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 June 28, 2020

 

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   82-1302696

(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) 319-1850

(Registrant’s telephone number, including area code)

 

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

 

Title of each class   Trading Symbol(s)   Name of each exchange on which registered
Common Stock, par value $0.0001 per share   FAT   The Nasdaq Stock Market LLC
Series B Cumulative Preferred Stock, par value $0.0001 per share   FATBP   The Nasdaq Stock Market LLC
Warrants to purchase Common Stock   FATBW   The Nasdaq Stock Market LLC

 

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

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T 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 [X] 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 3, 2020, there were 11,894,895 shares of common stock outstanding.

 

 

 

 

 

 

FAT BRANDS INC.

QUARTERLY REPORT ON FORM 10-Q

June 28, 2020

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION 3
Item 1. Consolidated Financial Statements (Unaudited)  3
     
  FAT Brands Inc. and Subsidiaries:  
  Consolidated Balance Sheets (Unaudited) 3
  Consolidated Statements of Operations (Unaudited) 4
  Consolidated Statements of Stockholders’ Equity (Unaudited) 5
  Consolidated Statements of Cash Flows (Unaudited) 6
  Notes to Consolidated Financial Statements (Unaudited) 7
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 33
Item 3. Quantitative and Qualitative Disclosures About Market Risk 42
Item 4. Controls and Procedures 42
     
PART II. OTHER INFORMATION 43
Item 1. Legal Proceedings 43
Item 1A. Risk Factors 44
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 44
Item 3. Defaults Upon Senior Securities 44
Item 4. Mine Safety Disclosures 44
Item 5. Other Information 44
Item 6. Exhibits 45
     
SIGNATURES 46

 

 2 

 

 

PART I — FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS (Unaudited)

 

FAT BRANDS INC.

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share data)

 

    June 28, 2020     December 29, 2019  
          (Audited)  
Assets                
Current assets                
Cash   $ 1,741     $ 25  
Restricted cash     1,347       -  
Accounts receivable, net of allowance for doubtful accounts of $470 and $595, as of June 28, 2020 and December 29, 2019, respectively     2,469       4,144  
Trade notes receivable, net of allowance for doubtful accounts of $103 and $37 as of June 28, 2020 and December 29, 2019, respectively     204       262  
Assets classified as held for sale     3,384       5,128  
Other current assets     985       929  
Total current assets     10,130       10,488  
                 
Non-current restricted cash     400       -  
Notes receivable – noncurrent, net of allowance for doubtful accounts of $270 and $112, as of June 28, 2020 and December 29, 2019, respectively     1,584       1,802  
Due from affiliates     34,729       25,967  
Deferred income taxes     3,556       2,032  
Operating lease right of use assets     2,776       860  
Goodwill     9,450       10,912  
Other intangible assets, net     27,557       29,734  
Other assets     708       755  
Total assets   $ 90,890     $ 82,550  
                 
Liabilities and Stockholders’ Equity                
Liabilities                
Current liabilities                
Accounts payable   $ 7,243     $ 7,183  
Deferred income, current portion     930       895  
Accrued expenses     6,192       6,013  
Accrued advertising     543       762  
Accrued interest payable     806       1,268  
Dividend payable on preferred shares (includes amounts due to related parties of $223 and $149 as of June 28, 2020 and December 29, 2019, respectively)     2,110       1,422  
Liabilities related to assets classified as held for sale     2,298       3,325  
Current portion of operating lease liability     368       241  
Current portion of long-term debt     661       24,502  
Total current liabilities     21,151       45,611  
                 
Deferred income – noncurrent     5,246       5,247  
Acquisition purchase price payable     4,259       4,504  
Preferred shares, net     15,456       15,327  
Deferred dividend payable on preferred shares (includes amounts due to related parties of $129 and $99 as of June 28, 2020 and December 29, 2019, respectively)     828       628  
Operating lease liability, net of current portion     2,471       639  
Long-term debt, net of current portion     43,925       5,216  
Derivative liability from conversion feature of preferred shares     1,142       -  
Total liabilities     94,478       77,172  
                 
Commitments and contingencies (Note 17)                
                 
Stockholders’ equity                
Common stock, $.0001 par value; 25,000,000 shares authorized; 11,894,895 and 11,860,299 shares issued and outstanding at June 28, 2020 and December 29, 2019, respectively     9,069       11,414  
Accumulated deficit     (12,657 )     (6,036 )
Total stockholders’ equity     (3,588 )     5,378  
Total liabilities and stockholders’ equity   $ 90,890     $ 82,550  

 

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

 

 3 

 

 

FAT BRANDS INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(dollars in thousands, except per share data)

 

For the thirteen and twenty-six weeks ended June 28, 2020 and June 30, 2019 (Unaudited)

 

    Thirteen Weeks Ended     Twenty-six Weeks Ended  
    June 28, 2020     June 30, 2019     June 28, 2020     June 30, 2019  
                         
Revenue                                
Royalties   $ 2,213     $ 3,663     $ 5,522     $ 7,127  
Franchise fees     273       994       449       1,306  
Store opening fees     -       184       -       289  
Advertising fees     613       1,031       1,544       2,008  
Management fees and other income     8       23       15       38  
Total revenue     3,107       5,895       7,530       10,768  
                                 
Costs and expenses                                
General and administrative expense     4,104       3,106       7,636       5,820  
Impairment of assets     3,174       -       3,174       -  
Refranchising loss (gain)     1,006       (467 )     1,544       51  
Advertising expense     613       1,031       1,544       2,008  
Total costs and expenses     8,897       3,670       13,898       7,879  
                                 
(Loss) income from operations     (5,790 )     2,225       (6,368 )     2,889  
                                 
Other income (expense), net                                
Interest expense, net     (289 )     (834 )     (1,911 )     (2,520 )
Interest expense related to preferred shares     (476 )     (431 )     (928 )     (862 )
Change in fair value-derivative liability     1,264       -       1,264       -  
Other expense, net     (49 )     (124 )     (64 )     (100 )
Total other income (expense), net     450       (1,389 )     (1,639 )     (3,482 )
                                 
(Loss) income before income tax expense     (5,340 )     836       (8,007 )     (593 )
                                 
Income tax (benefit) expense     (1,089 )     1,344       (1,386 )     625  
                                 
Net loss   $ (4,251 )   $ (508 )   $ (6,621 )   $ (1,218 )
                                 
Basic and diluted loss per common share   $ (0.36 )   $ (0.04 )   $ (0.56 )   $ (0.10 )
Basic and diluted weighted average shares outstanding     11,886       11,726       11,878       11,726  
Cash dividends declared per common share   $ -     $ -     $ -     $ -  

 

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

 

 4 

 

 

FAT BRANDS INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(dollars in thousands, except share data)

Unaudited

 

For the twenty-six weeks ended June 28, 2020

 

    Common Stock              
                Additional                    
          Par     paid-in           Accumulated        
    Shares     value     capital     Total     deficit     Total  
                                     
Balance at December 29, 2019     11,860,299     $ 1     $ 11,413     $ 11,414     $ (6,036 )   $ 5,378  
Net loss     -       -       -       -       (6,621 )     (6,621 )
Issuance of common stock in lieu of cash directors fees payable     34,596       -       135       135       -       135  
Share-based compensation     -       -       16       16       -       16  
Fair value of derivative liability     -       -       (2,406 )     (2,406 )             (2,406 )
Correction of recorded conversion rights associated with Series A-1 preferred shares     -       -       (90 )     (90 )     -       (90 )
                                                 
Balance at June 28, 2020     11,894,895     $ 1     $ 9,068     $ 9,069     $ (12,657 )   $ (3,588 )

 

For the twenty-six weeks ended June 30, 2019

 

    Common Stock              
                Additional                    
          Par     paid-in           Accumulated        
    Shares     value     capital     Total     deficit     Total  
                                     
Balance at December 30, 2018     11,546,589     $ 1     $ 10,756     $ 10,757     $ (5,018 )   $ 5,739  
Net loss     -       -       -       -       (1,218 )     (1,218 )
Common stock dividend     245,376       -       -       -       -       -  
Cash paid in lieu of fractional shares     -       -       (2 )     (2 )     -       (2 )
Issuance of common stock in lieu of cash directors fees payable     34,800       -       180       180       -       180  
Share-based compensation     -       -       159       159       -       159  
                                                 
Balance at June 30, 2019     11,826,765     $ 1     $ 11,093     $ 11,094     $ (6,236 )   $ 4,858  

 

For the thirteen weeks ended June 28, 2020

 

    Common Stock              
                Additional                    
          Par     paid-in           Accumulated        
    Shares     value     capital     Total     deficit     Total  
                                     
Balance at March 29, 2020     11,876,659     $ 1     $ 11,413     $ 11,414     $ (8,406 )   $ 3,008  
Net loss     -       -       -       -       (4,251 )     (4,251 )
Issuance of common stock in lieu of cash directors fees payable     18,236       -       60       60       -       60  
Share-based compensation     -       -       1       1       -       1  
Fair value of derivative liability                     (2,406 )     (2,406 )             (2,406 )
                                                 
Balance at June 28, 2020     11,894,895     $ 1     $ 9,068     $ 9,069     $ (12,657 )   $ (3,588 )

 

For the thirteen weeks ended June 30, 2019

 

    Common Stock              
                Additional                    
          Par     paid-in           Accumulated        
    Shares     value     capital     Total     deficit     Total  
                                     
Balance at March 31, 2019     11,807,349     $ 1     $ 10,925     $ 10,926     $ (5,728 )   $ 5,198  
Net loss     -       -       -       -       (508 )     (508 )
Issuance of common stock in lieu of cash directors fees payable     19,416       -       90       90       -       90  
Share-based compensation     -       -       78       78       -       78  
                                                 
Balance at June 30, 2019     11,826,765     $ 1     $ 11,093     $ 11,094     $ (6,236 )   $ 4,858  

 

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

 

 5 

 

 

FAT BRANDS INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

 

For the twenty-six weeks ended June 28, 2020 and June 30, 2019 (Unaudited)

 

    Twenty-six Weeks Ended  
    June 28, 2020     June 30, 2019  
Cash flows from operating activities                
Net loss   $ (6,621 )   $ (1,218 )
Adjustments to reconcile net loss to net cash used in operations:                
Deferred income taxes     (1,524 )     (330 )
Depreciation and amortization     500       271  
Share-based compensation     16       159  
Accretion of loan fees and interest     412       1,093  
Change in operating right of use assets     399       370  
Gain on sale refranchised restaurants     (165 )     (970 )
Accretion of preferred shares     38       32  
Accretion of purchase price liability     255       263  
Impairment of assets     3,174       -  
Fair value of derivative liability     (1,261 )     -  
Provision for (recovery of) bad debts     1,069       (91 )
Change in operating assets and liabilities:                
Accounts receivable     856       (456 )
Trade notes receivable     -       22  
Prepaid expenses and other current assets     (102 )     681  
Accounts payable and accrued expense     386       2,337  
Accrued advertising     (220 )     (352 )
Accrued interest receivable from affiliate     (1,554 )     (623 )
Tax Sharing Agreement liability     (154 )     (46 )
Accrued interest payable     (462 )     (1,185 )
Deferred income     33       (1,335 )
Dividend payable on preferred shares     889       577  
Other     42       (183 )
Total adjustments     2,627       234  
Net cash used in operating activities     (3,994 )     (984 )
                 
