Notes to Condensed Consolidated Financial
Statements (Unaudited)
Note 1. Description of Business
ARC Group, Inc., a
Nevada corporation (the “Company”), was incorporated in April 2000. The Company’s business is focused on the
development of the
Dick’s Wings
®
and
Fat Patty’s
®
franchises and the acquisition
of financial interests in other restaurant brands. The Dick’s Wings concept is currently comprised of traditional restaurants
like its
Dick’s Wings & Grill
®
restaurants and non-traditional units like the Dick’s Wings
concession stands that the Company has at TIAA Bank Field (formerly EverBank Field) and Jacksonville Veterans Memorial Arena in
Jacksonville, Florida. The Fat Patty’s concept is currently comprised of its traditional Fat Patty’s restaurants.
On December 19, 2016,
the Company acquired all of the issued and outstanding membership interests of Seediv, LLC, a Louisiana limited liability company
(“Seediv”), for $600,000 and an earn-out payment. Seediv is the owner and operator of the Dick’s Wings &
Grill restaurant located at 100 Marketside Avenue, Suite 301, in the Nocatee development in Ponte Vedra, Florida 32081 (the “Nocatee
Restaurant”) and the Dick’s Wings & Grill restaurant located at 6055 Youngerman Circle in Argyle Village in Jacksonville,
Florida 32244 (the “Youngerman Circle Restaurant”; together with the Nocatee Restaurant, the “Nocatee and Youngerman
Restaurants”). A description of the Company’s acquisition of Seediv is set forth herein under
Note 5 – Acquisition
of Seediv
.
On August
30, 2018, the Company closed upon an asset purchase agreement for the Fat Patty’s franchise (“Fat
Patty’s”). Fat Patty’s is comprised of four company-owned restaurants located at 1442 Winchester Avenue,
Ashland, Kentucky 41101, 5156 WV 34, Hurricane, West Virginia 25526, 3401 Rt. 60 East, Barboursville, West Virginia 25504,
and 1935 Third Avenue, Huntington, West Virginia 25702 (collectively, the “Fat Patty’s Restaurants”).
A
description of the Company’s acquisition of Seediv is set forth herein under
Note 6 – Acquisition of
Fat Patty’s.
At September 30, 2018,
the Company had 21 Dick’s Wings restaurants and three Dick’s Wings concession stands. Of the 21 restaurants, 16 were
located in Florida and five were located in Georgia. The Company’s concession stands were also located in Florida. Two of
the Company’s restaurants were owned by the Company, and the remaining 19 restaurants were owned and operated by franchisees.
The Company’s concession stands were also owned by the Company. In addition, the Company had four Fat Patty’s restaurants
at September 30, 2018. Of the four restaurants, three were located in West Virginia and one was located in Kentucky. All four of
the restaurants were owned by the Company.
Note 2. Basis of Presentation and Significant
Accounting Policies
Interim Financial Information
The accompanying unaudited
condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the
United States of America (“GAAP”)
applicable to a going concern
which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The unaudited condensed
consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Seediv, LLC. All intercompany
accounts and transactions were eliminated in consolidation.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
The
accompanying
unaudited condensed consolidated financial statements have been prepared in conformity with the instructions
to Form 10-Q and Article 8-03 of Regulation S-X and the related rules and regulations of the Securities and Exchange Commission
(the “SEC”). Accordingly, they do not include all of the information and footnotes required by accounting principles
generally accepted in the United States of America for complete financial statements. Certain information and footnotes disclosures
normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed
or omitted pursuant to SEC rules and regulations. Notwithstanding this, the Company believes that the disclosures herein are adequate
to make the information presented not misleading.
The unaudited condensed
consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes
thereto for the year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K. Information presented
as of December 31, 2017 is derived from the audited consolidated financial statements. The results of operations for the three-
and nine-month periods ended September 30, 2018 are not necessarily indicative of the results that the Company will have for any
subsequent quarter or full fiscal year.
This summary of significant
accounting policies is provided to assist the reader in understanding the Company’s financial statements. The financial statements
and notes thereto are representations of the Company’s management. The Company’s management is responsible for their
integrity and objectivity. These accounting policies conform to accounting principles generally accepted in the United States of
America (“GAAP”) and have been consistently applied in the preparation of the financial statements.
Estimates
The preparation of 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 amounts reported in the financial statements and accompanying notes. Actual results could differ
from those estimates.
Going Concern
Prior
to December 31, 2017, certain facts about the Company’s financial results created an uncertainty about the Company’s
ability to continue as a going concern.
The Company generated net income of $344,740 and cash flows from operations of $248,345
during the year ended December 31, 2017, and while the Company had a working capital deficit of $2,304,627 at September 30, 2018
and a loss from operations of $546,374 during the nine-month period ended September 30, 2018, it generated cash flows from operations
of $235,787 during the nine-month period ended September 30, 2018. The improvement was due primarily to the Company’s acquisition
of Seediv in December 2016 and its acquisition of Fat Patty’s in August 2018. In addition, the Company has received continued
financial support from related parties. As a result of these factors, the Company believes that the substantial doubt about its
ability to continue as a going concern had been alleviated as of December 31, 2017 and September 30, 2018.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
Segment Disclosure
The Company has both
Company-owned
restaurants and franchised restaurants
, all of which operate in the full-service casual dining industry in the United States.
Pursuant to the standards of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”)
Topic 280,
Segment Reporting
(“ASC 280”), the Company’s Chief Executive Officer and President,
who comprise the Company's Chief Operating Decision Maker function for the purposes of ASC 280, concluded that the Company operates
as a single segment for reporting purposes.
