of the following:

 

   September 30,   December 31, 
   2017   2016 
Loans receivable, net  $217,267   $83,663 
Less: current portion   (51,665)   (30,434)
Loans receivable, non-current  $165,602   $53,229 

 

Loans receivable includes loans to franchisees totaling, in the aggregate, $217,267 and $83,663, net of reserves for uncollectible loans of $25,000 at September 30, 2017 and December 31, 2016. The loans have original terms ranging from 6 months to 5 years, earn interest at rates ranging from 0% to 5%, and are being repaid on a weekly or monthly basis.

 

NOTE 6 – LOANS RECEIVABLE FROM RELATED PARTIES

 

At September 30, 2017 and December 31, 2016, the Company’s loans receivable from related parties consist of the following:

 

   September 30,   December 31, 
   2017   2016 
Loans receivable from related parties  $58,560   $71,667 
Less: current portion   (21,893)   (20,000)
Loans receivable from related parties, non-current  $36,667   $51,667 

 

Included in loans receivable from related parties at September 30, 2017 and December 31, 2016, is $58,560 and $71,667, respectively, related to an advance to the Chief Operating Officer (“COO”) and stockholder of CTI, in connection with a consulting agreement. Included in loans receivables from related parties at September 30, 2017, is $1,893 related to advance to employees.

 

NOTE 7 – PROPERTY AND EQUIPMENT, NET

 

As of September 30, 2017 and December 31, 2016 property and equipment consists of the following:

 

   September 30,   December 31, 
   2017   2016 
         
Furniture and equipment  $695,690   $517,603 
Leasehold improvements   1,257,647    665,350 
    1,953,337    1,182,953 
Less: accumulated depreciation and amortization   (336,134)   (110,408)
Property and equipment, net  $1,617,203   $1,072,545 

 

Depreciation expense amounted to $114,791 and $225,726, respectively, for the three and nine months ended September 30, 2017. Depreciation expense amounted to $47,986 and $77,484, respectively, for the three and nine months ended September 30, 2017.

 

 17 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 8 – GOODWILL AND OTHER INTANGIBLE ASSETS, NET

 

The Company’s intangible assets include a trademark with an indefinite useful life as well as franchise agreements and a non-compete agreement, which are amortized over useful lives of thirteen years and five years, respectively.

 

A summary of the intangible assets is presented below:

 

Intangible Assets  Trademark   Franchise Agreements  

Non-Compete

Agreement

   Total 
Intangible assets, net at December 31, 2016   2,524,000    1,157,204    21,445    3,702,649 
Amortization expense   -    (78,198)   (4,483)   (82,681)
Impairment of intangible assets   -    (410,225)   -    (410,225)
Intangible assets, net at September 30, 2017  $2,524,000   $668,781   $16,962   $3,209,743 
                     
Weighted average remaining amortization period at September 30, 2017 (in years)        10.3    2.8      

 

Amortization expense related to intangible assets amounted to $25,744 and $82,681, respectively, for the three and nine months ended September 30, 2017. Amortization expense related to intangible assets amounted to $27,862 and $82,982, respectively, for the three and nine months ended September 30, 2016.

 

The Company sustained operating and cash flow losses from inception which formed a basis for performing an impairment test of its Intangible Assets. The Company performed a recoverability test on the franchise agreements that failed the test based on its projected future undiscounted cash flows generated through the asset’s use and eventual disposal. We measured and recorded an impairment charge based on a measurement of fair value of those assets using an income approach. The key assumptions used in the estimates of projected cash flows utilized in both the test and measurement steps of the impairment analysis were projected revenues and royalty payments. These forecasts were based on actual revenues and take into account recent developments as well as the Company’s plans and intentions. Based upon the results of the undiscounted cash flow analysis, the Company recorded an impairment charge on the franchise agreements of $410,225 during the nine months ended September 30, 2017.

 

During the third quarter of 2017, the Company performed the annual assessment and determined that goodwill was impaired, and recorded impairment of goodwill of $2,521,468. The impairment charges resulted from decrease in the Company’s estimated undiscounted cash flows from the expected future operations of the assets. These estimates considered factors such as expected future operating income, operating trends and prospects, as well as the effects of demand, competition and other factors.

 

 18 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 9 – ACCOUNTS PAYABLES AND ACCRUED EXPENSES

 

Accounts payables and accrued expenses consist of the following:

 

   September 30,   December 31, 
   2017   2016 
Accounts payable  $1,440,107   $360,250 
Accrued payroll   128,302    28,554 
Accrued vacation   58,477    58,477 
Accrued board members fees   31,500    - 
Accrued professional fees   142,166    205,935 
Accrued rent expense   108,426    33,455 
Sales taxes payable (1)   242,110    111,760 
Other accrued expenses   102,092    167,910 
   $2,253,180   $966,341 

 

  (1) See Note 14 – Commitments and Contingencies –Taxes for detailed related to delinquent sales taxes.

 

NOTE 10 – DEFERRED REVENUE

 

At September 30, 2017 and December 31, 2016, deferred revenue consists of the following:

 

   September 30,   December 31, 
   2017   2016 
Customer deposits  $40,525   $46,441 
Franchise fees   1,207,001    1,256,526 
Unearned vendor rebates   169,405    - 
   $1,416,931   $1,302,967 

 

During the nine months ended September 30, 2017, the Company entered into a new agreement with a vendor whereby the vendor advanced the Company approximately $200,000 against future rebates that the Company will earn from the vendor.

 

NOTE 11 – OTHER CURRENT LIABILITIES

 

Other current liabilities consist of the following:

 

   September 30,   December 31, 
   2017   2016 
Gift card liability  $101,835   $91,318 
Marketing and co-op advertising fund liability   243,219    66,920 
   $345,054   $158,238 

 

 19 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 12 – CONVERTIBLE NOTES PAYABLE TO FORMER PARENT

 

On December 31, 2015, the Company issued a promissory note in the amount of $1,082,620 (the “2015 ARH Note”) to the holder of a majority of the Company’s common stock. The 2015 ARH Note has no stated interest rate or maturity date. The note is convertible into 231,990 shares of the Company’s common stock at $4.67 per share. The fair value of the Company’s common stock on the date the note was issued was $5.60 per share, creating an intrinsic value of $0.93 per share.

 

On December 15, 2016, the Company issued a promissory note in the amount of $2,621,842 (the “2016 ARH Note”) to the Former Parent. The 2016 ARH Note has no stated interest rate or maturity date. The note is convertible into 702,279 shares of the Company’s common stock at $3.73 per share. The 2016 ARH Note was issued with a three-year warrant for the purchase of 245,797 shares of the Company’s common stock at an exercise price of $9.33 per share, with an aggregate grant date value of $241,028. The Company allocated the proceeds to the 2016 ARH Note and related warrant based on the relative fair values at the time of issuance, resulting in an effective conversion price of $3.39 per share. The fair value of the Company’s common stock on the date the note was issued was $6.78 per share, creating an intrinsic value of $3.39 per share.

 

On February 15, 2017, the Company issued a promissory note in the amount of $980,949 (the “First 2017 ARH Note”) and on March 15, 2017, MMI issued a promissory note in the amount of $338,834 (the “Second 2017 ARH Note”), both to the Former Parent. The First 2017 ARH Note and the Second 2017 ARH Note bear no stated interest rate or maturity date and are convertible into 262,753 and 72,606 shares of the Company’s common stock at a conversion price of $3.73 per share and $4.67 per share, respectively, at a time to be determined by the Former Parent.

 

The First 2017 ARH Note and the Second 2017 ARH note include a three-year warrant for the purchase of 91,963 and 15,793 shares, respectively, of the Company’s common stock at an exercise price of $9.33 per share. The warrants issued in connection with the First 2017 ARH Note and the Second 2017 ARH note had a grant date value of $122,820 and $23,120, respectively. The Company allocated the proceeds to the First 2017 ARH Note and the Second 2017 ARH and related warrants based on the relative fair values at the time of issuance, resulting in an effective conversion price of $3.27 and $4.35 per share, respectively. The fair value of the Company’s common stock on the dates the notes were issued was $7.15 per share, creating an intrinsic value of $3.88 and $2.80 per share, respectively.

 

On July 18, 2017, the Company issued a convertible promissory note (the “Third 2017 ARH Note”) to the Former Parent in exchange for cash proceeds of $336,932. The Third 2017 ARH Note has no stated interest rate or maturity date and is convertible into shares of the Company’s common stock at a conversion price of $7.47 per share at a time to be determined by the lender. The Third 2017 ARH Note includes a three-year warrant for the purchase of 15,793 shares of the Company’s common stock at an exercise price of $9.33 per share, with an aggregate grant date value of $25,018.

 

The 2015 ARH Note, 2016 ARH Note, First 2017 ARH Note, Second 2017 ARH Note and Third 2017 ARH Note are together, the “ARH Notes”.

 

On March 14, 2017, the Former Parent elected to convert aggregate principal of $4,685,411 under the 2015 ARH Note, the 2016 ARH Note and the First 2017 ARH Note into an aggregate 1,197,022 shares of the Company’s common stock.

 

 20 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 12 – CONVERTIBLE NOTES PAYABLE TO FORMER PARENT, continued

 

On September 19, 2017, the Former Parent elected to convert aggregate principal of $675,766 under the Second 2017 ARH Note and the Third 2017 Note into an aggregate 117,731 shares of the Company’s common stock.

 

In accordance with ASC 470-20 “Debt with Conversion and other Options”, the intrinsic value related to the convertible notes results in a beneficial conversion feature which is recorded as a debt discount with a corresponding credit to additional paid in capital. The relative fair value of the warrant at the date of grant of is also recorded as a debt discount. For the nine months ended September 30, 2017 the Company recorded aggregate debt discounts of $170,958 and $1,085,985, respectively, related to the warrants and the beneficial conversion feature, on the ARH notes, which were amortized over the expected terms of the respective notes. The grant date fair value of the warrants issued was valued on the date of issuance using the Black-Scholes option pricing model with the following weighted average assumptions:

 

   For the Three Months Ended   For the Nine Months Ended 
   September 30,   September 30, 
   2017   2016   2017   2016 
Risk free interest rate   1.07%   0.00%   1.07% - 1.59 %   0.00%
Expected term (years)   3.00    -    3.00    - 
Expected volatility   43.50%   0.00%   43.50%   0.00%
Expected dividends   0.00%   0%   0.00%   0%
Stock price  $5.60   $0.00   $7.06 - $7.47   $0.00 

 

NOTE 13 – CONVERTIBLE NOTES PAYABLE

 

During the nine months ended September 30, 2017, the Company received an aggregate of $1,550,000 associated with the issuances of convertible promissory notes payable and warrants to various parties, of which convertible promissory notes in the aggregate amount of $300,000 were issued to related parties. The notes are convertible into shares of the Company’s common stock upon the occurrence of the initial public offering.at a 50% discount to the initial public offering price (the “Conversion Price”). If the convertible notes are not converted within six months, they are to be repaid with 10% interest. Maturity dates of various notes were extended subsequent to the nine months ended September 30, 2017. See Note 16 – Subsequent Events- Other Convertible Notes Payable for details related to subsequent issuances and extensions. In connection with the issuances of the convertible promissory notes, the Company issued three-year warrants for the purchase of an aggregate of 84,736 shares of the Company’s common stock exercisable at the Conversion Price (see Note 15 - Equity – Warrants).