Cash flows from investing activities                
Additions to property and equipment     (52 )     (34 )
Payments received on loans receivable     68       -  
Proceeds from sale of refranchised restaurants     698       870  
Change in due from affiliates     (7,040 )     (4,091 )
Acquisition of Elevation Burger, net of cash acquired     -       (2,332 )
Net cash used in investing activities     (6,326 )     (5,587 )
                 
Cash flows from financing activities                
Proceeds from borrowings and associated warrants, net of issuance costs     38,803       23,053  
Repayments of borrowings     (24,224 )     (16,417 )
Payments made on acquisition purchase price liability     (500 )     -  
Dividends paid in cash     -       (2 )
Change in operating lease liabilities     (296 )     (176 )
Net cash provided by financing activities     13,783       6,458  
                 
Net increase (decrease) in cash and restricted cash     3,463       (113 )
Cash and restricted cash at beginning of period     25       653  
Cash and restricted cash at end of period   $ 3,488     $ 540  
                 
Supplemental disclosures of cash flow information:                
Cash paid for interest   $ 2,526     $ 3,436  
Cash paid for income taxes   $ 17     $ 135  
                 
Supplemental disclosure of non-cash financing and investing activities:                
                 
Issuance of common stock in lieu of cash directors fees payable   $ 135     $ 180  
Income taxes receivable adjusting amounts due from affiliates   $ (154 )   $ (46 )

 

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

 

 6 

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

NOTE 1. ORGANIZATION AND RELATIONSHIPS

 

Organization and Nature of Business

 

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.” As of June 28, 2020, FCCG continues to control a significant voting majority of the Company.

 

The Company is a multi-brand franchisor specializing in fast casual and casual dining restaurant concepts around the world. As of June 28, 2020, the Company owns and franchises eight restaurant brands: Fatburger, Buffalo’s Cafe, Buffalo’s Express, Hurricane Grill & Wings, Ponderosa Steakhouses, Bonanza Steakhouses, Yalla Mediterranean and Elevation Burger. Combined, as of June 28, 2020, these brands franchise over 375 units worldwide and have more than 200 additional units under development.

 

The Company licenses the right to use its brand names 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.

 

COVID-19

 

In March 2020, the World Health Organization declared the outbreak of a novel coronavirus (COVID-19) as a pandemic, which continues to spread throughout the United States and other countries. As a result, Company franchisees have temporarily closed some retail locations, modified store operating hours, adopted a “to-go” only operating model, or a combination of these actions. These actions have reduced consumer traffic, all resulting in a negative impact to Company revenues. While the disruption to our business from the COVID-19 pandemic is currently expected to be temporary, there is a great deal of uncertainty around the severity and duration of the disruption. We may experience longer-term effects on our business and economic growth and changes in consumer demand in the U.S. and worldwide. The effects of COVID-19 may materially adversely affect our business, results of operations, liquidity and ability to service our existing debt, particularly if these effects continue in place for a significant amount of time.

 

Liquidity

 

The Company recognized a loss from operations of $6,368,000 during the twenty-six weeks ended June 28, 2020 and income from operations of $2,889,000 for the twenty-six weeks ended June 30, 2019, respectively. The Company recognized net losses of $6,621,000 and $1,218,000 during the twenty-six weeks ended June 28, 2020 and June 30, 2019, respectively. The reduction in earnings is primarily due to reductions in revenues and impairment of assets due to the effects of COVID-19, coupled with higher general and administrative costs.

 

On March 6, 2020, the Company completed a whole-business securitization (the “Securitization”) through the creation of a bankruptcy-remote issuing entity, FAT Brands Royalty I, LLC (“FAT Royalty”) in which FAT Royalty issued new notes (the “Securitization Notes”) pursuant to an indenture and the supplement thereto (collectively, the “Indenture”). Net proceeds from the issuance of the Securitization Notes were $37,314,000, which consisted of the combined face amount of $40,000,000, net of discounts of $246,000 and debt offering costs of $2,440,000 (See Note 10). A portion of the proceeds from the Securitization was used to repay the remaining $26,771,000 in outstanding balance under the Loan and Security Agreement and to pay the Securitization debt offering costs. The remaining proceeds from the Securitization are being used for working capital.

 

During the second quarter of 2020, the Company received loan proceeds in the amount of $1,532,000 from the Paycheck Protection Program administered by the Small Business Administration (“PPP”) in response to economic difficulties resulting from the outbreak of COVID-19. These loan proceeds relate to FAT Brands Inc. as well as five restaurant locations that are part of the Company’s refranchising program.

 

 7 

 

 

Subsequent to the end of the second quarter, on July 13, 2020, the Company entered into an underwriting agreement (the “Underwriting Agreement”) to issue and sell in a public offering (the “Offering”) 360,000 shares of 8.25% Series B Cumulative Preferred Stock (“Series B Preferred Stock”) and 1,800,000 warrants (the “2020 Series B Warrants”) to purchase common stock at $5.00 per share. The Company also granted the underwriters an option to purchase, for a period of 45 calendar days, up to an additional 54,000 shares Series B Preferred Stock and 270,000 of the 2020 Series B Warrants. In the Underwriting Agreement, the Company agreed to pay the underwriters an underwriting discount of 8.0% of the gross proceeds received by the Company in the Offering and issue five-year warrants exercisable for 1% of the securities sold in the Offering.

 

The Offering closed on July 16, 2020 with net proceeds to the Company of $8,211,000, which was net of $790,000 in underwriting and offering costs.

 

While the Company expects the COVID-19 pandemic to negatively impact its business, results of operations, and financial position, the related financial impact cannot be reasonably estimated at this time. However, the Company believes that the working capital from the Securitization, Series B Preferred Stock Offering, and PPP proceeds, combined with royalties and franchise fees collected from the limited operations of its franchisees, and disciplined management of the Company’ operating expenses will be sufficient for the twelve months of operations following the issuance of this Form 10-Q.

 

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

Nature of operations – The Company operates on a 52-week calendar and its fiscal year ends on the last Sunday of the calendar year. 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. Both fiscal 2020 and 2019 are 52-week years.

 

Principles of consolidation – The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. The operations of Elevation Burger have been included since its acquisition on June 19, 2019. Intercompany accounts have been eliminated in consolidation.

 

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 acquired, sold or 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.

 

Financial statement reclassification – Certain account balances from prior periods have been reclassified in these consolidated financial statements to conform to current period classifications.

 

 8 

 

 

Credit and Depository Risks – Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and accounts receivable. Management reviews each of its customer’s financial conditions prior to entry into a franchise or other agreement and believes that it has adequately provided for any exposure to potential credit losses. As of June 28, 2020, accounts receivable, net of allowance for doubtful accounts, totaled $2,469,000, with no customer representing more than 10% of that amount. As of December 29, 2019, the Company had two customers each representing 20% of accounts receivable, net of allowance for doubtful accounts.

 

The Company maintains cash deposits in national financial institutions. From time to time the balances for these accounts exceed the Federal Deposit Insurance Corporation’s (“FDIC”) insured amount. Balances on interest bearing deposits at banks in the United States are insured by the FDIC up to $250,000 per account. As of June 28, 2020, the Company had uninsured deposits in the amount of $1,859,000. As of December 29, 2019, the Company had no accounts with uninsured balances.

 

Restricted Cash – The Company has restricted cash consisting of funds required to be held in trust in connection with the Company’s Securitization. The current portion of restricted cash at June 28, 2020 consisted of $1,347,000. Non-current restricted cash of $400,000 at June 28, 2020 represents interest reserves required to be set aside for the duration of the securitized debt. There were no restricted cash balances as of December 29, 2019.

 

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. As of June 28, 2020 and December 29, 2019, accounts receivable were stated net of an allowance for doubtful accounts of $470,000 and $595,000, respectively.

 

Trade notes receivable – Trade notes receivable are created when an agreement is reached to settle a delinquent franchisee receivable account 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.

 

Assets classified as held for sale – Assets are classified as held for sale when the Company commits to a plan to sell the asset, the asset is available for immediate sale in its present condition and an active program to locate a buyer at a reasonable price has been initiated. The sale of these assets is generally expected to be completed within one year. The combined assets are valued at the lower of their carrying amount or fair value, net of costs to sell and included as current assets on the Company’s consolidated balance sheet. Assets classified as held for sale are not depreciated. However, interest attributable to the liabilities associated with assets classified as held for sale and other related expenses are recorded as expenses in the Company’s consolidated statement of operations.

 

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 trademarks, 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.

 

 9 

 

 

Fair Value Measurements - The Company determines the fair market values of its financial assets and liabilities, as well as non-financial assets and liabilities that are recognized or disclosed at fair value on a recurring basis, based on the fair value hierarchy established in U.S. GAAP. As necessary, the Company measures its financial assets and liabilities using inputs from the following three levels of the fair value hierarchy:

 

Level 1 inputs are quoted prices in active markets for identical assets or liabilities.
Level 2 inputs are observable for the asset or liability, either directly or indirectly, including quoted prices in active markets for similar assets or liabilities.
Level 3 inputs are unobservable and reflect the Company’s own assumptions.

 

Other than the derivative liability, the Company does not have a material amount of financial assets or liabilities that are required to be measured at fair value on a recurring basis under U.S. GAAP (See Note 11). None of the Company’s non-financial assets or non-financial liabilities are required to be measured at fair value on a recurring basis. Assets recognized or disclosed at fair value in the consolidated financial statements on a nonrecurring basis include items such as property and equipment, operating lease assets, goodwill and other intangible assets, which are measured at fair value if determined to be impaired.

 

The Company has not elected to use fair value measurement for any assets or liabilities for which fair value measurement is not presently required. However, the Company believes the fair values of cash equivalents, restricted cash, accounts receivable, assets held for sale and accounts payable approximate their carrying amounts due to their short duration.

 

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.

 

A two-step approach is utilized 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.

 

Franchise Fees: The franchise arrangement is documented in the form of a franchise agreement. The franchise arrangement requires the Company to perform various activities to support the brand that do not directly transfer goods and services to the franchisee, but instead represent a single performance obligation, which is the transfer of the franchise license. The services provided by the Company are highly interrelated with the franchise license and are considered a single performance obligation. 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.

 

The franchise fee may be adjusted at management’s discretion or in a situation involving store transfers. Deposits are non-refundable upon acceptance of the franchise application. In the event a franchisee does not comply with their development timeline for opening franchise stores, the franchise rights may be terminated, and franchise fee revenue is recognized for non-refundable deposits.

 

 10 

 

 

Store opening fees – Prior to September 29, 2019, the Company recognized store opening fees in the amount of $35,000 to $60,000 from the up-front fees collected from franchisees upon store opening. The amount of the fee was dependent on brand and location (domestic versus international stores). The remaining balance of the up-front fees were then amortized as franchise fees over the life of the franchise agreement. If the fees collected were less than the respective store opening fee amounts, the full up-front fees were recognized at store opening. The store opening fees were 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 were higher due to the additional cost of travel.