Revenue Recognition
On January 1, 2018,
the Company adopted the provisions of FASB ASC 606,
Revenue From Contracts With Customers
(“ASC 606”). ASC 606
supersedes the current revenue recognition guidance, including industry-specific guidance. ASC 606
provides
a single framework in which revenue is required to be recognized to depict the transfer of goods or services to customers in amounts
that reflect the consideration to which a company expects to be entitled in exchange for those goods or services.
The Company
adopted this new guidance effective the first day of fiscal year 2018, using the
modified retrospective method of adoption
.
Under this method, the cumulative effect of initially adopting the guidance was recognized as an adjustment to the opening balance
of equity at January 1, 2018. Therefore, the comparative period has not been adjusted and continues to be reported under the previous
revenue recognition guidance. The details of the significant changes and quantitative impact of the changes are discussed below.
Franchise Fees
ASC 606 impacted the
timing of recognition of franchise fees. Under previous guidance, these fees were typically recognized upon the opening of restaurants.
Under ASC 606, the fees are deferred and recognized as revenue over the term of the individual franchise agreements. The effect
of the required deferral of fees received in a given year will be mitigated by the recognition of revenue from fees retrospectively
deferred from prior years. As a result of the adoption of ASC 606, the Company recognized deferred franchise fees in the amount
of $196,478 on its condensed consolidated balance sheets as of January 1, 2018 and an increase in its accumulated deficit by the
same amount on that date.
Advertising Funds
ASC 606 also impacted
the accounting for transactions related to the Company’s general advertising fund. Under previous guidance, franchisee contributions
to and expenditures by the fund were not included in the Company’s condensed consolidated financial statements. Under ASC
606, the Company records contributions to and expenditures by the fund as revenue and expenses within the Company’s condensed
consolidated financial statements. The Company recognized contributions to and expenditures by the fund of $46,816 and $145,076
during the three- and nine-month periods ended September 30, 2018.
Gift Card Funds
Additionally, ASC 606 impacted the accounting
for transactions related to the Company’s gift card program. Under previous guidance, estimated breakage income on gift cards
was deferred until it was deemed remote that the unused gift card balance would be redeemed. Under ASC 606, breakage income on
gift cards is recognized as gift cards are utilized. This effect of this change on the Company’s financial statements was
negligible.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
Impact on Financial Statements
The following table
summarizes the impacts of adopting the revenue recognition standard on the Company’s condensed consolidated financial statements
as of and for the three- and nine-month periods ended September 30, 2018:
|
|
|
|
|
Adjustments
|
|
|
|
|
|
|
As
Reported
|
|
|
Franchise
Fees
|
|
|
Advertising
Funds
|
|
|
Balances
Without
Adoption
|
|
Condensed Consolidated Balance Sheets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred franchise fees
|
|
$
|
26,803
|
|
|
$
|
(26,803
|
)
|
|
$
|
—
|
|
|
$
|
—
|
|
Total current liabilities
|
|
|
3,054,745
|
|
|
|
(26,803
|
)
|
|
|
—
|
|
|
|
3,027,942
|
|
Deferred franchise fees, net of current portion
|
|
|
124,411
|
|
|
|
(124,411
|
)
|
|
|
—
|
|
|
|
—
|
|
Total liabilities
|
|
|
14,421,071
|
|
|
|
(124,411
|
)
|
|
|
—
|
|
|
|
14,296,660
|
|
Accumulated deficit
|
|
|
(4,875,520
|
)
|
|
|
151,214
|
|
|
|
—
|
|
|
|
(4,724,306
|
)
|
Total stockholders’ deficit
|
|
|
(324,617
|
)
|
|
|
151,214
|
|
|
|
—
|
|
|
|
(173,403
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Condensed Consolidated Statements of Operations – Three-Month Period Ended
September 30, 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Franchise and other revenue
|
|
$
|
231,983
|
|
|
$
|
(6,500
|
)
|
|
$
|
(42,806
|
)
|
|
$
|
182,677
|
|
Franchise and other revenue – related party
|
|
|
23,256
|
|
|
|
(750
|
)
|
|
|
(4,010
|
)
|
|
|
18,496
|
|
Total revenue
|
|
|
2,452,702
|
|
|
|
(7,250
|
)
|
|
|
(46,816
|
)
|
|
|
2,398,636
|
|
General and administrative expenses
|
|
|
418,301
|
|
|
|
—
|
|
|
|
(46,816
|
)
|
|
|
371,485
|
|
Total operating expenses
|
|
|
2,916,504
|
|
|
|
—
|
|
|
|
(46,816
|
)
|
|
|
2,869,688
|
|
Loss from operations
|
|
|
(463,802
|
)
|
|
|
(7,250
|
)
|
|
|
—
|
|
|
|
(471,052
|
)
|
Net income
|
|
|
97,467
|
|
|
|
(7,250
|
)
|
|
|
—
|
|
|
|
90,217
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Condensed Consolidated Statements of Operations – Nine-Month Period Ended
September 30, 2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Franchise and other revenue
|
|
$
|
690,892
|
|
|
$
|
(19,250
|
)
|
|
$
|
(125,958
|
)
|
|
$
|
545,684
|
|
Franchise and other revenue – related party
