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 July 1, 2018

 

OR

 

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

 

Commission file number 001-38250

 

FAT Brands Inc.

(Exact name of registrant as specified in its charter)

 

Delaware   08-2130269
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

 

9720 Wilshire Blvd., Suite 500

Beverly Hills, CA 90212

(Address of principal executive offices, including zip code)

 

(310) 402-0600

(Registrant’s telephone number, including area code)

 

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 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 [X]    

 

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

 

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

 

As of August 13, 2018, there were 11,342,532 shares of common stock outstanding.

 

 

 

 
 

 

FAT BRANDS INC.

QUARTERLY REPORT ON FORM 10-Q

July 1, 2018

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION  
Item 1. Financial Statements (Unaudited) 1
     
  FAT Brands Inc. and Subsidiaries:  
  Consolidated Balance Sheets 1
  Consolidated Statements of Operations 2
  Consolidated Statement of Stockholders’ Equity 3
  Consolidated Statement of Cash Flows 4
  Notes to Consolidated Financial Statements 5
     
  Fatburger North America:  
  Balance Sheets 20
  Statements of Operations 21
  Statement of Stockholder’s Equity 22
  Statements of Cash Flows 23
  Notes to Financial Statements 24
     
  Buffalo’s Franchise Concept Inc. and Subsidiary  
  Consolidated Balance Sheets 31
  Consolidated Statements of Operations 32
  Consolidated Statement of Stockholder’s Equity 33
  Consolidated Statements of Cash Flows 34
  Notes to Consolidated Financial Statements 35
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 42
Item 3. Quantitative and Qualitative Disclosures About Market Risk 56
Item 4. Controls and Procedures 56
     
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 57
Item 1A. Risk Factors 57
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 57
Item 3. Defaults Upon Senior Securities 58
Item 4. Mine Safety Disclosures 58
Item 5. Other Information 58
Item 6. Exhibits 59
     
SIGNATURES 60

 

 
 

 

PART I — FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS (Unaudited)

 

FAT BRANDS INC.

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

 

    July 1, 2018     December 31, 2017  
    (Unaudited)     (Audited)  
Assets                
Current assets                
Cash   $ 955     $ 32  
Accounts receivable, net of allowance for doubtful accounts of $676 and $679, respectively     1,308       918  
Trade notes receivable, net of allowance for doubtful accounts of $17     152       77  
Other current assets     354       153  
Total current assets     2,769       1,180  
                 
Trade notes receivable – noncurrent, net of allowance of $17 for doubtful accounts     244       346  
Due from affiliates     8,967       7,963  
Deferred income taxes     1,815       937  
Goodwill     7,356       7,356  
Other intangible assets, net     10,955       11,011  
Other assets     371       7  
Buffalo’s creative and advertising fund     -       436  
Total assets   $ 32,477     $ 29,236  
                 
Liabilities and Stockholders’ Equity                
Liabilities                
Accounts payable   $ 2,404     $ 2,439  
Deferred income     1,162       1,772  
Accrued expenses     1,487       1,761  
Accrued advertising     761       348  
Dividend payable on common shares     1,352       -  
Accrued interest payable to FCCG     -       405  
Dividend payable on mandatorily redeemable preferred shares     53       -  
Current portion of note payable to FCCG     950       -  
Current portion of long-term debt     2,063       -  
Total current liabilities     10,232       6,725  
                 
Deferred income - noncurrent     5,745       1,941  
Mandatorily redeemable preferred shares     9,888       -  
Deferred dividend payable on mandatorily redeemable preferred shares     25       -  
Notes payable to FCCG     -       18,125  
Buffalo’s creative and advertising fund-contra     -       436  
Total liabilities     25,890       27,227  
                 
Commitments and contingencies (Note 13)                
                 
Stockholders’ equity                
Common stock, $.0001 par value; 25,000,000 shares authorized; 11,184,767 and 10,000,000 shares issued and outstanding at July 1, 2018 and December 31, 2017, respectively     8,990       2,622  
Accumulated deficit     (2,403 )     (613 )
Total stockholders’ equity     6,587       2,009  
Total liabilities and stockholders’ equity   $ 32,477     $ 29,236  

 

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

 

 1 

 

 

FAT BRANDS INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(dollars in thousands, except share data)

 

For the thirteen and twenty-six weeks ended July 1, 2018 (Unaudited)

 

    Thirteen Weeks     Twenty-Six Weeks  
             
Revenue                
Royalties   $ 2,860     $ 5,432  
Franchise fees     299       698  
Store opening fees     105       105  
Advertising fees     630       1,226  
Management fees     14       32  
Total revenue     3,908       7,493  
                 
General and administrative expenses                
Compensation and employee benefits     1,459       2,790  
Travel and entertainment     203       327  
Professional fees     348       558  
Advertising expense     630       1,226  
Other     441       824  
Total general and administrative expenses     3,081       5,725  
                 
Income from operations     827       1,768  
                 
Non-operating income (expense)                
Interest expense, net     (222 )     (436 )
Interest expense related to mandatorily redeemable preferred shares     (78 )     (78 )
Depreciation and amortization     (40 )     (73 )
Other expense, net     (2 )     (3 )
Total non-operating expense     (342 )     (590 )
                 
Income before taxes     485       1,178  
                 
Income tax expense     112       296  
                 
Net income   $ 373     $ 882  
                 
Basic income per common share   $ 0.04     $ 0.09  
Basic weighted average shares outstanding     10,179       10,090  
Diluted income per common share   $ 0.04     $ 0.09  
Diluted weighted average shares outstanding     10,179       10,090  
Cash dividends declared per common share   $ 0.12     $ 0.24  

 

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

 

 2 

 

 

FAT BRANDS INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(dollars in thousands, except share data)

 

   Common Stock         
   Shares   Par value  

Additional paid-in

capital

   Total   Accumulated Deficit   Total 
                         
Balance at December 31, 2017   10,000,000   $1   $2,621   $2,622   $(613)  $2,009 
                               
Cumulative-effect adjustment from adoption of ASU 2014-09, Revenue from Contracts with Customers   -    -    -    -    (2,672)   (2,672)
Net income   -    -    -    -    882    882 
Dividends on common stock   -    -    (2,551)   (2,551)   -    (2,551)
Issuance of stock in lieu of director fees payable   41,772    -    330    330    -    330 
Issuance of common stock in payment of related party note   989,395    -    7,272    7,272    -    7,272 
Issuance of stock in lieu of dividend payable to FCCG   153,600    -    960    960    -    960 
Issuance of warrants to purchase common stock   -    -    112    112    -    112 
Share-based compensation   -    -    245    245    -    245 
                               
Balance at July 1, 2018   11,184,767   $1   $8,989   $8,990   $(2,403)  $6,587 

 

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

 

 3 

 

 

FAT BRANDS INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(dollars in thousands)

For the twenty-six weeks ended July 1, 2018 (Unaudited)

 

    
Cash flows from operating activities     
Net income  $882 
Adjustments to reconcile net income to net cash provided by operations:     
Deferred income taxes   (66)
Recovery of bad debts   (8)
Depreciation and amortization   85 
Share-based compensation   245 
Change in:     
Accounts receivable   (264)
Trade notes receivable   27 
Prepaid expenses   (201)
Accounts payables and accrued expense   (410)
Accrued advertising   (176)
Accrued interest payable   (405)
Deferred dividend on mandatorily redeemable shares   78 
Deferred income   (290)
Total adjustments   (1,385)
Net cash used in operating activities   (503)
      
Cash flows from investing activities     
Investment in equipment   (88)
Net cash used in investing activities   (88)
      
Cash flows from financing activities     
Issuance of mandatorily redeemable preferred shares and associated warrants   8,000 
Proceeds from borrowings, net of issuance costs   1,882 
Repayments of loans from FCCG   (7,903)
Change in due from affiliates   (218)
Dividends paid in cash   (240)
Deposit toward potential equity issue   (7)
Net cash provided by financing activities   1,514 
      
Net increase in cash   923 
Cash at beginning of period   32 
Cash at end of period  $955 
      
Supplemental disclosures of cash flow information:     
Cash paid for interest  $1,319 
Cash paid for income taxes  $116 
      
Supplemental disclosure of non-cash financing and investing activities:     
Assets acquired under capital leases and accrued expenses  $121 
Dividends payable on common stock  $1,352 
Dividends reinvested in common stock  $960 
Note payable to FCCG converted to common and preferred stock  $9,272 
Director fees converted to common stock  $330 
Income taxes payable offset against amounts due from affiliates  $204 

 

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

 

 4 

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

NOTE 1 – ORGANIZATION AND RELATIONSHIPS

 

FAT Brands Inc. (the “Company”) was formed on March 21, 2017 as a wholly-owned subsidiary of Fog Cutter Capital Group Inc. (“FCCG”). On October 20, 2017, the Company completed an initial public offering and issued additional shares of common stock representing 20 percent of its ownership (the “Offering”). The Company’s common stock trades on the Nasdaq Capital Market under the symbol “FAT.”

 

Concurrent with the Offering, two subsidiaries of FCCG, Fatburger North America, Inc. (“Fatburger”) and Buffalo’s Franchise Concepts, Inc. (“Buffalo’s”) were contributed to the Company by FCCG in exchange for a $30,000,000 note payable (the “Related Party Debt”). FCCG also contributed the newly acquired operating subsidiaries of Homestyle Dining LLC: Ponderosa Franchising Company, Bonanza Restaurant Company, Ponderosa International Development, Inc. and Puerto Rico Ponderosa, Inc. (collectively, “Ponderosa”). These subsidiaries conduct the worldwide franchising of the Ponderosa Steakhouse Restaurants and the Bonanza Steakhouse Restaurants. The Company provided $10,550,000 of the net proceeds from the Offering to FCCG to consummate the acquisition of Homestyle Dining LLC.