 

During the fourth quarter of 2019, the Company performed a study of other public company restaurant franchisors’ application of ASC 606 and determined that a preferred, alternative industry application exists in which the store opening fee portion of the franchise fees is amortized over the life of the franchise agreement rather than at milestones of standalone performance obligations in the franchise agreements. In order to provide financial reporting consistent with other franchise industry peers, the Company applied this preferred, alternative application of ASC 606 during the fourth quarter of 2019 on a prospective basis. As a result of the adoption of this preferred accounting treatment under ASC 606, the Company discontinued the recognition of store opening fees upon store opening and began accounting for the entire up-front deposit received from franchisees as described above in Franchise Fees. A cumulative adjustment to store opening fees and franchise fees was recorded in the fourth quarter of 2019 for store opening fees recognized during the first three quarters of 2019. (See “Immaterial Adjustments Related to Prior Periods”, below.)

 

Royalties – In addition to franchise fee revenue, the Company collects a royalty calculated as a percentage of net sales from our franchisees. Royalties range from 0.75% to 6% and are recognized as revenue when the related sales are made by the franchisees. Royalties collected in advance of sales are classified as deferred income until earned.

 

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 Company’s consolidated statement of operations. Assets and liabilities associated with the related advertising fees are reflected in the Company’s consolidated balance sheet.

 

Share-based compensation – The Company has a 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 14 for more details on the Company’s share-based compensation.

 

Earnings per share – The Company reports basic earnings or loss 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. Any potentially dilutive securities that have an anti-dilutive impact on the per share calculation are excluded. During periods in which the Company reports a net loss, diluted weighted average shares outstanding are equal to basic weighted average shares outstanding because the effect of all potentially dilutive securities would be anti-dilutive. As of June 28, 2020 and June 30, 2019, there were no potentially dilutive securities excluded from the calculation of diluted loss per common share due to a loss for the period.

 

The Company declared a stock dividend on February 7, 2019 and issued 245,376 shares of common stock in satisfaction of the stock dividend (See Note 16). Unless otherwise noted, earnings per share and other share-based information for 2020 and 2019 have been adjusted retrospectively to reflect the impact of the stock dividend.

 

Immaterial Adjustments Related to Prior Periods

 

During the fourth quarter of 2019, the Company identified two immaterial potential adjustments to its previously issued financial statements. These potential adjustments are (1) its assessment of the Series A-1 Fixed Rate Cumulative Preferred Stock and (2) its treatment of the store opening component of its franchise fees under ASC 606. Based on its assessment of the Series A-1 Fixed Rate Cumulative Preferred Stock, the Company determined that an error occurred in the analysis of the rights that the holders of the Series A-1 Fixed Rate Cumulative Preferred Stock have with respect to the conversion of the securities into shares of the Company’s common stock. In our reassessment, the conversion rights did not represent a beneficial conversion feature as we had initially concluded at the time of issuance. A cumulative correction was recorded to additional paid in capital during the first quarter of 2020 in the amount of $90,000.

 

 11 

 

 

The Company originally adopted ASC 606 on January 1, 2018. During the fourth quarter of 2019, the Company performed a study of other public company restaurant franchisors’ application of ASC 606 and determined that a preferred, alternative industry application exists in which the store opening fee portion of the franchise fees is amortized over the life of the franchise agreement rather than at milestones of standalone performance obligations in the franchise agreements. In order to provide financial reporting consistent with other franchise industry peers, the Company applied this preferred, alternative application of ASC 606 during the fourth quarter of 2019 on a prospective basis effective December 31, 2018.

 

In accordance with SEC Staff Accounting Bulletin (“SAB”) No. 99, Materiality, codified in ASC 250 (“ASC 250”), Presentation of Financial Statements, and SAB 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Consolidated Statements of Income, Balance Sheets, Shareholders Equity and Cash Flows, also codified in ASC 250, management assessed the materiality of (1) the error in its treatment of the beneficial conversion feature related to the Series A-1 Fixed Rate Cumulative Preferred Stock and (2) the adoption of the preferential accounting treatment under ASC 606. Based on such analysis of quantitative and qualitative factors, the Company has determined that neither the error nor the adoption of the preferential accounting treatment under ASC 606, in aggregate or individually, were material to any of the reporting periods affected, and no amendments to previously filed 10-Q or 10-K reports with the SEC are required.

 

Recently Adopted Accounting Standards

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.” This ASU adds, modifies and removes several disclosure requirements relative to the three levels of inputs used to measure fair value in accordance with Topic 820, “Fair Value Measurement.” The Company adopted this ASU on December 30, 2019. The adoption of this standard did not have a material effect on the Company’s financial position, results of operations or cash flows.

 

The FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40). The new guidance reduces complexity for the accounting for costs of implementing a cloud computing service arrangement and aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The Company adopted this ASU on December 30, 2019. The adoption of this standard did not have a material effect on the Company’s financial position, results of operations or cash flows.

 

The FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes: This standard removes certain exceptions for recognizing deferred taxes for investments, performing intraperiod allocation and calculating income taxes in interim periods. It also adds guidance in certain areas, including the recognition of franchise taxes, recognition of deferred taxes for tax goodwill, allocation of taxes to members of a consolidated group, computation of annual effective tax rates related to enacted changes in tax laws, and minor improvements related to employee stock ownership plans and investments in qualified affordable housing projects accounted for using the equity method. The Company adopted this ASU on December 30, 2019. The adoption of this standard did not have a material effect on the Company’s financial position, results of operations or cash flows.

 

NOTE 3. ACQUISITIONS AND SIGNIFICANT TRANSACTIONS

 

Acquisition of Elevation Burger

 

On June 19, 2019, the Company completed the acquisition of EB Franchises, LLC, a Virginia limited liability company, and its related companies (collectively, “Elevation Burger”) for a purchase price of up to $10,050,000. Elevation Burger is the franchisor of Elevation Burger restaurants, with 44 locations in the U.S. and internationally.

 

 12 

 

 

The purchase price consists of $50,000 in cash, a contingent warrant to purchase 46,875 shares of the Company’s common stock at an exercise price of $8.00 per share (the “Elevation Warrant”), and the issuance to the Seller of a convertible subordinated promissory note (the “Elevation Note”) with a principal amount of $7,509,816, bearing interest at 6.0% per year and maturing in July 2026. The Elevation Warrant is only exercisable in the event that the Company merges with FCCG. The Seller Note is convertible under certain circumstances into shares of the Company’s common stock at $12.00 per share. In connection with the purchase, the Company also loaned $2,300,000 in cash to the Seller under a subordinated promissory note (the “Elevation Buyer Note”) bearing interest at 6.0% per year and maturing in August 2026. The balance owing to the Company under the Elevation Buyer Note may be used by the Company to offset amounts owing to the Seller under the Elevation Note under certain circumstances. In addition, the Seller will be entitled to receive earn-out payments of up to $2,500,000 if Elevation Burger realizes royalty fee revenue in excess of certain amounts. As of the date of the acquisition, the fair market value of this contingent consideration totaled $531,000. As of June 28, 2020, and December 29, 2019, the contingent purchase price payable totaled $680,000 and $633,000, respectively, which includes the accretion of interest expense at an effective interest rate of 18%.

 

The purchase documents contain customary representations and warranties of the Seller and provides that the Seller will, subject to certain limitations, indemnify the Company against claims and losses incurred or suffered by the Company as a result of, among other things, any inaccuracy of any representation or warranty of the Seller contained in the purchase documents.

 

The preliminary assessment of the fair value of the net assets and liabilities acquired by the Company for the acquisition of Elevation Burger was estimated at $7,193,000. The allocation of the consideration to the preliminary valuation of net tangible and intangible assets acquired is presented in the table below (in thousands):

 

Cash   $ 10  
Goodwill     521  
Other intangible assets     7,140  
Other assets     558  
Current liabilities     (91 )
Deferred franchise fees     (758 )
Other liabilities     (187 )
Total net identifiable assets   $ 7,193  

 

Descriptions of the Company’s assessment of impairment of the goodwill and other intangible assets acquired in this acquisition related to COVID-19 are located in Note 6.

 

nOTE 4. REFRANCHISING

 

As part of its ongoing franchising efforts, the Company may, from time to time, make opportunistic acquisitions of operating restaurants in order to convert them to franchise locations or acquire existing franchise locations to resell to another franchisee across all of its brands.

 

Certain assets designated by the Company for refranchising meet the criteria requiring that they be classified as held for sale. As a result, the following assets have been classified as held for sale on the accompanying consolidated balance sheet as of June 28, 2020 (in thousands):

 

    June 28, 2020  
       
Property, plant and equipment   $ 1,213  
Operating lease right of use assets     2,171  
Total   $ 3,384  

 

Operating lease liabilities related to the assets classified as held for sale in the amount of $2,298,000, have been classified as current liabilities on the accompanying consolidated balance sheet as of June 28, 2020.

 

 13 

 

 

During the thirteen and twenty-six weeks ended June 28, 2020, refranchising operations incurred losses of $1,006,000 and $1,544,000, respectively, compared to a gain of $467,000 and a loss of $51,000, respectively, for the corresponding periods in 2019. The refranchising results for the twenty-six weeks ended June 28, 2020 include a gain of $165,000 relating to the sale and refranchising of two restaurant locations, compared to gains of $970,000 from the sale and refranchising of two restaurant locations in the 2019 period.

 

During the fiscal year ended December 29, 2019, a franchisee had entered into an agreement with the Company by which it agreed to sell two existing franchised locations to the Company for its refranchising program. Additionally, during the fiscal year, the Company had completed transactions to sell the two locations to new owners. During the second quarter of 2020, as a result of COVID-19, the locations acquired from the existing franchisee became unavailable. The Company is determining alternative operating restaurants that can be used as a replacement for the new owners.

 

Note 5. NOTES RECEIVABLE

 

Notes receivable consist of trade notes receivable and the Elevation Buyer Note.

 

Trade notes receivable are created when a settlement is reached relating to a delinquent franchisee account and the entire balance is not immediately paid. Trade notes receivable generally 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. As of June 28, 2020, the trade notes had been fully reserved. At December 29, 2019, these trade notes receivable totaled $250,000, net of reserves of $123,000.

 

The Elevation Buyer Note was funded in connection with the purchase of Elevation Burger (See Note 3). The Company loaned $2,300,000 in cash to the Seller under a subordinated promissory note bearing interest at 6.0% per year and maturing in August 2026. This Note is subordinated in right of payment to all indebtedness of the Seller arising under any agreement or instrument to which the Seller or any of its affiliates is a party that evidences indebtedness for borrowed money that is senior in right of payment to the Elevation Buyer Note, whether existing on the effective date of the Elevation Buyer Note or arising thereafter. The balance owing to the Company under the Elevation Buyer Note may be used by the Company to offset amounts owing to the Seller under the Elevation Note under certain circumstances. As part of the total consideration for the Elevation acquisition, the Elevation Buyer Note was recorded at a carrying value of $1,903,000, which was net of a discount of $397,000. As of June 28, 2020, and December 29, 2019, the balance of the Elevation Note was $1,788,000 and $1,814,000, respectively, which were net of discounts of $308,000 and $352,000, respectively. During the thirteen and twenty-six weeks ended June 28, 2020, the Company recognized $53,000 and $106,000, respectively, in interest income. During the thirteen and twenty-six weeks ended June 30, 2019, the Company recognized $4,200 in interest income.