|
|
|
100,994
|
|
|
|
(26,014
|
)
|
|
|
(19,118
|
)
|
|
|
55,862
|
|
Total revenue
|
|
|
4,868,193
|
|
|
|
(45,264
|
)
|
|
|
(145,076
|
)
|
|
|
4,677,853
|
|
General and administrative expenses
|
|
|
720,033
|
|
|
|
—
|
|
|
|
(145,076
|
)
|
|
|
574,957
|
|
Total operating expenses
|
|
|
5,414,567
|
|
|
|
—
|
|
|
|
(145,076
|
)
|
|
|
5,269,491
|
|
Loss from operations
|
|
|
(546,374
|
)
|
|
|
(45,264
|
)
|
|
|
—
|
|
|
|
(591,638
|
)
|
Net income
|
|
|
89,550
|
|
|
|
(45,264
|
)
|
|
|
—
|
|
|
|
44,286
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Condensed Consolidated Statement of Cash Flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
89,550
|
|
|
$
|
(45,264
|
)
|
|
$
|
—
|
|
|
$
|
44,286
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred franchise fees
|
|
|
(45,264
|
)
|
|
|
45,264
|
|
|
|
—
|
|
|
|
—
|
|
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
Disaggregation of Revenue
The following table
disaggregate revenue by primary geographical market and source:
|
|
Three Months
Ended
September 30,
2018
|
|
|
Nine Months
Ended
September 30,
2018
|
|
Primary geographic markets
|
|
|
|
|
|
|
|
|
Florida
|
|
$
|
1,377,676
|
|
|
$
|
3,694,208
|
|
Georgia
|
|
|
47,050
|
|
|
|
146,009
|
|
Kentucky
|
|
|
232,744
|
|
|
|
232,744
|
|
West Virginia
|
|
|
795,232
|
|
|
|
795,232
|
|
Total revenue
|
|
$
|
2,452,702
|
|
|
$
|
4,868,193
|
|
|
|
|
|
|
|
|
|
|
Sources of revenue
|
|
|
|
|
|
|
|
|
Restaurant sales
|
|
$
|
2,197,463
|
|
|
$
|
4,076,307
|
|
Royalties
|
|
|
197,369
|
|
|
|
591,847
|
|
Franchise fees
|
|
|
7,250
|
|
|
|
45,264
|
|
Advertising fund fees
|
|
|
46,816
|
|
|
|
145,077
|
|
Other revenue
|
|
|
3,804
|
|
|
|
9,698
|
|
Total revenue
|
|
$
|
2,452,702
|
|
|
$
|
4,868,193
|
|
Contract Balances
The following table
presents changes in deferred franchise fees as of and for the nine-month period ended September 30, 2018:
|
|
Total
Liabilities
|
|
Deferred franchise fees at January 1, 2018
|
|
$
|
196,478
|
|
Revenue recognized during the period
|
|
|
(45,264
|
)
|
New deferrals due to cash received
|
|
|
—
|
|
Deferred franchise fees at September 30, 2018
|
|
$
|
151,214
|
|
Anticipated Future Recognition of Deferred
Franchise Fees
The following table
presents the estimated franchise fees to be recognized in the future related to performance obligations that were unsatisfied at
September 30, 2018:
Year
|
|
Franchise
Fees
Recognized
|
|
2018
|
|
$
|
7,250
|
|
2019
|
|
|
25,719
|
|
2020
|
|
|
24,000
|
|
2021
|
|
|
22,923
|
|
2022
|
|
|
21,000
|
|
Thereafter
|
|
|
50,322
|
|
Total
|
|
$
|
151,214
|
|
The estimated franchise fees for 2018 represent
the fees to be recognized during the remainder of the 2018 fiscal year.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
Other Receivables and Payables
Other receivables
was
comprised primarily of receipts from credit card sales by Company-owned Fat Patty’s restaurants that occurred after the Company
completed the acquisition of Fat Patty’s that were held by the former owner of Fat Patty’s, all of which are expected
to be collected in full by the Company during the next 12 months. Other payables included within accounts payable and accrued expenses
consisted of $243,261 of accounts payable owed to the former owner of Fat Patty’s for alcohol and other items purchase by
the former owner of Fat Patty’s in connection with the operation of the franchise.
Intangible Assets
The Company acquired various intangible
assets in connection with the acquisition of Fat Patty’s. Intangible assets include a tradename, an assembled workforce and
a non-compete agreement. The Company amortizes the assembled workforce and non-compete agreement on a straight-line basis over
the expected period of benefit, which is three and five years, respectively. The tradename has an indefinite life and is not subject
to amortization but tested for impairment on an annual basis. The amount of amortization recognized for the assembled workforce
and non-compete agreement was $759 during the three- and nine-month periods ended September 30, 2018.
Recent Accounting Pronouncements
In February 2016, the
FASB issued ASU 2016-02,
Leases
(“ASU 2016-02”). ASU 2016-02 requires that lease arrangements longer than
12 months result in the lessee recognizing a lease asset and liability. Leases will be classified as either finance or operating,
with classification affecting the pattern of expense recognition in the income statement. ASU 2016-02 is effective for interim
and annual periods beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact
that the adoption of ASU 2016-02 will have on its financial statements.
In November 2016, the
FASB issued ASU 2016-18,
Statement of Cash Flows: Restricted Cash
(“ASU 2016-18”). ASU 2016-18 provides guidance
on the presentation of restricted cash or restricted cash equivalents in the statement of cash flows. The guidance is effective
for interim and annual periods beginning after December 15, 2017. The adoption of ASU 2016-18 did not have a material impact on
the Company’s financial statements.