 

The Company did not begin operations until October 20, 2017. As a result, prior year comparative results are not presented in the accompanying statement of operations and statement of cash flows.

 

At July 1, 2018, certain Company officers and directors controlled, directly or indirectly, a significant voting majority of the Company.

 

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of operations – FAT Brands Inc. is a multi-brand franchising company specializing in fast casual restaurant concepts around the world through its subsidiaries: Fatburger, Buffalo’s and Ponderosa. Each subsidiary licenses the right to use its brand name and provides franchisees with operating procedures and methods of merchandising. Upon signing a franchise agreement, the franchisor is committed to provide training, some supervision and assistance, and access to operations manuals. As needed, the franchisor will also provide advice and written materials concerning techniques of managing and operating the restaurants.

 

Fatburger restaurants serve a variety of freshly made-to-order Fatburgers, Turkeyburgers, Chicken Sandwiches, Veggieburgers, French fries, onion rings, soft-drinks and milkshakes.

 

Buffalo’s grants franchises for the operation of casual dining restaurants (Buffalo’s Southwest Cafés) and quick service restaurants outlets (Buffalo’s Express). These restaurants specialize in the sale of Buffalo-Style chicken wings, chicken tenders, burgers, ribs, wrap sandwiches, and salads.

 

Ponderosa and Bonanza Steakhouses offer guests a high-quality buffet and broad array of great tasting, affordably-priced steak, chicken and seafood entrées. Buffets at Ponderosa and Bonanza Steakhouses feature a large variety of all you can eat salads, soups, appetizers, vegetables, breads, hot main courses and desserts. Bonanza Steak & BBQ operates full service steakhouses with fresh farm-to-table salad bar, including a menu showcase of USDA flame-grilled steaks, house-smoked BBQ and contemporized interpretations of traditional American classics.

 

The Company also co-brands its franchise concepts. These co-branded restaurants sell products of multiple affiliated brands and share back-of-the-house facilities.

 

The Company operates on a 52-week calendar and its fiscal year ends on the Sunday closest to December 31. Consistent with the industry practice, the Company measures its stores’ performance based upon 7-day work weeks. Using the 52-week cycle ensures consistent weekly reporting for operations and ensures that each week has the same days, since certain days are more profitable than others. The use of this fiscal year means a 53rd week is added to the fiscal year every 5 or 6 years. In a 52-week year, all four quarters are comprised of 13 weeks. In a 53-week year, one extra week is added to the fourth quarter. The year 2018 will be a 52-week year

 

Principles of consolidation – The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries: Fatburger, Buffalo’s and Ponderosa. Intercompany accounts have been eliminated in consolidation.

 

 5 

 

 

Use of estimates in the preparation of the consolidated financial statements – The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include the determination of fair values of certain financial instruments for which there is no active market, the allocation of basis between assets sold and retained, and valuation allowances for notes receivable and accounts receivable. Estimates and assumptions also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Franchise fees and royalty revenue – Franchise fee revenue from the sale of individual franchises is recognized over the term of the individual franchise agreement. Unamortized non-refundable deposits collected in relation to the sale of franchises are recorded as deferred franchise fees. In addition to franchise fee revenue, the Company collects a royalty ranging from 0.75% to 6% of gross sales from restaurants operated by franchisees. Royalties are recorded as revenue as the related sales are made by the franchisees. Any royalties received prior to the related sales are deferred and recognized when earned. Costs relating to continuing franchise support are expensed as incurred.

 

Store opening fees – The Company recognizes store opening fees of $45,000 and $60,000 for domestic and international stores, respectively, from the up-front fees collected from franchisees. The remaining balance of the up-front fees are then amortized as franchise fees over the life of the franchise agreement. If the fees collected are less than the respective store opening fee amounts, the full up-front fees are recognized at opening. The $45,000 and $60,000 are based on out-of-pocket costs to the Company for each store opening and are primarily comprised of labor expenses associated with training, store design, and supply chain setup. International fees recognized are higher due to the additional cost of travel.

 

Advertising – The Company requires advertising payments from franchisees based on a percent of net sales. The Company also receives, from time to time, payments from vendors that are to be used for advertising. Advertising funds collected are required to be spent for specific advertising purposes. Advertising revenue and associated expense is recorded on the statement of operations. Assets and liabilities associated with the related advertising fees are consolidated on the Company’s balance sheet.

 

Goodwill and other intangible assets – Intangible assets are stated at the estimated fair value at the date of acquisition and include goodwill, trademarks, and franchise agreements. Goodwill and other intangible assets with indefinite lives, such as trademark, are not amortized but are reviewed for impairment annually or more frequently if indicators arise. All other intangible assets are amortized over their estimated weighted average useful lives, which range from nine to twenty-five years. Management assesses potential impairments to intangible assets at least annually, or when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. Judgments regarding the existence of impairment indicators and future cash flows related to intangible assets are based on operational performance of the acquired businesses, market conditions and other factors.

 

Accounts receivable – Accounts receivable are recorded at the invoiced amount and are stated net of an allowance for doubtful accounts. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the existing accounts receivable. The allowance is based on historical collection data and current franchisee information. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

 

Trade notes receivable – Trade notes receivable are created when an agreement to settle a delinquent franchisee receivable account is reached and the entire balance is not immediately paid. Generally, trade notes receivable include personal guarantees from the franchisee. The notes are made for the shortest time frame negotiable and will generally carry an interest rate of 6% to 7.5%. Reserve amounts on the notes are established based on the likelihood of collection.

 

 6 

 

 

Share-based compensation – The Company has a non-qualified stock option plan which provides for options to purchase shares of the Company’s common stock. Options issued under the plan may have a variety of terms as determined by the Board of Directors including the option term, the exercise price and the vesting period. Options granted to employees and directors are valued at the date of grant and recognized as an expense over the vesting period in which the options are earned. Cancellations or forfeitures are accounted for as they occur. Stock options issued to non-employees as compensation for services are accounted for based upon the estimated fair value of the stock option. The Company recognizes this expense over the period in which the services are provided. Management utilizes the Black-Scholes option-pricing model to determine the fair value of the stock options issued by the Company. See Note 11 for more details on the Company’s share-based compensation.

 

Income taxes – Effective October 20, 2017, the Company entered into a Tax Sharing Agreement with FCCG that provides that FCCG will, to the extent permitted by applicable law, file consolidated federal, California and Oregon (and possibly other jurisdictions where revenue is generated, at FCCG’s election) income tax returns with the Company and its subsidiaries. The Company will pay FCCG the amount that its tax liability would have been had it filed a separate return. As such, the Company accounts for income taxes as if it filed separately from FCCG.

 

The Company accounts for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on the differences between financial reporting and tax reporting bases of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. Realization of deferred tax assets is dependent upon future earnings, the timing and amount of which are uncertain.

 

We utilize a two-step approach to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained upon tax authority examination, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon the ultimate settlement.

 

Earnings per share – The Company reports basic earnings per share in accordance with FASB ASC 260, “Earnings Per Share”. Basic earnings per share is computed using the weighted average number of common shares outstanding during the reporting period. Diluted earnings per share is computed using the weighted average number of common shares outstanding plus the effect of dilutive securities during the reporting period. All outstanding stock options and warrants to purchase common stock were excluded from the computation of diluted net loss per share for the period presented because none of those instruments currently have exercise prices below the market price of the shares.

 

Recently Adopted Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue From Contracts With Customers (Topic 606), requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods and services to customers. The updated standard replaces most existing revenue recognition guidance in U.S. GAAP. These standards became effective for the Company on January 1, 2018.

 

These standards require that the transaction price received from customers be allocated to each separate and distinct performance obligation. The transaction price attributable to each separate and distinct performance obligation is then recognized as the performance obligations are satisfied as specified in the contract. The agreements for services provided by the Company related to upfront fees received from franchisees (such as initial or renewal fees) do not currently contain separate and distinct performance obligations from the franchise right and thus those upfront fees will be recognized as revenue over the term of each respective franchise agreement. Previously, we recognized upfront franchise fees such as initial and renewal fees when the related services have been provided, which is when a store opened for initial fees and when renewal options became effective for renewal fees. These standards require any unamortized portion of fees received prior to adoption be presented in the consolidated balance sheet as a contract liability.

 

 7 

 

 

The new standards also had an impact on transactions previously not included in the Company’s revenues and expenses such as franchisee contributions to and subsequent expenditures from advertising arrangements we have with our franchisees. The Company did not previously include these contributions and expenditures in its consolidated statements of operations or cash flows. Under the new standards, the Company will recognize advertising fees and the related expense in its consolidated statements of operations or cash flows. The Company will also consolidate the assets and liabilities related to advertising funds on its balance sheet.

 

These standards will not impact the recognition of our sales-based royalties from franchisees, which is generally our largest source of revenue. We have implemented internal controls related to the recognition and presentation of the Company’s revenues under these new standards.

 

The Company adopted ASU 2014-09 on January 1, 2018 using the modified retrospective method, in which the cumulative effect of applying the standard would be recognized at the date of initial application. An adjustment to increase deferred revenue in the amount of $3,482,000 was established on the date of adoption relating to fees received through December 31, 2017 that would have been deferred and recognized over the term of each respective franchise store agreement if the new guidance had been applied in the past. A deferred tax asset of $810,000 related to this contract liability was also established on the date of adoption. These adjustments had the effect of increasing beginning accumulated deficit by approximately $2,672,000.

 

Adopting the new accounting standards for revenue affected several financial statement line items for the twenty-six weeks ended July 1, 2018. The following tables provide the affected amounts as reported in these Unaudited Consolidated Financial Statements compared with what they would have been if the previous accounting guidance had remained in effect.