 

NOTE 14 – COMMITMENTS AND CONTINGENCIES

 

Litigations, Claims and Assessments

 

In 2017, Limestone Associates LLC (“Limestone”) filed a complaint against ARH in the Civil Court of the City of New York, County of New York, #78549/2017 for commercial non-payment of rent for the amount of $25,748 plus cost and disbursements of this proceeding. In May 2018, Limestone filed a complaint against ARH and Mr. Morgan in the Supreme Court of the State of New York, County of New York, index # 154469 seeking $1,357,243 in damages for rent, interest and other expenses.

 

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MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 14 – COMMITMENTS AND CONTINGENCIES

 

Litigations, Claims and Assessments, continued

 

In the normal course of business, the Company may be involved in legal proceedings, claims and assessments arising in the ordinary course of business. In the opinion of management, such matters are currently not expected to have a material impact on the Company’s financial statements.

 

The Company records legal costs associated with loss contingencies as incurred and accrues for all probable and estimable settlements.

 

Employment Agreements

 

On January 23, 2015, the Company entered into an employment agreement (the “COO Agreement”) with its Chief Operations Officer (the “COO”). The COO Agreement provides for a base salary of $22,500 per month and performance-based bonuses, as well as standard employee insurance and other benefits as defined in the COO Agreement. The COO Agreement expired on January 23, 2017.

 

On January 23, 2015, the Company entered into an employment agreement (the “DBD Agreement”) with its Director of Brand Development (the “DBD”). The DBD Agreement provides for a base salary of $12,500 per month and performance-based bonuses, as well as standard employee insurance and other benefits as defined in the DBD Agreement. Upon the execution of the DBD Agreement, the DBD received 21,428 shares of immediately vested Company common stock valued at $1.31 per share or $28,000. The DBD Agreement expired on January 23, 2017.

 

The Company entered into an at-will employment agreement with each of (i) Robert Morgan, as former Chief Executive Officer (the “CEO Agreement”), (ii) Grady Metoyer, as former Chief Financial Officer (the “CFO Agreement”) and (iii) Rodney Silva, as Chief Culture Officer (the “CCO Agreement). The employment agreements are effective as of the date the Company receives at least $5,000,000 in gross proceeds from an SEC qualified offering under the Offering Statement under Regulation A+ under the Securities Act of 1933, as amended. The term of these employment agreements are two years and are automatically extended for successive one-year periods unless either party delivers a 60-day notice of termination. These employment agreements did not become effective since the company terminated its Regulation A+ offering on March 29, 2018, yielding proceeds of approximately $143,497. See Note 16 – Subsequent Events - Termination of Offering.

 

Taxes

 

The Company failed in certain instances in paying sales taxes collected from customers in specific states that impose a tax on sales of the Company’s products. The Company had accrued for approximate $242,110, which includes interest, liability as of September 30, 2017 related to this matter.

 

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MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 14 – COMMITMENTS AND CONTINGENCIES, continued

 

Consulting Agreement

 

On August 1, 2015, the Company entered into a consulting agreement (the “Consulting Agreement) with an officer of CTI, who is also a stockholder of CTI, (the “Consultant”). The Consulting Agreement has a term of five years, and automatically extends for successive one-year periods, unless either party provides written notice of termination at least 60 days prior to the end of the term. Pursuant to the terms of the agreement, the Consultant will receive a base fee of $11,667 per month. In connection with the agreement, the Company provided a $100,000 advance to the consultant, to be repaid in equal monthly installments of $1,667, over the term of the consulting agreement (See Note 6 – Loans Receivable from Related Parties).

 

Operating Leases

 

On September 15, 2017, the Company became obligated for payments pursuant to three new lease agreements for restaurant spaces with lease terms ranging from 5 years to 10 years, exclusive of options to renew. Minimum rent payments pursuant to these lease agreements range from $5,916 to $7,532 per month.

 

NOTE 15 – EQUITY

 

Common Stock Issuances

 

On July 21, 2017, the Company issued 6,696 shares of common stock of the company to an investor at a purchase price of $7.47 per share providing $50,000 of proceeds to the Company.

 

On August 25, 2017, the Company issued an aggregate of 42,856 shares of common stock of the company to investors at a purchase price of $7.47 per share providing $320,000 of proceeds to the Company.

 

On September 1, 2017, the Company issued 6,698 shares of common stock of the company to an investor at a purchase price of $7.47 per share providing $50,000 of proceeds to the Company.

 

During the nine months ended September 30, 2017, the Company issued 1,314,753 shares of its restricted common stock upon conversion of ARH Notes in the aggregate principal amount of $5,361,177 (See Note 10 – Convertible Notes Payable to Former Parent).

 

Stock Option and Stock Issuance Plan

 

The Company’s board of directors and shareholders adopted and approved on July 27, 2017 and September 21, 2017, respectively, the Stock Option and Stock Issuance Plan (“2017 Plan”), effective September 21, 2017, under which stock options and restricted stock may be granted to officers, directors, employees and consultants. Under the 2017 Plan, the company reserved 1,071,428 shares of common stock, no par value per share, for issuance. As of September 30, 2017, 1,039,292 shares of common stock were outstanding under the 2017 Plan.

 

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MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 15 – EQUITY, continued

 

Warrant and Option Valuation

 

The Company has computed the fair value of warrants and options granted using the Black-Scholes option pricing model. The expected term used for warrants and options issued to non-employees is the contractual life. The Company is utilizing an expected volatility figure based on a review of the historical volatilities, over a period of time, equivalent to the expected life of the instrument being valued, of similarly positioned public companies within its industry. The risk-free interest rate was determined from the implied yields from U.S. Treasury zero-coupon bonds with a remaining term consistent with the expected term of the instrument being valued.

 

Options Granted

 

On July 27, 2017, the Company issued stand-alone non-qualified stock options, not pursuant to a plan, to purchase an aggregate of 33,750 shares of the Company’s common stock to its franchisees. The options are fully vested on the date of issuance and have an exercise price of $9.33 per share. The options expire three years from the date of issuance. The options have a grant date value of $47,583. The Company has estimated the fair value of the options granted using the Black-Scholes model using the following assumptions: expected volatility of 37%, risk-free rate of 1.52%, expected term of 3 years, expected dividends of 0%, and stock price of $7.47.

 

Restricted Common Stock Issuances

 

In May 2017, Muscle Maker granted 119,709 shares of its restricted common stock to its employees and consultants, with an aggregate grant date value of $1,117,403 or $9.33 per share. The restricted common stock awards granted to the employees will vest in five equal installments with the first installment vesting on the date of grant and the remaining installments vesting on the first day of each of the next four calendar years thereafter. In the event of resignation or termination for any reason of an employee or consultant that received such shares, any remaining non-vested shares will be forfeited. These awards were granted under the 2017 Plan.

 

Effective July 20, 2017, the Company entered into a Master Services Agreement (the “MSA”), with a consultant for marketing services to the Company in connection with the Regulation A + offering. Pursuant to the terms of the MSA, the Company issued 52,307 shares of fully vested restricted common stock at a value of $3.25 per share with an aggregate value of $170,000, as well as a cash fee of $145,000.

 

On September 21, 2017, the Company granted an aggregate amount of 32,136 shares of its restricted common stock at a price of $9.33 per share to its directors. The restricted common stock awards granted to the directors are subject to graded vesting in the following installments: (i) 66.67% as of the date of grant and (ii) four installments of 8.333% vesting on the first day of each of the next four calendar months.

 

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MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 15 – EQUITY, continued

 

Restricted Common Stock Issuances, continued

 

At September 30, 2017, the unamortized value of the restricted common stock was $842,084. The unamortized amount will be expensed over a weighted average period of 3.26 years. A summary of the activity related to the restricted common stock for the nine months ended September 30, 2017 is presented below:

 

       Weighted 
       Average Grant 
   Total   Date Fair Value 
Outstanding at January 1, 2017   -   $- 
Granted   204,152    7.77 
Forfeited   (1,285)   9.33 
Vested   (97,659)   9.33 
Outstanding at September 30, 2017   105,208   $8.00 

 

Stock-Based Compensation Expense

 

Stock-based compensation related to restricted stock issued to employees, directors and consultants amounted to $474,348 and $745,135, respectively, for the three and nine months September 30, 2017, of which $301,660 and $564,020, respectively, was recorded in general and administrative expenses, $2,688 and $11,115 , respectively, was recorded in labor expense within restaurant operating expenses and $170,000 and $170,000 , respectively, was recorded in consulting expenses. Stock-based compensation related to restricted stock issued to employees, directors and consultants amounted to $0 and $3,684, respectively, for the three and nine months September 30, 2016, of which $0 and $3,684, respectively, was recorded in general and administrative expenses.

 

Stock-based compensation related to options issued to franchisees amounted to $47,583 and $47,583, respectively, for the three and nine months ended September 30, 2017 which was offset against franchisee royalties and fees in the statement of operations.

 

Warrants

 

On April 21, 2016, the Company granted a three-year warrant for the purchase of 5,356 shares of the Company’s common stock at an exercise price of $9.33 per share to a franchisee and developer of the Company in exchange for services. The warrant had a grant date value of $3,684.

 

On July 25, 2017, a warrant was exercised for the 5,356 shares of common stock of the Company at an exercise price of $9.33 per share for gross proceeds of $50,000.

 

A summary of warrants activity during the nine months ended September 30, 2017 is presented below (See Note 12 —Convertible Notes Payable to Former Parent and Note 13 —Convertible Notes Payable for warrants issued during the nine months ended September 30, 2017):

 

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MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 15 – EQUITY, continued

 

Warrants, continued

 

           Weighted 
       Weighted   Average 
       Average   Remaining 
   Number of   Exercise   Life 
   Warrants   Price   In Years 
Outstanding, December 31, 2016   318,116   $8.84    2.2 
Issued   208,285    9.33      
Exercised   (5,356)   9.33      
Outstanding, September 30, 2017   521,045    9.03    2.2 
                
Exercisable, September 30, 2017   521,045   $9.03    2.2 

 

The grant date fair value of warrants granted during the nine months ended September 30, 2017 and 2016 was determined on the date of issuance using the Black-Scholes option pricing model with the following assumptions: expected volatility, dividend rate, risk free interest rate and the expected life. The Company calculates the expected volatility using the historical volatility of comparable companies over the most recent period equal to the expected term and evaluates the extent to which available information indicates that future volatility may differ from historical volatility. The expected dividend rate is zero as the Company does not expect to pay or declare any cash dividends on common stock. The risk-free rates for the expected terms of the stock options are based on the U.S. Treasury yield curve in effect at the time of the grant. The Company has not experienced significant exercise activity on stock options. Due to the lack of historical information, the Company determined the expected term of its stock option awards issued using the simplified method. In applying the Black-Scholes option pricing model, the Company used the following assumptions:

 

   For the Three Months Ended   For the Nine Months Ended 
   September 30,   September 30, 
   2017   2016   2017   2016 
Risk free interest rate   1.07%   0.00%   1.07% - 1.59 %   0.00%
Expected term (years)   3.00    -    3.00    - 
Expected volatility   43.50%   0.00%   43.50%   0.00%
Expected dividends   0.00%   0%   0.00%   0%
Stock price  $5.60   $0.00   $7.06 - $7.47   $0.00 

 

 26 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 16 – SUBSEQUENT EVENTS

 

Company-Owned Restaurants

 

Subsequent to September 30, 2017 and through the date of the issuance of these consolidated financial statements, the Company opened two additional company-owned restaurants.