In January 2017, the
FASB issued ASU 2017-01,
Business Combinations (Topic 805): Clarifying the Definition of a Business
(“ASU
2017-01”). ASU 2017-01 provides a more robust framework to use in determining when a set of assets and activities is considered
a business. ASU 2017-01 is effective for fiscal years, and interim periods within those fiscal years, beginning after December
15, 2017. Early adoption is permitted for certain transactions. The adoption of ASU 2017-01 did not have a material impact on the
Company’s financial statements.
In
March 2018, the FASB issued ASU 2018-05,
Income Taxes (Topic 740)
(“ASU 2018-05”).
ASU 2018-05
provides guidance on accounting for the income tax effects of the Tax Cuts and Jobs Act of 2017 (the “Act”), which
impacts U.S. corporate tax rates, business-related exclusions, and deductions and credits. The Act also has tax consequences for
many companies that operate internationally. The guidance in ASU 2018-05 addresses situations in which the accounting for certain
income tax effects of the Act is incomplete by the time financial statements are issued for the reporting period that includes
the enactment date of December 22, 2017. The new guidance requires companies to report provisional amounts if a reasonable estimate
of the tax impact can be determined. If a provisional amount cannot be reasonably determined, the entity should continue to apply
ASC Topic 740 based on the provisions of the tax laws that were in effect immediately prior to the Act being enacted.
The
adoption of ASU 2018-05 did not have a material impact on the Company’s financial statements.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
The Company reviewed
all other significant newly-issued accounting pronouncements and concluded that they either are not applicable to the Company’s
operations or that no material effect is expected on the Company’s financial statements as a result of future adoption.
Note 3. Net Income Per Share
The Company calculates
basic and diluted net income per share in accordance with ASC Topic 260,
Earnings per Share
. Basic net income per share
is based on the weighted-average number of shares of the Company’s common stock outstanding during the applicable period
and is calculated by dividing the reported net income for the applicable period by the weighted-average number of shares of common
stock outstanding during the applicable period. Diluted net income per share is calculated by dividing the reported net income
for the applicable period by the weighted-average number of shares of common stock outstanding during the applicable period, as
adjusted to give effect to the exercise or conversion of all potentially dilutive securities outstanding at the end of the applicable
period.
The following table
sets forth the computation of basic and diluted net income / (loss) per share:
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
2018
|
|
|
September 30,
2017
|
|
|
September 30,
2018
|
|
|
September 30,
2017
|
|
Numerator
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income / (loss)
|
|
$
|
97,467
|
|
|
$
|
(89
|
)
|
|
$
|
89,550
|
|
|
$
|
87,675
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding — basic
|
|
|
6,524,427
|
|
|
|
6,773,041
|
|
|
|
6,795,644
|
|
|
|
6,768,839
|
|
Dilutive effect of potential shares of common stock
|
|
|
30,000
|
|
|
|
-0-
|
|
|
|
15,165
|
|
|
|
-0-
|
|
Weighted average shares outstanding – basic
|
|
|
6,554,427
|
|
|
|
6,773,041
|
|
|
|
6,810,809
|
|
|
|
6,768,839
|
|
Basic net income / (loss) per share
|
|
$
|
0.01
|
|
|
$
|
(0.00
|
)
|
|
$
|
0.01
|
|
|
$
|
0.01
|
|
Fully diluted net income / (loss) per share
|
|
$
|
0.01
|
|
|
$
|
(0.00
|
)
|
|
$
|
0.01
|
|
|
$
|
0.01
|
|
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
Note 4. Investment in Paradise on Wings
On January 20, 2014,
the Company entered into a contribution agreement with Paradise on Wings Franchise Group, LLC, a Utah limited liability company
that is the franchisor of the
Wing Nutz
®
brand of restaurants (“Paradise on Wings”). In connection
with the execution of the contribution agreement, on January 20, 2014, the Company and the incumbent members of Paradise on Wings
entered into an amended and restated operating agreement of Paradise on Wings to reflect the terms of the contribution agreement.
The transactions contemplated by the contribution agreement and operating agreement were completed on January 20, 2014.
On September 30, 2017,
the Company sold its 50% ownership interest in Paradise on Wings to Seenu G. Kasturi, the Company’s President, Chief Financial
Officer and Chairman of the Board of Directors, for $24,000.
The Company performed
a review of its investment in Paradise on Wings at the end of its 2016 fiscal year and determined that an “other-than-temporary”
decline in the value of the investment had occurred and that a loss on impairment equal to its then carrying amount of $348,143
should be recognized. Accordingly, the carrying amount of the Company’s investment in Paradise on Wings was zero at December
31, 2017 and 2016. In addition, because the carrying amount of the Company’s investment in Paradise on Wings was zero at
December 31, 2017 and 2016, the amount of the Company’s share of net loss incurred by Paradise on Wings that was recognized
by the Company during the three- and nine-month periods ended September 30, 2017 was zero.
