ONE Group Hospitality, Inc. quarterly report, Q2 FY2014

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ONE Group Hospitality, Inc. — Q2 2014 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2014. Unaudited consolidated results. The company develops and operates upscale restaurants and lounges, including STK, and manages food-and-beverage operations for hospitality venues. At quarter-end it owned and operated eight locations and managed eight. The 2013 comparison reflects the operating business before the October 2013 reverse merger and recapitalization.

Financial performance and position

  • Revenue: Q2 revenue was $12.27 million, up 11.7% from $10.98 million. Six-month revenue was $22.54 million, up 2.6% from $21.96 million. Q2 owned-unit revenue rose 10.9%, while six-month owned-unit revenue declined 1.3%; management and incentive fees rose 15.6% for Q2 and 23.6% for the first half.
  • Profit: Q2 net income was $3.15 million versus a $534,000 loss; six-month net income was $2.10 million versus a $688,000 loss. Income attributable to the company was $3.01 million for Q2 and $2.29 million for six months. Results included derivative income of $2.83 million and $2.78 million, respectively, from a noncash fair-value remeasurement. Continuing-operations income was $3.49 million for Q2 and $3.38 million for six months; discontinued-operations losses were $346,000 and $1.27 million.
  • Cash flow: First-half operating cash use was $2.92 million, compared with $1.40 million a year earlier. Investing cash use was $2.22 million, including $2.75 million of property and equipment purchases. Financing provided $533,000. Cash fell $4.56 million to $7.12 million from year-end 2013.
  • Margins and costs: Food and beverage costs were 24.9% of owned-unit revenue in Q2 versus 26.2% a year earlier; unit operating expenses were 58.9% versus 61.5%. For the first half, food and beverage costs were 25.6% versus 26.1%, while unit operating expenses rose to 62.5% from 59.8%. General and administrative expense increased to $2.19 million in Q2 and $4.10 million for six months, largely due to public-company costs and corporate expansion. Pre-opening costs also increased with the new Washington, D.C. STK.
  • Non-GAAP measures: Adjusted EBITDA attributable to the company was $1.65 million for Q2 versus $1.46 million, but $2.66 million for six months versus $3.27 million. Adjusted net income attributable to the company was $707,000 for Q2 versus $794,000, and $889,000 for six months versus $2.26 million. These management-defined measures exclude items including derivative income and discontinued operations and are not GAAP substitutes.
  • Liquidity and debt: Current assets were $12.42 million and current liabilities $9.60 million at June 30. The company had $4.99 million outstanding on its BankUnited credit facility and $5,000 of other current notes payable. The facility’s interest rate was 5% at quarter-end. An August 6 amendment increased facility capacity to as much as $9.1 million, changed covenants, and the company reported compliance with the new covenants as of June 30.
  • Other balance-sheet items: Total assets were $33.58 million, total liabilities $23.48 million, and total stockholders’ equity including noncontrolling interest $10.10 million. Net future operating lease commitments, after stated sublease income, totaled $88.57 million.

Material changes versus prior comparable periods

  • Q2 revenue growth reflected the Washington, D.C. opening and higher comparable owned-unit revenue, partly offset by the Perry Hotel renovation-related interruption. Comparable owned or managed STK sales increased 4.5% in Q2 and 5.2% for the first half.
  • Management-fee growth benefited from STK Las Vegas and increased activity at London’s ME Hotel. First-half owned-unit revenue was pressured by the Perry Hotel closure and renovation; the company expected the STK there to reopen in Q4 2014.
  • Lower discontinued-operations losses helped the year-over-year net-income comparison. The company exited or closed several underperforming concepts, including Tenjune, Heraea and other locations.
  • General and administrative expense rose sharply following the merger and transition to public-company reporting. Cash declined, operating cash use increased, and capital spending was higher than in the prior first half.

Outlook, commentary, risks and unusual items

  • Management expected to open a Miami STK in Q4 2014; Orlando and Chicago STKs and a Milan hotel food-and-beverage project were planned for 2015. The company also announced an STK Rebel Miami hotel location for 2015.
  • Management targeted two to three STK openings annually over the next three years, at least one new hospitality project every 12 to 18 months, and approximately 1% annual same-store sales growth. These are expectations, not guarantees; expansion depends on capital, locations, management talent and available opportunities.
  • Fiscal 2014 capital expenditures were estimated at approximately $7 million. Management said cash, operations, landlord construction allowances and available credit were expected to fund needs for 12–18 months, while noting funding may not be sufficient beyond that period or if operating cash flow underperforms.
  • On June 19, the Perry Hotel notified the company it was terminating its food-and-beverage service agreement. The hotel paid $2.0 million on July 28; under an agreement with a former minority owner, the company reported a net receipt of $1.2 million. The termination did not affect the STK lease at the hotel.
  • Operating results may fluctuate with restaurant openings, startup costs, seasonality, weather, consumer demand, competition and food costs, particularly beef. Management noted that new restaurants often have higher costs and lower margins during startup.
  • Management disclosed a material weakness in internal control over financial reporting: insufficient accounting personnel with the expertise to prepare, record and review complex transactions and GAAP financial statements. Disclosure controls were deemed ineffective as of June 30; the company was seeking a permanent financial-reporting hire.
  • The company reported ordinary-course litigation, with management not expecting a material adverse effect. It reported no legal proceedings in Part II and no off-balance-sheet arrangements.

Important facts for investors to verify

  • How much reported earnings growth depended on the noncash $2.78 million first-half derivative gain, and how underlying restaurant and management-fee performance is progressing.
  • Whether operating cash flow improves, and whether the company can fund planned openings and lease obligations without further financing.
  • Execution, timing and cost of planned restaurant and hospitality projects, including the Miami reopening and announced 2015 locations.
  • The financial and operating effects of the Perry Hotel service-agreement termination and the expected net $1.2 million payment.
  • Remediation of the disclosed material weakness, including staffing and the reliability of future financial reporting.
  • Growth in general and administrative costs, startup expenses, discontinued-operation obligations and the substantial long-term lease commitments.