 

Subsequent to September 30, 2017 and through the date of the issuance of these consolidated financial statements, various franchisees opened eight franchised restaurants and closed thirteen franchised restaurants.

 

From March 2018 through July 2018, as a cost saving measure, the Company closed eight of its thirteen corporate locations. As a result of these closures, the Company’s subsidiaries have been involved in several lawsuits as outlined below under litigations, claims and assessments. Subsequent to September 30, 2017, circumstances indicated that the carrying value of certain assets may be impaired, the company performed the appropriate analysis, and recorded impairment charges for those assets in the amount of $1,375,790.

 

Convertible Notes Payable to Former Parent

 

On April 6, 2018, the Company issued a $475,000 convertible promissory note (the “2018 ARH Note”) to the Former Parent. The 2018 ARH Note has no stated interest rate or maturity date and is convertible into shares of the Company’s common stock at a conversion price of $0.50 per share at a time to be determined by the lender.

 

On April 11, 2018, the Former Parent elected to partially convert the 2018 ARH Note for the principal of $392,542 into 785,085 shares of the Company’s common stock.

 

Convertible Notes

 

Subsequent to September 30, 2017 the Company received an aggregate of $799,340 associated with the issuances of convertible promissory notes payable to various parties. The notes are automatically converted into common stock at the Conversion Price upon the earlier of the closing of the offering or the maturity dates of the notes.

 

On January 4, 2018 the Company issued a $100,000 convertible promissory note. The note bears no stated interest or maturity date. The note as amended and extended on January 29, 2018, will automatically convert into shares of the Company’s common stock upon the earlier of (a) twelve months from the extension date or (b) the approval of the Form 1-A Registration Statement, at a 50% discount to the initial public offering price.

 

During January 24, 2018 to January 25, 2018, the Company received an aggregate of $150,000 associated with the issuances of convertible promissory notes payable, of which $100,000 were issued to a related party, as amended and extended on or about January 29, 2018, with a stated interest rate of 10% per the original 60-day-term, convertible at the option of the holder into common stock at a price per share of $1.625 (50% of initial public offering price), and, if not converted, will become due and payable along with the principal amount upon the earlier of (a) six months following the extension or (b) the approval of the Form 1-A Registration Statement.

 

In January 2018, the Company and certain note holders, including related parties, agreed to extend the maturity date of additional notes payables and convertible notes payable in the aggregate principal amount of $2,151,800 to be upon the earlier of the closing of the initial public offering, but no later than July 29, 2018. See automatic note conversion and further note extension during August 2018.

 

 27 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 16 – SUBSEQUENT EVENTS, continued

 

Convertible Notes, continued

 

During May 8, 2018 to July 11, 2018, the Company received an aggregate of $972,000 associated with the issuances of convertible promissory notes payable, of which $550,000 were issued to a related party. The notes bear no stated interest or maturity date. The notes are convertible into shares of the Company’s stock upon the earlier of (a) six months from the issue date or (b) the first day the company’s stock is publicly traded or (c) converted at the option of the holder. In connection with the issuances of the convertible promissory notes, the Company issued three-year warrants for the purchase of an aggregate of 486,000 shares of MMI’s common stock at an exercise price of $3.25 per share.

 

On or about January 23, 2019, the Company and certain note holders, including related parties, agreed to extend the maturity date of the convertible notes payable, as amended and extended on or about August 2018, in the aggregate principal amount of $1,550,000 to be upon the earlier of (a) January 24, 2020 or (b) the first day the company’s stock is publicly traded. All interest due and payable on the notes, shall be converted into shares of common stock at a conversion price of $1.00 per share.

 

Subsequent to September 30, 2017, other convertible promissory notes with an aggregate principal amount of $1,871,340 were automatically converted into 1,525,425 shares of the Company’s common stock pursuant to the terms of the notes.

 

Other Notes Payable

 

Subsequent to September 30, 2017 to December 31, 2017, the Company received an aggregate of $555,000 associated with the issuances of promissory notes, as amended and extended, payable to various parties, of which $335,000 were issued to a related party with a stated interest rate of 10% per the original 60-day-term.

 

On January 4, 2018 the Company issued a $25,000 promissory note to a related party. The note has a stated interest of 10% over the original term of sixty days. The note as amended and extended on January 29, 2018 becomes due and payable upon the earlier of (a) six month following the date of extension or (b) the approval of the Form 1-A Registration Statement.

 

On January 24, 2018, the Company entered into a promissory note with an unrelated third party in the principal amount of $511,765 with a maturity date of March 30, 2018. The note is issued with a 15% original issue discount of which the Company received cash proceeds of $435,000. In connection with the promissory note, the Company issued three-year warrants for the purchase of an aggregate of 78,733 shares of the Company’s common stock with an exercise price per share at 50% of initial public offering price. The warrant contains a cashless exercise provision and piggyback registration rights as to the common stock underlying the warrants subsequent to the filing and effectiveness of the Form 8-A with the SEC following the closing of the initial public offering. In the event of default, the principal amount of the note is to be increased by 30% of the original principal amount and another three-year warrant for the purchase of an additional 78,333 shares of the Company’s common stock with an exercise price per share at 50% of initial public offering price, which together with the original warrant would constitute 100% warrant coverage. The Company has since defaulted on the note and note was subsequently converted into SPA Notes (see Note 16 Subsequent Events - 15% Senior Secured Convertible Notes).

 

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MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 16 – SUBSEQUENT EVENTS, continued

 

Other Notes Payable, continued

 

On February 7, 2018, the Company and a note holder entered into an amendment to a promissory note issued by the Company on May 31, 2017, whereby the parties agreed to (i) extend the term of the note to March 15, 2018 and (ii) the Company agreed to payments on the following dates: (a) $70,000 upon entering into the amendment and (b) $100,000 on March 15, 2018. See Note 14 – Subsequent Events - Litigations, Claims and Assessments for further action taken by the note holder.

 

On or about January 23, 2019, the Company and certain note holders, including related parties, agreed to extend the maturity date of the notes payable, as amended and extended on or about August 2018, in the aggregate principal amount of $560,000 to be upon the earlier of (a) January 24, 2020 or (b) the first day the company’s stock is publicly traded. All interest due and payable on the notes, shall be converted into shares of common stock at a conversion price of $1.00 per share

 

Termination of Offering

 

On March 29, 2018, the Company decided to terminate its Regulation A+ offering in order to register its common stock with the SEC under the Securities Exchange Act of 1934, as amended, using a Form 8-A12g and become a publicly reporting company. Prior to terminating the Regulation A+ offering, the Company sold 44,153 shares in the offering at $3.25 per share, yielding proceeds of approximately $143,497.

 

15% Senior Secured Convertible Notes

 

From September 12, 2018 through the date of the issuance of these consolidated financial statements, the Company entered into securities purchase agreements with several accredited investors (the “Investors”) providing for the sale by the Company to the investors of 15% SPA Notes in the aggregate amount of $2,470,000, which included $635,000 in convertible notes converted into SPA Notes (the “September 2018 Offering”). The Notes bear interest at 15% per annum paid quarterly and mature 18 months from issuance. Following the initial closing, there shall be two additional closings in the amount of $1,000,000 each provided the Company achieves certain business milestones outlined in the Securities Purchase Agreement.

 

In addition to the SPA Notes, the Investors also received warrants to purchase common stock of the Company (the “Warrants”) to acquire an aggregate of 1,082,000 shares of common stock of the Company. The Warrants are exercisable for five years at an exercise price of $1.20. The Investors may exercise the Warrants on a cashless basis.

 

The Securities Purchase Agreements require that until the Listing Event, Catalytic Capital LLC holds the right to designate one member and one observer to the board of directors of the Company and that the Company shall engage an investor relations firm mutually agreed to by the Company and Catalytic Capital LLC from the time of the Listing Event until six months after the Listing Event. The Company is also required to engage Insight Advisory as a consultant to provide business and financial advice.

 

The Company granted the Investors piggy back registration rights with respect to the shares of common stock underlying the Notes and the Warrants.

 

 29 
 

 

MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 16 – SUBSEQUENT EVENTS, continued

 

Sale of CTI

 

On May 24, 2018, the Company entered into a stock purchase agreement between John Guild, JohnG Solutions LLC and CTI in which the Company agreed to sell their 70% ownership in CTI for a total purchase price of $1.00.

 

Employment Agreements

 

On January 17, 2018, Grady Metoyer resigned as the Company’s Chief Financial Officer, effective immediately.

 

In connection with the resignation of Grady Metoyer, on January 25, 2018, the Company’s board of directors appointed Ferdinand Groenewald as its Vice President of Finance, Principal Financial Officer and Principal Accounting Officer. The Company entered into an at-will employment agreement with Ferdinand Groenewald for a one-year term that is to commence as of the date the Company successfully receives at least $5,000,000 in gross proceeds from an SEC qualified offering under Offering Statement under Regulation A+ under the Securities Act of 1933, as amended.

 

On April 11, 2018, Robert E. Morgan resigned as Chief Executive Officer, President and Director of the Company and all other positions with subsidiaries of the Company.

 

On April 16, 2018, Kevin Mohan was appointed by the Company to serve as the Interim President of the Company.

 

On April 30, 2018, Tim M. Betts resigned as a director of the Company for personal reasons.

 

On May 1, 2018, the Company appointed Michael J. Roper as Chief Executive Officer (“CEO”) of the Company and entered into an Employment Agreement with Mr. Roper. In addition, Mr. Mohan resigned as Interim President of the Company.

 

On May 29, 2018, Ferdinand Groenewald, the Vice President of Finance, Principal Financial Officer and Principal Accounting Officer, notified Muscle Maker, Inc. (the “Company”) that he is resigning from his positions with the Company and its subsidiaries effective May 29, 2018.

 

On September 26, 2018, Muscle Maker, Inc. (the “Company”) appointed Ferdinand Groenewald as Chief Financial Officer of the Company and entered into an Employment Agreement with Mr. Groenewald.

 

On September 26, 2018, the Company appointed Kenneth Miller as Chief Operating Officer of the Company and entered into an Employment Agreement with Mr. Miller.

 

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MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 16 – SUBSEQUENT EVENTS, continued

 

Employment Agreements, continued

 

On October 26, 2018, the Company entered into an Employment Agreement with Michael Roper, which replaced his employment agreement from May 2018. Pursuant to the Employment Agreement, Mr. Roper will continue to be employed as Chief Executive Officer of the Company for a period of two years unless earlier terminated pursuant to the terms of the agreement. The Employment Agreement will be automatically extended upon listing the Company on a national exchange and raising $3,000,000 (the “IPO”). During the term of the Employment Agreement, Mr. Roper will be entitled to a base salary at the annualized rate of $250,000, which will be increased to $275,000 upon achieving various milestones required by the Investors that participated in the September 2018 Offering and again to $350,000 upon the Company completing the IPO. Mr. Roper will be eligible for a discretionary performance bonus to be paid in cash or equity, provided, however, no cash bonus will be paid until the closing of the IPO. Mr. Roper is entitled to $100,000 bonus upon closing of the IPO. In addition to 350,000 restricted stock units previously granted, the Company agreed to issue Mr. Roper up to 250,000 additional restricted stock units. In the event the Company raises $3 million or $5 million, then Mr. Roper will receive 150,000 restricted stock units or 250,000 restricted stock units, respectively. In addition, Mr. Roper will receive 100,000 restricted stock units upon the one- and two-year anniversaries of his employment.