Set
forth below is a summary of the unaudited income statement of Paradise on Wings for the three- and nine-month periods ended September
30, 2017 provided to the Company by Paradise on Wings
:
Statement of Operations
|
|
Three Months
Ended
September 30,
2017
|
|
|
Nine Months
Ended
September 30,
2017
|
|
Revenue
|
|
$
|
74,831
|
|
|
$
|
226,273
|
|
Operating expenses
|
|
|
(234,525
|
)
|
|
|
(484,436
|
)
|
Loss from operations
|
|
|
(159,694
|
)
|
|
|
(258,163
|
)
|
Other expense
|
|
|
(104,203
|
)
|
|
|
(182,398
|
)
|
Net loss
|
|
$
|
(263,897
|
)
|
|
$
|
(440,561
|
)
|
|
|
|
|
|
|
|
|
|
Company’s share of net loss
|
|
$
|
(131,949
|
)
|
|
$
|
(220,281
|
)
|
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
Set
forth below is a summary of the unaudited balance sheet of Paradise on Wings at September 30, 2017 provided to the Company by Paradise
on Wings:
Balance Sheet
|
|
September 30,
2017
|
|
Current assets
|
|
$
|
119,837
|
|
Equity investment
|
|
|
-0-
|
|
Total assets
|
|
$
|
119,837
|
|
|
|
|
|
|
Total liabilities
|
|
$
|
110,120
|
|
Equity
|
|
|
9,717
|
|
Total liabilities and equity
|
|
$
|
119,837
|
|
Note 5. Acquisition of Seediv
On December 19, 2016,
the Company entered into a membership interest purchase agreement with Seenu G. Kasturi pursuant to which the Company agreed to
acquire all of the issued and outstanding membership interests of Seediv from Mr. Kasturi. Seediv is the owner and operator of
the Nocatee and Youngerman Restaurants. The closing of the acquisition occurred simultaneously with the execution of the membership
interest purchase agreement by the Company and Mr. Kasturi on December 19, 2016.
In connection with
the acquisition of Seediv, the Company agreed to make an earnout payment to Mr. Kasturi and recorded $20,897 of contingent consideration
as the estimated initial fair value of the earnout payment. A description of the manner by which the earnout payment was valued
is set forth herein under
Note 10. Fair Value Measurements
. As of December 31, 2017, the Company calculated the earnout
payment in accordance with the provisions of the membership interest purchase agreement and determined that the earnout payment
was $199,682. The Company made a payment of $144,326 to Mr. Kasturi with respect to the earnout payment during the three- and nine-month
periods ended September 30, 2018. Accordingly, the outstanding balance of contingent consideration was $55,356 and $199,682 at
September 30, 2018 and December 31, 2017, respectively.
Note 6. Acquisition of Fat Patty’s
On August
3, 2018, the Company entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”) with CSA, Inc.,
a West Virginia corporation (“CSA”), CSA Investments, LLC, a West Virginia limited liability company
(“CSA Investments”), CSA of Teays Valley, Inc., a West Virginia corporation (“CSA Teays Valley”),
CSA, Inc. of Ashland, a Kentucky corporation (“CSA Ashland”), Fat Patty’s, LLC, a West Virginia limited
liability company (“FPLLC”), and Clint Artrip, an individual (“Artrip”; together with CSA, CSA
Investments, CSA Teays Valley, and CSA Ashland, FPLLC, the “Sellers”), pursuant to which the Company agreed to
acquire all of the assets associated with Fat Patty’s (the “Fat Patty’s Acquisition”). The Company
agreed to pay the Sellers $12,352,000 for the assets, of which $12,000,000 was to be paid to the Sellers at closing, $40,000
was to be paid to the Sellers within 10 days after the closing and the remaining $312,000 will be paid to the Sellers on the
first anniversary of the closing. The closing of the Fat Patty’s Acquisition occurred on August 30, 2018, however, as
discussed below, the Company entered into a separate related agreement with a third party that resulted in a direct transfer
of the Properties (as defined below) from the Sellers to the third party. Accordingly, in substance, the Company only
acquired the net assets detailed below for a purchase price of $852,000.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
In connection with
the Fat Patty’s Acquisition, the Company entered into a secured convertible promissory note with Seenu G. Kasturi on August
30, 2018 pursuant to which the Company borrowed $622,929 from Mr. Kasturi to help finance the Fat Patty’s Acquisition. All
principal and accrued but unpaid interest is due and payable by the Company in full on the earlier of (i) the fifth (5
th
)
anniversary of the date of the note, or (ii) the date that Mr. Kasturi demands repayment in full by providing written notice thereof
to the Company. Interest accrues at the rate of six percent (6%) per annum and is payable in full on the maturity date. Mr. Kasturi
has the right, at any time during the term of the note and from time to time, to convert all of any portion of the outstanding
principal of the note, together with accrued and unpaid interest payable thereon, into shares of the Company’s common stock
at a conversion rate of $1.36 per share. The note is secured by all of the assets of the Company.
Also
on August 3, 2018,
the Company entered into a purchase and sale agreement with Store Capital Acquisitions, LLC, a Delaware
limited liability company (“Store Capital”), pursuant to which the Company agreed to sell all of the real property
acquired in the Fat Patty’s Acquisition to Store Capital (the “Property Acquisition”). The real property consists
of the four properties upon which the restaurants acquired in the Asset Acquisition are located (collectively, the “Properties”).
Store Capital agreed to pay the Company $11,500,000 for the Properties at closing. Title to the Properties was transferred directly
from the applicable Sellers to Store Capital, and the purchase price for the Properties was paid by Store Capital directly to Sellers.
Accordingly, the Company never took title to, or ownership of, the Properties. As a result, the ultimate purchase price paid by
the Company was $852,000, which was the difference between the $12,352,000 purchase price for the assets that the Company agreed
to pay to the Sellers and the $11,500,000 purchase price for the Properties that was paid by Store Capital. The closing of the
Property Acquisition occurred on August 30, 2018.
