Notes to Unaudited Condensed Consolidated Financial Statements
1. Nature of Operations and Basis of Presentation
Nature of Operations
Zoe’s Kitchen, Inc. (the "Company", "Zoës", "we" or "us") primarily develops and operates fast-casual restaurants serving a distinct menu of freshly prepared Mediterranean-inspired dishes. As of
April 16, 2018
, we operated
251
Company-owned restaurants and
three
franchise restaurants in
20
states across the United States. We have determined that we have
one
operating and reportable segment. All of our revenues are derived in the United States. All of our assets are located in the United States.
Interim Financial Statements
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles and practices of the United States of America ("GAAP") for interim financial information. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement of the results for interim periods have been included.
Certain information and footnote disclosures normally included in audited consolidated financial statements presented in accordance with GAAP have been omitted pursuant to rules and regulations of the Securities and Exchange Commission (the "SEC"). Due to the seasonality of our business, results for any interim financial period are not necessarily indicative of the results that may be achieved for a full fiscal year. In addition, quarterly results of operations may be impacted by the timing and amount of sales and costs associated with the opening of new restaurants. These interim unaudited condensed consolidated financial statements do not represent complete financial statements and should be read in conjunction with our annual financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended December 25, 2017 (the "2017 Form 10-K"). While the condensed consolidated balance sheet data as of December 25, 2017 was derived from audited financial statements, it does not include all disclosures required by GAAP.
Comprehensive Income (Loss)
Comprehensive income (loss) is the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Comprehensive income (loss) is the same as net income (loss) for all periods presented. Therefore, a separate statement of comprehensive income (loss) is not included in the accompanying condensed consolidated financial statements.
Principles of Consolidation
The unaudited condensed consolidated financial statements include the accounts of Zoe’s Kitchen, Inc. and its wholly owned subsidiaries, Zoe’s Kitchen USA, LLC and Soho Franchising, LLC. All intercompany accounts and transactions have been eliminated in consolidation. The condensed consolidated financial statements presented herein reflect our financial position, results of operations and cash flows in conformity with GAAP.
Fiscal Year
We operate on a 52- or 53-week fiscal year that ends on the last Monday of the calendar year. Fiscal year ended
December 31, 2018
consists of 53 weeks and fiscal year ended
December 25, 2017
consisted of 52 weeks. Our first fiscal quarter consists of 16 weeks, and each of our second, third and fourth fiscal quarters consists of 12 weeks, except for a 53-week year when the fourth quarter has 13 weeks.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions, such as valuation of long-lived, definite and indefinite-lived assets, estimated useful lives of assets, the reasonably assured lease terms of operating leases, the construction costs of leases where the Company is considered the owner during and after the construction period, allowance for doubtful accounts, the fair value related to equity-based compensation, the calculation of self-insurance reserves, and deferred tax valuation allowances, that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Recently Adopted Accounting Standards
In March 2018, the FASB issued ASU No. 2018-05, "Income Taxes (Topic 740) - Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin ("SAB") No. 118," which incorporates paragraphs from SAB 118 in to the accounting codification. SAB 118 addressed the application of GAAP in the reporting period in which the Tax Cuts and Jobs Act (the "2017 Tax Act"), which the Company has adopted. See Note 8 for more information regarding effects of the 2017 Tax Act.
In May 2017, the FASB issued ASU No. 2017-09, “Compensation - Stock Compensation (Topic 718) - Scope of Modification Accounting,” which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. An entity will account for the effects of a modification unless the fair value of the modified award is the same as the original award, the vesting conditions of the modified award are the same as the original award, and the classification of the modified award as an equity instrument or liability instrument is the same as the original award. We adopted this amendment effective December 26, 2017. The adoption of this guidance did not impact our condensed consolidated financial statements.
In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments,” which provides specific guidance regarding presentation and classification on a variety of cash payments and receipts. Among the issues addressed is the classification of proceeds from the settlement of insurance claims. We adopted this amendment effective December 26, 2017. The adoption of this guidance did not impact our condensed consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-04, "Liabilities - Extinguishments of Liabilities (Subtopic 405-20)", which amends subtopic 405-20 to provide a scope exception that requires breakage for prepaid stored-value product liabilities to be accounted for consistent with the breakage guidance in Topic 606. We adopted this amendment effective December 26, 2017. The adoption of this guidance did not impact our condensed consolidated financial statements.