 

As of July 1, 2018 (in thousands)

 

   Amounts As Reported   Amounts Under Previous Accounting Guidance 
Unaudited Consolidated Balance Sheet:          
Accounts receivable  $1,308   $1,231 
Due from affiliates  $8,967   $8,493 
Deferred income taxes  $1,815   $1,003 
Buffalo’s Creative and Advertising Fund  $-   $330 
Buffalo’s Creative and Advertising Fund - Contra  $-   $330
Accounts payable  $2,404   $2,081 
Deferred income  $6,907   $3,790 
Accrued expenses  $1,487   $1,476 
Accrued advertising  $761   $545 

Accumulated deficit

  $(2,403)  $(97

 

For the twenty-six weeks ended July 1, 2018 (in thousands except per share data)

 

    As Reported     Amounts Under Previous Accounting Guidance  
Unaudited Consolidated Statement of Operations:                
Franchise fees   $ 698     $ 331  
Advertising fees   $ 1,226     $ -  
Advertising expense   $ 1,226     $ -  
Net income   $ 882     $ 516  
Earnings per common share - basic   $ 0.09     $ 0.05  
Earnings per common share - diluted   $ 0.09     $ 0.05  

  

 8 

 

 

For the twenty-six weeks ended July 1, 2018 (in thousands)

 

    As Reported     Amounts Under Previous Accounting Guidance  
Unaudited Consolidated Statement of Cash Flows:                
Net income   $ 882     $ 516  
Adjustments to reconcile net income to net cash provided by operating activities:                
Accounts receivable   $ (264 )   $ (313 )
Deferred income   $ (290 )     77  
Accounts payable and accrued expenses   $ (410 )   $ (643 )
Accrued advertising   $ (176 )   $ 197  
Increase in due from affiliates   $ (218 )   $ (530 )

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The new guidance is intended to reduce diversity in practice in how transactions are classified in the statement of cash flows. This ASU is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2017. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles — Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment, which simplifies the accounting for goodwill impairment. This ASU removes Step 2 of the goodwill impairment test, which requires hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The new guidance also requires disclosure of the amount of goodwill at reporting units with zero or negative carrying amounts. ASU 2017-04 is effective for the Company beginning January 1, 2020. We elected to early adopt this standard when performing our annual goodwill impairment test in 2017. The adoption of this ASU did not have a significant financial impact on our consolidated financial statements.

 

In May 2017, the FASB issued ASU 2017-09, Compensation — Stock Compensation (Topic 718): Scope of Modification Accounting. This standard provides clarification on when modification accounting should be used for changes to the terms or conditions of a share-based payment award. This standard does not change the accounting for modifications but clarifies that modification accounting guidance should only be applied if there is a change to the value, vesting conditions, or award classification and would not be required if the changes are considered non-substantive. The amendments in this ASU are effective beginning January 1, 2018, with early adoption permitted. This ASU is to be applied prospectively on and after the effective date. We adopted this ASU during 2017. The adoption of this ASU did not have a significant financial impact on our consolidated financial statements.

 

Recently Issued Accounting Standards

 

In February 2016, the FASB issued ASU 2016-02, Leases, requiring a lessee to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases with a lease term of more than twelve months. Leases will continue to be classified as either financing or operating, with classification affecting the recognition, measurement and presentation of expenses and cash flows arising from a lease. This ASU is effective for interim and annual period beginning after December 15, 2018 and requires a modified retrospective approach to adoption for lessees related to capital and operating leases existing at, or entered into after, the earliest comparative period presented in the financial statements, with certain practical expedients available. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements.

 

In June 2018, the FASB issued ASU No.2018-07, Compensation- Stock Compensation (Topic 718). Improvements to Nonemployee Share-Based Payment Accounting. The amendments in this update expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. Prior to this update, Top 718 applied only to share-based transactions to employees. Consistent with the accounting requirements for employee share-based payment awards, nonemployee share-based payment awards within the scope of Topic 718 are measured at grant-date fair value of the equity instruments that an entity is obligated to issue when the good has been delivered or the service has been rendered and any other conditions necessary to earn the right to benefit from the instruments have been satisfied. The amendments in the update are effective for public business entities form fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. Early adoption is permitted, but no earlier than an entity’s adoption date of Topic 606. The adoption of this accounting standard is not expected to have a material effect on the Company’s consolidated financial statements.

 

 9 

 

 

Note 3. GOODWILL

 

Goodwill consists of the following (in thousands):

 

   July 1, 2018   December 31, 2017 
Goodwill:          
Fatburger  $529   $529 
Buffalo’s   5,365    5,365 
Ponderosa   1,462    1,462 
Total goodwill  $7,356   $7,356 

 

Note 4. OTHER INTANGIBLE ASSETS

 

Intangible assets consist of the following (in thousands):

 

   July 1, 2018   December 31, 2017 
Trademarks:          
Fatburger  $2,135   $2,135 
Buffalo’s   27    27 
Ponderosa   7,230    7,230 
Total trademarks   9,392    9,392 
           
Franchise agreements:          
Ponderosa – cost   1,640    1,640 
Ponderosa – accumulated amortization   (77)   (21)
Total franchise agreements   1,563    1,619 
Total  $10,955   $11,011 

 

The expected future amortization of the Company’s capitalized franchise agreements is as follows (in thousands):

 

Fiscal year:    
2018  $55 
2019   110 
2020   110 
2021   110 
2022   110 
Thereafter   1,068 
Total  $1,563 

 

Note 5. DEFERRED INCOME

 

Deferred income is as follows:

 

   July 1, 2018   December 31, 2017 
         
Deferred franchise fees  $6,122   $2,781 
Deferred royalties   785    932 
Total  $6,907   $3,713 

 

Note 6. Income Taxes

 

Effective October 20, 2017, the Company entered into a Tax Sharing Agreement with FCCG that provides that FCCG will, to the extent permitted by applicable law, file consolidated federal, California and Oregon (and possibly other jurisdictions where revenue is generated, at FCCG’s election) income tax returns with the Company and its subsidiaries. The Company will pay FCCG the amount that its current tax liability would have been had it filed a separate return. To the extent the Company’s required payment exceeds its share of the actual combined income tax liability (which may occur, for example, due to the application of FCCG’s net operating loss carryforwards), the Company will be permitted, in the discretion of a committee of its board of directors comprised solely of directors not affiliated with or having an interest in FCCG, to pay such excess to FCCG by issuing an equivalent amount of its common stock in lieu of cash, valued at the fair market value at the time of the payment. An inter-company receivable of approximately $8,967,000 due from FCCG and its affiliates will be applied first to reduce excess income tax payment obligations to FCCG under the Tax Sharing Agreement.

 

 10 

 

 

For financial reporting purposes, the Company has recorded a tax provision calculated as if the Company files its tax returns on a stand-alone basis. The amount payable to FCCG determined by this calculation of $204,000 was offset against amounts due from FCCG as of July 1, 2018 (see Note 10).

 

Deferred taxes reflect the net effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for calculating taxes payable on a stand-alone basis. Significant components of the Company’s deferred tax assets and liabilities are as follows (in thousands):

 

   July 1, 2018   December 31, 2017 
Deferred tax assets (liabilities)          
Deferred income  $1,801   $882 
Reserves and accruals   456    451 
Intangibles   (416)   (372)
Deferred state income tax   (51)   (25)
Loss carryforward   25    1 
Total  $1,815   $937 

 

Components of the income tax provision are as follows (in thousands):

 

   Twenty-Six Weeks 
   Ended July 1, 2018 
Current     
Federal  $204 
State   49 
Foreign   109 
    362 
Deferred     
Federal   (46)
State   (20)
    (66)
Total income tax provision  $296 

 

Income tax provision related to continuing operations differ from the amounts computed by applying the statutory income tax rate of 21% to pretax income as follows (in thousands):

 

  

Twenty-Six

Weeks Ended

July 1, 2018
 
     
Tax provision at statutory rate   21%
State and local income taxes   2%
Other   2%
Total income tax provision   25%

 

As of July 1, 2018, the Company’s subsidiaries’ annual tax filings for the prior three years are open for audit by Federal and for the prior four years for state tax agencies. The Company is the beneficiary of indemnification agreements from the prior owners of the subsidiaries for tax liabilities related to periods prior to their contribution. Management evaluated the Company’s overall tax positions and has determined that no provision for uncertain income tax positions is necessary as of July 1, 2018.

 

 11 

 

 

Note 7. Senior Secured Redeemable Debentures

 

On April 27, 2018, the Company established a credit facility with TCA Global Credit Master Fund, LP, a Cayman Islands limited partnership (“TCA”). The Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with TCA, pursuant to which TCA agreed to lend the Company up to $5,000,000 through the purchase of Senior Secured Redeemable Debentures issued by the Company (the “Debentures”).

 

A total of $2,000,000 was funded by TCA in connection with the initial closing on April 27, 2018, and the Company issued to TCA an initial Debenture with a face amount of $2,000,000, maturing on October 27, 2019 and bearing interest at the rate of 15% per annum. The Company had the right to prepay the Debentures, in whole or in part, at any time prior to maturity without penalty. The Debentures required interest only payments during the first four months, followed by fully amortizing payments for the balance of the term. The Company paid a commitment fee of 2% of issued Debentures for the facility and agreed to pay an investment banking fee of $170,000. The Company used the net proceeds for working capital purposes and repayment of other indebtedness.

 

The amounts borrowed under the Purchase Agreement were guaranteed by the Company’s operating subsidiaries and by FCCG, pursuant to a Guaranty Agreement in favor of TCA. The Company’s obligations under the Debentures were also secured by a Security Agreement, granting TCA a security interest in substantially all of its assets. In addition, FCCG’s obligations under the Guaranty Agreement were secured by a pledge in favor of TCA of certain shares of common stock that Fog Cutter holds in the Company. During the term of the Purchase Agreement, the Company was prohibited from incurring additional indebtedness, with customary exceptions for ordinary course financing arrangements and subordinated indebtedness.