In connection with
the Property Acquisition, the Company entered into a master lease agreement (the “Master Lease”) with Store Capital
on August 30, 2018 pursuant to which the Company leased each of the Properties from Store Capital. The initial term of the lease
expires on August 31, 2038. The Company has the option to extend the term of the lease for four additional successive periods of
five years each. The aggregate base annual rent is $876,875 and is subject to annual increases commencing September 1, 2019 in
an amount equal to the lesser of: (i) 1.75%, or (ii) 1.25 times the change in the Consumer Price Index. The Company is
responsible for all costs and obligations relating to the Properties.
The acquisition of
Fat Patty’s was accounted for as a business combination
using the acquisition method of accounting
in accordance with Accounting Standard Codification (“ASC”) 805,
Business Combinations
(“ASC 805”),
with the Company considered the acquirer of Fat Patty’s. In accordance with ASC 805, the assets acquired and the liabilities
assumed have been measured at fair value based on various preliminary estimates, with the remaining purchase price, if any, recorded
as goodwill.
For
purposes of measuring the estimated fair value, where applicable, of the assets acquired and the liabilities assumed as reflected
in the
accompanying unaudited condensed consolidated financial statements
, the guidance in ASC
820,
Fair Value Measurements and Disclosures
(“ASC 820”) has been applied, which establishes a framework for
measuring fair value. In accordance with ASC 820, fair value is an exit price and is defined as “the price that would be
received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement
date.” The Company incurred $82,929 of acquisition-related transaction costs. Under ASC 805, acquisition-related transaction
costs and acquisition-related restructuring charges are not included as components of consideration transferred but are accounted
for as expenses in the period in which the costs are incurred. Accordingly, the Company recognized $82,929 of acquisition-related
transaction costs during the three- and nine-month periods ended September 30, 2018. The acquisition-related transaction costs
were recorded in general and administrative expenses.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
The assets acquired
and liabilities assumed were comprised of the following:
Cash
|
|
$
|
7,100
|
|
Inventory
|
|
|
91,424
|
|
Intangible assets
|
|
|
844,840
|
|
Equipment
|
|
|
614,295
|
|
Total assets acquired
|
|
|
1,557,659
|
|
|
|
|
|
|
Gift card liabilities
|
|
|
(80,466
|
)
|
Total liabilities assumed
|
|
|
(80,466
|
)
|
|
|
|
|
|
Gain on bargain purchase option
|
|
|
(625,193
|
)
|
Net assets acquired with note payable and deferred compensation liability
|
|
$
|
852,000
|
|
The purchase price allocation is preliminary
as of September 30, 2018. The preliminary estimates of fair values recorded are Level 3 inputs that have been determined by management
based upon various market and income analyses and recent asset appraisals. The purchase price allocation will remain preliminary
until the Company finalizes a third-party valuation, determines the fair values of assets acquired and liabilities assumed, and
determines the actual transaction costs incurred. The final amounts allocated to assets acquired and liabilities assumed and the
transaction costs incurred could differ from the preliminary recorded amounts.
The
fair value of the identifiable assets acquired and liabilities assumed of $1,477,193 exceeded the purchase price of Fat Patty’s
by $625,193. Consequently, the Company reassessed the recognition and measurement of identifiable assets acquired and liabilities
assumed and concluded that the valuation procedures and resulting measures were appropriate. As a result, the Company recognized
a gain of $625,193 during the three- and nine-month periods ended September 30, 2018 in connection with the acquisition.
The
Sellers of Fat Patty’s received cash without any earnouts or indemnification holdbacks, which was the primary motivation
for the sale of Fat Patty’s. This was the primary reason the acquisition resulted in a bargain purchase.
The
gain was recorded in the other income in the accompanying condensed consolidated statements of operations.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
The
following table summarizes
certain financial information for the three- and nine-month periods
ended September 30, 2018 contained in the accompanying
unaudited condensed consolidated financial statements and
certain unaudited pro forma financial information for the three- and nine-month periods ended September
30, 2018 and 2017 as if the acquisition of Fat Patty’s had occurred on January 1, 2017:
|
|
Three Months
Ended
September 30,
2018
|
|
|
Nine Months
Ended
September 30,
2018
|
|
|
Three Months
Ended
September 30,
2017
|
|
|
Nine Months
Ended
September 30,
2017
|
|
Revenue
|
|
$
|
4,415,657
|
|
|
$
|
12,720,014
|
|
|
$
|
3,964,788
|
|
|
$
|
11,980,207
|
|
Income from continuing operations
|
|
|
(13,051
|
)
|
|
|
1,256,629
|
|
|
|
168,493
|
|
|
|
149,061
|
|
Net income
|
|
|
548,218
|
|
|
|
1,892,553
|
|
|
|
186,352
|
|
|
|
646,998
|
|
Net income per share – basic
|
|
$
|
0.08
|
|
|
$
|
0.28
|
|
|
$
|
0.03
|
|
|
$
|
0.10
|
|
Net income per share – fully diluted
|
|
$
|
0.08
|
|
|
$
|
0.28
|
|
|
$
|
0.03
|
|
|
$
|
0.10
|
|
The results of operations
for Fat Patty’s were included in the Company's results of operations beginning August 30, 2018. The actual amounts of revenue
and net income for Fat Patty’s that are included in the Company’s condensed consolidated statements of operations for
the three- and nine-month periods ended September 30, 2018 were $1,027,976 and $52,077, respectively.