 

Note 6. GOODWILL and other intangible assets

 

Goodwill

 

Goodwill consists of the following (in thousands):

 

    June 28, 2020     December 29, 2019  
Goodwill:                
Fatburger   $ 529     $ 529  
Buffalo’s     5,365       5,365  
Hurricane     2,772       2,772  
Ponderosa and Bonanza     -       1,462  
Yalla     263       263  
Elevation Burger     521       521  
Total goodwill   $ 9,450     $ 10,912  

 

 14 

 

 

Other Intangible Assets

 

Other intangible assets consist of trademarks and franchise agreements that were classified as identifiable intangible assets at the time of the brands’ acquisition by the Company or by FCCG prior to FCCG’s contribution of the brands to the Company at the time of the initial public offering (in thousands):

 

    June 28, 2020     December 29, 2019  
Trademarks:                
Fatburger   $ 2,135     $ 2,135  
Buffalo’s     27       27  
Hurricane     6,840       6,840  
Ponderosa and Bonanza     5,518       7,230  
Yalla     1,530       1,530  
Elevation Burger     4,690       4,690  
Total trademarks     20,740       22,452  
                 
Franchise agreements:                
Hurricane – cost     4,180       4,180  
Hurricane – accumulated amortization     (643 )     (482 )
Ponderosa and Bonanza – cost     1,640       1,640  
Ponderosa and Bonanza – accumulated amortization     (298 )     (243 )
Elevation Burger – cost     2,450       2,450  
Elevation Burger – accumulated amortization     (512 )     (263 )
Total franchise agreements     6,817       7,282  
Total Other Intangible Assets   $ 27,557     $ 29,734  

 

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

 

Fiscal year:        
2020   $ 467  
2021     932  
2022     932  
2023     932  
2024     932  
Thereafter     2,622  
Total   $ 6,817  

 

In response to the adverse effects of COVID-19, we considered whether goodwill and other intangible assets needed to be evaluated for impairment as of June 28, 2020, specifically related to goodwill and the trademark assets. Given the uncertainty regarding the severity, duration and long-term effects of COVID-19, making estimates of the fair value of these assets at this time is significantly affected by assumptions related to ongoing operations including but not limited to the timing of lifting of restrictions on restaurant operating hours, in-house dining limitations or other restrictions that largely limited restaurants to take-out and delivery sales, customer engagement with our brands, the short-term and long-term impact on consumer discretionary spending, and overall global economic conditions.

 

In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. The fair value technique used in this instance is classified as Level 3, where unobservable inputs are used when little or no market data is available. In performing the quantitative test for impairment of goodwill, the Company used the income approach method of valuation that includes the discounted cash flow method to determine the fair value of goodwill and intangible assets. Significant assumptions made by management in estimating fair value under the discounted cash flow model include future trends in sales, operating expenses, overhead expenses, depreciation, capital expenditures and changes in working capital, along with an appropriate discount rate based on the Company’s estimated cost of equity capital and after-tax cost of debt.

 

 15 

 

 

In performing the impairment review of the tradename, the Company used the relief of royalty method under the income approach method of valuation. Significant assumptions used to determine fair value under the relief of royalty method include future trends in sales, a royalty rate and a discount rate to be applied to the forecast revenue stream.

 

In performing the impairment review of the franchise agreement assets, the Company used the residual earnings method under the income approach method of valuation. Significant assumptions used to determine fair value under the residual earnings method include future trends in sales, a royalty rate and a discount rate to be applied to the forecast revenue stream.

 

As a result of these analyses, when considering the available facts, assessments and judgments, as of June 28, 2020, the Company recorded goodwill impairment charges of $1,462,000 and tradename impairment charges of $1,712,000 relating to the Ponderosa and Bonanza brands.

 

Because of the risks and uncertainties related to the COVID-19 pandemic events, the negative effects on the operations of our franchisees could prove to be worse than we currently estimate and lead us to record additional non-cash goodwill or other intangible asset impairment charges in the future periods.

 

Note 7. DEFERRED INCOME

 

Deferred income is as follows (in thousands):

 

    June 28, 2020     December 29, 2019  
             
Deferred franchise fees   $ 5,493     $ 5,417  
Deferred royalties     359       422  
Deferred advertising revenue     324       303  
Total   $ 6,176     $ 6,142  

 

Note 8. 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 $29,529,000 due from FCCG and its affiliates will be applied first to reduce excess income tax payment obligations to FCCG under the Tax Sharing Agreement.

 

For financial reporting purposes, the Company has recorded a tax benefit as of June 28, 2020, calculated as if the Company files its tax returns on a stand-alone basis. The amount receivable from FCCG determined by this calculation of $154,000 and $46,000 was added to amounts due from FCCG as of June 28, 2020 and June 30, 2019, respectively, (See Note 12.)

 

 16 

 

 

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):

 

    June 28, 2020     December 29, 2019  
Deferred tax assets (liabilities)                
Deferred income   $ 1,508     $ 1,353  
Reserves and accruals     208       208  
Intangibles     (154 )     (614 )
Deferred state income tax     (135 )     (91 )
Tax credits     477       244  
Share-based compensation     192       192  
Property and equipment     (137 )     (137 )
Net operating loss carryforwards     1,661       894  
Other     (64 )     (17 )
Total   $ 3,556     $ 2,032  

 

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

 

    Twenty-six Weeks
Ended
June 28, 2020
    Twenty-six Weeks
Ended
June 30, 2019
 
Current                
Federal   $ (118 )   $ 318  
State     22       262  
Foreign     233       375  
      137       955  
Deferred                
Federal     (1,312 )     (89 )
State     (211 )     (241 )
      (1,523 )     (330 )
Total income tax (benefit) expense   $ (1,386 )   $ 625  

 

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

 

    Twenty-six Weeks
Ended
    Twenty-six Weeks
Ended
 
    June 28, 2020     June 30, 2019  
             
Tax benefit at statutory rate   $ (1,681 )   $ (124 )
State and local income taxes     (150 )     14  
Foreign taxes     233       375  
Tax credits     (233 )     (375 )
Dividends on preferred stock     361       643  
Other     84       92  
Total income tax expense (benefit)   $ (1,386 )   $ 625  

 

As of June 28, 2020, 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 its ownership of the subsidiaries. Management evaluated the Company’s overall tax positions and has determined that no provision for uncertain income tax positions is necessary as of June 28, 2020.

 

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NOTE 9. LEASES

 

The Company has recorded seven operating leases for corporate offices and for certain restaurant properties that are in the process of being refranchised. The Company is not a guarantor to the leases for the restaurant locations. The leases have remaining lease terms ranging from nine months to seven years. Three of the leases also have options to extend the term for 5 to 10 years. The Company recognized lease expense of $720,000 and $702,000 for the twenty-six weeks ended June 28, 2020 and June 30, 2019, respectively. The Company recognized lease expense of $367,000 and $355,000 for the thirteen weeks ended June 28, 2020 and June 30, 2019, respectively. The weighted average remaining lease term of the operating leases (not including optional lease extensions) at June 28, 2020 was 5.6 years.

 

Operating lease right of use assets and operating lease liabilities relating to the operating leases are as follows (in thousands):

 

    June 28, 2020     December 29, 2019  
             
Right of use assets   $ 4,947     $ 4,076  
Lease liabilities   $ 5,137     $ 4,206  

 

The operating lease right of use assets and operating lease liabilities include obligations relating to the optional term extensions available on the five restaurant leases based on management’s intention to exercise the options. At adoption of ASC 842, the discount rate used to calculate the carrying value of the right of use assets and lease liabilities was 15.9% as this was consistent with the Company’s incremental borrowing rate at the time.

 

The contractual future maturities of the Company’s operating lease liabilities as of June 28, 2020, including anticipated lease extensions, are as follows (in thousands):

 

Fiscal year:        
2020   $ 545  
2021     1,141  
2022     1,183  
2023     1,223  
2024     1,028  
Thereafter     4,737  
Total lease payments     9,857  
Less imputed interest     (4,720
Total   $ 5,137  

 

Supplemental cash flow information for the twenty-six weeks ended June 28, 2020 related to leases is as follows (in thousands):

 

Cash paid for amounts included in the measurement of operating lease liabilities:        
Operating cash flows from operating leases   $ 412  
Operating lease right of use assets obtained in exchange for new lease obligations:        
Operating lease liabilities   $ 2,174  

 

Note 10. DEBT

 

Loan and Security Agreement

 

On January 29, 2019, the Company as borrower, and its subsidiaries and affiliates as guarantors, entered into a Loan and Security Agreement (the “Loan and Security Agreement”) with The Lion Fund, L.P. and The Lion Fund II, L.P. (collectively, “Lion”). Pursuant to the Loan and Security Agreement, the Company borrowed $20.0 million from Lion, and utilized the proceeds to repay the existing $16.0 million term loan from FB Lending, LLC plus accrued interest and fees, and provide additional general working capital to the Company.

 

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The term loan under the Loan and Security Agreement was due to mature on June 30, 2020. Interest on the term loan accrued at an annual fixed rate of 20.0% and was payable quarterly. In connection with the Loan and Security Agreement, the Company issued to Lion a warrant to purchase up to 1,167,404 shares of the Company’s common stock at $0.01 per share (the “Lion Warrant”), exercisable only if the amounts outstanding under the Loan and Security Agreement were not repaid in full by June 30, 2020, as extended. If the Loan and Security Agreement was repaid in full prior to June 30, 2020, the Lion Warrant would be terminated in its entirety.

 

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

 

The Loan and Security Agreement was subsequently amended several times which allowed the Company to increase its borrowing by $3,500,000 in connection with the acquisition of Elevation Burger; extended the exercise date of the Lion Warrant to June 30, 2020; extended the due date for certain quarterly payments and imposed associated extension and other loan fees.

 

On March 6, 2020, the Company repaid the Lion Loan and Security Agreement in full by making a total payment of approximately $26,771,000. This consisted of $24,000,000 in principle, approximately $2,120,000 in accrued interest and $651,000 in penalties and fees. As a result of the prepayment, the Lion Warrant was cancelled in its entirety.

 

The Company recognized interest expense on the Loan and Security Agreement of $1,783,000 for the thirteen and twenty-six weeks ended June 28, 2020, which includes $212,000 for amortization of all unaccreted debt offering costs at the time of the repayment and $650,000 in penalties and fees. The Company recognized interest expense on the Loan and Security Agreement of $1,076,000 and $1,796,000 for the thirteen and twenty-six weeks ended June 30, 2019.

 

Elevation Note

 

On June 19, 2019, the Company completed the acquisition of Elevation Burger. A portion of the purchase price included the issuance to the Seller of a convertible subordinated promissory note (the “Elevation Note”) with a principal amount of $7,509,816, bearing interest at 6.0% per year and maturing in July 2026. The Elevation Note is convertible under certain circumstances into shares of the Company’s common stock at $12.00 per share. In connection with the valuation of the acquisition of Elevation Burger, the Elevation Note was recorded on the financial statements of the Company at $6,185,000, which is net of a loan discount of $1,295,000 and debt offering costs of $30,000.