 

On October 26, 2018, the Company entered into an Employment Agreement with Kevin Mohan. Pursuant to the Employment Agreement, Mr. Mohan will be engaged as Chief Investment Officer of the Company for a period of two years unless earlier terminated pursuant to the terms of the agreement. The Employment Agreement will be automatically extended upon the IPO. During the term of the Employment Agreement, Mr. Mohan will be entitled to a base salary at the annualized rate of $156,000, which will be increased to $175,000 upon the IPO. Mr. Mohan will be eligible for a discretionary performance bonus to be paid in cash following the closing of the IPO. Mr. Mohan is entitled to $50,000 bonus upon closing of the IPO. The Company agreed to issue Mr. Mohan up to 200,000 additional restricted stock units. In the event the Company raises $3 million or $5 million, then Mr. Mohan will receive 100,000 restricted stock units or 200,000 restricted stock units, respectively.

 

Litigations, Claims and Assessments

 

On March 27, 2018 a convertible note holder filed a complaint in the Iowa District Court for Polk County #CVCV056029 against the Company for failure to pay the remaining balance due on a promissory note in the amount of $100,000, together with interest, attorney fees and other costs of $171,035. On June 6, 2018 a default judgement was entered against the Company for the amount of $171,035.

 

In May 2018, the Company, Former Parent and Robert E. Morgan (the former CEO of the Company) were listed as defendants to a lawsuit filed by Crownhall Realty, LLC (“Crownhall”) in the Supreme Court of the State of New York county of New York, #154467. Crownhall is seeking $1,034,087 in damages for rent, interest and other expenses.

 

On October 3, 2018, the Company, ARH and Robert E. Morgan entered into a settlement agreement with Crownhall and Limestone agreeing to forfeit all security deposits in the amount of $87,093, pay an upfront amount of $25,000 and an additional $175,000 to be paid over 20 months. This agreement settles litigation surrounding two closed locations, which the plaintiffs were seeking a total of $2,391,330 in past damages for rent, interest and other expenses.

 

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MUSCLE MAKER, INC. & SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

NOTE 16 – SUBSEQUENT EVENTS, continued

 

Litigations, Claims and Assessments, continued

 

On or about December 1, 2017, a landlord commenced legal proceedings in the Supreme Court of New Jersey, Special Civil Part, Union County docket number LT-010222-17 due to the Company’s default under the lease. This was resolved by the Company on January 23, 2018. The Company again defaulted under the terms of the lease and the landlord evicted the Company from the premises.

 

On or about April 5, 2018, the Company and Former Parent, Inc entered into a settlement agreement with 918-924 Belmont, LLC for $100,000 regarding past rents owed, other charges and the termination of its lease at this location. The settlement calls for monthly payments of $8,333 thru March 2019.

 

In April 2018, the Company and Former Parent was listed as a defendant in a lawsuit filed by a landlord (“Former Landlord”) in the Superior Court of the State of California. The Former Landlord is seeking $531,594 in damages for rent, interest and other expenses. The original lease was for a 5-year period and commenced on or about September 30, 2015. On January 15, 2019, the Company and the Former Landlord entered a settlement and release agreement. Pursuant to the settlement the Company shall pay the amount of $531,594 as follows (i) first payment of $49,815, net of security deposit of $11,185, on or before January 23, 2019, (ii) second payment of $25,000 on or before February 28, 2019 and (iii) thereafter sixty-nine payments of $6,400 on or before the 15th of each month beginning on March 15, 2019. Conditioned on the Company making twelve timely installment payments of $6,400, the Company would be released of the remaining liability pursuant to the judgement.

 

On May 4, 2018, Stratford Road Partners, LLC (“Stratford”) filed suit against the Company’s subsidiary for non-payment of rent in the small Claims court in the state of North Carolina. Since then the property has been vacated and the landlord offered a settlement of $10,000 with no further lease obligation. The Company has not signed the settlement agreement dated June 30, 2018.

 

In May 2018, Resolute Contractors, Inc, Quality Tile, MTL Construction, Genesis Electric, JNB Interiors and Captive Aire filed a Mechanics Lien for labor, service, equipment and materials in the total amount of $98,005. The Company intends to set up various payment plans with these vendors.

 

On May 25, 2018, the Civil Court of the City of New York, County of New York, entered into a settlement agreement between the Company and a landlord, in the amount of $55,891 for past due rent. The Company agreed to make the following payments (i) $15,000 on or before May 31, 2018, and (ii) $40,891 on or before September 4,2018. These amounts have been paid in full.

 

On September 25, 2018, the Supreme Court of the State of New York, County of Rockland, entered into a judgement in favor of a creditor, in the amount of $69,367. The Company worked with legal counsel and on October 22, 2018, the Company entered into a settlement agreement with the credit in the amount of $36,000 that was payable on or before November 16, 2018.

 

On December 12, 2018, the Company was listed as a defendant to a lawsuit filed by a landlord in the Superior Court of the State of California. Fountain Valley is seeking approximately $121,000 in damages for rent, interest and other expenses. On February 15, 2019, the company entered into a settlement agreement and payment plan in the amount of $85,000.

 

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ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following discussion and analysis of the results of operations and financial condition of Muscle Maker, Inc. (“Muscle Maker”), together with its subsidiaries (collectively, the “Company”) as of September 30, 2017 and 2016 and for the nine months ended September 30, 2017 and 2016 should be read in conjunction with our financial statements and the notes to those financial statements that are included elsewhere in Quarterly Report on Form 10-Q. References in this Management’s Discussion and Analysis of Financial Condition and Results of Operations to “us,” “we,” “our,” and similar terms refer to Muscle Maker. “Muscle Maker Grill” refers to the name under which our corporate and franchised restaurants do business. This Annual Report contains forward-looking statements as that term is defined in the federal securities laws. The events described in forward-looking statements contained in this Annual Report may not occur. Generally, these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of our plans or strategies, projected or anticipated benefits from acquisitions to be made by us, or projections involving anticipated revenues, earnings or other aspects of our operating results. The words “may,” “will,” “expect,” “believe,” “anticipate,” “project,” “plan,” “forecast,” “model,” “proposal,” “should,” “may,” “intend,” “estimate,” and “continue,” and their opposites and similar expressions, are intended to identify forward-looking statements. We caution you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond our control, which may influence the accuracy of the statements and the projections upon which the statements are based. Reference is made to “Factors That May Affect Future Results and Financial Condition” in this Item 7 for a discussion of some of the uncertainties, risks and assumptions associated with these statements.

 

OVERVIEW

 

We operate under the name Muscle Maker Grill as a franchisor and owner-operator of Muscle Maker Grill restaurants. As of September 30, 2017, our restaurant system included thirteen Company-owned restaurants, of which one was in the pre-opening phase, and thirty-nine franchised restaurants.

 

Muscle Maker Grill is a fast-casual restaurant concept that specializes in preparing healthy-inspired, high-quality, fresh, made-to-order lean, protein-based meals featuring chicken, seafood, pasta, burgers, wraps and flat breads. In addition, we feature freshly prepared entrée salads and an appealing selection of sides, protein shakes and fruit smoothies. We operate in the approximately $47 billion fast casual restaurant segment, which we believe has created significant recent disruption in the restaurant industry and is rapidly gaining market share from adjacent restaurant segments, resulting in significant growth opportunities for healthier restaurant concepts such as Muscle Maker Grill.

 

We believe our healthier restaurant concept delivers a highly differentiated customer experience by combining the quality and hospitality that customers commonly associate with our full service and fast casual restaurant competitors with the convenience and value customers generally expect from traditional fast food restaurants. The foundation of our brand is based on our core values of quality, empowerment, respect, service and value.

 

As of September 30, 2017, we had an accumulated deficit of $13,880,663 and expect to continue to incur substantial operating and net losses for the foreseeable future. In its report on our consolidated financial statements for the year ended December 31, 2016, our independent registered public accounting firm included an explanatory paragraph relating to our ability to continue as a going concern. See “Liquidity and Capital Resources – Availability of Additional Funds and Going Concern” and Note 1 – Business Organization and Nature of Operations - Going Concern and Management’s Plans to Notes to Consolidated Financial Statements for additional information describing the circumstances that led to the inclusion of this explanatory paragraph.

 

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Key Financial Definitions

 

Total Revenues

 

Our revenues are derived from three primary sources: company restaurant sales, franchise revenues and vendor rebates. Franchise revenues are comprised of franchise royalty revenues collected based on 5% of franchisee net sales and, to a lesser extent, other franchise revenues which include initial and renewal franchisee fees. Vendor rebates are received based on volume purchases or services from both company owned and franchise owned locations.

 

Food and Beverage Costs

 

Food and beverage costs include the direct costs associated with food, beverage and packaging of our menu items at company-operated restaurants. The components of food, beverages and supplies are variable in nature, change with sales volume, are affected by menu mix and are subject to fluctuations in commodity costs. The current management team in place since May 2018 has the opinion that food and beverage costs for 2016 and 2017 are too high and has begun implementing multiple operational changes to lower food and paper costs.

 

Labor

 

Restaurant labor costs, including preopening labor, consists of company-operated restaurant-level management and hourly labor costs, including salaries, wages, payroll taxes, workers’ compensation expense, benefits and bonuses paid to our company-operated restaurant-level team members. Like other cost items, we expect restaurant labor costs at our company-operated restaurants to increase due to inflation and as our company restaurant revenues grows. Factors that influence labor costs include minimum wage and employer payroll tax legislation, mandated health care costs and operational productivity established by the management team. The current management team in place since May 2018 has the opinion that labor costs for 2016 and 2017 are too high and has begun implementing operational changes to lower restaurant level labor costs overall.

 

Rent

 

Restaurant rent, including preopening rental charges, consist of company-operated restaurant-level rental or lease payments applicable to executed rental or lease agreements. In many cases these rental payments may include payments for common area maintenance as well as property tax assessments. The current management team in place since May 2018 has the opinion that rent costs for 2016 and 2017 as a percentage of total restaurant sales are too high. Our rent strategy moving forward consists of a variable rent structure calculated on net sales of the restaurant. While this can have a negative effect on higher volume locations where we cannot leverage a fixed rent, it provides a downside protection for lower volume locations. While we cannot guarantee a favorable variable rent expense in all future leases, it is in our forecasts at an 8% average level.

 

Other restaurant operating expenses

 

Other restaurant operating expenses, including preopening operating expenses, consist of company-operated restaurant-level ancillary expenses not inclusive of food and beverage, labor and rent expense. These expenses are generally marketing, advertising, merchant and bank fees, utilities, leasehold and equipment repairs and maintenance. A portion of these costs are associated with third party delivery services such as Uber Eats, Grub Hub, DoorDash, Seamless, etc. The fees associated with these third-party delivery services can range up to 25% of the total order being delivered. Management believes delivery is a critical component of our business model and industry trends will continue to push consumers towards delivery. Our cost structure will need to be adjusted to reflect a different pricing model, portion sizes, menu offerings, etc to potentially offset these rising costs of delivery.