 

The Company recognized interest expense of $63,000 for the thirteen and twenty-six weeks ended July 1, 2018.

 

The entire balance of the Debenture was paid in full on July 3, 2018 and the credit facility was terminated. As a result, the full amount of the Debentures was classified as a current liability on the accompanying financial statements.

 

Note 8. NOTE PAYABLE To FCCG

 

Effective October 20, 2017, FCCG contributed two of its operating subsidiaries, Fatburger and Buffalo’s, to the Company in exchange for an unsecured promissory note with a principal balance of $30,000,000, bearing interest at a rate of 10.0% per annum, and maturing in five years (the “Related Party Debt”). The contribution was consummated pursuant to a Contribution Agreement between the Company and FCCG. Approximately $19,778,000 of the note payable to FCCG was subsequently repaid, reducing the balance to $10,222,000 at June 26, 2018. On June 27, 2018, the Company entered into the Note Exchange Agreement, as amended, under which it agreed with FCCG to exchange $9,272,053 of the remaining balance of the Company’s outstanding Related Party Debt for shares of capital stock of the Company in the following amounts:

 

  $2,000,000 of the Related Party Debt balance was exchanged for 20,000 shares of Series A Fixed Rate Cumulative Preferred Stock of the Company at $100 per share and warrants to purchase 25,000 of the Company’s common stock with an exercise price of $8.00 per share; and
     
  A portion of the remaining Related Party Debt balance of $7,272,053 was exchanged for 989,395 shares of Common Stock of the Company, representing an exchange price of $7.35 per share, which was the closing trading price of the Common Stock on June 26, 2018.

 

Following the exchange, the remaining balance of the Related Party Debt was $950,000.

 

The transactions described above were exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”) pursuant to the exemption for transactions by an issuer not involving any public offering under Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D of the Securities Act and in reliance on similar exemptions under applicable state laws.

 

The Company recognized interest expense on the note payable to FCCG of $412,000 and $864,000 for the thirteen and twenty-six weeks ended July 1, 2018, respectively.

 

 12 

 

 

Note 9. MANDaTORilY REDEEMABLE PREFERRED STOCK

 

On June 8, 2018, the Company filed a Certificate of Designation of Rights and Preferences of Series A Fixed Rate Cumulative Preferred Stock with the Secretary of State of the State of Delaware (the “Certificate of Designation”), designating a total of 100,000 shares of Series A Preferred Stock. The Certificate of Designation contains the following terms pertaining to the Series A Preferred Stock:

 

Dividends - Holders of Series A Preferred Stock will be entitled to receive cumulative dividends on the $100.00 per share stated liquidation preference of the Series A Preferred Stock, in the amount of (i) cash dividends at a rate of 9.9% per year, plus (ii) deferred dividends equal to 4.0% per year, payable on the Mandatory Redemption Date (defined below).

 

Voting Rights - As long as any shares of Series A Preferred Stock are outstanding and remain unredeemed, the Company may not, without the majority vote of the Series A Preferred Stock, (a) alter or change adversely the rights, preferences or voting power given to the Series A Preferred Stock, (b) enter into any merger, consolidation or share exchange that adversely affects the rights, preferences or voting power of the Series A Preferred Stock, (c) authorize or increase any other series or class of stock that has rights senior to the Series A Preferred Stock, or (d) waive or amend the dividend restrictions in Sections 3(d) or 3(e) of the Certificate of Designation. The Series A Preferred Stock will not have any other voting rights, except as may be provided under applicable law.

 

Liquidation and Redemption - Upon (i) the five-year anniversary of the initial issuance date (June 8, 2023), or (ii) the earlier liquidation, dissolution or winding-up of the Company (the “Mandatory Redemption Date”), the holders of Series A Preferred Stock will be entitled to cash redemption of their shares in an amount equal to $100.00 per share plus any accrued and unpaid dividends.

 

In addition, prior to the Mandatory Redemption Date, the Company may optionally redeem the Series A Preferred Stock, in whole or in part, at the following redemption prices per share, plus any accrued and unpaid dividends:

 

  (i) On or prior to June 30, 2021: $115.00 per share.
  (ii) After June 30, 2021 and on or prior to June 30, 2022: $110.00 per share.
  (iii) After June 30, 2022: $100.00 per share.

 

Holders of Series A Preferred Stock may also optionally cause the Company to redeem all or any portion of their shares of Series A Preferred Stock beginning any time after the two-year anniversary of the initial issuance date for an amount equal to $100.00 per share plus any accrued and unpaid dividends, which amount may be settled in cash or Common Stock of the Company, at the option of the holder. If a holder elects to receive Common Stock, the shares will be issued based on the 20-day volume weighted average price of the Common Stock immediately preceding the date of the holder’s redemption notice.

 

On June 7, 2018, the Company entered into a Subscription Agreement for the issuance and sale (the “Offering”) of 800 units (the “Units”), with each Unit consisting of (i) 100 shares of the Company’s newly designated Series A Fixed Rate Cumulative Preferred Stock (the “Series A Preferred Stock”) and (ii) a warrant to purchase 125 shares of the Company’s Common Stock (the “Warrants”) at $8.00 per share. The sales price of each Unit was $10,000, resulting in gross proceeds to the Company from the initial closing of $8,000,000.

 

On June 27, 2018, the Company entered into a Note Exchange Agreement, as amended, under which it agreed with FCCG to exchange all but $950,000 of the remaining balance of the Company’s outstanding Promissory Note issued to the FCCG on October 20, 2017, in the original principal amount of $30,000,000 (the “Note”). At the time, the Note had an estimated outstanding balance of principal plus accrued interest of $10,222,000 (the “Note Balance”).

 

On June 27, 2018 $9,272,053 of the Note Balance was exchanged for shares of capital stock of the Company and warrants in the following amounts (the “Exchange Shares”):

 

  $2,000,000 of the Note Balance was exchanged for 20,000 shares of Series A Fixed Rate Cumulative Preferred Stock of the Company at $100 per share and warrants to purchase 25,000 of the Company’s common stock at an exercise price of $8.00 per share; and
     
  $7,272,053 of the Note Balance was exchanged for 989,395 shares of Common Stock of the Company, representing an exchange price of $7.35 per share, which was the closing trading price of the Common Stock on June 26, 2018.

 

 13 

 

 

Each of these stock issuances was exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”) pursuant to the exemption for transactions by an issuer not involving any public offering under Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D of the Securities Act and in reliance on similar exemptions under applicable state laws. Each of the investors in the Offering represented that it is an accredited investor within the meaning of Rule 501(a) of Regulation D and was acquiring the securities for investment only and not with a view towards, or for resale in connection with, the public sale or distribution thereof. The securities were offered without any general solicitation by the Company or its representatives.

 

The Company classified the Series A Preferred Stock as long-term debt because it contains an unconditional obligation requiring the Company to redeem the instruments at $100.00 per share on the Mandatory Redemption Date. The Warrants have been recorded as additional paid-in capital. On the issuance date, the Company allocated the proceeds between the Series A Preferred Stock and the Warrants based on the relative fair values of each. The aggregate values assigned upon issuance of each component were as follows (amounts in thousands except Price per Unit):

 

    Warrants (equity component)     Mandatorily Redeemable Preferred Stock (debt component)     Total  
Subscription Agreement:                        
Price per Unit   $ 108.75     $ 9,891.25     $ 10,000.00  
Gross proceeds   $ 87     $ 7,913     $ 8,000  
Issuance costs     -       -       -  
Net proceeds     87       7,913       8,000  
Exchange Shares:     25       1,975       2,000  
Total proceeds   $ 112     $ 9,888     $ 10,000  
                         
Balance sheet impact at issuance:                        
Long-term debt   $ -     $ 9,888     $ 9,888  
Additional paid-in capital   $ 112     $     $ 112  

 

The Company recorded interest expense relating to the Series A Preferred Stock of $78,000 during the thirteen and twenty-six weeks ending July 1, 2018.

 

Note 10. Related Party Transactions

 

The Company had open accounts with affiliated entities under the common control of FCCG resulting in net amounts due to the Company of $8,967,000 as of July 1, 2018. Beginning October 20, 2017, the receivable from FCCG bears interest at a rate of 10% per annum. During the thirteen and twenty-six weeks ended July 1, 2018, $248,000 and $481,000, respectively, of accrued interest income was added to the balance of the receivable from FCCG.

 

Prior to the Offering, the Company’s operations were insignificant other than structuring the Offering. During this time, FCCG provided executive administration and accounting services for the Company. The Company reimbursed FCCG for out-of-pocket costs associated with these services, but there was no allocation of FCCG’s overhead costs. Effective with the Offering, the Company assumed all direct and indirect administrative functions relating to its business.

 

During the twenty-six week period ending July 1, 2018, the Company recognized payables to FCCG in the amount of $204,000 for use of FCCG’s net operating losses for tax purposes (See Note 6).

 

 14 

 

 

Note 11. Stock based incentive plans

 

Effective September 30, 2017, the Company adopted the 2017 Omnibus Equity Incentive Plan (the “Plan”). The Plan is a comprehensive incentive compensation plan under which the Company can grant equity-based and other incentive awards to officers, employees and directors of, and consultants and advisers to, FAT Brands Inc. and its subsidiaries. The Plan provides a maximum of 1,000,000 shares available for grant.

 

During the twenty-six weeks ended July 1, 2018, the Company granted stock options to purchase 25,000 shares under the Plan to an employee, each with an exercise price equal to $12.00 per share and subject to a three-year vesting requirement, with one-third of the options vesting each year. Options that are not exercised will expire 10 years following the grant date.