 

As of June 28, 2020, the carrying value of the Elevation Note was $5,778,000 which is net of the loan discount of $1,008,000 and debt offering costs of $61,000. The Company recognized interest expense relating to the Elevation Note during the thirteen weeks ended June 28, 2020 in the amount of $175,000, which included amortization of the loan discount of $70,000 and amortization of $2,000 in debt offering costs. The Company recognized interest expense relating to the Elevation Note during the twenty-six weeks ended June 28, 2020 in the amount of $364,000, which included amortization of the loan discount of $141,000 and amortization of $5,000 in debt offering costs. The Company recognized interest expense of $23,000 on the Elevation Note for the thirteen and twenty-six weeks ended June 30, 2019. The effective interest rate for the Elevation Note during the twenty-six weeks ended June 28, 2020 was 12.7%.

 

The Elevation Note is a general unsecured obligation of Company and is subordinated in right of payment to all indebtedness of the Company arising under any agreement or instrument to which Company or any of its Affiliates is a party that evidences indebtedness for borrowed money that is senior in right of payment. FCCG has guaranteed payment of the Elevation Note.

 

Securitization

 

On March 6, 2020, the Company completed a whole-business securitization (the “Securitization”) through the creation of a bankruptcy-remote issuing entity, FAT Brands Royalty I, LLC (“FAT Royalty”) in which FAT Royalty issued new notes (the “Securitization Notes”) pursuant to an indenture and the supplement thereto (collectively, the “Indenture”).

 

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The new notes consist of the following:

 

Note    

Public

Rating

  Seniority   Issue Amount     Coupon     First Call Date   Final Legal Maturity Date
                               
A-2     BB   Senior   $ 20,000,000       6.50 %   4/27/2021   4/27/2026
B-2     B   Senior Subordinated   $ 20,000,000       9.00 %   4/27/2021   4/27/2026

 

Net proceeds from the issuance of the Securitization Notes were $37,314,000, which consists of the combined face amount of $40,000,000, net of discounts of $246,000 and debt offering costs of $2,440,000. The discount and offering costs will be accreted as additional interest expense over the expected term of the Securitization Notes.

 

A portion of the proceeds from the Securitization was used to repay the remaining $26,771,000 in outstanding balance under the Loan and Security Agreement with Lion and to pay Securitization debt offering costs. The remaining proceeds from the Securitization will be used for working capital.

 

While the Securitization Notes are outstanding, scheduled payments of principal and interest are required to be made on a quarterly basis. It is expected that the Securitization Notes will be repaid prior to the Final Legal Maturity Date, with the anticipated repayment date occurring in January 2023 for the A-2 Notes and October 2023 for the B-2 Notes (the “Anticipated Repayment Dates”). If the Company has not repaid or refinanced the Securitization Notes prior to the applicable Anticipated Repayment Date, additional interest expense will begin to accrue and all additional proceeds will be utilized for additional amortization, as defined in the Indenture.

 

In connection with the Securitization, FAT Royalty and each of the FAT Brands Franchising Entities (as defined in the Indenture) entered into a Management Agreement with the Company, dated as of the Closing Date (the “Management Agreement”), pursuant to which the Company agreed to act as manager of FAT Royalty and each of the FAT Brands Franchise Entities. The Management Agreement provides for a management fee payable monthly by FAT Royalty to the Company in the amount of $200,000, subject to three percent (3%) annual increases (the “Management Fee”). The primary responsibilities of the manager are to perform certain franchising, distribution, intellectual property and operational functions on behalf of the FAT Brands Franchise Entities pursuant to the Management Agreement.

 

The Notes are secured by substantially all of the assets of FAT Royalty, including the equity interests in the FAT Brands Franchising Entities. The restrictions placed on the Company’s subsidiaries require that the Company’s principal and interest obligations have first priority, after the payment of the Management Fee and certain other FAT Royalty expenses (as defined in the Indenture), and amounts are segregated monthly to ensure appropriate funds are reserved to pay the quarterly principal and interest amounts due. The amount of monthly cash flow that exceeds the required monthly debt service is generally remitted to the Company. Once the required obligations are satisfied, there are no further restrictions, including payment of dividends, on the cash flows of the subsidiaries. As of June 28, 2020, the Company was in compliance with these covenants.

 

The Notes have not been and will not be registered under the Securities Act or the securities laws of any jurisdiction. No Notes or any interest or participation thereof may be reoffered, resold, pledged or otherwise transferred unless such Note meets certain requirements as described in the Indenture.

 

The Notes are subject to certain financial and non-financial covenants, including a debt service coverage ratio calculation, as defined in the Indenture. In the event that certain covenants are not met, the Notes may become partially or fully due and payable on an accelerated schedule. In addition, the Company may voluntarily prepay, in part or in full, the Notes in accordance with the provisions in the Indenture.

 

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As of June 28, 2020, the recorded balance of the Securitization Notes was $37,420,000, which is net of debt offering costs of $2,347,000 and original issue discount of $233,000. The Company recognized interest expense on the Securitization Notes of $886,000 for the thirteen weeks ended June 28, 2020, which includes $103,000 for amortization of debt offering costs and $7,000 for amortization of the original issue discount. The Company recognized interest expense on the Securitization Notes of $1,173,000 for the twenty-six weeks ended June 28, 2020, which includes $136,000 for amortization of debt offering costs and $12,000 for amortization of the original issue discount. The effective interest rate of the Securitization Notes was 9.4% for the twenty-six weeks ended June 28, 2020.

 

Paycheck Protection Program Loans

 

During the thirteen weeks ended July 28, 2020, the Company received loan proceeds in the amount of approximately $1,532,000 under the Paycheck Protection Program (the “PPP Loans”). The Paycheck Protection Program, established as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. The loans and accrued interest are forgivable after eight weeks as long as the borrower uses the loan proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels. The amount of loan forgiveness will be reduced if the borrower terminates employees or reduces salaries during the eight-week period.

 

The PPP Loans relate to FAT Brands Inc. as well as five restaurant locations that are part of the Company’s refranchising program. While the Company currently believes that its use of the loan proceeds will meet the conditions for forgiveness of the loans, there can be no assurance that the Company will be eligible for forgiveness of the loan, in whole or in part. Any unforgiven portion of the PPP Loans is payable over two years at an interest rate of 1%, with a deferral of payments for the first six months.

 

Note 11. PREFERRED STOCK

 

Series B Cumulative Preferred Stock

 

On October 3 and October 4, 2019, the Company completed the initial closing of its continuous public offering (the “Series B Preferred Offering”) of up to $30,000,000 of units (the “Series B Units”) at $25.00 per Series B Unit, with each Series B Unit comprised of one share of 8.25% Series B Cumulative Preferred Stock (“Series B Preferred Stock”) and 0.60 warrants (the “Series B Warrants”) to purchase common stock at $8.50 per share, exercisable for five years.

 

The offering includes up to 1,200,000 shares of Series B Preferred Stock and Series B Warrants initially exercisable to purchase up to an aggregate of 720,000 shares of our common stock. The shares of Series B Preferred Stock and Series B Warrants will be issued separately but can only be purchased together in the Series B Preferred Offering. Each Warrant will be immediately exercisable and will expire on the five-year anniversary of the date of issuance.

 

The Company will pay cumulative dividends on the Series B Preferred Stock from and including the date of original issuance in the amount of $2.0625 per share each year, which is equivalent to 8.25% of the $25.00 liquidation preference per share. Dividends on the Series B Preferred Stock will be payable quarterly in arrears based on the Company’s fiscal quarters.

 

The Company may not redeem the Series B Preferred Stock before the first anniversary of the initial issuance date. After the first anniversary of the initial issuance date the Company has the option to redeem the Series B Preferred Stock, in whole or in part, for cash plus any accrued and unpaid dividends to the date of redemption at the following redemption price per share:

 

  After the first anniversary and on or prior to the second anniversary at $27.50 per share
  After the second anniversary and on or prior to the third anniversary at $26.125 per share
  After the third anniversary at $25.00 per share

 

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The Series B Preferred Stock will mature on the five-year anniversary of the initial issuance date or the earlier liquidation, dissolution or winding-up of the Company. Upon maturity, the holders of Series B Preferred Stock will be entitled to receive cash redemption of their shares in an amount equal to $25.00 per share plus any accrued and unpaid dividends.

 

Holders of Series B Preferred Stock have the option to cause the Company to redeem all or any portion of their Series B Preferred Stock following the first anniversary of the initial issuance date for cash at the following redemption prices per share, plus any accrued and unpaid dividends:

 

  After the first anniversary and on or prior to the second anniversary at $22.00 per share
  After the second anniversary and on or prior to the third anniversary at $22.50 per share
  After the third anniversary and on or prior to the fourth anniversary at $23.00 per share
  After the fourth anniversary at $25.00 per share

 

The rights of holders of Series B Preferred Stock to receive their liquidation preference also will be subject to the proportionate rights of our Series A Fixed Rate Cumulative Preferred Stock and any other class or series of our capital stock ranking in parity with the Series B Preferred Stock as to liquidation.

 

As of June 28, 2020, there were 57,140 shares of Series B Preferred Stock outstanding.

 

The Company classified the Series B Preferred Stock as long-term debt because it contains an unconditional obligation requiring the Company to redeem the instruments at the maturity date (October 3, 2024) or upon the election of the holders as described above in cash. The associated Series B Warrants have been recorded as additional paid-in capital. On the issuance date, the Company allocated the proceeds between the Series B Preferred Stock and the Series B Warrants based on the relative fair values of each.

 

As of June 28, 2020, the net Series B Preferred Stock balance was $1,108,000 including an unaccreted debt discount of $14,000 and unamortized debt offering costs of $306,000. The Company recognized interest expense on the Series B Preferred Stock of $48,000 for the thirteen weeks ended June 28, 2020, which includes amortization of debt offering costs of $18,000. The Company recognized interest expense on the Series B Preferred Stock of $96,000 for the twenty-six weeks ended June 28, 2020, which includes accretion expense of the debt discount of $1,000 and amortization of debt offering costs of $36,000. The year-to-date effective interest rate for the Series B Preferred Stock for 2020 was 17.8%.

 

On July 13, 2020, the Company entered into an agreement to exchange the 34,284 outstanding Series B Warrants for 285,700 new warrants (the “Series B Offering Warrants”), pursuant to Warrant Exchange Agreements with the holders of the Series B Warrants in consideration of their consent to amend and restate the terms of the Series B Cumulative Preferred Stock .On July 15, 2020, the Company filed an Amended and Restated Certificate of Designation of Rights and Preferences of Series B Cumulative Preferred Stock with the Secretary of State of Delaware (See Note 20).

 

Series A Fixed Rate Cumulative 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 (“Series A 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.

 

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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 “Series A 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 Series A 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.

 

As of June 28, 2020, there were 100,000 shares of Series A Preferred stock outstanding, issued in the following two transactions:

 

  (i) 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) warrants (the “Series A Warrants”) to purchase 127 shares of the Company’s common stock at $7.83 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 and the issuance of 80,000 shares of Series A Preferred Stock and Series A Warrants to purchase 102,125 shares of common stock (the “Subscription Warrants”).

 

  (ii) 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 200 Units consisting of 20,000 shares of Series A Fixed Rate Cumulative Preferred Stock of the Company at $100 per share and Series A Warrants to purchase 25,530 of the Company’s common stock at an exercise price of $7.83 per share (the “Exchange Warrants”); and
     
  $7,272,053 of the Note Balance was exchanged for 1,010,420 shares of common stock of the Company, representing an exchange price of $7.20 per share, which was the closing trading price of the common stock on June 26, 2018.