 

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Depreciation and Amortization

 

Depreciation and amortization primarily consist of the depreciation of property and equipment and amortization of intangible assets at the restaurant level.

 

General and Administrative Expenses

 

General and administrative expenses include expenses associated with corporate and administrative functions that support our operations, including wages, benefits, travel expense, stock-based compensation expense, legal and professional fees, training, and other corporate costs. This expense item also includes national advertising and marketing campaigns to promote brand awareness which includes, but is not limited to, television, radio, social media, billboards, point-of-sale materials, sponsorships, and multi-media. We expect we will incur incremental general and administrative expenses as a result of this offering and as a public company. A certain portion of these expenses are related to the preparation of an initial stock offering and should be considered one-time expenses.

 

Other (Expense) Income

 

Other (expenses) income primarily consists of amortization of debt discounts on the convertible notes payable to Former Parent and interest expense related to convertible notes payable.

 

Income Taxes

 

Income taxes represent federal, state, and local current and deferred income tax expense.

 

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Consolidated Results of Operations

 

Three Months Ended September 30, 2017 Compared with Three Months Ended September 30, 2016

 

The following table represents selected items in our consolidated statements of operations for the three months ended September 30, 2017 and 2016, respectively:

 

   For the Three Months Ended 
   September 30, 
   2017   2016 
Revenues:          
Company restaurant sales, net of discounts  $1,300,638   $1,017,844 
Franchise royalties and fees   791,716    616,916 
Other revenues   262,879    362,530 
Total Revenues   2,355,233    1,997,290 
           
Operating Costs and Expenses:          
Restaurant operating expenses:          
Food and beverage costs   639,518    409,692 
Labor   687,813    458,226 
Rent   318,831    327,197 
Other restaurant operating expenses   351,905    175,797 
Total restaurant operating expenses   1,998,067    1,370,912 
Costs of other revenues   97,082    103,009 
Depreciation and amortization   140,535    75,848 
Impairment of intangible assets   410,225    - 
Impairment of goodwill   2,521,468    - 
General and administrative expenses   2,352,007    1,521,416 
Total Costs and Expenses   7,519,384    3,071,185 
Loss from Operations   (5,164,151)   (1,073,895)
           
Other (Expense) Income:          
Other income   2,798    6,261 
Interest income, net   6,392    3,997 
Amortization of debt discount   (195,702)   (35,351)
Total Other Expense, net   (186,512)   (25,093)
           
Net Loss Before Income Tax   (5,350,663)   (1,098,988)
Income tax benefit (provision)   (31,821)   (31,821)
Net Loss   (5,382,484)   (1,130,809)
Net loss attributable to the non-controlling interest   (518,550)   (296,335)
Net Loss Attributable to Controlling Interest  $(4,863,934)  $(834,474)

 

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Revenues

 

Company total revenues totaled $2,355,233 for the three months ended September 30, 2017 compared to $1,997,290 for the three months ended September 30, 2016. The 17.9% increase was primarily attributable to the addition of three Company-owned restaurants, which opened subsequent September 30, 2016.

 

We generated restaurant sales, net of discounts, of $1,300,638 for the three months ended September 30, 2017 compared to $1,017,844, for the three months ended September 30, 2016. This represented an increase of $282,794, or 27.8%, which resulted primarily from the increase in company owned restaurant sales due to the addition of three Company-owned restaurants, which opened subsequent September 30, 2016.

 

Franchise royalties and fees for the three months ended September 30, 2017 and September 30, 2016 totaled $791,716 compared to $616,916, respectively. The $174,800 increase is primarily attributable to recognition of vendor rebates and deferred revenue for franchise agreements that have been terminated.

 

Other revenues decreased from $362,530 for the three months ended September 30, 2016 to $262,879 for the three months ended September 30, 2017, representing a decrease of $99,651 or 27.5%. The decrease is attributed to fewer hardware and equipment sales during the period compared to the prior period.

 

Operating Costs and Expenses

 

Operating costs and expenses consist of restaurant food and beverage costs, restaurant labor expense, restaurant rent expense, other restaurant operating expenses, cost of other revenues, depreciation and amortization expenses and general and administrative expenses (inclusive of labor).

 

Restaurant food and beverage costs for the three months ended September 30, 2017 and September 30, 2016 totaled $639,518, or 49.2%, as a percentage of restaurant sales, and $409,692, or 40.3%, as a percentage of restaurant sales, respectively. The $229,826 increase results primarily from the addition of three new Company-owned locations noted above. The increase as a percentage of sales is primarily attributable to the impact of preopening training in which food and beverage inventory is utilized to train staff on the preparation of menu items, as well as lost efficiencies with new staff in portioning and preparation.

 

Restaurant labor for the three months ended September 30, 2017 and September 30, 2016 totaled $687,813, or 52.9%, as a percentage of restaurant sales, and $458,226, or 45.0%, as a percentage of restaurant sales, respectively. The $229,587 increase results primarily from the addition of three new Company-owned locations noted above. The increase as a percentage of sales is primarily attributable to the impact of preopening training with newly hired staff, as well as lost efficiencies that are inherent in the start-up of new restaurants given the high level of attrition and retraining that occurs. Additionally, it is estimated that it takes approximately four to six months of extensive marketing efforts to effectively generate brand awareness in new geographical locations. These factors negatively impact labor margins in the early phases of operations of new restaurants.

 

Restaurant rent expense for the three months ended September 30, 2017 and September 30, 2016 totaled $318,831, or 24.5%, as a percentage of restaurant sales, and $327,197, or 32.2%, as a percentage of restaurant sales, respectively. The decrease is due to a tenant allowance of approximately $53,000 that we received at one of our Company owned locations.

 

Other restaurant operating expenses for the three months ended September 30, 2017 and September 30, 2016 totaled $351,905, or 27.1% as a percentage of restaurant sales, and $175,797, or 17.3% as a percentage of restaurant sales, respectively. The $176,108 increase results primarily from the addition of three new Company-owned locations noted above.

 

Cost of other revenues for the three months ended September 30, 2017 and September 30, 2016 totaled $97,082, or 36.9%, as a percentage of other revenue, and $103,009, or 28.4%, as a percentage of other revenue, respectively. The $5,927 decrease results primarily from efficiencies established with enhanced inventory management controls.

 

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Depreciation and amortization expense for the three months ended September 30, 2017 and September 30, 2016 totaled $140,535 and $75,848, respectively. The $64,687 increase is primarily attributable to depreciation of new property and equipment related to the addition of four new company owned locations.

 

Impairment of intangible assets for the three months ended September 30, 2017 totaled $410,225 The impairment of the intangible assets was based on a recoverability test on the franchise agreements that failed the test based on projected future undiscounted cash flows.

 

Impairment of goodwill for the three months ended September 30, 2017, totaled $2,521,468. The impairment charges resulted from decrease in the company’s estimates undiscounted cash flows from the expected future operations of the assets. These estimates considered factors such as expected future operating income, operating trends and prospects, as well as the effects of demands, competition and other factors.

 

General and administrative expenses for the three months ended September 30, 2017 and September 30, 2016 totaled $2,352,007, or 99.9% of total revenue, and $1,521,416, or 76.2% of total revenue, respectively. The $830,591 increase is primarily attributable to the “build-up” of the company’s corporate infrastructure to support new company owned store growth as well as third party related expenses to prepare the Company for a private placement offering and IPO. Wages and related expenses increased approximately $165,000 compared to the prior year with the addition of key management positions. Third party accounting and legal fees increased $539,000 with temporary accounting services and nonrecurring legal reorganizational research to facilitate SEC financial statement preparation. Restricted stock compensation increased approximately $302,000 for restricted stock issued in 2017 and not in 2016. Partially offset by the following decreases of approximately $37,000 in temporary services, approximately $21,000 in consulting fees, approximately $13,000 in recruiting fees, approximately $14,000 in leased equipment, approximately in $14,000 in travel expenses and other miscellaneous expenses.

 

Loss from Operations

 

Our loss from operations for the three months ended September 30, 2017 and September 30, 2016 totaled $5,164,151 or 219.3% of total revenues and $1,073,895, or 53.8% of total revenue, respectively. The increased loss of $4,090,256 is attributable to growth in general administrative expenses to build company infrastructure, inefficiencies in preopening expenses, new rental charges, local and national marketing campaigns, and third-party consulting services to facilitate our anticipated private placement and IPO. In addition to impairment charges of our intangible assets and goodwill attributed an aggregate amount of $2,931,693 for reasons discussed previously.

 

Other (Expense) Income

 

Other (expense) income for the three months ended September 30, 2017 and September 30, 2016 totaled $(186,512) and $(25,093) respectively. The $161,419 increase in expense was primarily attributable to amortization of debt discount of approximately $160,351 in connection with convertible notes payable to a former related party.

 

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Net Loss

 

Our net loss for the three months ended September 30, 2017 increased by $4,251,674 to $5,382,484 as compared to $1,130,810 for the three months ended September 30, 2016, resulting primarily from significant increases in general and administrative expenses incurred for the contemplated IPO as well as employee expenses incurred for restricted stock. In addition, impairment charges in 2017 associated with intangible assets and goodwill in an aggregate amount of $2,931,693. Our net loss attributable to the controlling interest was $518,550 and $296,335 for the three months ended September 30, 2017 and September 30, 2016, respectively.

 

Nine Months Ended September 30, 2017 Compared with Nine Months Ended September 30, 2016

 

The following table represents selected items in our consolidated statements of operations for the Nine months ended September 30, 2017 and 2016, respectively:

   For the Nine Months Ended 
   September 30, 
   2017   2016 
Revenues:          
Company restaurant sales, net of discounts  $3,958,653   $1,895,426 
Franchise royalties and fees   1,728,933    1,463,521 
Other revenues   558,469    557,900 
Total Revenues   6,246,055    3,916,847 
           
Operating Costs and Expenses:          
Restaurant operating expenses:          
Food and beverage costs   1,622,316    728,041 
Labor   1,920,441    861,994 
Rent   915,637    464,132 
Other restaurant operating expenses   870,968    387,148 
Total restaurant operating expenses   5,329,362    2,441,315 
Costs of other revenues   210,563    256,726 
Depreciation and amortization   308,407    160,466 
Impairment of intangible assets   410,225    - 
Impairment of goodwill   2,521,468    - 
General and administrative expenses   5,884,594    3,206,501 
Total Costs and Expenses   14,664,619    6,065,008 
Loss from Operations   (8,418,564)   (2,148,161)
           
Other (Expense) Income:          
Other income   88,027    6,563 
Interest income, net   7,152    4,851 
Amortization of debt discount   (3,956,792)   (102,228)
Total Other (Expense) Income, net   (3,861,613)   (90,814)
           
Net Loss Before Income Tax   (12,280,177)   (2,238,975)
Income tax benefit (provision)   (95,462)   (95,462)
Net Loss   (12,375,639)   (2,334,437)
Net loss attributable to the non-controlling interest   (2,336,614)   (599,037)
Net Loss Attributable to Controlling Interest  $(10,039,025)  $(1,735,400)

 

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Revenues

 

Company total revenues totaled $6,246,055 for the nine months ended September 30, 2017 compared to $3,916,847 for the nine months ended September 30, 2016. The 59.5% increase was primarily attributable to the addition of three Company-owned restaurants, which opened subsequent September 30, 2016.