 

The weighted average fair value of the non-qualified stock options granted during the twenty-six weeks ended July 1, 2018 and the assumptions used in the Black-Scholes valuation model to record the stock-based compensation are as follows:

 

   Including
Non-Employee Options
 
Weighted average fair value per option granted  $2.17 
Expected dividend yield   4.00%
Expected volatility   31.73%
Risk-free interest rate   1.60% - 2.63%
Expected term (in years)   

5.75 – 9.31

 
Weighted average exercise price per share  $12.00 

 

The Company’s stock option activity for the twenty-six weeks ended July 1, 2018 can be summarized as follows:

 

   Number of Shares   Weighted Average
Exercise Price
   Weighted Average Remaining Contractual
Life (Years)
 
Stock options outstanding at December 31, 2017   362,500   $12.00    9.3 
Grants   25,000   $12.00    9.7 
Forfeited   (5,000)  $12.00    - 
Expired   -   $-    - 
Stock options outstanding at July 1, 2018   382,500   $12.00    9.4 
Stock options exercisable at July 1, 2018   -           

 

The Company recognized share-based compensation expense in the amount of $120,000 and $245,000 during the thirteen and twenty-six weeks ended July 1, 2018, with a related tax benefit of approximately $32,000 and $66,000, respectively. There remains $495,000 of related share-based compensation relating to these non-vested grants, which will be recognized over the remaining vesting period, subject to future forfeitures.

 

The Company does not have a specific policy regarding the source of shares to be delivered upon the exercise of stock options. As such, new shares may be issued or shares may be repurchased in the market. As of July 1, 2018, the Company did not expect to repurchase shares during the next fiscal year.

 

In addition to the stock options listed above, the Company has issued the following outstanding warrants to purchase shares of its common stock:

 

Warrants issued on October 20, 2017 to purchase 80,000 shares of the Company’s stock granted to the selling agent in the Company’s initial public offering (the “Common Stock Warrants”). The Common Stock Warrants are exercisable commencing April 20, 2018 through October 20, 2022. The exercise price for the Common Stock Warrants is $15 per share. The Common Stock Warrants provide that upon exercise, the Company may elect to redeem the Common Stock Warrants in cash by paying the difference between the applicable exercise price and the then-current fair market value of the common stock. At the time of the Offering, the Common Stock Warrants were valued at approximately $124,000, using the Black-Scholes model and the following assumptions: market price of shares: $12.00; risk free interest rate: 0.99%; expected volatility: 31.73%; expected dividend yield: 4%; and expected term: 5 years.

 

 15 

 

 

Warrants issued on June 7, 2018 to purchase 100,000 shares of the Company’s common stock at $8.00 per share (the “Subscription Warrants”). The Subscription Warrants were issued as part of the Subscription Agreement (see Note 9). The Subscription Warrants may be exercised at any time or times beginning on the issue date and ending on the five year anniversary of the issue date. At the time of the Offering, the Subscription Warrants were valued at approximately $87,000, using the Black-Scholes model and the following assumptions: market price of shares: $7.24; risk free interest rate: 1.78%; expected volatility: 31.73%; expected dividend yield: 6.63%; and expected term: 5 years.

 

Warrants issued on June 27, 2018 to purchase 25,000 shares of the Company’s common stock at $8.00 per share (the “Exchange Warrants”). The Exchange Warrants were issued as part of the Exchange (see Notes 8 and 9). The Exchange Warrants may be exercised at any time or times beginning on the issue date and ending on the five year anniversary of the issue date. At the time of the Exchange, the Exchange Warrants were valued at approximately $25,000, using the Black-Scholes model and the following assumptions: market price of shares: $7.51; risk free interest rate: 1.79%; expected volatility: 31.73%; expected dividend yield: 6.39%; and expected term: 5 years.

 

Note 12. DIVIDENDS ON COMMON STOCK

 

The Company’s Board of Directors has declared the following quarterly dividends on common stock during the twenty-six weeks ending July 1, 2018:

 

Declaration Date  Record Date  Payment Date  Dividend Per Share   Amount of Dividend 
February 8, 2018  March 30, 2018  April 16, 2018  $0.12   $1,200,000 
June 27, 2018  July 6, 2018  July 16, 2018  $0.12    1,351,517 
              $2,551,517 

 

On both dividend payment dates, FCCG elected to reinvest its dividend from its original 8,000,000 shares at the close of the IPO in newly issued common shares of the Company at the closing market price of the shares on the payment date. As a result, on April 16, 2018, the Company issued 153,600 shares of common stock to FCCG at a price of $6.25 per share in satisfaction of the $960,000 dividend payable. On July 16, 2018, the Company issued 157,765 shares of common stock to FCCG at a price of $6.085 per share in satisfaction of the $960,000 dividend payable.

 

The issuance of these shares to FCCG was exempt from registration under the Securities Act in reliance on Section 4(a)(2) of the Securities Act and Rule 506 promulgated under Regulation D under the Securities Act as transactions by an issuer not involving a public offering. FCCG acquired the securities for investment only and not with a view to or for sale in connection with any distribution thereof.

 

Note 13. Commitments and Contingencies

 

Litigation

 

Eric Rojany, et al. v. FAT Brands Inc., et al., Superior Court of California for the County of Los Angeles, Case No. BC708539.

 

On June 7, 2018, Eric Rojany filed a complaint, personally and on behalf of all others similarly situated, against the Company, Andrew Wiederhorn, Ron Roe, Fog Cutter Capital Group, Inc., Tripoint Global Equities, LLC and members of the Company’s board of directors. The complaint alleges that the defendants are responsible for false and misleading statements and omitted material facts in connection with the Company’s initial public offering, which resulted in declines in the price of the Company’s common stock. The plaintiff stated that he intends to certify the complaint as a class action and is seeking compensatory damages in an amount to be determined at trial. The Company and other defendants dispute the allegations of the lawsuit and intend to vigorously defend against the claims.

 

 16 

 

 

P&K Food Market, Inc. vs. Buffalo’s Franchise Concepts, Inc., Fog Cutter Capital Group, Shaun Curtis, Andy Wiederhorn et al., Superior Court of California for the County of Los Angeles, Case No. 18STLC09534.

 

On July 13, 2018, P&K Food Market, Inc. (“P&K”) filed a complaint against Buffalo’s Franchise Concepts, Inc., Fog Cutter Capital Group, Shaun Curtis, and Andy Wiederhorn for Breach of Contract, Fraudulent Misrepresentation and Unlawful Offer and Sale of Franchise By Means of Untrue Statements or Omissions of Material Fact Under Cal. Corp. Code §§31201; 31202; 31300; and 31301. The case was filed in connection with the sale of an affiliate-owned “Buffalo’s Café” restaurant located in Palmdale, California. The lawsuit seeks general damages, special damages, punitive damages, restitution, interest, costs and attorneys’ fees and costs related to the alleged unlawful sale of the Palmdale restaurant. The franchisor and related parties intend to vigorously defend the allegations.

 

The Company is obligated to indemnify its officers and directors to the extent permitted by applicable law in connection with these actions, and have insurance for such individuals, to the extent of the limits of the applicable insurance policies and subject to potential reservations of rights. The Company is also obligated to indemnify Tripoint Global Equities, LLC relating to the Rojany matter. These proceedings are in their early stages and the Company is unable to predict the ultimate outcome of either matter. There can be no assurance that the defendants will be successful in defending against this action.

 

The Company is involved in other claims and legal proceedings from time-to-time that arise in the ordinary course of business.

 

The Company does not believe that the ultimate resolution of these actions will have a material adverse effect on its business, financial condition, results of operations, liquidity or capital resources.

 

Operating Leases

 

The Company leases corporate headquarters located in Beverly Hills, California comprising 5,478 square feet of space, pursuant to a lease that expires on April 30, 2020.

 

We believe that all our existing facilities are in good operating condition and adequate to meet our current and foreseeable needs.

 

Note 14. geographic information AND MAJOR FRANCHISEES

 

Revenues by geographic area are as follows (in thousands):

 

   Thirteen Weeks
Ended
July 1, 2018
   Twenty-Six Weeks Ended
July 1, 2018
 
United States  $2,895   $5,643 
Other countries   1,013    1,850 
Total revenues  $3,908   $7,493 

 

Revenues are shown based on the geographic location of our licensee restaurants. All our assets are located in the United States.

 

During the thirteen and twenty-six weeks ended July 1, 2018, no individual franchisee accounted for more than 10% of the Company’s revenues.

 

 17 

 

 

NOTE 15 – OPERATING SEGMENTS

 

Operating segments consist of (i) franchising operations conducted through Fatburger, (ii) franchising operations conducted through Buffalo’s and (iii) franchising operations conducted through Ponderosa. Each segment operates with its own management and personnel, with additional centralized support from the Company. The actual cost of the support provided by the Company is allocated to each operating segment. The following is a summary of each of the operating segments for the twenty-six weeks ended July 1, 2018 (dollars in thousands):

 

   Fatburger   Buffalo’s   Ponderosa   Combined 
                 
Revenues                    
Royalties  $2,631   $666   $2,135   $5,432 
Franchise fees   669    9    20    698 
Store opening fees   105    -    -    105 
Advertising fees   611    293    322    1,226 
Management fees   32    -    -    32 
Total revenues   4,048    968    2,477    7,493 
                     
Expenses                    
General and administrative   2,307    700    1,963    4,970 
                     
Income from operations   1,741    268    514    2,523 
                     
Other income (expense)   152    305    (52)   405 
                     
Income before income tax expense  $1,893   $573   $462   $2,928 

 

Reconciliation to consolidated net income (in thousands)

 

  

Twenty-Six

Weeks Ended

July 1, 2018
 
     
Combined segment net income before taxes  $2,928 
Corporate general and administrative expenses   (755)
Corporate other expense, net   (995)
Income tax expense   (296)
Net income  $882 

 

NOTE 16 – SUBSEQUENT EVENTS

 

Acquisition of Hurricane Grill & Wings

 

On July 3, 2018, the Company completed the acquisition of Hurricane AMT, LLC, a Florida limited liability company (“Hurricane”), for a purchase price of $12,500,000. Hurricane is the franchisor of Hurricane Grill & Wings and Hurricane BTW Restaurants. The purchase price of $12,500,000 was delivered through the payment of $8,000,000 in cash and the issuance to the Sellers of $4,500,000 of equity units of the Company valued at $10,000 per unit, or a total of 450 units. Each unit consists of (i) 100 shares of the Company’s newly designated Series A-1 Fixed Rate Cumulative Preferred Stock (the “Series A-1 Preferred Stock”) and (ii) a warrant to purchase 125 shares of the Company’s Common Stock at $8.00 per share (the “Hurricane Warrants”). The Company also entered into a Registration Rights Agreement with the Sellers under which the Company agreed to prepare and file a registration statement with the Securities and Exchange Commission (“SEC”) to register for resale the Series A-1 Preferred Stock and shares of Common Stock issuable upon exercise of the Hurricane Warrants and upon conversion of the Series A-1 Preferred Stock.