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers." This update was issued to replace the current revenue recognition guidance, creating a more comprehensive revenue model. In August 2015, the FASB issued ASU 2015-14 to defer the effective date for adoption. The update is now effective for reporting periods beginning after December 15, 2017. In March 2016, April 2016, May 2016, and December 2016 the FASB also issued ASU 2016-08, ASU 2016-10, ASU 2016-12 and ASU 2016-20, respectively, to further clarify performance obligations and licensing implementation guidance and other general topics. We adopted this amendment using the modified retrospective approach for the fiscal year and quarter beginning December 26, 2017. See Note 2 for additional information regarding our revenue policies, sources of revenue, and contract balances.
Recently Issued Accounting Standards
In January 2017, the FASB issued ASU No. 2017-04, “Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment,” which eliminates Step 2 from the goodwill impairment test. Under the new standard, annual and interim goodwill impairment tests will compare the fair value of a reporting unit with its carrying amount. An impairment charge will be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill. The pronouncement is effective for goodwill impairments tests in fiscal years beginning after December 15, 2019 and
should be applied on a prospective basis. Early adoption is permitted for goodwill impairment tests performed after January 1, 2017. We do not expect the adoption of ASU 2017-04 to have a material impact on our financial position or results of operations.
In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)," which requires entities to recognize lease assets and lease liabilities on the balance sheet and disclose key information about leasing arrangements. Previous lease accounting did not require certain lease types to be recognized on the balance sheet. In January 2018, the FASB issued ASU 2018-01 which provides an optional transition practical expedient under Topic 842 to not evaluate land easements that were not previously accounted for as leases under current lease guidance. This update is an amendment to the codification and is effective for fiscal years beginning after December 15, 2018 including interim periods within those fiscal years applied using a modified retrospective approach. Early adoption is permitted. We are currently evaluating the impact of the adoption of ASU 2016-02 on our financial position and results of operations, but expect that it will result in a significant increase in our long-term assets and liabilities given we have a significant number of leases which are not reflected on the balance sheet under current GAAP. In addition, rental payments under most of our leases for which we are the accounting owner will no longer be considered debt service applied to deemed landlord financing and interest expense. Instead, these rental payments will be classified as rent expense.
2. Revenue
On December 26, 2017 we adopted Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers, using the modified retrospective approach. The adoption of the standard did not have a material impact on our financial position or results from operations. The new standard did not impact our recognition of restaurant sales or royalty fees. Revenue recognized related to gift card breakage was also not impacted as we have historically recognized breakage in proportion to the pattern of customer redemption. Refer to Note 1 of our 2017 Form 10-K for our policies on revenue recognition from restaurant sales, gift cards and royalty fee accounting. Comparative period information presented in this report has not been restated and it continues to be reported under the accounting standard in effect during those periods.
Contract Balances
Contract liabilities and receivables from customers consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
April 16,
2018
|
|
December 25,
2017
|
|
Sales receivable
(1)
|
|
1,000
|
|
|
1,170
|
|
|
Gift card liability
(2)
|
|
1,197
|
|
|
1,732
|
|
|
Deferred revenue, current
(2)
|
|
128
|
|
|
23
|
|
(1) Included in balance of Trade accounts receivable, net of allowance for doubtful accounts on our unaudited condensed consolidated balance sheet.
(2) Included in balance of Accrued expenses and other on our unaudited condensed consolidated balance sheet.