The unaudited pro forma
financial information has been presented for informational purposes only and
is not necessarily
indicative of the actual results that would have occurred had the acquisition been consummated on January 1, 2017 or of the future
results of the combined entities
. For additional information about the Company’s acquisition of Fat Patty’s,
please refer to the Company’s Current Reports on Form 8-K filed with the Securities and Exchange Commission on August 9,
2018 and September 5, 2018.
Note 7. Inventory
Inventory was comprised
of the following at September 30, 2018 and December 31, 2017, respectively:
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
Food
|
|
$
|
89,334
|
|
|
$
|
23,987
|
|
Beverages
|
|
|
50,300
|
|
|
|
21,430
|
|
Total
|
|
$
|
139,634
|
|
|
$
|
45,417
|
|
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
Note 8. Property and Equipment, Net
Property and equipment,
including capital lease assets, were comprised of the following at September 30, 2018 and December 31, 2017, respectively:
|
|
September 30,
2018
|
|
|
December 31,
2017
|
|
Land, buildings and improvements
|
|
$
|
11,500,000
|
|
|
$
|
-0-
|
|
Leasehold improvements
|
|
|
295,133
|
|
|
|
69,472
|
|
Furniture, fixtures and equipment
|
|
|
823,282
|
|
|
|
78,621
|
|
Subtotal
|
|
|
12,618,415
|
|
|
|
148,093
|
|
Less: accumulated depreciation
|
|
|
(120,110
|
)
|
|
|
(48,979
|
)
|
Total
|
|
$
|
12,498,305
|
|
|
$
|
99,114
|
|
The land, buildings and improvements of
$11,500,000 at September 30, 2018 consisted of gross assets acquired on the capital lease with related depreciation expense and
accumulated depreciation of $24,000. Depreciation expense was $49,481 and
$68,688
during the
three- and nine-month periods ended September 30, 2018, respectively, and w
as
$4,571 and $11,902
during the three- and nine-month periods
ended September 30, 2017
.
Note 9. Intangible Assets
The Company acquired
various intangible assets in connection with the acquisition of Fat Patty’s. Intangible assets include a tradename valued
at $810,000, an assembled workforce valued at $15,556 and a non-compete agreement valued at $18,526 at September 30, 2018. The
Company did not have any intangible assets at December 31, 2017. The Company amortizes the assembled workforce and non-compete
agreement on a straight-line basis over the expected period of benefit, which is three and five years, respectively. The tradename
has an indefinite life and is not subject to amortization but tested for impairment on an annual basis. The amount of amortization
recognized for the assembled workforce and non-compete agreement was $759 during the three- and nine-month periods ended September
30, 2018.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
The following table
presents the future amortization expense to be recognized from the Company’s intangible assets at September 30, 2018:
Year
|
|
Amortization
Expense to be
Recognized
|
|
2018
|
|
$
|
2,275
|
|
2019
|
|
|
9,101
|
|
2020
|
|
|
9,101
|
|
2021
|
|
|
7,324
|
|
2022
|
|
|
3,768
|
|
Thereafter
|
|
|
2,512
|
|
Total
|
|
$
|
34,081
|
|
The amortization expense to be recognized
for 2018 represent the expenses to be recognized during the remainder of the 2018 fiscal year.
Note 10. Fair Value Measurements
On
January 20, 2014, the Company purchased a 50% ownership interest in Paradise on Wings. On December 19, 2016, the Company acquired
all of the issued and outstanding membership interests of Seediv. A description of the investment in Paradise on Wings and the
acquisition of Seediv is set forth herein under
Note 4. Investment in Paradise on Wings
and
Note 5. Acquisition of Seediv
,
respectively.
On September 30, 2017, the Company sold
its 50% ownership interest in Paradise on Wings to Seenu G. Kasturi for $24,000. Paradise on Wings incurred a loss of $440,561
during the period beginning January 1, 2017 and ending September 30, 2017. As a result, the carrying amount of the Company’s
investment in Paradise on Wings was zero at September 30, 2017.
In connection with
the acquisition of Seediv, the Company agreed to pay contingent consideration in the form of an earn-out payment. The Company determined
that the fair value of the liability for the contingent consideration was estimated to be $20,897 at the acquisition date. The
Company determined the fair value of the contingent consideration based on a probability-weighted approach derived from earn-out
criteria estimates and a probability assessment with respect to the likelihood of achieving the earn-out criteria. The measurement
was based upon significant inputs not observable in the market, including internal projections and an analysis of the target markets.
The resultant probability-weighted contingent consideration was discounted using a discount rate based upon the weighted-average
cost of capital.
At each reporting date,
the Company revalues the contingent consideration to the reporting date fair value and records increases and decreases in the fair
value as income or expense under general and administrative expenses in the Company’s condensed consolidated statements of
operations. Increases or decreases in the fair value of the contingent consideration may result from, among other things, changes
in discount periods and rates, changes in the timing and amount of earn-out criteria, and changes in probability assumptions with
respect to the likelihood of achieving the various earn-out criteria.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
As of December 31,
2017, the Company calculated the earnout payment in accordance with the provisions of the membership interest purchase agreement
and determined that the earnout payment was $199,682. The Company recognized additional Seediv compensation expense in the amount
of $178,785 in connection with the earnout payment and the liability for the contingent consideration was increased by $178,785
to $199,682 at December 31, 2017. The Company made payments in the amount of $144,326 to Mr. Kasturi with respect to the earnout
payment during the nine-month period ended September 30, 2018. Accordingly, the outstanding balance of contingent consideration
was $55,356 and $199,682 at September 30, 2018 and December 31, 2017, respectively.