 

Holders of Series A-1 Preferred Stock will be entitled to receive cumulative dividends on the $100.00 per share stated liquidation preference of the Series A-1 Preferred Stock, in the amount of cash dividends at a rate of 6.0% per year. Upon (i) the five-year anniversary of the initial issuance date (July 3, 2023), or (ii) the earlier liquidation, dissolution or winding-up of the Company (the “Series A-1 Mandatory Redemption Date”), the holders of Series A-1 Preferred Stock will be entitled to cash redemption of their shares in an amount equal to $100.00 per share plus any accrued and unpaid dividends. In addition, prior to the Series A-1 Mandatory Redemption Date, the Company may optionally redeem the Series A-1 Preferred Stock, in whole or in part, at par plus any accrued and unpaid dividends.

 

Holders of Series A-1 Preferred Stock may also optionally cause the Company to redeem all or any portion of their shares of Series A-1 Preferred Stock beginning any time after the two-year anniversary of the initial issuance date for an amount equal to $100.00 per share plus any accrued and unpaid dividends, which amount may be settled in cash or Common Stock of the Company, at the option of the holder. If a holder elects to receive Common Stock, shares will be issued as payment for redemption at the rate of $12.00 per share of Common Stock.

 

Debt Facility

 

On July 3, 2018, the Company as borrower, and certain of the Company’s direct and indirect subsidiaries and affiliates as guarantors, entered into a new Loan and Security Agreement (the “Loan Agreement”) with FB Lending, LLC (the “Lender”). Pursuant to the Loan Agreement, the Company borrowed $16.0 million in a term loan from the Lender. The Company used a portion of the loan proceeds to fund (i) the cash payment of $8.0 million to the members of Hurricane and closing costs in connection with the acquisition of Hurricane, and (ii) to repay borrowings of $2.0 million plus interest and fees owing under the Company’s existing loan facility with TCA Global Credit Master Fund, LP (See Note 7). The Company intends to use the remaining proceeds for additional acquisitions and general working capital purposes.

 

 18 

 

 

The new term loan under the Loan Agreement matures on June 30, 2020. Interest on the term loan accrues at an annual fixed rate of 15.0%. The Company may prepay all or a portion of the outstanding principal and accrued unpaid interest under the Loan Agreement at any time upon prior notice to the Lender, subject to a prepayment penalty of 10% in the first year and 5% in the second year of the term loan. The Company is required to prepay all or a portion of the outstanding principal and accrued unpaid interest under the Loan Agreement in connection with certain dispositions of assets, extraordinary receipts, issuances of additional debt or equity, or a change of control of the Company. In connection with the Loan Agreement, the Company also issued to the Lender a warrant to purchase up to 499,000 shares of the Company’s Common Stock at $7.35 per share (the “Lender Warrant”).

 

As security for its obligations under the Loan Agreement, the Company granted a lien on substantially all of its assets to the Lender. In addition, certain of the Company’s direct and indirect subsidiaries and affiliates entered into a Guaranty (the “Guaranty”) in favor of the Lender, pursuant to which they guaranteed the obligations of the Company under the Loan Agreement and granted as security for their guaranty obligations a lien on substantially all of their assets.

 

The Loan Agreement contains customary affirmative and negative covenants, including covenants that limit or restrict the Company’s ability to, among other things, incur other indebtedness, grant liens, merge or consolidate, dispose of assets, pay dividends or make distributions, in each case subject to customary exceptions. The Loan Agreement also includes customary events of default that include, among other things, non-payment, inaccuracy of representations and warranties, covenant breaches, events that result in a material adverse effect (as defined in the Loan Agreement), cross default to other material indebtedness, bankruptcy, insolvency and material judgments. The occurrence and continuance of an event of default could result in the acceleration of the Company’s obligations under the Loan Agreement and an increase in the interest rate by 5.0% per annum.

 

Restaurant Openings and Closures

 

Subsequent to July 1, 2018, franchisees have not opened or closed any additional franchise locations.

 

Dividend Payable

 

On July 16, 2018, FCCG elected to reinvest its dividend from its original 8,000,000 shares at the close of the IPO of $960,000 in newly issued common shares of the Company at $6.085 per share, the closing market price of the shares on that date. As a result, the Company issued 157,765 shares of common stock to FCCG in satisfaction of the dividend payable.

 

The issuance of these shares to FCCG was exempt from registration under the Securities Act in reliance on Section 4(a)(2) of the Securities Act and Rule 506 promulgated under Regulation D under the Securities Act as transactions by an issuer not involving a public offering. FCCG acquired the securities for investment only and not with a view to or for sale in connection with any distribution thereof. (See Note 12)

 

Litigation

 

Daniel Alden, et al. v. FAT Brands Inc., et al., Superior Court of California for the County of Los Angeles, Case No. BC716017.

 

On August 2, 2018, Daniel Alden and others filed a complaint, personally and on behalf of all others similarly situated, against the Company, Andrew Wiederhorn, Ron Roe, Fog Cutter Capital Group, Inc., Tripoint Global Equities, LLC and members of the Company’s board of directors. The complaint alleges that the defendants are responsible for false and misleading statements and omitted material facts in connection with the Company’s initial public offering, which resulted in declines in the price of the Company’s common stock. The plaintiff stated that he intends to certify the complaint as a class action and is seeking compensatory damages in an amount to be determined at trial. The Company and other defendants dispute the allegations of the lawsuit and intend to vigorously defend against the claims.

 

The Company is obligated to indemnify its officers and directors to the extent permitted by applicable law in connection with this action, and has insurance for such individuals, to the extent of the limits of the applicable insurance policies and subject to potential reservations of rights. The Company is also obligated to indemnify Tripoint Global Equities, LLC relating to this matter. These proceedings are in their early stages and the Company is unable to predict the ultimate outcome of either matter. There can be no assurance that the defendants will be successful in defending against this action.

 

 19 

 

 

FATBURGER NORTH AMERICA, INC.

 

Balance Sheets

July 1, 2018 and December 31, 2017

 

   July 1, 2018   December 31, 2017 
   (unaudited)   (audited) 
Assets          
Current assets          
Cash  $-   $- 
Accounts receivable, net   572,981    472,430 
Other current assets   8,358    8,358 
Total current assets   581,339    480,788 
           
Due from affiliates   8,037,883    7,172,833 
           
Deferred income taxes   1,780,669    1,037,728 
           
Trademarks   2,134,800    2,134,800 
           
Goodwill   529,400    529,400 
Total assets  $13,064,091   $11,355,549 
           
Liabilities and Stockholder’s Equity          
Current liabilities          
Deferred income  $1,100,671   $1,732,249 
Accounts payable   1,093,417    1,452,668 
Accrued advertising   544,571    348,454 
Accrued expenses   857,415    868,828 
           
Total current liabilities   3,596,074    4,402,199 
           
Deferred income – noncurrent   5,201,966    1,605,500 
           
Total liabilities   8,798,040    6,007,699 
           
Commitments and contingencies (Note 6)          
           
Stockholder’s equity          
Common stock, $.01 par value, 1,000 shares authorized, issued and outstanding   10    10 
Additional paid-in capital   5,664,705    5,664,705 
Accumulated deficit   (1,398,664)   (316,865)
           
Total stockholder’s equity   4,266,051    5,347,850 
           
Total liabilities and stockholder’s equity  $13,064,091   $11,355,549 

 

The accompanying notes are integral part of these financial statements.

 

 20 

 

 

FATBURGER NORTH AMERICA, INC.

 

Statements of Income

For the Twenty-six weeks ended July 1, 2018 and June 25, 2017

 

   Thirteen Weeks Ended   Twenty-Six Weeks Ended 
   July 1, 2018   June 25, 2017   July 1, 2018   June 25, 2017 
   (unaudited)   (unaudited)   (unaudited)   (unaudited) 
Revenues                    
Royalties  $1,342,958   $1,221,728   $2,631,051   $2,375,195 
Franchise fees   285,615    358,310    669,163    1,153,326 
Store opening fees   104,747    -    104,747    - 
Advertising fees   294,087    -    610,685    - 
Management fees   15,000    15,000    32,500    30,000 
                     
Total revenues   2,042,407    1,595,038    4,048,146    3,558,521 
                     
General and administrative expenses                    
General and administrative   858,929    715,245    1,696,089    1,295,459 
Advertising expense   294,087    -    610,685      
                     
Total general and administrative expenses   1,153,016    715,245    2,306,774    1,295,459 
                     
Income from operations   889,391    879,793    1,741,372    2,263,062 
                     
Non-operating income (expense)                    
Interest income   84,742    -    163,699    - 
Depreciation and amortization   (8,268)   -    (8,633)   - 
Other   (2,394)   -    (2,979)   - 
Total non-operating income (expense)   74,080    -    152,087    - 
                     
Income before taxes   963,471    879,793    1,893,459    2,263,062 
                     
Income tax expense   225,428    323,686    450,007    820,217 
                     
Net income  $738,043   $556,107   $1,443,452   $1,442,845 
                     
Net income per common share - Basic  $738.04   $556.11   $1,443.45   $1442.85 
                     
Shares used in computing net income per common share   1,000    1,000    1,000    1,000 

 

The accompanying notes are integral part of these financial statements.