Revenue recognized during the period that was included in liability balances at the beginning of the period consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Sixteen weeks ended
|
|
|
|
April 16, 2018
|
|
Gift card liability
|
|
$
|
1,009
|
|
|
Deferred revenue, current
|
|
$
|
23
|
|
3. Supplemental Information
Property and equipment, net consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
April 16,
2018
|
|
December 25,
2017
|
|
Buildings under deemed landlord financing
|
|
24,380
|
|
|
26,580
|
|
|
Leasehold improvements
|
|
161,032
|
|
|
153,425
|
|
|
Machinery and equipment
|
|
41,344
|
|
|
39,510
|
|
|
Furniture and fixtures
|
|
8,427
|
|
|
7,988
|
|
|
Automobiles
|
|
3,825
|
|
|
3,946
|
|
|
Computer equipment
|
|
17,808
|
|
|
17,013
|
|
|
Construction in progress
|
|
5,322
|
|
|
6,073
|
|
|
Property and equipment, gross
|
|
262,138
|
|
|
254,535
|
|
|
Less: Accumulated depreciation
|
|
(68,862
|
)
|
|
(62,849
|
)
|
|
Total Property and equipment, net
|
|
$
|
193,276
|
|
|
$
|
191,686
|
|
Accrued expenses and other consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
April 16,
2018
|
|
December 25,
2017
|
|
Accrued payroll and payroll taxes
|
|
$
|
5,136
|
|
|
$
|
5,168
|
|
|
Accrued capital purchases
|
|
1,747
|
|
|
2,031
|
|
|
Sales tax payable
|
|
2,184
|
|
|
945
|
|
|
Gift card liability
|
|
1,197
|
|
|
1,732
|
|
|
Other accrued expenses
|
|
4,478
|
|
|
4,768
|
|
|
Total Accrued expenses and other
|
|
$
|
14,742
|
|
|
$
|
14,644
|
|
4. Fair Value Measurements
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and all other current liabilities approximate fair values due to the short maturities of these instruments.
5. Bank Line of Credit and Term Loan
On November 7, 2017, we entered into a credit facility with JPMorganChase Bank, National Association (the "2017 Credit Facility"). The 2017 Credit Facility consists of a revolving loan commitment in the aggregate amount of
$50.0 million
, together with an incremental revolving credit commitment up to an aggregate amount of
$25.0 million
. The 2017 Credit Facility has a
five
year term and matures on November 7, 2022. As of
April 16, 2018
, we had
$16.5 million
of indebtedness under the 2017 Credit Facility.
On November 7, 2017, we repaid in full our outstanding
$12.5 million
indebtedness under our previous credit facility with Wells Fargo Bank, National Association (the "2015 Credit Facility") using funds drawn on our 2017 Credit Facility. Upon repayment, the 2015 Credit Facility and all related agreements were terminated. In addition, we wrote-off all unamortized loan costs, resulting in a loss on extinguishment of debt of
$0.1 million
.
Revolving credit loans under the 2017 Credit Facility bear interest, at the Company’s election, at either the LIBOR plus an applicable margin or the base rate plus an applicable margin. The base rate consists of the highest of the prime rate, the federal funds rate plus
0.5%
and LIBOR for a one-month interest period plus
1.0%
. The applicable margin and associated loan commitment fee consists of four pricing levels based on the Company’s consolidated total debt ratio. The weighted-average interest rate was
3.1%
for the
sixteen weeks ended April 16, 2018
.
Applicable margin and commitment fee rates shall be the rates per annum set for in the table below:
|
|
|
|
|
|
|
|
|
|
|
|
|
Applicable Margin
|
|
|
|
Total Debt Ratio
|
|
Base Rate
|
|
LIBOR
|
|
Commitment Fee Rate
|
|
>2.0 to 1.0
|
|
0.875%
|
|
1.875%
|
|
0.35%
|
|
≤ 2.0 to 1.0 but > 1.5 to 1.0
|
|
0.750%
|
|
1.750%
|
|
0.30%
|
|
≤ 1.5 to 1.0 but > 1.0
|
|
0.625%
|
|
1.625%
|
|
0.25%
|
|
≤1.0 to 1.0
|
|
0.500%
|
|
1.500%
|
|
0.20%
|
The 2017 Credit Facility includes specific financial covenants such as a leverage ratio and an interest coverage ratio. We are also subject to other customary covenants, including limitations on additional borrowings, dividend payments and acquisitions. As of
April 16, 2018
, we were in compliance with these financial and other covenants.
6. Equity-based Compensation
In connection with our initial public offering in April 2014 (the "IPO"), we adopted the 2014 Omnibus Incentive Plan (the “2014 Incentive Plan”), which provides for grants of stock options, stock appreciation rights, restricted stock, other stock-based awards and other cash-based awards available to directors, officers and other employees of us and our subsidiaries, as well as others performing consulting or advisory services to us. The number of shares of common stock available for issuance under the 2014 Incentive Plan may not exceed
1,905,799
.