 

We generated restaurant sales, net of discounts, of $3,958,653 for the nine months ended September 30, 2017 compared to $1,895,426, for the nine months ended September 30, 2016. This represented an increase of $2,063,227, or 108.9%, which resulted primarily from the increase in company owned restaurant sales due to the addition of three Company-owned restaurants, which opened subsequent September 30, 2016.

 

Franchise royalties and fees for the nine months ended September 30, 2017 and September 30, 2016 totaled $1,728,933 compared to $1,463,521, respectively. The $265,412 increase is primarily attributable to recognition of deferred revenue for franchise agreements that have been terminated.

 

Other revenues increased from $557,900 for the nine months ended September 30, 2016 to $558,469 for the nine months ended September 30, 2017, representing an increase of $569 or 0.1%. The increase is primarily attributable to CTI’s revenue increases for 3rd party sales growth.

 

Operating Costs and Expenses

 

Operating costs and expenses consist of restaurant food and beverage costs, restaurant labor expense, restaurant rent expense, other restaurant operating expenses, cost of other revenues, depreciation and amortization expenses and general and administrative expenses.

 

Restaurant food and beverage costs for the nine months ended September 30, 2017 and September 30, 2016 totaled $1,622,316, or 41.0%, as a percentage of restaurant sales, and $728,041, or 38.4%, as a percentage of restaurant sales, respectively. The $894,275 increase results primarily from the addition of three new Company-owned locations noted above. The increase as a percentage of sales is primarily attributable to the impact of preopening training in which food and beverage inventory is utilized to train staff on the preparation of menu items, as well as lost efficiencies with new staff in portioning and preparation.

 

Restaurant labor for the nine months ended September 30, 2017 and September 30, 2016 totaled $1,920,441, or 48.5%, as a percentage of restaurant sales, and $861,994, or 45.5%, as a percentage of restaurant sales, respectively. The $1,058,447 increase results primarily from the addition of three new Company-owned locations noted above. The increase as a percentage of sales is primarily attributable to the impact of preopening training with newly hired staff, as well as lost efficiencies that are inherent in the start-up of new restaurants given the high level of attrition and retraining that occurs. Additionally, it is estimated that it takes approximately four to six months of extensive marketing efforts to effectively generate brand awareness in new geographical locations. These factors negatively impact labor margins in the early phases of operations of new restaurants.

 

Restaurant rent expense for the nine months ended September 30, 2017 and September 30, 2016 totaled $915,637, or 23.1%, as a percentage of restaurant sales, and $464,132, or 24.5%, as a percentage of restaurant sales, respectively. The $451,505 increase results primarily from the addition of three new Company-owned locations noted above. The increase as a percentage of sales is primarily attributable to the impact of recognizing rental expense prior to store openings, thus rental expenses incurred without offsetting revenues. Additionally, we have executed new lease agreements that have higher rental charges as a percentage of current sales volumes than historical agreements. As the company seeks to grow brand concepts, several factors are considered when deciding on leased locations. These include, but are not limited to, estimated foot traffic, lease term, lease rate, adjacent businesses, surrounding community economics, etc. As such, new lease agreements may tend to have a higher percentage of revenue as the brand establishes itself in new markets and the surrounding markets themselves grow.

 

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Other restaurant operating expenses for the nine months ended September 30, 2017 and September 30, 2016 totaled $870,968, or 22.0% as a percentage of restaurant sales, and $387,148, or 20.4% as a percentage of restaurant sales, respectively. The $483,820 increase results primarily from the addition of three new Company-owned locations, which opened subsequent September 30, 2016.

 

Cost of other revenues for the nine months ended September 30, 2017 and September 30, 2016 totaled $210,563, or 37.7%, as a percentage of other revenue, and $256,726, or 46.0%, as a percentage of other revenue, respectively. The $46,163 decrease results primarily from efficiencies establish with enhanced inventory management controls.

 

Depreciation and amortization expense for the nine months ended September 30, 2017 and September 30, 2016 totaled $308,407 and $160,466, respectively. The $147,941 increase is primarily attributable to depreciation of new fixed assets related to the addition of three new company owned locations.

 

Impairment of intangible assets for the nine months ended September 30, 2017 totaled $410,225 The impairment of the intangible assets was based on a recoverability test on the franchise agreements that failed the test based on projected future undiscounted cash flows.

 

Impairment of goodwill for the nine months ended September 30, 2017, totaled $2,521,468. The impairment charges resulted from decrease in the company’s estimates undiscounted cash flows from the expected future operations of the assets. These estimates considered factors such as expected future operating income, operating trends and prospects, as well as the effects of demands, competition and other factors.

 

General and administrative expenses for the nine months ended September 30, 2017 and September 30, 2016 totaled $5,884,594, or 94.2% of total revenue, and $3,206,501, or 81.9% of total revenue, respectively. The $2,678,093 increase is primarily attributable to the “build-up” of the company’s corporate infrastructure to support new company owned stores as well as third party related expenses to prepare the Company for a private placement offering and IPO. Wages and related expenses increased approximately $569,000 compared to the prior year with the addition of key management positions. Advertising and marketing increased approximately $301,000 to grow national brand awareness. Third party accounting and legal fees increased $948,000 with temporary accounting services and nonrecurring legal reorganizational research to facilitate SEC financial statement preparation. Audit fees increased approximately $206,000 with audits for 2015 and 2016. Restricted stock compensation increased approximately $564,000 for restricted stock issued in 2017 and not in 2016. Additionally, bonuses increased approximately $75,000 for incentives related to IPO efforts. CTI G&A expenses increased $56,000 primarily due to an increased sales head count to drive revenue growth. It is anticipated that general and administrative expenses during the 4th quarter of calendar 2017 will not decline due to audit, accounting and legal fees incurred to support the targeted IPO. Additionally, there will be compensation and third-party expenses incurred during the 4th quarter for the issuance of restricted stock to certain employees and third-party groups. Partially offset by a decrease in other miscellaneous expenses.

 

Loss from Operations

 

Our loss from operations for the nine months ended September 30, 2017 and September 30, 2016 totaled $8,418,564 or 134.8% of total revenues and $2,148,161, or 54.8% of total revenue, respectively. The increased loss of $6,270,403 is attributable to growth in general administrative expenses to build company infrastructure, inefficiencies in preopening expenses, new rental charges, local and national marketing campaigns, and third-party consulting services to facilitate our anticipated private placement and IPO. In addition to impairment charges of our intangible assets and goodwill attributed an aggregate amount of $2,931,693 for reasons discussed previously.

 

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Other (Expense) Income

 

Other (expense) income for the nine months ended September 30, 2017 and September 30, 2016 totaled $(3,861,613) and $(90,814) respectively. The $3,770,799 increase in expense was primarily attributable to increase in amortization of debt discount of approximately $(3,854,564) in connection with convertible notes payable to a former related party, partially offset by an increase in other income of $81,464.

 

Net Loss

 

Our net loss for the nine months ended September 30, 2017 increased by $10,041,202 to $12,375,639 as compared to $2,334,437 for the nine months ended September 30, 2016, resulting primarily from an increase in amortization of debt discounts to a former related party totaling $3,854,564 and significant increases in general and administrative expenses incurred for the contemplated IPO as well as employee expenses incurred for restricted stock. In addition, impairment charges in 2017 associated with intangible assets and goodwill in an aggregate amount of $2,931,693. Our net loss attributable to the controlling interest was $10,039,025 and $1,735,400 for the nine months ended September 30, 2017 and September 30, 2016, respectively.

 

Liquidity and Capital Resources

 

Liquidity.

 

We measure our liquidity in a number of ways, including the following:

 

  

September 30,

2017

  

December 31,

2016

 
Cash  $143,401   $335,724 
Working Capital Deficiency  $(3,348,332)  $(1,723,852)
Convertible notes payable, including related parties  $1,550,000   $- 
Convertible notes payable to Former Parent (Gross)  $-   $3,704,462 

 

Availability of Additional Funds and Going Concern

 

Based upon our working capital deficiency and accumulated deficit of $3,348,332 and $13,880,663, respectively, as of September 30, 2017, plus our use of $2,639,623 of cash in operating activities during the nine months ended September 30, 2017, we require additional equity and/or debt financing to continue our operations. These conditions raise substantial doubt about our ability to continue as a going concern for at least one year from the date of this filing.

 

During prior periods our operations have primarily been funded through proceeds from American Restaurant Holdings in exchange for equity and debt.

 

Our principal source of liquidity to date has been provided from American Restaurant Holdings, who is a private equity restaurant group, by loans from related and unrelated third parties and the sale of common stock through private placements. More specifically, American Restaurant Holdings has invested over $5 million in growth capital into Muscle Maker to date.

 

We expect to have ongoing needs for working capital in order to (a) fund operations; plus (b) expand operations by opening additional corporate-owned restaurants. To that end, we may be required to raise additional funds through equity or debt financing. However, there can be no assurance that we will be successful in securing additional capital. If we are unsuccessful, we may need to (a) initiate cost reductions; (b) forego business development opportunities; (c) seek extensions of time to fund our liabilities, or (d) seek protection from creditors.

 

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In addition, if we are unable to generate adequate cash from operations, and if we are unable to find sources of funding, it may be necessary for us to sell one or more lines of business or all or a portion of our assets, enter into a business combination, or reduce or eliminate operations. These possibilities, to the extent available, may be on terms that result in significant dilution to our shareholders or that result in our shareholders losing all of their investment in our Company.

 

If we are able to raise additional capital, we do not know what the terms of any such capital raising would be. In addition, any future sale of our equity securities would dilute the ownership and control of your shares and could be at prices substantially below prices at which our shares currently trade. Our inability to raise capital could require us to significantly curtail or terminate our operations. We may seek to increase our cash reserves through the sale of additional equity or debt securities. The sale of convertible debt securities or additional equity securities could result in additional and potentially substantial dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations and liquidity. In addition, our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties.

 

Our condensed consolidated financial statements included elsewhere in this 10-Q document have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”), which contemplate our continuation as a going concern and the realization of assets and the satisfaction of liabilities in the normal course of business. The carrying amounts of assets and liabilities presented in the consolidated financial statements do not necessarily purport to represent realizable or settlement values. The consolidated financial statements do not include any adjustment that might result from the outcome of this uncertainty.

 

Sources and Uses of Cash for the Nine Months Ended September 30, 2017 and September 30, 2016

 

For the nine months ended September 30, 2017 and 2016, we used cash of $2,639,623 and $1,001,253, respectively, in operations. Our cash used for the nine months ended September 30, 2017 was primarily attributable to our net loss of $12,375,639, adjusted for net non-cash income in the aggregate amount of $8,496,836, partially offset by $1,239,180 of net cash provided by changes in the levels of operating assets and liabilities. Our cash used for the nine months ended September 30, 2016 was primarily attributable to our net loss of $2,334,437, adjusted for net non-cash income in the aggregate amount of $525,930, partially offset by $807,254 of net cash provided by changes in the levels of operating assets and liabilities.