 

 21 

 

 

FATBURGER NORTH AMERICA, INC.

 

Statement of Stockholder’s Equity

For the Twenty-Six Weeks Ended July 1, 2018

 

   Common Stock   Additional Paid-In   Accumulated     
   Shares   Amount   Capital   Deficit   Total 
                     
Balance at December 31, 2017   1,000   $10   $5,664,705   $(316,865)  $5,347,850 
                          
Cumulative-effect adjustment from adoption of ASU 2014-09, Revenue from Contracts with Customers   -    -    -    (2,525,251)   (2,525,251)
                          
Net income   -    -    -    1,443,452    1,443,452 
                          
Balance at July 1, 2018   1,000   $10   $5,664,705   $(1,398,664)   4,266,051 

 

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

 

 22 

 

 

FATBURGER NORTH AMERICA, INC.

 

Statements of Cash Flows

For the Twenty-Six Weeks Ended July 1, 2018 and June 25, 2017

 

    Twenty-Six Weeks Ended  
    July 1, 2018     June 25, 2017  
    (unaudited)     (unaudited)  
Cash flows from operating activities                
Net income   $ 1,443,452     $ 1,442,845  
Adjustments to reconcile net income to net cash provided by operating activities:                
Deferred income taxes     -       297,700  
Provision for bad debt expense     8,057       115,428  
Depreciation expense     8,633       -  
Changes in operating assets and liabilities:                
Accounts receivable     (108,608 )     (197,028 )
Other current assets     -       (6,933
Accounts payable and accrued expenses     (370,664 )     158,011  
Accrued advertising     196,117       319,786  
Deferred income taxes     (66,800 )     -  
Deferred income     (236,504 )     (910,845 )
                 
Total adjustments     (569,769 )     (223,881 )
                 
Net cash provided by operating activities     873,683       1,218,964  
                 
Cash flows from financing activities                
Dividends paid     -       (1,000,000 )
Change in due from affiliates     (873,683 )     (218,964 )
                 
Net cash used in financing activities     (873,683 )     (1,218,964 )
                 
Net increase in cash     -       -  
Cash, beginning of period     -       -  
Cash, end of period   $ -     $ -  
                 
Supplemental Disclosure of cash flow Information                
Cash paid for income taxes   $ 67,371     $ 4,807  
Supplemental Disclosure of Noncash Investing and Financing Activities                
Income tax payable offset against amounts due from affiliates   $ 398,341     $ 499,445  

 

The accompanying notes are integral part of these financial statements.

 

 23 

 

 

FATBURGER NORTH AMERICA, INC.

 

Notes to Financial Statements

For the Twenty-Six Weeks Ended July 1, 2018 and June 25, 2017

(unaudited)

 

Note 1. Nature of Business

 

Fatburger North America, Inc., a Delaware corporation (referred to in these financial statements as the “Company”), was formed on March 28, 1990 and is a wholly-owned subsidiary of FAT Brands Inc. Prior to its transfer to FAT Brands Inc. on October 20, 2017, the Company was owned by Fog Cutter Capital Group Inc. (“FCCG”). FCCG owns the controlling interest in FAT Brands Inc. The Company was previously a subsidiary of Fatburger Holdings as the result of a stock purchase transaction in August 2001 and was transferred to FCCG on March 24, 2011.

 

The Company franchises and licenses the right to use the Fatburger name, operating procedures and method of merchandising to franchisees. Upon signing a franchise agreement, the Company is committed to provide training, some supervision and assistance, and access to Operations Manuals. As needed, the Company will also provide advice and written materials concerning techniques of managing and operating the restaurants. The franchises are operated under the name “Fatburger.” Each franchise agreement term is typically for 15 years with two additional 10-year options available. Additionally, the Company conducts a multi-market advertising campaign to enhance the corporate name and image, which is funded through advertising revenues received from its franchisees and to a lesser extent, other restaurant locations owned and operated by subsidiaries of FCCG.

 

As of July 1, 2018, there were 151 franchise restaurant locations operated by third parties in Arizona, California, Colorado, Nevada, Washington, Canada, China, UAE, the UK, Kuwait, Saudi Arabia, Egypt, Iraq, Pakistan, Philippines, Indonesia, Panama, Japan, Malaysia, Qatar and Tunisia (the Franchisees). 

 

Note 2. BASIS OF PRESENTATION

 

The accompanying interim financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to prevent the information presented from being misleading. These financial statements should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and the notes thereto included elsewhere herein.

 

The information provided in this report reflects all adjustments (consisting solely of normal, recurring items) that are, in the opinion of management, necessary to present fairly the financial position and the results of operations for the periods presented. Interim results are not necessarily indicative of results to be expected for a full year.

 

Accounts Receivable: Accounts receivable consist primarily of royalty and advertising fees from franchisees reduced by reserves for the estimated amount deemed uncollectible due to bad debts. As of July 1, 2018 and December 31, 2017, allowance for doubtful accounts was $554,874 and $546,928, respectively.

 

 24 

 

 

Credit and Depository Risks: Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and accounts receivable. The Company’s customer base consists of franchisees located in Arizona, California, Colorado, Nevada, Washington, Canada, China, UAE, the UK, Kuwait, Saudi Arabia, Egypt, Iraq, Pakistan, Philippines, Indonesia, Panama, Japan, Malaysia, Qatar and Tunisia. Management reviews each of its customer’s financial conditions prior to signing a franchise agreement and believes that it has adequately provided for any exposure to potential credit losses.

 

The Company maintains cash deposits in national financial institutions. The Company has not experienced any losses in such accounts and believes its cash balances are not exposed to significant risk of loss.

 

Compensated Absences: Employees of FCCG who provide reimbursed services to the Company earn vested rights to compensation for unused vacation time. Accordingly, the Company accrues the amount of vacation compensation that employees have earned but not yet taken at the end of each fiscal year.

 

Revenue Recognition: Franchise fee revenue from the sale of individual franchises is recognized over the term of the individual franchise agreement. Unamortized non-refundable deposits collected in relation to the sale of franchises are recorded as deferred franchise fees. In addition to franchise fee revenue, the Company collects a royalty ranging from 3% to 6% of gross sales from restaurants operated by franchisees. Royalties are recorded as revenue as the related sales are made by the franchisees. Any royalties received prior to the related sales are deferred and recognized when earned. Costs relating to continuing franchise support are expensed as incurred.

 

Typically, franchise fees are $50,000 for each domestic location and are collected 50% upon signing a deposit agreement and 50% at the signing of a lease and related franchise agreement. International franchise fees are typically $65,000 for each location and are payable 100% upon signing a deposit agreement. The franchise fee may be adjusted at management’s discretion or in situations involving store transfers. Deposits are nonrefundable upon acceptance of the franchise application. In the event that franchisees default on their development timelines for opening franchise stores, the franchise rights are terminated and franchise fee revenue is recognized in the amount of the remaining non-refundable deposits.

 

During the twenty-six weeks ended July 1, 2018, six franchise locations were opened and seven were closed or otherwise left the franchise system. Of the opened location, three were in California and, one each in Canada, Japan and the Philippines. Of the closed locations, two each were closed in the UAE, Pakistan, California and one in China. During the twenty-six weeks ended June 25, 2017, eleven franchise locations were opened and fifteen were closed or otherwise left the franchise system. Of the new franchise locations, two each were opened in California, Canada and China and one each were in Qatar, Egypt, Pakistan, Panama and the UK. Of the closed franchise locations, two each were in Washington and Saudi Arabia and one each were in California, Hawaii, Indonesia, UAE, Oman, Egypt, Canada, India, Bahrain, Pakistan and Tunisia.

 

In addition to franchise fee revenue, the Company collects a royalty of 3% to 6% of net sales from its franchisees. Royalties are recognized as revenue as the related sales are made by the franchisees. Royalties collected in advance are classified as deferred income until earned.

 

Store opening fees -- The Company recognizes store opening fees of $45,000 and $60,000 for domestic and international stores, respectively, from the up-front fees collected from franchisees. The remaining balance of the up-front fees are then amortized as franchise fees over the life of the franchise agreement. If the fees collected are less than the respective store opening fee amounts, the full up-front fees are recognized at opening. The $45,000 and $60,000 are based on out-of-pocket costs to the Company for each store opening and are primarily comprised of labor expenses associated with training, store design, and supply chain setup. International fees recognized are higher due to the additional cost of travel.

 

 25 

 

 

Advertising: The Company requires advertising payments of 1.95% of net sales from Fatburger restaurants located in the Los Angeles marketing area and up to 2.00% of net sales from stores located outside of the Los Angeles marketing area. International locations pay 0.20% to 2.00%. The Company also receives, from time to time, payments from vendors that are to be used for advertising. Advertising funds are required to be spent for specific advertising purposes. Advertising revenue and associated expense is recorded on the statement of operations. Assets and liabilities associated with advertising fees are consolidated on the Company’s balance sheet.

 

Income Taxes: The Company accounts for income taxes using the asset and liability approach. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. Deferred taxes are classified as current or noncurrent, depending on the classification of the assets and liabilities to which they relate.