The following table summarizes our stock option plan activity during the
sixteen weeks ended
April 16, 2018
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options
|
|
Weighted Average Exercise Price
|
|
Outstanding as of December 25, 2017
|
|
1,092,123
|
|
|
$
|
23.27
|
|
|
Granted
|
|
144,565
|
|
|
14.05
|
|
|
Exercised
|
|
(717
|
)
|
|
15.00
|
|
|
Forfeited
|
|
(6,485
|
)
|
|
22.82
|
|
|
Expired
|
|
(4,652
|
)
|
|
25.75
|
|
|
Outstanding as of April 16, 2018
|
|
1,224,834
|
|
|
$
|
22.18
|
|
Included in the stock option plan activity above are
250,000
stock options that vested immediately upon completion of the IPO and
185,679
stock options that vest in
five
equal annual installments following the date of the grant. All other options vest in
four
equal annual installments following the date of the grant. All options have a contractual term of
10
years.
The following table reflects the weighted-average assumptions utilized in the Black-Scholes option-pricing model to value the stock options granted.
|
|
|
|
|
|
|
|
|
Sixteen Weeks Ended
|
|
|
|
April 16, 2018
|
|
Expected volatility
(1)
|
|
31.0%
|
|
Risk-free rate of return
|
|
2.7%
|
|
Expected life (in years)
(2)
|
|
6.3
|
|
Dividend yield
|
|
0%
|
|
Weighted-average fair value per share at date of grant
|
|
$5.09
|
(1) Expected volatility was based on competitors within the industry.
(2) Expected life was calculated using the simplified method, which is an average of the contractual term of the option and its ordinary vesting period, as we do not have sufficient historical data for determining the expected term of our stock option awards.
The following table summarizes our restricted stock unit plan activity during the
sixteen weeks ended April 16, 2018
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted Stock Units
|
|
Weighted Average Grant Date Fair Value
|
|
Non-vested at December 25, 2017
|
|
106,620
|
|
|
$
|
24.32
|
|
|
Granted
|
|
191,914
|
|
|
14.07
|
|
|
Vested
|
|
(40,721
|
)
|
|
25.76
|
|
|
Forfeited
|
|
(2,605
|
)
|
|
21.45
|
|
|
Non-vested at April 16, 2018
|
|
255,208
|
|
|
$
|
16.41
|
|
The fair value of the non-vested restricted stock units is based on the closing price on the date of grant. All of our non-vested restricted stock units vest in
three
or
four
equal annual installments following the date of the grant.
As of
April 16, 2018
and December 25, 2017,
65,516
shares of restricted stock with a weighted average grant date fair value of
$13.36
were non-vested. All shares of restricted stock vest in
five
equal annual installments following the date of the grant.
We recognized equity-based compensation as a component of general and administrative expenses of
$1.1 million
and
$0.9 million
during the
sixteen weeks ended
April 16, 2018
and
April 17, 2017
, respectively. As of
April 16, 2018
, total unrecognized compensation expense related to non-vested stock awards was
$9.2 million
, which is expected to be recognized over a weighted-average period of
3.0
years.
7. Earnings Per Share
Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted average shares outstanding during the period, without consideration of common stock equivalents. Diluted net income (loss) per share is calculated by adjusting weighted average shares outstanding for the dilutive effect of common stock equivalents outstanding for the period, determined using the treasury-stock method.
The following table presents the computation of basic and diluted net income (loss) per share for the period indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sixteen Weeks Ended
|
|
|
|
April 16,
2018
|
|
April 17,
2017
|
|
Net income (loss) (in thousands):
|
|
$
|
(3,619
|
)
|
|
$
|
19
|
|
|
Shares:
|
|
|
|
|
|
Basic weighted average shares outstanding
|
|
19,507,441
|
|
|
19,472,124
|
|
|
Diluted weighted average shares outstanding
|
|
19,507,441
|
|
|
19,528,915
|
|
|
Earnings (loss) per share:
|
|
|
|
|
|
Basic EPS
|
|
$
|
(0.19
|
)
|
|
$
|
0.00
|
|
|
Diluted EPS
|
|
$
|
(0.19
|
)
|
|
$
|
0.00
|
|
During the
sixteen weeks ended
April 16, 2018
, there were
1,069,105
stock options,
82,004
restricted stock units and
14,489
restricted stock shares excluded from the diluted earnings per share calculation because their inclusion would have been anti-dilutive. During the
sixteen weeks ended
April 17, 2017
, there were
607,105
stock options,
85,094
restricted stock units and
no
restricted stock shares excluded from the diluted earnings per share calculation because their inclusion would have been anti-dilutive.
