ONE Group Hospitality, Inc. — 2016 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2016; filed April 5, 2017. The filing provides annual comparisons with 2015, not a separate fourth-quarter income statement. The company develops and operates upscale restaurants, principally STK, and manages food-and-beverage operations for hotels and casinos.
Business context and reporting period
At year-end, the company reported 11 owned and operated locations, 13 managed restaurants and lounges, and one licensed restaurant; its portfolio included 14 STK restaurants. It also provided food-and-beverage services at six hotels and casinos. Owned-unit sales drive most revenue, while management and incentive fees provide a smaller, less capital-intensive revenue stream.
Financial performance
| Metric | 2016 | 2015 |
|---|---|---|
| Total revenue | $72.4 million | $60.5 million |
| Net income (loss) | $(16.5) million | $7.1 million |
| Net income (loss) attributable to ONE Group | $(16.7) million | $6.9 million |
| Cash from operating activities | $2.1 million | $2.0 million |
| Cash used in investing activities | $(10.1) million | $(12.7) million |
| Cash from financing activities | $8.0 million | $4.7 million |
| Adjusted EBITDA attributable to ONE Group | $4.5 million | $5.2 million |
- Revenue increased 19.6%. Owned-unit net revenue rose 21.6% to $63.9 million, mainly from Orlando’s opening and full-year contributions from restaurants opened in 2015. Management and incentive fee revenue increased 6.9% to $8.5 million, principally due to UK incentive fees.
- Comparable owned STK sales declined 4.1%; comparable sales for owned and managed STK units declined 2.3%. The company attributed weakness partly to lower sales at its two New York locations in the second half of 2016.
- Food and beverage costs were 24.9% of owned-unit revenue, compared with 25.1% in 2015. Unit operating expenses were 64.4% of total revenue (65.1% in 2015); general and administrative expenses were 15.4% of revenue (17.7% in 2015).
- The company recorded a $10.4 million income-tax expense, including a roughly $12.0 million valuation allowance against U.S. deferred tax assets. In 2015, it recorded a $9.3 million tax benefit. The 2015 result also benefited from $6.1 million of derivative income, versus $0.1 million in 2016; public warrants expired in February 2016.
- Adjusted EBITDA is a company-defined non-GAAP measure. It declined from $5.2 million to $4.5 million attributable to ONE Group; it should not be treated as a substitute for GAAP results.
Liquidity, debt, and obligations
- Year-end cash was $1.6 million, offset by a $0.7 million cash overdraft; management reported cash net of overdrafts of approximately $0.9 million. The company had a $3.9 million working-capital deficit.
- Reported debt obligations totaled approximately $17.2 million before the $0.8 million warrant-related discount. This included $9.5 million under BankUnited term loans, $1.4 million of equipment financing, and $6.25 million of promissory notes. The unsecured notes generally bear 10% interest and mature in 2021; BankUnited term loans bear 5% interest and are secured by substantially all assets.
- The company failed its tangible-net-worth covenant at December 31, 2016. BankUnited waived the breach on March 30, 2017 and modified the covenant definition to exclude changes in deferred-tax valuation allowances. The filing says management expected continued compliance under the revised definition.
- Operating lease commitments, net of minimum rental receipts, were approximately $124.6 million, including $6.8 million due within one year. Total contractual obligations, including debt and estimated interest, were $145.6 million.
- Management expected operating cash flow and landlord construction allowances to fund planned operations and capital spending for at least the next 12 months, but warned that additional financing might be needed and was not assured. Planned 2017 capital expenditures were approximately $3.3 million.
Changes, outlook, risks, and unusual items
- Growth in reported revenue did not translate into GAAP profitability: the company moved from $7.1 million net income in 2015 to a $16.5 million net loss in 2016. The tax valuation allowance and the prior-year derivative gain and tax benefit materially affect the comparison.
- Management expected 2017 same-store sales to remain flat and anticipated margin improvement as operations matured, while acknowledging that improvement was not assured. It targeted two to three STK openings annually, primarily through licensing, and one to two new F&B projects every 12 months. It identified up to 50 potential STK markets but cautioned that openings depended on licensees, suitable sites, financing, and staffing.
- Following third-party approaches, the board authorized a review of strategic alternatives; there was no timetable or assurance of a transaction or strategy change. The 2016 rights offering generated about $3.8 million net, primarily for planned restaurant development.
- Material operating changes included the December 2016 closure and lease termination of STK DC, liquidation of the Edinburgh project in February 2017, and termination of the Boston lease in March 2017. Denver opened in January 2017. San Diego was expected to open in 2017; Austin and Dallas were expected in early 2018. New Puerto Rico and Middle East licensed locations were planned.
- Management identified material weaknesses in financial reporting controls, including an inadequate close and review process, segregation-of-duties and IT access deficiencies, and insufficient journal-entry review. Disclosure controls and internal control over financial reporting were deemed ineffective at year-end. Remediation was underway, with completion targeted during 2017 but timing and cost uncertain. The auditor expressed an opinion on the financial statements but was not engaged to audit internal controls.
- Principal risks include limited liquidity and access to financing, substantial lease commitments and secured debt, dependence on a small number of high-revenue locations, declining comparable sales, labor and commodity cost inflation, and risks from licensing and international expansion. The company also cited seasonality, severe weather, competition, and food-safety and regulatory risks.
- The company reported ordinary-course claims and industry employment litigation; management did not expect the ultimate outcome to materially adversely affect consolidated financial position or results. No off-balance-sheet arrangements were reported.
Important facts for investors to verify
- Whether operating cash flow, landlord allowances, and financing can support the cash needs, debt service, and planned expansion given the working-capital deficit and low net cash balance.
- Whether the BankUnited covenant waiver and revised tangible-net-worth definition remain effective and whether the company stays in compliance with all loan covenants.
- Whether the 2016 tax valuation allowance is appropriate and how future taxable income, deferred tax assets, and tax expense evolve.
- Whether comparable sales stabilize and the planned margin improvements and new openings are achieved without further closures or material cost overruns.
- Whether management remediates the disclosed material weaknesses on schedule and whether subsequent filings identify adjustments or additional control deficiencies.
- The status and outcome of the strategic alternatives review, and the economics, funding, and dilution effects of any resulting transaction or financing.