ONE Group Hospitality, Inc. annual report, FY2019

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Business context and reporting period

The ONE Group Hospitality, Inc. (NASDAQ: STKS) filed this Form 10-K for the fiscal year ended December 31, 2019; it is an annual report, not a standalone fourth-quarter report. The company develops, operates, manages and licenses restaurants and provides food-and-beverage services. At year-end it had 55 venues, including 20 STK locations and 24 Kona Grill restaurants. Kona Grill’s 24 domestic restaurants were acquired on October 4, 2019, so its results are included only from that date.

Financial results and liquidity

Amounts below are in millions of dollars unless stated otherwise.

Metric20192018
Total revenue$120.7$85.6
Operating income$12.8$5.8
Net income attributable to ONE Group$20.8$3.3
Operating cash flow$8.4$6.4
Cash and cash equivalents at year-end$12.3$1.6
Long-term debt, including current portion$48.3$10.8
  • Revenue increased 41.0%; owned restaurant revenue rose to $108.8 million from $74.0 million, while management, license and incentive fees were $11.9 million versus $11.6 million.
  • Operating margin was 10.6%, compared with 6.8%. Owned restaurant cost of sales was 25.7% of owned revenue, roughly flat with 25.6%; owned restaurant operating expenses rose to 62.5% from 61.8%.
  • Net income included an $11.0 million bargain-purchase gain on Kona Grill and an $11.2 million income tax benefit, principally reflecting release of a deferred-tax valuation allowance. It also included a $2.7 million non-cash investment impairment, $2.5 million of transaction costs and $0.9 million loss on early debt extinguishment. These items make reported earnings less representative of recurring operations.
  • Adjusted EBITDA, a non-GAAP measure, was $14.9 million versus $11.4 million; $14.3 million was attributable to the company, versus $10.5 million in 2018.
  • Investing cash outflow was $30.4 million, including $26.0 million of acquisition-related payments net of acquired cash. Financing provided $33.1 million, including debt borrowings; capital expenditures were $4.4 million gross and approximately $3.9 million net of landlord incentives.
  • The October 2019 Goldman Sachs facility provides a $48.0 million term loan and $12.0 million revolving facility, both maturing in October 2024. The company reported $48.3 million of debt and no revolver borrowings at year-end; it was in covenant compliance then. Stated interest margins are 5.75%–6.75% for LIBOR loans and 4.75%–5.75% for base-rate loans.
  • Operating lease liabilities were $102.7 million at year-end, with $180.9 million in undiscounted future lease payments. Current assets of $27.1 million were slightly below current liabilities of $28.1 million. Management reported negative working capital as typical for its restaurant operations.

Material changes versus the prior comparable period

  • The Kona Grill acquisition was the primary driver of revenue growth, contributing $23.7 million of 2019 revenue after closing. It also expanded assets substantially; total assets rose to $206.6 million from $56.0 million.
  • Domestic STK same-store sales increased 8.3%, with average check rising to $109 from $106. Acquired Kona Grill comparable sales increased 3.9% in the fourth quarter versus the prior-year quarter; its average check for the post-acquisition period was $26.
  • General and administrative expense increased 3.2% to $11.5 million, but declined as a share of revenue to 9.5% from 13.0%.
  • Debt increased following the acquisition financing. The company also replaced financing arrangements twice during 2019 and recorded early-extinguishment costs.

Outlook, risks and contingencies

  • Management planned to integrate Kona Grill over the following 12 months, expand STK and hospitality services largely through licensing and management, and target five to six STK openings and one to two new hospitality agreements annually. These are stated plans, not guaranteed outcomes.
  • COVID-19 had a significant adverse effect beginning in early March 2020. Several restaurants were temporarily closed and others shifted to takeout and delivery. Management expected material negative effects in the first and second quarters of 2020, reduced staffing and deferred capital projects, and projected a return toward normal operations in late Q2 or early Q3, subject to events outside its control.
  • Management said cash from operations and the Goldman Sachs facility were expected to fund operations for at least 12 months, based on operating performance. COVID-19, covenant requirements, leverage-based limits on revolver availability and the facility’s $1.5 million minimum-liquidity covenant create meaningful financing risks.
  • Key operating risks include discretionary consumer spending and business travel, restaurant competition, food and labor cost inflation, reliance on leases and long-term occupancy commitments, integration of Kona Grill, and dependence on licensees and hospitality partners. The company does not hedge commodity or foreign-exchange exposure.
  • The company disclosed ordinary-course litigation, including lease and employee-related claims, with a stated possible-loss range of zero to $2.2 million; management believed the matters would not materially affect its financial position or results. Bagatelle-related investments were written down to zero after the sublease was not renewed and the company assessed recovery as unlikely.
  • Management concluded disclosure controls and internal control over financial reporting were effective at December 31, 2019. However, it excluded Kona Grill from its internal-control assessment; Kona represented 44.9% of consolidated assets and 19.7% of revenue at the specified reporting measures.

Important facts for investors to verify

  1. How much 2019 earnings and future earnings depend on nonrecurring acquisition and tax items, and how recurring Kona Grill performance compares with management’s integration expectations.
  2. Post-filing COVID-19 effects on restaurant openings, sales, cash burn, liquidity, covenant compliance and access to the revolving facility; the filing’s recovery expectations were highly uncertain.
  3. Debt terms, borrowing availability and covenant headroom, alongside substantial lease commitments and the company’s ability to meet fixed obligations under weaker operating conditions.
  4. Whether same-store sales and restaurant-level margins remain positive after the acquisition period, and whether the stated expansion plans can be achieved without excessive capital needs.
  5. The final Kona Grill purchase-price allocation and any subsequent changes to acquisition estimates; the filing said the accounting was preliminary.