8. Income Taxes
In December 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was enacted. The 2017 Tax Act includes a number of changes to existing U.S. tax laws that impact the Company, most notably a reduction of the U.S. corporate income tax rate from 35 percent to 21 percent for tax years beginning after December 31, 2017.
The Company recognized the income tax effects of the 2017 Tax Act in its 2017 financial statements in accordance with Staff Accounting Bulletin No. 118, which provides SEC staff guidance for the application of ASC Topic 740, "Income Taxes", in the reporting period in which the 2017 Tax Act was signed into law. As such, the Company’s financial results reflect the income tax effects of the 2017 Tax Act for which the accounting under ASC Topic 740 is complete and provisional amounts for those specific income tax effects of the 2017 Tax Act for which the accounting under ASC Topic 740 is incomplete but a reasonable estimate could be determined. The Company included provisional estimates of income tax effects of the 2017 Tax Act as of April 18, 2016.
Provision for income taxes was
$0.2 million
for the
sixteen weeks ended
April 16, 2018
compared to
$0.4 million
for the
sixteen weeks ended
April 17, 2017
. The effective tax rate was
(6)%
and
95%
for the
sixteen weeks ended
April 16, 2018
and
April 17, 2017
, respectively. Our tax expense for the year primarily reflects the accrual of income tax expense related to a valuation allowance in connection with the tax amortization of the Company’s goodwill that was not available to offset existing deferred tax assets. Due to the uncertain timing of the reversal of this temporary difference, it cannot be considered as a source of future taxable income for purposes of determining a valuation allowance; therefore the deferred tax liability cannot offset deferred tax assets. As part of the 2017 Tax Act, NOL’s generated in 2018 and later are not subject to an expiration period and are available to offset 80% of taxable income in the year in which they are utilized. The indefinite carryforward period of 2018 and subsequent NOL’s can be used as support for the realization of indefinite-lived deferred tax liabilities to the extent that such NOL’s do not exceed 80% of the goodwill that was not available to offset existing deferred tax assets. Accordingly, the Company has recognized a deferred tax asset for the estimated NOL generated during 2018. Our quarterly provision for income taxes is measured using an annual estimated effective tax rate for the full year applied to period earnings. The comparison of our effective tax rate between periods is significantly impacted by the level of pre-tax income earned and projected for the year.
We continue to monitor and evaluate the rationale for recording a full valuation allowance for the net amount of the deferred tax assets which are in excess of the indefinite-lived deferred tax assets and liabilities. We intend to continue maintaining a full valuation allowance on these net deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. Release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to change on the basis of the level of profitability that we are able to actually achieve.
9. Commitments and Contingencies
Franchise Agreement
Our Kentucky franchise agreement, which requires the franchisee to remit continuing royalty fees at a specified percentage of the franchisee's gross sales revenue, provides that we as franchisor, or its authorized representative, will: (a) provide franchisee with written schedules of all foods, food products, beverages, and other items for sale, and the furniture, fixtures, supplies and equipment necessary and required for the operation of the restaurant; (b) provide franchisee with a list of approved suppliers for the products and services necessary and required for the restaurant; (c) upon the reasonable written request of franchisee, render reasonable advisory services by telephone or in writing pertaining to the operation of the restaurant; (d) provide franchisee with a sample of the standard Zoës Kitchen menu, and any modifications to the menu; (e) loan franchisee a copy of the system's operating manual and any supplements to the manual that may be published by us; and, (f) provide franchisee the opportunity to participate in group purchasing programs that we may use, develop, sponsor or provide on terms and conditions determined solely by us. In addition, as a condition to the commencement of business by any of our franchises, the franchisee must attend and successfully complete our training program. The costs related to our franchise agreement are not significant.
Litigation
We are currently involved in various claims and legal actions that arise in the ordinary course of our business, including claims resulting from employment related matters. None of these claims, most of which are covered by insurance, has had a material effect on us, and as of the date of this report, we are not party to any material pending legal proceedings and are not aware of any claims that could have a material adverse effect on our business, financial condition, results of operations or cash flows. However, a significant increase in the number of these claims or an increase in amounts owing under successful claims could materially and adversely affect our business, financial condition, results of operations or cash flows.