 

During the nine months ended September 30, 2017, cash used in investing activities was $529,496, of which $580,384 was used to purchase property and equipment, and $50,888 was used to issue loans to franchisees and a related parties net amount of repayments. During the nine months ended September 30, 2016, cash used in investing activities was $735,158, of which $751,968 was used to purchase property and equipment, and $16,810 was used to issue loans to franchisees and related parties net of repayments

 

Net cash provided by financing activities for the nine months ended September 30, 2017 was $2,976,796 of which $1,138,800 was proceeds from convertible notes payable to American Restaurant Holdings, $300,000 proceeds from convertible notes from other related parties, $1,250,000 proceeds from convertible notes to various parties, $50,000 in proceeds from the exercise of warrants and $420,000 in proceeds from the issuance of restricted stock, and $182,004 of advance from American Restaurant Holdings. Net cash provided by financing activities for the nine months ended September 30, 2016 was $2,146,650 of which $2,154,750 was proceeds from convertible notes payable to American Restaurant Holdings, partially offset by $8,100 of repayments of notes payable.

 

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Critical Accounting Policies

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period.

 

Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Significant estimates include:

 

  the fair value of assets acquired, and liabilities assumed in a business combination;
  the assessment of recoverability of long-lived assets, including property and equipment, goodwill and intangible assets;
  the estimated useful lives of intangible and depreciable assets;
  the recognition of revenue; and
  the recognition, measurement and valuation of current and deferred income taxes

 

Estimates and assumptions are periodically reviewed, and the effects of any material revisions are reflected in the financial statements in the period that they are determined to be necessary. Actual results could differ from those estimates and assumptions.

 

Intangible Assets

 

We account for recorded intangible assets in accordance with ASC 350 “Intangibles - Goodwill and Other”. In accordance with ASC 350, we do not amortize intangible assets with indefinite useful lives. Our goodwill and trademarks are deemed to have indefinite lives, and accordingly are not amortized, but are evaluated for impairment at least annually, or more often whenever changes in facts and circumstances may indicate that the carrying value may not be recoverable. The Accounting Standards Codification (“ASC”) requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment). Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value. Significant judgment is required to estimate the fair value of reporting units which includes estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment.

 

Other intangible assets include franchise agreements and a non-compete agreement which are amortized on a straight-line basis over their estimated useful lives of 13 years and 5 years, respectively.

 

Impairment of Long-Lived Assets

 

When circumstances, such as adverse market conditions, indicate that the carrying value of a long-lived asset may be impaired, we perform an analysis to review the recoverability of the asset’s carrying value, which includes estimating the undiscounted cash flows (excluding interest charges) from the expected future operations of the asset. These estimates consider factors such as expected future operating income, operating trends and prospects, as well as the effects of demand, competition and other factors. If the analysis indicates that the carrying value is not recoverable from future cash flows, an impairment loss is recognized to the extent that the carrying value exceeds the estimated fair value. Any impairment losses are recorded as operating expenses, which reduce net income.

 

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Deferred Revenue

 

Deferred revenue consists of initial franchise fees received by us, for which the restaurant has not yet opened, as well as unearned vendor rebates and customer deposits accrued in connection with technology sales and services by CTI. We collect initial franchise fees when franchise agreements are signed and recognize the initial franchise fees as revenue when the store is opened, which is when we have performed substantially all initial services required by the franchise agreement.

 

Revenue Recognition

 

In accordance with the Accounting Standard Codification Topic 605 “Revenue Recognition” (“ASC 605”), We recognizes revenue when the following four criteria are met: (1) delivery has occurred or services rendered; (2) persuasive evidence of an arrangement exists; (3) there are no continuing obligations to the customer; and (4) the collection of related accounts receivable is probable.

 

Restaurant Sales

 

Retail store revenue at our operated restaurants are recognized when payment is tendered at the point of sale, net of sales tax and other sales related taxes.

 

Franchise Royalties and Fees

 

Royalties and franchise fees principally consist of royalties and franchise fees. Royalties are based on a percentage of franchisee revenue. Initial franchise fees are recognized upon opening of a restaurant or granting of a new franchise term, which is when we performed substantially all material obligations and initial services required by the franchise agreement. We recognize renewal fees in income when a renewal agreement becomes effective.

 

We have supply agreements with certain food and beverage vendors. Pursuant to the terms of these agreements, rebates are provided to us based upon the dollar volume of purchases for all our owned and franchised restaurants from these vendors. Rebates, net of rebates attributable to company owned stores, are recorded as revenue during the period in which the related food and beverage purchases are made. Company owned store rebates are recorded net of cost of goods sold.

 

Other Revenues

 

Through our subsidiary, CTI, we derive revenue from the sale of POS computer systems, cash registers, digital menu boards and camera systems, and from the provision of related consulting and support services, which generally include implementation, installation and training services. We recognize revenue when persuasive evidence of an arrangement exists, delivery of the product or service has occurred, the fee is fixed or determinable and collectability is reasonably assured.

 

Income Taxes

 

We account for income taxes under Accounting Standards Codification (“ASC”) 740 Income Taxes (“ASC 740”). Under ASC 740, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities and net operating loss and credit carryforwards using enacted tax rates in effect for the year in which the differences are expected to impact taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

 

ASC 740 also clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.

 

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Tax benefits claimed or expected to be claimed on a tax return are recorded in our financial statements. A tax benefit from an uncertain tax position is only recognized if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution.

 

Our policy is to classify assessments, if any, for tax related interest as interest expense and penalties as general and administrative expenses in the consolidated statements of operations.

 

Recently Issued Accounting Pronouncements

 

See Note 3 to our condensed consolidated financial statements for the nine months ended September 30, 2017.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Not applicable.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

 

(a) Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of September 30, 2017. Based on such evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that, as of the end of the period covered by this Quarterly Report, our disclosure controls and procedures were not effective because of a material weakness in our internal control over financial reporting as discussed below.

 

Notwithstanding this material weakness, our Chief Executive Officer and Chief Financial Officer have concluded that the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q present fairly, in all material respects, the financial position of the Company at September 30, 2017 and December 31, 2016 and the consolidated results of operations and cash flows for each of the three and nine months ended September 30, 2017 and 2016 presented herein in conformity with U.S. generally accepted accounting principles.

 

(b) Management’s Annual Report on Internal Control Over Financial Reporting

 

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as required by Sarbanes-Oxley (SOX) Section 404(a). The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s Principal Executive Officer and Principal Financial Officer and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s consolidated financial statements for external purposes in accordance with United States generally accepted accounting principles.

 

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Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with US GAAP. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projection of any evaluation of effectiveness to future periods is subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. In connection with management’s assessment of our internal control over financial reporting as required under Section 404 of the Sarbanes-Oxley Act of 2002, we identified the following material weaknesses in our internal control over financial reporting as of September 30, 2017:

 

The Company does not have written documentation of our internal control policies and procedures.
The Company does not have sufficient resources in its accounting function, which restricts the Company’s ability to gather, analyze and properly review information related to financial reporting in a timely manner. In addition, due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions, the custody of assets and the recording of transactions should be performed by separate individuals.
The Company has inadequate controls to ensure that information necessary to properly record transactions is adequately communicated on a timely basis from non-financial personnel to those responsible for financial reporting.

 

Remediation of Material Weaknesses in Internal Control over Financial Reporting

 

As a company with limited resources, the Company does not have the resources to fund sufficient staff to ensure a complete segregation of responsibilities within the accounting function. However, Company management does review, and will increase the review of the financial statements. This action, in addition to future improvements, will minimize any risk of a potential material misstatement occurring.

 

(c) Changes in Internal Control over Financial Reporting

 

There have been no changes in our internal control over financial reporting that occurred during the third quarter of the nine months ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

From time to time, we are a defendant or plaintiff in various legal actions that arise in the normal course of business. We record legal costs associated with loss contingencies as incurred and have accrued for all probable and estimable settlements.

 

We are not currently involved in any material disputes and do not have any material litigation matters pending except:

 

In April 2018, Muscle Maker and ARH was listed as a defendant in a lawsuit filed by a landlord in the Superior Court of the State of California. The landlord is seeking $531,594 in damages for rent, interest and other expenses. The original lease was for a 5-year period and commenced on or about September 30, 2015. On January 18, 2019, the Company successfully worked out a settlement and payment plan with the Plaintiff pursuant to a confidential settlement agreement.

 

On May 4, 2018, Stratford Road Partners, LLC (“Stafford”) filed suit against us and our subsidiary for non-payment of rent in the small Claims court in the state of North Carolina. Since then the property has been vacated and the landlord offered a settlement of $10,000 with no further lease obligation. As of the date of this report the company has not signed the settlement agreement dated June 30, 2018.

 

In May 2018, Muscle Maker, ARH and Robert E. Morgan (the former CEO of the Company) were listed as defendants to a lawsuit filed by Crownhall Realty, LLC (“Crownhall”) in the Supreme Court of the State of New York county of New York, #154467. Crownhall is seeking $1,034,087 in damages for rent, interest and other expenses. The original lease was for a 10-year period of time and commenced on January 1, 2016. In 2017, Limestone Associates LLC (“Limestone”) filed a complaint against ARH in the Civil Court of the City of New York, County of New York, #78549/2017 for commercial non-payment of rent for the amount of $25,748 plus cost and disbursements of this proceeding. In May 2018, Limestone filed a complaint against ARH and Mr. Morgan in the Supreme Court of the State of New York, County of New York, index # 154469 seeking $1,357,243 in damages for rent, interest and other expenses. On October 3, 2018, the Company, ARH and Robert E. Morgan entered into a settlement agreement with Crownhall and Limestone agreeing to forfeit all security deposits in the amount of $87,093, pay an upfront amount of $25,000 and an additional $175,000 to be paid over 20 months. This agreement settles litigation surrounding two closed locations, which the plaintiffs were seeking a total of $2,391,330 in past damages for rent, interest and other expenses.

 

On May 25, 2018, the Civil Court of the City of New York, County of New York, entered into a settlement agreement between the Company and a landlord, in the amount of $55,891 for past due rent. The Company agreed to make the following payments (i) $15,000 on or before May 31, 2018, and (ii) $40,891 on or before September 4,2018. These amounts have been paid in full.

 

On December 12, 2018, Muscle Maker was listed as a defendant to a lawsuit filed by a landlord in the Superior Court of the State of California. The landlord is seeking approximately $121,000 in damages for rent, interest and other expenses. On February 15, 2019, the company entered into a settlement agreement and payment plan in the amount of $85,000.

 

Resolute Contractors, Inc, Quality Tile, MTL Construction, Genesis Electric, JNB Interiors and Captive Aire filed a Mechanics Lien for labor, service, equipment and materials in the total amount of $98,005.22.

 

On or about May 1, 2018, a suit was filed in the Supreme Court of the State of New York, County of Rockland, by Imperial Bag & Paper seeking $44,585 in past due amounts for goods received. The company entered into a payment plan and as of January 2019 this amount has been paid in full.

 

On or about April 5, 2018, American Restaurant Holdings, Inc entered into a settlement agreement with 918-924 Belmont, LLC for $100,000 regarding past rents owed, other charges and the termination of its lease at this location. The settlement calls for monthly payments of $8,333 thru March 2019.