 

The Company classifies the Series A Preferred Stock as long-term debt because it contains an obligation to issue a variable number of common shares for a fixed monetary amount. As of June 28, 2020, the net Series A Preferred Stock balance was $9,925,000 which is net of an unaccreted debt discount of $65,000 and unamortized debt offering costs of $11,000.

 

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The Company recognized interest expense on the Series A Preferred Stock of $708,000 for the twenty-six weeks ended June 28, 2020, which includes accretion expense of $11,000 as well as $2,000 for the amortization of debt offering costs. For the thirteen weeks ended June 28, 2020, the Company recognized interest expense of $354,000, which includes accretion expense of $5,000 as well as $1,000 for the amortization of the debt offering costs. The Company recognized interest expense on the Series A Preferred Stock of $708,000 for the twenty-six weeks ended June 30, 2019, which includes accretion expense of $11,000 as well as $2,000 for the amortization of debt offering costs. For the thirteen weeks ended June 30, 2019, the Company recognized interest expense of $354,000, which includes accretion expense of $5,500 as well as $1,000 for the amortization of the debt offering costs. The year-to-date effective interest rate for the Series A Preferred Stock for 2020 was 14.3%.

 

Derivative Liability Relating to the Conversion Feature of the Series A Preferred Stock

 

As stated above, holders of Series A Preferred Stock have the option to 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 (the “Conversion Option”). 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 8, 2020, the Conversion Option became exercisable. As of that date, the Company calculated the estimated fair value of the Conversion Option to be $2,406,000 and recorded a derivative liability in that amount, together with an offsetting reduction in Additional Paid-In Capital. As of June 28, 2020, the Company calculated the estimated fair value of the Conversion Option to be $1,142,000 and adjusted the carrying value of the derivative liability accordingly and recognized $1,264,000 as a change in the fair market value of the derivative liability.

 

On July 13, 2020, the Company entered into agreements with each of the holders of the Series A Preferred Stock regarding the redemption of their shares. Holders of 85,000 of the outstanding shares agreed to a full redemption in cash payments. Fog Cutter Capital Group Inc., the holder of the remaining 15,000 outstanding shares, agreed to redeem its Series A Preferred Stock in exchange for newly issued Series B Preferred Stock of the Company. As a result of these agreements, the Conversion Option was terminated as of July 13, 2020 (See Note 20).

 

Series A-1 Fixed Rate Cumulative Preferred Stock

 

On July 3, 2018, the Company filed with the Secretary of State of the State of Delaware a Certificate of Designation of Rights and Preferences of Series A-1 Fixed Rate Cumulative Preferred Stock (the “Series A-1 Certificate of Designation”), designating a total of 200,000 shares of Series A-1 Fixed Rate Cumulative Preferred Stock (the “Series A-1 Preferred Stock”). As of June 28, 2020, there were 45,000 shares of Series A-1 Preferred Stock issued and outstanding. The Series A-1 Certificate of Designation contains the following terms pertaining to the Series A-1 Preferred Stock:

 

Dividends. 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.

 

Voting Rights. As long as any shares of Series A-1 Preferred Stock are outstanding and remain unredeemed, the Company may not, without the majority vote of the Series A-1 Preferred Stock, (a) materially and adversely alter or change the rights, preferences or voting power given to the Series A-1 Preferred Stock, (b) enter into any merger, consolidation or share exchange that materially and adversely affects the rights, preferences or voting power of the Series A-1 Preferred Stock, or (c) waive or amend the dividend restrictions in Sections 3(d) or 3(e) of the Certificate of Designation. The Series A-1 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 (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 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.

 

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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 $11.75 per share of common stock.

 

As of June 28, 2020, there were 45,000 shares of Series A-1 Preferred Stock outstanding.

 

The Company classifies the Series A-1 Preferred Stock as long-term debt because it contains an obligation to issue a variable number of common shares for a fixed monetary amount.

 

As of June 28, 2020, the net Series A-1 Preferred Stock balance was $4,421,000 which is net of an unaccreted debt discount of $58,000 and unamortized debt offering costs of $21,000.

 

The Company recognized interest expense on the Series A-1 Preferred Stock of $123,000 for the twenty-six weeks ended June 28, 2020, which was net of an adjustment to the debt discount in the amount of $15,000, as well as $3,000 for the amortization of debt offering costs. The Company recognized interest expense on the Series A-1 Preferred Stock of $74,000 for the thirteen weeks ended June 28, 2020, which included recognized accretion expense of $4,000, as well as $1,000 for the amortization of debt offering costs. The Company recognized interest expense on the Series A-1 Preferred Stock of $154,000 for the twenty-six weeks ended June 30, 2019, which included recognized accretion expense of $16,000, as well as $3,000 for the amortization of debt offering costs. The Company recognized interest expense on the Series A-1 Preferred Stock of $77,000 for the thirteen weeks ended June 30, 2019, which included recognized accretion expense of $8,000, as well as $1,700 for the amortization of debt offering costs. The year-to-date effective interest rate for the Series A-1 Preferred Stock for 2020 was 5.6%.

 

On July 13, 2020, the Company entered into an agreement to exchange all outstanding shares of Series A-1 Preferred Stock, plus accrued dividends thereon, for shares of newly issued Series B Preferred Stock valued at $25.00 per share pursuant to a Settlement, Redemption and Release Agreement with the holders of such shares (See Note 20).

 

The issuance of the Series A Preferred Stock and Series A-1 Preferred Stock 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.

 

Note 12. Related Party Transactions

 

Due from Affiliates

 

On April 24, 2020, the Company entered into an Intercompany Revolving Credit Agreement with FCCG (“Intercompany Agreement”). The Company had previously extended credit to FCCG pursuant to a certain Intercompany Promissory Note (the “Original Note”), dated October 20, 2017, with an initial principal balance of $11,906,000. Subsequent to the issuance of the Original Note, the Company and certain of its direct or indirect subsidiaries made additional intercompany advances. Pursuant to the Intercompany Agreement, the revolving credit facility bears interest at a rate of 10% per annum, has a five-year term with no prepayment penalties, and has a maximum capacity of $35,000,000. All additional borrowings under the Intercompany Agreement are subject to the approval of the Board of Directors, in advance, on a quarterly basis and may be subject to other conditions as set forth by the Company. The initial balance under the Intercompany Agreement totaled $21,067,000 including the balance of the Original Note, borrowings subsequent to the Original Note, accrued and unpaid interest income, and other adjustments through December 29, 2019. As of June 28, 2020, the balance receivable under the Intercompany Agreement was $29,529,000.

 

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During the twenty-six weeks ended June 28, 2020, the Company recorded a receivable from FCCG in the amount of $154,000 under the Tax Sharing Agreement, which was added to the intercompany receivable. During the twenty-six weeks ended June 30, 2019, the Company recorded a receivable from FCCG in the amount of $46,000 under the Tax Sharing Agreement (See Note 8).

 

Effective July 5, 2018, the Company made a preferred capital investment in Homestyle Dining LLC, a Delaware limited liability corporation (“HSD”) in the amount of $4.0 million (the “Preferred Interest”). FCCG owns all of the common interests in HSD. The holder of the Preferred Interest is entitled to a 15% priority return on the outstanding balance of the investment (the “Preferred Return”). Any available cash flows from HSD on a quarterly basis are to be distributed to pay the accrued Preferred Return and repay the Preferred Interest until fully retired. On or before the five-year anniversary of the investment, the Preferred Interest is to be fully repaid, together with all previously accrued but unpaid Preferred Return. FCCG has unconditionally guaranteed repayment of the Preferred Interest in the event HSD fails to do so. As of June 28, 2020, the balance receivable, including accrued and unpaid interest income, under the Preferred Interest was $5,200,000.

 

Series B Cumulative Preferred Stock

 

On October 3 and October 4, 2019, the Company completed the initial closing of its continuous public offering (the “Series B Preferred Offering”) of up to $30,000,000 of units (the “Series B Units”) at $25.00 per Series B Unit, with each Series B Unit comprised of one share of 8.25% Series B Cumulative Preferred Stock (“Series B Preferred Stock”) and 0.60 warrants (the “Series B Warrants”) to purchase common stock at $8.50 per share, exercisable for five years. At the initial closing of the Preferred Offering, the Company completed the sale of 43,080 Series B Units for gross proceeds of $1,077,000.

 

As of June 28, 2020, the following reportable related persons participated in the initial closing of the Company’s Preferred Offering:

 

  Andrew Wiederhorn, the Company’s Chief Executive Officer, acquired 20,000 Series B Units for $500,000 comprised of 20,000 shares of Series B Preferred Stock and 12,000 Series B Warrants to purchase 12,000 shares of the Company’s common stock at $8.50 per share, and
     
  Squire Junger, a member of the Company’s Board of Directors, acquired 5,000 Series B Units for $125,000 comprised of 5,000 shares of Series B Preferred Stock and 3,000 Series B Warrants to purchase 3,000 shares of the Company’s common stock at $8.50 per share.
     
  In aggregate, Mr. Wiederhorn, Mr. Junger, and other related parties acquired 33,000 Series B Units for $825,000 comprised of 33,000 shares of Series B Preferred Stock and 19,800 Series B Warrants to purchase 19,800 shares of the Company’s common stock at $8.50 per share.

 

Note 13. SHAREHOLDERS’ EQUITY

 

As of June 28, 2020, and December 29, 2019, the total number of authorized shares of common stock was 25,000,000, and there were 11,894,895 and 11,860,299 shares of common stock outstanding, respectively.

 

Below are the changes to the Company’s common stock during the twenty-six weeks ended June 28, 2020:

 

  On February 11, 2020, the non-employee members of the board of directors elected to receive their compensation in shares of the Company’s common stock in lieu of cash. As such, the Company issued a total of 16,360 shares of common stock at a value of $4.585 per share to the non-employee members of the board of directors as consideration for accrued directors’ fees.
     
  On May 12, 2020, the non-employee members of the board of directors elected to receive their compensation in shares of the Company’s common stock in lieu of cash. As such, the Company issued a total of 18,236 shares of common stock at a value of $3.29 per share to the non-employee members of the board of directors as consideration for accrued directors’ fees.

 

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Note 14. SHARE-BASED COMPENSATION

 

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 1,021,250 shares available for grant.

 

All of the stock options issued by the Company to date have included a vesting period of three years, with one-third of each grant vesting annually. The Company’s stock option activity for fiscal year ended June 28, 2020 can be summarized as follows:

 

    Number of Shares     Weighted
Average
Exercise
Price
    Weighted Average Remaining Contractual
Life (Years)
 
Stock options outstanding at December 29, 2019     722,481     $ 8.45       8.0  
Grants     -       -       -  
Forfeited     (127,648 )     7.60       8.3  
Expired     -       -       -  
Stock options outstanding at June 28, 2020     594,833     $ 8.64       7.9  
Stock options exercisable at June 28, 2020     296,145     $ 9.85       7.7  

 

The assumptions used in the Black-Scholes valuation model to record the stock-based compensation are as follows:

 

      Including Non-Employee Options  
Expected dividend yield     4.00% - 10.43 %
Expected volatility     30.23% - 31.73 %
Risk-free interest rate     1.52% - 2.85 %
Expected term (in years)     5.50 – 5.75  

 

The Company recognized share-based compensation expense in the amount of $15,000 and $16,000 during the thirteen and twenty-six weeks ended June 28, 2020, respectively. The Company recognized share-based compensation expense in the amount of $78,000 and $159,000 during the thirteen and twenty-six weeks ended June 30, 2019, respectively. As of June 28, 2020, there remains $59,000 of share-based compensation expense relating to non-vested grants, which will be recognized over the remaining vesting period, subject to future forfeitures.