 

Income Per Common Share: Income per share data was computed using the weighted-average number of shares outstanding during each year.

 

Use of Estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates.

 

Segment information: The Company has international and domestic licensed operations. Our chief operating decision maker (“CODM”) is our Chief Executive Officer; our CODM reviews financial performance and allocates resources at an overall level on a recurring basis. Therefore, Management has determined that the Company has one operating segment and one reportable segment.

 

Recently Adopted Accounting Standards: In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue From Contracts With Customers (Topic 606), requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods and services to customers. The updated standard replaces most existing revenue recognition guidance in U.S. GAAP. These standards became effective for the Company on January 1, 2018.

 

These standards require that the transaction price received from customers be allocated to each separate and distinct performance obligation. The transaction price attributable to each separate and distinct performance obligation is then recognized as the performance obligations are satisfied as specified by the contract. The agreements for services provided by the Company related to upfront fees received from franchisees (such as initial or renewal fees) do not currently contain separate and distinct performance obligations from the franchise right and thus those upfront fees will be recognized as revenue over the term of each respective franchise agreement. Previously, we recognized upfront franchise fees such as initial and renewal fees when the related services have been provided, which is when a store opened for initial fees and when renewal options became effective for renewal fees. These standards require any unamortized portion of fees received prior to adoption be presented in the consolidated balance sheet as a contract liability.

 

The new standards also had an impact on transactions previously not included in the Company’s revenues and expenses such as franchisee contributions to and subsequent expenditures from advertising arrangements we have with our franchisees. The Company did not previously include these contributions and expenditures in its consolidated statements of operations or cash flows. Under the new standards, the Company will recognize advertising fees and the related expense in its consolidated statements of operations or cash flows. The Company will also consolidate the assets and liabilities related to advertising fees on its balance sheet.

 

 26 

 

 

These standards will not impact the recognition of our sales-based royalties from franchisees, which is generally our largest source of revenue. We have implemented internal controls related to the recognition and presentation of the Company’s revenues under these new standards.

 

The Company adopted ASU 2014-09 on January 1, 2018 using the modified retrospective method, in which the cumulative effect of applying the standard would be recognized at the date of initial application. An adjustment to increase deferred revenue in the amount of $3,201,000 was established on the date of adoption relating to fees received through December 31, 2017 that would have been deferred and recognized over the term of each respective franchise store agreement if the new guidance had been applied in the past. A deferred tax asset of $676,000 related to this contract liability was also established on the date of adoption. These adjustments had the effect of increasing beginning retained deficit by approximately $2,525,000.

 

Adopting the new accounting standards for revenue affected several financial statement line items for the thirteen weeks ended July 1, 2018. The following tables provide the affected amounts as reported in these Unaudited Consolidated Financial Statements compared with what they would have been if the previous accounting guidance had remained in effect.

 

As of July 1, 2018

 

    Amounts As Reported     Amounts Under Previous Accounting Guidance  
Unaudited Balance Sheet:                
Deferred income taxes   $ 1,780,669     $ 1,104,528  
Deferred income   $ 6,302,637     $ 3,438,994  

Retained earnings (deficit)

  $ (1,398,664 )   $ 788,838  

 

For the twenty-six weeks ended July 1, 2018

 

    As Reported     Amounts Under Previous
Accounting
Guidance
 
Unaudited Statement of Operations:                
Franchise fees   $ 669,163     $ 331,415  
Advertising fees   $ 610,685     $ -  
Advertising expense   $ 610,685     $ -  
Net income   $ 1,443,452     $ 1,105,703  
Earnings per common share - basic   $ 1,443.45     $ 1,105.70  
Earnings per common share - diluted   $ 1,443.45     $ 1,105.70  

 

For the twenty-six weeks ended July 1, 2018

 

    As Reported     Amounts Under Previous Accounting Guidance  
Unaudited Statement of Cash Flows:                
Net income   $ 1,443,452     $ 1,105,703  
Adjustments to reconcile net income to net cash provided by operating activities:                
Deferred income   $ (236,504 )   $ 101,245

 

 27 

 

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The new guidance is intended to reduce diversity in practice in how transactions are classified in the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2017 and the Company adopted the standard effective January 1, 2018. The adoption of this standard did not have a material impact on the Company’s financial statements.

 

Recently Issued Accounting Standards:

 

In February 2016, the FASB issued ASU 2016-02, Leases, requiring a lessee to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases with a lease term of more than twelve months. Leases will continue to be classified as either financing or operating, with classification affecting the recognition, measurement and presentation of expenses and cash flows arising from a lease. This ASU is effective for interim and annual period beginning after December 15, 2018. The adoption of ASU 2016-02 is not expected to have a significant effect on the Company’s financial statements.

  

In June 2018, the FASB issued ASU No.2018-07, Compensation- Stock Compensation (Topic 718). Improvements to Nonemployee Share-Based Payment Accounting. The amendments in this update expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. Prior to this update, Top 718 applied only to share-based transactions to employees. Consistent with the accounting requirements for employee share-based payment awards, nonemployee share-based payment awards within the scope of Topic 718 are measured at grant-date fair value of the equity instruments that an entity is obligated to issue when the good has been delivered or the service has been rendered and any other conditions necessary to earn the right to benefit from the instruments have been satisfied. The amendments in the Update are effective for public business entities form fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. Early adoption is permitted, but no earlier than an entity’s adoption date of Topic 606. The adoption of this accounting standard is not expected to have a material effect on the Company’s consolidated financial statements.

 

Note 3. DEFERRED INCOME

 

Deferred income is as follows:

 

    July 1, 2018     December 31, 2017  
Deferred franchise fees   $ 5,525,230     $ 2,438,000  
Deferred royalties     777,407       899,749  
                 
Total   $ 6,302,637     $ 3,337,749  
                 
Deferred income – current   $ 1,100,671     $ 1,732,249  
Deferred income – noncurrent     5,201,966       1,605,500  
                 
Total   $ 6,302,637     $ 3,337,749  

 

Note 4. Income Taxes

 

The Company files its Federal and most state income tax returns on a consolidated basis with FCCG. For financial reporting purposes, the Company has recorded a tax provision calculated as if the Company files all of its tax returns on a stand-alone basis. The taxes payable to FCCG determined by this calculation of $398,341 and $499,445 were offset against amounts due from affiliates as of July 1, 2018 and June 25, 2017, respectively (see Note 5).

 

Deferred taxes reflect the net effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for calculating taxes payable on a stand-alone basis. Significant components of the Company’s deferred tax assets are as follows:

 

   July 1, 2018   December 31, 2017 
Current deferred tax assets (liabilities)          
Deferred franchise fees and royalties  $1,529,119   $778,827 
Allowances and accruals   289,613    280,895 
State tax accrual   (38,063)   (21,994)
Total  $1,780,669   $1,037,728 

 

 28 

 

 

Components of the income tax provision are as follows:

 

    Twenty-Six Weeks Ended  
    July 1, 2018     June 25, 2017  
Current            
Federal   $ 398,341     $ 499,445  
State     51,095       18,265  
Foreign     67,371       4,807  
      516,807       522,517  
Deferred                
Federal     (60,843 )     275,842  
State     (5,957 )     21,858  
      (66,800 )     297,700  
Total income tax provision   $ 450,007     $ 820,217  

 

Income tax provision related to continuing operations differ from the amounts computed by applying the statutory income tax rate of 21% and 34% to pretax loss as follows for the thirteen weeks ended July 1, 2018 and June 25, 2017, respectively:

 

   Twenty-Six Weeks Ended 
   July 1, 2018   June 25, 2017 
Statutory rate   21%   34%
State and local income taxes   2%   1%
Other   1%   1%
Effective tax rate   24%   36%

 

As of July 1, 2018, the Company’s annual tax filings for the prior three years are open for audit by Federal and for the prior four years for state tax agencies. Management evaluated the Company’s overall tax positions and has determined that no provision for uncertain income tax positions is necessary as of July 1, 2018 and June 25, 2017.

 

Note 5. Related Party Transactions

 

The Company had open accounts with affiliated entities under the common control of FCCG resulting in net amounts due to the Company of $8,037,883 and $7,172,833 as of July 1, 2018 and December 31, 2017, respectively.

 

Effective in 2012, FCCG’s operations were structured in such a way that significant direct and indirect administrative functions were provided to the Company. These services include operational personnel to sell franchise rights, assist with training franchisees and assisting franchises with opening restaurants. FCCG also provided executive administration and accounting services for the Company.

 

Prior to becoming a subsidiary of FAT Brands, the Company reimbursed FCCG for these expenses in the approximate amounts of $730,373 for the twenty-six weeks ended June 25, 2017. Management reviewed the expenses recorded at FCCG and identified the common expenses that shall be allocated to the subsidiaries. These expenses were allocated based on an estimate of management’s time spent on the activities of FCCG and its subsidiaries, and further allocated among the subsidiaries pro rata based on each subsidiary’s respective revenues as a percentage of overall revenues of the subsidiaries. The Company believes that the allocation of expenses is not materially different from what it would have been if the Company was a stand-alone entity.

 

During the twenty-six weeks ended July 1, 2018 and June 25, 2017, the Company recognized payables to FCCG in the amount of $398,341 and $499,445, respectively, for use of FCCG’s net operating losses for tax purposes.

 

 29 

 

 

Note 6. Commitments and Contingencies

 

The Company is involved in litigation in the normal course of business. The Company believes that the result of this litigation will not have a material adverse effect on the Company’s financial condition.

 

Note 7. geographic information AND MAJOR FRANCHISEES

 

Revenues by geographic area are as follows:

 

    Thirteen Weeks ended     Twenty-Six Weeks ended  
    July 1, 2018     June 25, 2017     July 1, 2018     June 25, 2017  
                         
United States   $ 1,283,313     $ 849,891   <