 

On or about June 29, 2018, an arbitrator ruled all claims denied from a previous suit filed in 2013. The original suit was titled John Marques and J. Crown, Inc., Cross-Claim and Third-Party Plaintiffs v. Muscle Maker Franchising, LLC, Cross-Claim Defendant, and Rodney Silva and Robert Morgan, Third Party Defendants, Docket No. MID-L-4223-13, Superior Court of New Jersey Law Division: Middlesex County.

 

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A convertible note holder filed a complaint in the Iowa District Court for Polk County #CVCV056029 against MMB, LLC, a subsidiary of the Company, for failure to pay the remaining balance due on a promissory note in the amount of $100,000, together with interest, attorney fees and other costs are $171,035. A default judgement was entered against MMB, LLC.

 

Muscle Maker or its subsidiaries failed in certain instances in paying past state and local sales taxes collected from customers in specific states that impose a tax on sales of the Company’s products during 2017. The Company had accrued a liability for approximately $356,000 as of December 31, 2017 related to this matter. All current state and local sales taxes from January 1, 2018 for open company owned locations have been fully paid and in a timely manner. The Company has completed or is in discussions on payment plans with the various state or local entities for these past owed amounts.

 

Item 1A. Risk Factors.

 

An investment in the Company’s Common Stock involves a high degree of risk. You should carefully consider the risks described below as well as other information provided to you in this Quarterly Report on Form 10-Q, including information in the section of this document entitled “Information Regarding Forward Looking Statements.” The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently believe are immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected, the value of our Common Stock could decline, and you may lose all or part of your investment.

 

Risks Related to Our Business and Industry

 

We have a history of operating losses and our auditors have indicated that there is a substantial doubt about our ability to continue as a going concern.

 

To date, we have not been profitable and have incurred significant losses and cash flow deficits. For the nine months ended September 30, 2017 and December 31, 2016, we reported net losses of $12,375,639 and $4,219,687, respectively, and negative cash flow from operating activities of $2,639,667 and $2,110,702, respectively. As of September 30, 2017, we had an aggregate accumulated deficit of $13,880,663. We anticipate that we will continue to report losses and negative cash flow. As a result of these net losses and cash flow deficits and other factors, our independent auditors issued an audit opinion with respect to our financial statements for the two years ended December 31, 2016 that indicated that there is a substantial doubt about our ability to continue as a going concern.

 

Our financial statements do not include any adjustments that might result from the outcome of this uncertainty. These adjustments would likely include substantial impairment of the carrying amount of our assets and potential contingent liabilities that may arise if we are unable to fulfill various operational commitments. In addition, the value of our securities would be greatly impaired. Our ability to continue as a going concern is dependent upon generating sufficient cash flow from operations and obtaining additional capital and financing. If our ability to generate cash flow from operations is delayed or reduced and we are unable to raise additional funding from other sources, we may be unable to continue in business. For further discussion about our ability to continue as a going concern and our plan for future liquidity, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations”

 

We will need additional capital to fund our operations, which, if obtained, could result in substantial dilution or significant debt service obligations. We may not be able to obtain additional capital on commercially reasonable terms, which could adversely affect our liquidity and financial position.

 

At September 30, 2017, Muscle Maker had a cash balance of approximately $78,683, a working capital deficit of approximately $3,348,332, and an accumulated deficit of approximately $13,880,663. As of February 11, 2019, Muscle Maker had a cash balance of approximately $245,000 (unaudited). Even if we are able to substantially increase revenues and reduce operating expenses, we may need to raise additional capital. In order to continue operating, we may need to obtain additional financing, either through borrowings, private offerings, public offerings, or some type of business combination, such as a merger, or buyout, and there can be no assurance that we will be successful in such pursuits. We may be unable to acquire the additional funding necessary to continue operating. Accordingly, if we are unable to generate adequate cash from operations, and if we are unable to find sources of funding, it may be necessary for us to sell one or more lines of business or all or a portion of our assets, enter into a business combination, or reduce or eliminate operations. These possibilities, to the extent available, may be on terms that result in significant dilution to our shareholders or that result in our shareholders losing all of their investment in our Company. In order to satisfy the Company’s monthly expenses and continue in operation through September 30, 2019, the Company will need to raise a minimum of $2,000,000. In order to fully implement our business plan for 2019, the Company will need to raise a minimum of $5,000,000.

 

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If we are able to raise additional capital, we do not know what the terms of any such capital raising would be. In addition, any future sale of our equity securities would dilute the ownership and control of your shares and could be at prices substantially below prices at which our shares currently trade. Our inability to raise capital could require us to significantly curtail or terminate our operations. We may seek to increase our cash reserves through the sale of additional equity or debt securities. The sale of convertible debt securities or additional equity securities could result in additional and potentially substantial dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations and liquidity. In addition, our ability to obtain additional capital on acceptable terms is subject to a variety of uncertainties. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all. Any failure to raise additional funds on favorable terms could have a material adverse effect on our liquidity and financial condition.

 

We are vulnerable to changes in consumer preferences and economic conditions that could harm our business, financial condition, results of operations and cash flow.

 

Food service businesses depend on consumer discretionary spending and are often affected by changes in consumer tastes, national, regional and local economic conditions and demographic trends. Factors such as traffic patterns, weather, fuel prices, local demographics, troop deployments or base closures specific to our military locations and the type, number and locations of competing restaurants may adversely affect the performances of individual locations. In addition, economic downturns, inflation or increased food or energy costs could harm the restaurant industry in general and our locations in particular. Adverse changes in any of these factors could reduce consumer traffic or impose practical limits on pricing that could harm our business, financial condition, results of operations and cash flow. There can be no assurance that consumers will continue to regard healthy-inspired fast food favorably or that we will be able to develop new menu items that appeal to consumer preferences. Our business, financial condition and results of operations depend in part on our ability to anticipate, identify and respond to changing consumer preferences and economic conditions. In addition, the restaurant industry is currently under heightened legal and legislative scrutiny related to menu labeling and resulting from the perception that the practices of restaurant companies have contributed to nutritional, caloric intake, obesity or other health concerns of their guests. If we are unable to adapt to changes in consumer preferences and trends, we may lose customers and our revenues may decline or our costs to produce our products could significantly increase.

 

Our growth strategy depends in part on opening new restaurants in existing and new markets, including military bases and expanding our franchise system. We may be unsuccessful in opening new company-operated or franchised restaurants or establishing new markets, which could adversely affect our growth.

 

One of the key means to achieving our growth strategy will be through opening new restaurants and operating those restaurants on a profitable basis. Our ability to open new restaurants is dependent upon a number of factors, many of which are beyond our control, including our and our franchisees’ ability to:

 

  identify available and suitable restaurant sites;
  compete for restaurant sites;
  reach acceptable agreements regarding the lease or purchase of locations;
  obtain or have available the financing required to acquire and operate a restaurant, including construction and opening costs, which includes access to build-to-suit leases and equipment financing leases at favorable interest and capitalization rates;
  respond to unforeseen engineering or environmental problems with leased premises;
  avoid the impact of inclement weather, natural disasters and other calamities;
  hire, train and retain the skilled management and other employees necessary to meet staffing needs;
  obtain, in a timely manner and for an acceptable cost, required licenses, permits and regulatory approvals and respond effectively to any changes in local, state or federal law and regulations that adversely affect our and our franchisees’ costs or ability to open new restaurants; and
  control construction and equipment cost increases for new restaurants.

 

There is no guarantee that a sufficient number of suitable restaurant sites will be available in desirable areas, military bases or on terms that are acceptable to us in order to achieve our growth plan. If we are unable to open new restaurants or sign new franchisees, or if existing franchisees do not open new restaurants, or if restaurant openings are significantly delayed, our revenues or earnings growth could be adversely affected and our business negatively affected.

 

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As part of our long-term growth strategy, we may enter into geographic markets, including military bases, in which we have little or no prior operating or franchising experience through company-operated restaurant growth and through franchise development agreements. The challenges of entering new markets include, but are not limited to: difficulties in hiring experienced personnel; unfamiliarity with local real estate markets and demographics; food distribution networks; lack of marketing efficiencies; operational support efficiencies; consumer unfamiliarity with our brand; and different competitive and economic conditions, consumer tastes and discretionary spending patterns that are more difficult to predict or satisfy than in our existing markets. Consumer recognition of our brand has been important in the success of company-operated and franchised restaurants in our existing markets. Restaurants we open in new markets may take longer to reach expected sales and profit levels on a consistent basis and may have higher construction, occupancy and operating costs than existing restaurants, thereby affecting our overall profitability. Any failure on our part to recognize or respond to these challenges may adversely affect the success of any new restaurants. Expanding our franchise system could require the implementation, expense and successful management of enhanced business support systems, management information systems and financial controls as well as additional staffing, franchise support and capital expenditures and working capital.

 

Due to brand recognition and logistical synergies, as part of our growth strategy, we also intend to open new restaurants in areas where we have existing restaurants. The operating results and comparable restaurant sales for our restaurants could be adversely affected due to close proximity with our other restaurants and market saturation.

 

New restaurants, once opened, may not be profitable or may close.

 

Some of our restaurants open with an initial start-up period of higher than normal sales volumes, which subsequently decrease to stabilized levels. In new markets, the length of time before average sales for new restaurants stabilize is less predictable and can be longer as a result of our limited knowledge of these markets and consumers’ limited awareness of our brand. In addition, our average restaurant revenues and comparable restaurant sales may not increase at the rates achieved over the past several years. Our ability to operate new restaurants profitably and increase average restaurant revenues and comparable restaurant sales will depend on many factors, some of which are beyond our control, including:

 

  consumer awareness and understanding of our brand;
  Troop deployments, reductions or closures of our military base locations;
  general economic conditions, which can affect restaurant traffic, local labor costs and prices we pay for the food products and other supplies we use;
  consumption patterns and food preferences that may differ from region to region;
  changes in consumer preferences and discretionary spending;
  difficulties obtaining or maintaining adequate relationships with distributors or suppliers in new markets;
  increases in prices for commodities, including proteins;
  inefficiency in our labor costs as the staff gains experience;
  competition, either from our competitors in the restaurant industry or our own restaurants;
  temporary and permanent site characteristics of new restaurants;
  changes in government regulation; and
  other unanticipated increases in costs, any of which could give rise to delays or cost overruns.

 

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

 

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

 

The consumer target area of our and our franchisees’ restaurants varies by location, depending on a number of factors, including population density, other local retail and business attractions, area demographics and geography. As a result, the opening of a new restaurant in or near markets in which we or our franchisees’ already have restaurants could adversely impact sales at these existing restaurants. Existing restaurants could also make it more difficult to build our and our franchisees’ consumer base for a new restaurant in the same market. Our core business strategy does not entail opening new restaurants that we believe will materially affect sales at our or our franchisees’ existing restaurants. However, we cannot guarantee there will not be significant impact in some cases, and we may selectively open new restaurants in and around areas of existing restaurants that are operating at or near capacity to effectively serve our customers. Sales cannibalization between our restaurants may become significant in the future as we continue to expand our operations and could affect our sales growth, which could, in turn, materially and adversely affect our business, financial condition and results of operations.

 

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