 

Note 15. WARRANTS

 

As of June 28, 2020, the Company had issued the following outstanding warrants to purchase shares of its common stock:

 

  Warrants issued on October 20, 2017 to purchase 81,700 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 $14.69 per share, and the Common Stock Warrants were valued at $124,000 at the date of grant. 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.
     
  Warrants issued on June 7, 2018 to purchase 102,125 shares of the Company’s common stock at an exercise price of $7.83 per share (the “Subscription Warrants”). The Subscription Warrants were issued as part of the Subscription Agreement (see Note 11). The Subscription Warrants were valued at $87,000 at the date of grant. 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.

 

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  Warrants issued on June 27, 2018 to purchase 25,530 shares of the Company’s common stock at an exercise price of $7.83 per share (the “Exchange Warrants”). The Exchange Warrants were issued as part of the Exchange (See Note 11). The Exchange Warrants were valued at $25,000 at the date of grant. 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.
     
  Warrants issued on July 3, 2018 to purchase 57,439 shares of the Company’s common stock at an exercise price of $7.83 per share (the “Hurricane Warrants”). The Hurricane Warrants were issued as part of the acquisition of Hurricane. The Hurricane Warrants were valued at $58,000 at the date of grant. The Hurricane 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.
     
  Warrants issued on July 3, 2018 to purchase 509,604 shares of the Company’s common stock at an exercise price of $7.20 per share (the “Lender Warrant”). The Lender Warrant was issued as part of the $16 million credit facility with FB Lending, LLC. The Lender Warrant was valued at $592,000 at the date of grant. The Lender Warrant may be exercised at any time or times beginning on the issue date and ending on the five-year anniversary of the issue date (See Note 20).
     
  Warrants issued on July 3, 2018 to purchase 66,691 shares of the Company’s common stock at an exercise price of $7.20 per share (the “Placement Agent Warrants”). The Placement Agent Warrants were issued to the placement agents of the $16 million credit facility with FB Lending, LLC (See Note 10). The Placement Agent Warrants were valued at $78,000 at the date of grant. The Placement Agent 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.

 

  Warrants issued on June 19, 2019, in connection with the acquisition of Elevation Burger (See Note 3), to purchase 46,875 shares of the Company’s common stock at an exercise price of $8.00 per share (the “Elevation Warrant”), exercisable for a period of five years, but only in the event of a merger of the Company and FCCG, commencing on the second business day following the potential merger and ending on the five year anniversary thereafter, at which time the Elevation Warrant shall terminate The Elevation Warrants were not valued at the date of grant due to the contingency relating to their exercise.
     
  Warrants issued between October 3, 2019 and December 29, 2019, in connection with the sale of Series B Units (See Note 11), to purchase 34,284 shares of the Company’s common stock at an exercise price of $8.50 per share (the “Series B Warrants”), exercisable for a period of five years from October 3, 2019. The outstanding Series B Warrants were valued at $21,000 at the date of grant (See Note 20).
     

 

The Company’s warrant activity for the thirteen weeks ended June 28, 2020 is as follows:

 

     

Number of

Shares

   

Weighted

Average

Exercise Price

   

Weighted

Average

Remaining

Contractual

Life (Years)

 
Warrants outstanding at December 29, 2019       2,091,652     $ 3.57       4.0  
Grants       -       -       -  
Exercised       -       -       -  
Forfeited       (1,167,404 )     0.01       4.8  
Expired       -       -       -  
Warrants outstanding at June 28, 2020       924,248     $ 8.08       3.1  
Warrants exercisable at June 28, 2020       877,373     $ 8.08       3.0  

 

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The range of assumptions used to establish the value of the warrants using the Black-Scholes valuation model are as follows:

 

      Warrants  
Expected dividend yield     4.00% - 6.63 %
Expected volatility     30.23% - 31.73 %
Risk-free interest rate     0.99% - 1.91 %
Expected term (in years)     3.80 - 5.00  

 

Note 16. DIVIDENDS ON COMMON STOCK

 

Our Board of Directors did not declare a dividend during the twenty-six weeks ended June 28, 2020.

 

The Company declared a stock dividend on February 7, 2019 equal to 2.13% on its common stock, representing the number of shares equal to $0.12 per share of common stock based on the closing price as of February 6, 2019. The stock dividend was paid on February 28, 2019 to stockholders of record as of the close of business on February 19, 2019. The Company issued 245,376 shares of common stock at a per share price of $5.64 in satisfaction of the stock dividend. No fractional shares were issued, instead the Company paid stockholders cash-in-lieu of shares.

 

Note 17. 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, and Daniel Alden, et al. v. FAT Brands Inc., et al., Superior Court of California for the County of Los Angeles, Case No. BC716017.

 

On June 7, 2018, FAT Brands, Inc., Andrew Wiederhorn, Ron Roe, James Neuhauser, Edward H. Rensi, Marc L. Holtzman, Squire Junger, Silvia Kessel, Jeff Lotman, Fog Cutter Capital Group Inc., and Tripoint Global Equities, LLC (collectively, the “Original Defendants”) were named as defendants in a putative securities class action lawsuit entitled Rojany v. FAT Brands, Inc., Case No. BC708539 (the “Rojany Case”), in the Superior Court of the State of California, County of Los Angeles. On July 31, 2018, the Rojany Case was designated as complex, pursuant to Rule 3.400 of the California Rules of Court and assigned the matter to the Complex Litigation Program. On August 2, 2018, the Original Defendants were named defendants in a second putative class action lawsuit, Alden v. FAT Brands, Case No. BC716017 (the “Alden Case”), filed in the same court. On September 17, 2018, the Rojany and Alden Cases were consolidated under the Rojany Case number. On October 10, 2018, plaintiffs Eric Rojany, Daniel Alden, Christopher Hazelton-Harrington and Byron Marin (“Plaintiffs”) filed a First Amended Consolidated Complaint against FAT Brands, Inc., Andrew Wiederhorn, Ron Roe, James Neuhauser, Edward H. Rensi, Fog Cutter Capital Group Inc., and Tripoint Global Equities, LLC (collectively, “Defendants”), thereby removing Marc L. Holtzman, Squire Junger, Silvia Kessel and Jeff Lotman as defendants. On November 13, 2018, Defendants filed a Demurrer to First Amended Consolidated Complaint. On January 25, 2019, the Court sustained Defendants’ Demurrer to First Amended Consolidated Complaint with Leave to Amend in Part. Plaintiffs filed a Second Amended Consolidated Complaint on February 25, 2019. On March 27, 2019, Defendants filed a Demurrer to the Second Amended Consolidated Complaint. On July 31, 2019, the Court sustained Defendants’ Demurrer to the Second Amended Complaint in Part, narrowing the scope of the case. Defendants filed their Answer to the Second Amended Consolidated Complaint on November 12, 2019. On January 29, 2020, Plaintiffs filed a Motion for Class Certification. Plaintiffs’ Motion for Class Certification is fully briefed, and the hearing on Plaintiffs’ Motion for Class Certification is set for September 10, 2020. Defendants dispute Plaintiffs’ allegations and will continue to vigorously defend themselves in this litigation.

 

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Adam Vignola, et al. v. FAT Brands Inc., et al., United States District Court for the Central District of California, Case No. 2:18-cv-07469.

 

On August 24, 2018, the Original Defendants were named as defendants in a putative securities class action lawsuit entitled Vignola v. FAT Brands, Inc., Case No. 2:18-cv-07469-PSG-PLA, in the United States District Court for the Central District of California. On October 23, 2018, Charles Jordan and David Kovacs (collectively, “Lead Plaintiffs”) moved to be appointed lead plaintiffs, and the Court granted Lead Plaintiffs’ motion on November 16, 2018. On January 15, 2019, Lead Plaintiffs filed a First Amended Class Action Complaint against the Original Defendants. The allegations and claims for relief asserted in Vignola are substantively identical to those asserted in the Rojany Case. Defendants filed a Motion to Dismiss First Amended Class Action Complaint, or, in the Alternative, to Stay the Action In Favor of a Prior Pending Action. On June 14, 2019, the Court denied Defendants’ motion to stay but granted Defendants’ motion to dismiss the First Amended Class Action Complaint, with Leave to Amend. Lead Plaintiffs filed a Second Amended Class Action Complaint on August 5, 2019. On September 9, 2019, Defendants’ filed a Motion to Dismiss the Second Amended Class Action Complaint. On December 17, 2019, the Court granted Defendants’ Motion to Dismiss the Second Amended Class Action Complaint in Part, Without Leave to Amend. The allegations remaining in Vignola are substantively identical to those remaining in the Rojany Case. Defendants filed their Answer to the Second Amended Class Action Complaint on January 14, 2020. On December 27, 2019, Lead Plaintiffs filed a Motion for Class Certification. By order entered March 16, 2020, the Court denied Lead Plaintiffs’ Motion for Class Certification. By order entered April 1, 2020, the Court set various deadlines for the case, including a fact discovery cut-off of December 29, 2020, expert discovery cut-off of February 23, 2021 and trial date of March 30, 2021. On July 16, 2020, the parties reached an agreement in principle to settle this case, pursuant to which lead plaintiffs will dismiss their claims against defendants with prejudice in exchange for a payment by or on behalf of defendants of $75,000. The parties are in the process of documenting this settlement.

 

The Company is obligated to indemnify its officers and directors to the extent permitted by applicable law in connection with the above actions, 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 under certain conditions relating to the Rojany and Vignola matters. These proceedings are ongoing and the Company is unable to predict the ultimate outcome of these matters. There can be no assurance that the defendants will be successful in defending against these actions.

 

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 6,137 square feet of space, pursuant to a lease that expires on September 29, 2025, as well as an additional 2,915 square feet of space pursuant to a lease amendment that expires on February 29, 2024. The Company leases 1,775 square feet of space in Plano, Texas for pursuant to a lease that expires on March 31, 2021. As part of the acquisition of Elevation Burger, the Company assumed a lease of 5,057 square feet of space in Falls Church, Virginia that expires on December 31, 2020. The Company subleases approximately 2,500 square feet of this lease to an unrelated third party. The Company is not a guarantor to the leases of the Yalla restaurants that are being refranchised.

 

The Company believes that all existing facilities are in good operating condition and adequate to meet current and foreseeable needs.

 

Note 18. geographic information AND MAJOR FRANCHISEES

 

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

 

    Thirteen Weeks Ended     Twenty-six Weeks Ended  
    June 28, 2020     June 30, 2019     June 28, 2020     June 30, 2019  
United States   $ 2,564     $ 5,059     $ 6,273     $ 9,070  
Other countries     543       836       1,257       1,698  
Total revenues   $ 3,107     $ 5,895     $ 7,530     $ 10,768  

 

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

 

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During the twenty-six weeks ended June 28, 2020 and June 30, 2019, no individual franchisee accounted for more than 10% of the Company’s revenues.

 

NOTE 19. OPERATING SEGMENTS

 

With minor exceptions, the Company’s operations are comprised exclusively of franchising a growing portfolio of restaurant brands. This growth strategy is centered on expanding the footprint of existing brands and acquiring new brands through a centralized management organization which provides substantially all executive leadership, marketing, training and accounting services. While there are variations in the brands, the nature of the Company’s business is fairly consistent across its portfolio. Consequently, management assesses the progress of the Company’s operations as a whole, rather than by brand or location, which become more significant as the number of brands has increased.

 

As part of its ongoing franchising efforts, the Company will, from time to time, make opportunistic acquisitions of operating restaurants in order to convert them to franchise locations. During the refranchising period, the Company may operate the restaurants.

 

The Company’s chief operating decision maker (“CODM”) is the Chief Executive Officer. The 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 and reportable segment.

 

NOTE 20. SUBSEQUENT EVENTS

 

Pursuant to FASB ASC 855, Management has evaluated all events and transactions that occurred from June 28, 2020 through the date of issuance of these financial statements. During this period, the Company did not have any significant subsequent events other than those described below:

 

Underwritten Public Offering

 

On July 13, 2020, the Company entered into an underwriting agreement (the “Underwriting Agreement”) to issue and sell in a public offering (the “Offering”) 360,000 shares of 8.25% Series B Cumulative Preferred Stock (“Series B Preferred Stock”) and 1,800,000 warrants (the “2020 Series B Warrants”) to purchase common stock at $5.00 per share. The Company also granted the underwriters an option to purchase, for a period of 45 calendar days, up to an additional 54,000 shares Series B Preferred Stock and 270,000 of the 2020 Series B Warrants. In the Underwriting Agreement, the Company agreed to pay the underwriters an underwriting discount of 8.0% of the gross proceeds received by the Company in the Offering and issue five-year warrants exercisable for 1% of the securities sold in the Offering.

 

In connection with the Offering, on July 15, 2020 the Company filed with the Secretary of State of Delaware an Amended and Restated Certificate of Designation of Rights and Preferences of Series B Cumulative Preferred Stock, designating a total of 850,000 shares of Series B Preferred Stock (the “Certificate of Designation”), and on July 16, 2020 entered into a Warrant Agency Agreement with VStock Transfer, LLC, to act as the Warrant Agent for the Warrants (the “Warrant Agency Agreement”). The Warrant Agency Agreement sets forth the terms of the Warrants and includes the form of Warrant Certificate issued to investors in the Offering. The Warrants are exercisable beginning on the earlier of one year from the date of issuance or the consummation of a consolidation, merger or other similar business combination transaction involving the Company (or any of its subsidiaries) and its parent company, Fog Cutter Capital Group Inc., and will expire on July 16, 2025.

 

The Offering closed on July 16, 2020 with net proceeds to the Company of $8,211,000, which was net of $790,000 in underwriting and offering costs.

 

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Exchange Transactions

 

On July 13, 2020, the Company entered into the following additional transactions:

 

  1. The Company entered into an agreement to redeem 80,000 outstanding shares of the Series A Preferred Stock, plus accrued dividends thereon, held by Trojan Investments, LLC pursuant to a Stock Redemption Agreement that provides for the redemption at face value of a portion of such shares for cash from the proceeds of the Offering and the balance to be redeemed in $2 million tranches every six months, with the final payment due by December 31, 2021.
     
  2. The Company entered into an agreement to redeem 5,000 outstanding shares of Series A Preferred Stock, plus accrued dividends thereon, held by Ridgewood Select Value Fund LP and its affiliate at face value for cash from the proceeds of the Offering.
     
  3. The Company entered into an agreement to exchange 15,000 outstanding shares of Series A Preferred Stock, plus accrued dividends thereon, held by Fog Cutter Capital Group, Inc. at face value for shares of Series B Preferred Stock valued at $25.00 per share.
     
  4. The Company entered into an agreement to exchange all outstanding shares of Series A-1 Fixed Rate Cumulative Preferred Stock, plus accrued dividends thereon, for shares of Series B Preferred Stock valued at $25.00 per share pursuant to a Settlement, Redemption and Release Agreement with the holders of such shares; and
     
  5. The Company entered into an agreement to exchange 34,284 outstanding Series B Warrants issued in October 2019 for 285,700 Warrants (the same class issued in the offering), pursuant to Warrant Exchange Agreements with the holders of the warrants in consideration of their consent to amend and restate the terms of the Series B Cumulative Preferred Stock.

 

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.

 

Warrant Purchase

 

On July 30, 2020, the Company entered into a warrant purchase agreement (the “Lender Warrant Purchase Agreement”) to purchase the Lender Warrant for $249,500. Issued by the Company on July 3, 2018, the Lender Warrant grants the right to purchase 509,604 shares of the Company’s common stock at an exercise price of $7.20 per share. The Lender Warrant may be exercised at any time or times beginning on the issue date and ending on the five-year anniversary of the issue date (See Note 15).

 

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

 

The following discussion and analysis of our results of operations, financial condition and liquidity and capital resources should be read in conjunction with our financial statements and related notes for the thirteen and twenty-six weeks ended June 28, 2020 and June 30, 2019, as applicable. Certain statements made or incorporated by reference in this report and our other filings with the Securities and Exchange Commission, in our press releases and in statements made by or with the approval of authorized personnel constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and are subject to the safe harbor created thereby. Forward-looking statements reflect intent, belief, current expectations, estimates or projections about, among other things, our industry, management’s beliefs, and future events and financial trends affecting us. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “may,” “will” and variations of these words or similar expressions are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Although we believe the expectations reflected in any forward-looking statements are reasonable, such statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, including but not limited to, COVID-19. These differences can arise as a result of the risks described in the section entitled “Item 1A. Risk Factors” in our Annual Report on Form 10-K filed on April 28, 2020 “Item 1A. Risk Factors” and elsewhere in this report, as well as other factors that may affect our business, results of operations, or financial condition. Forward-looking statements in this report speak only as of the date hereof, and forward-looking statements in documents incorporated by reference speak only as of the date of those documents. Unless otherwise required by law, we undertake no obligation to publicly update or revise these forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks and uncertainties, we cannot assure you that the forward-looking statements contained in this report will, in fact, transpire.

 

COVID-19

 

In March 2020, the World Health Organization declared the outbreak of a novel coronavirus (COVID-19) as a pandemic, which continues to spread throughout the United States and other countries. As a result, Company franchisees have temporarily closed some retail locations, reduced or modified store operating hours, adopted a “to-go” only operating model, or a combination of these actions. These actions have reduced consumer traffic, all resulting in a negative impact to Company revenues. While the disruption to our business from the COVID-19 pandemic is currently expected to be temporary, there is a great deal of uncertainty around the severity and duration of the disruption, and also the longer-term effects on our business and economic growth and consumer demand in the U.S. and worldwide. The effects of COVID-19 may materially adversely affect our business, results of operations, liquidity and ability to service our existing debt, particularly if these effects continue in place for a significant amount of time.

 

As of June 28, 2020, the Company recorded goodwill impairment charges of $1,462,000 and tradename impairment charges of $1,712,000 relating to the Ponderosa and Bonanza brands. As additional information becomes available regarding the potential impact and the duration of the negative financial effects of the current pandemic, the Company may determine that additional impairment adjustments to the recorded value of trademarks, goodwill and other intangible assets may be necessary.

 

Executive Overview

 

Business overview

 

FAT Brands Inc., formed in March 2017 as a wholly owned subsidiary of Fog Cutter Capital Group, Inc. (“FCCG”), is a leading multi-brand restaurant franchising company that develops, markets, and acquires predominantly fast casual restaurant concepts around the world. On October 20, 2017, we completed an initial public offering and issued additional shares of common stock representing 20 percent of our ownership (the “Offering”). As of June 28, 2020, FCCG continues to control a significant voting majority of the Company.

 

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As a franchisor, we generally do not own or operate restaurant locations, but rather generate revenue by charging franchisees an initial franchise fee as well as ongoing royalties. This asset light franchisor model provides the opportunity for strong profit margins and an attractive free cash flow profile while minimizing restaurant operating company risk, such as long-term real estate commitments or capital investments. Our scalable management platform enables us to add new stores and restaurant concepts to our portfolio with minimal incremental corporate overhead cost, while taking advantage of significant corporate overhead synergies. The acquisition of additional brands and restaurant concepts as well as expansion of our existing brands are key elements of our growth strategy.

 

As of June 28, 2020, the Company owns eight restaurant brands: Fatburger, Buffalo’s Cafe, Buffalo’s Express, Hurricane Grill & Wings, Ponderosa and Bonanza Steakhouses, Elevation Burger and Yalla Mediterranean that franchise over 375 locations worldwide.

 

Operating segments

 

With minor exceptions, our operations are comprised exclusively of franchising a growing portfolio of restaurant brands. Our growth strategy is centered on expanding the footprint of existing brands and acquiring new brands through a centralized management organization which provides substantially all executive leadership, marketing, training and accounting services. While there are variations in the brands, the nature of our business is fairly consistent across our portfolio. Consequently, our management assesses the progress of our operations as a whole, rather than by brand or location, which has become more significant as the number of brands has increased.

 

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 and reportable segment.

 

Results of Operations

 

We operate on a 52-week or 53-week fiscal year ending on the last Sunday of the calendar year. In a 52-week fiscal year, each quarter contains 13 weeks of operations. In a 53-week fiscal year, each of the first, second and third quarters includes 13 weeks of operations and the fourth quarter includes 14 weeks of operations, which may cause our revenue, expenses and other results of operations to be higher due to an additional week of operations. The 2020 and 2019 fiscal years are each 52-week years.

 

Results of Operations of FAT Brands Inc.

 

The following table summarizes key components of our combined results of operations for the thirteen weeks and twenty-six weeks ended June 28, 2020 and June 30, 2019. Except for the short period subsequent to its acquisition, the results of Elevation Burger were not included in the operations for the periods ended June 30, 2019 because that subsidiary was acquired by the Company on June 19, 2019.

 

(In thousands)

 

    Thirteen Weeks Ended     Twenty-six Weeks Ended  
    June 28, 2020     June 30, 2019     June 28, 2020     June 30, 2019  
Statement of operations data:                                
                                 
Revenues                                
Royalties   $ 2,213     $ 3,663     $ 5,522     $ 7,127  
Franchise fees     273       994       449       1,306  
Store opening fees     -       184       -       289  
Advertising fees     613       1,031       1,544       2,008  
Management fees and other income     8       23       15       38  
Total revenues     3,107       5,895       7,530       10,768  
                                 
Costs and expenses                                
General and administrative expenses     4,104       3,106       7,636       5,820  
Advertising expenses     613       1,031       1,544       2,008  
Impairment of assets     3,174       -       3,174       -  
Refranchising restaurant losses (gains)     1,006       (467     1,544       51  
Costs and expenses     8,897       3,670       13,898       7,879  
                                 
 (Loss) income from operations     (5,790     2,225       (6,368     2,889  
                                 
Other income (expense), net     450       (1,389 )     (1,639 )     (3,482 )