The following table
presents the contingent consideration recorded by the Company in connection with the acquisition of Seediv within the fair value
hierarchy utilized to measure fair value on a recurring basis at September 30, 2018 and December 31, 2017, respectively:
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
September 30, 2018
|
|
$
|
-0-
|
|
|
$
|
55,356
|
|
|
$
|
-0-
|
|
December 31, 2017
|
|
$
|
-0-
|
|
|
$
|
199,682
|
|
|
$
|
-0-
|
|
The earnout payment
was to be calculated based on the earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the
Nocatee and Youngerman Restaurants during the year ended December 31, 2017. As of December 31, 2017, the EBITDA for the Nocatee
and Youngerman Circle Restaurants was utilized to compute the ending contingent consideration liability. As a result, the fair
value measurement of the contingent consideration represented a Level 2 fair value measurement at September 30, 2018 and December
31, 2017 because it was based on other significant observable inputs.
The Company’s
other financial instruments consist of cash and cash equivalents, accounts and ad fund receivables, notes receivable, capital lease
assets and liabilities, accounts payable, accrued expenses and notes payable. The estimated fair values of the cash and cash equivalents,
accounts and ad fund receivables, notes receivable, accounts payable, accrued expenses and notes payable (and the related beneficial
conversion feature associated with the notes payable) approximate their respective carrying amounts due to the short-term maturities
of these instruments. The estimated fair value of the capital lease obligation approximated its carrying amount as the interest
rate is implicit in the underlying lease.
Note 11. Notes Receivable
In September 2014, the Company made a loan
to one of its franchisees in the aggregate original principal amount of $6,329. The loan was for a term of three years, was payable
in monthly installments, and did not require the payment of any interest. A total of $25 of principal was outstanding under the
loan at December 31, 2017. The loan was paid off in full during the nine-month period ended September 30, 2018.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
In June 2016, the Company
made a loan to one of its franchisees under a promissory note in the aggregate original principal amount of $25,000. In July 2016,
the Company made an additional loan to the same franchisee under a line of credit agreement for an aggregate original principal
amount of up to $28,136. In September 2016, the Company made an additional loan to the same franchisee under a second line of credit
agreement for an aggregate original principal amount of up to $25,000. The loan under the promissory note is for a term of two
years, is payable in monthly installments beginning January 1, 2017, and accrues interest at a rate of 5% per annum beginning September
1, 2016. The loan under the $28,136 line of credit agreement was for a term of two years, was payable in monthly installments beginning
January 1, 2017, and did not require the payment of any interest. The loan was repaid in full during the year ended December 31,
2017. The loan under the $25,000 line of credit agreement is for a term of two years, is payable in monthly installments beginning
January 1, 2017 and accrues interest at a rate of 5% per annum beginning October 1, 2016. A total of $6,858 and $25,944 of principal
was outstanding under the loans at September 30, 2018 and December 31, 2017, respectively.
Interest
in the aggregate amount of $139 and $657 accrued and was paid in full under the loans during the three- and nine-month periods
ended September 30, 2018, respectively. Interest in the aggregate amount of $425 and $1,515 accrued under the loans
during the three- and nine-month periods ended September 30, 2017, respectively, and payments of interest in the aggregate amount
of $425 and $2,354 were made under the loans during the three- and nine-month periods ended September 30, 2017.
No accrued
interest was outstanding under the loans at September 30, 2018 or December 31, 2017.
In October 2017, the
Company made a loan to one of its franchisees in the aggregate original principal amount of $7,659. The loan is due and payable
in full on December 1, 2020, is payable in monthly installments beginning January 1, 2018, and does not require the payment of
any interest. The full amount of the loan was outstanding on December 31, 2017. A total of $5,745 and $7,659 of principal was outstanding
under the loan at September 30, 2018 and December 31, 2017, respectively
.
The carrying value of the Company’s
outstanding notes receivable was $12,603 and $33,628 at September 30, 2018 and December 31, 2017, respectively, all of which was
due from unrelated third parties. Of these amounts, $9,412 and $3,191 were classified as short-term and long-term notes receivable,
respectively, at September 30, 2018, and $28,522 and $5,106 were classified as short-term and long-term notes receivable, respectively,
at December 31, 2017. The Company generated interest income of
$425 and $1,515
during the
three- and nine-month periods ended September 30, 2018, and
generated interest income of $543 and $1,931
during the three- and nine-month periods ended September 30, 2017
. The Company did not have any interest receivable outstanding
at September 30, 2018 or December 31, 2017.
Note 12. Debt Obligations
As
of December 31, 2016, the Company had principal in the amount of $16,103 outstanding under its credit facility with Blue Victory
Holdings, Inc., a Nevada corporation (“Blue Victory”), and repaid $824,250 under the credit facility. During the year
ended December 31, 2017, the Company borrowed $61,721 under the credit facility and repaid $77,824 to Blue Victory under the credit
facility. The Company did not borrow any funds under the credit facility during the nine-month period ended September 30, 2018.
Accordingly, there was no principal outstanding under the credit facility at September 30, 2018 or December 31, 2017.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
During the year ended
December 31, 2017, the Company borrowed
$372,049 from Blue Victory and repaid $341,546 to
Blue Victory under a separate loan.
Accordingly, the amount of principal outstanding under the loan was $30,503 at December
31, 2017. The Company borrowed $23,481 under the loan during the nine-month period ended September 30, 2018. Accordingly, the amount
of principal outstanding under the loan was $53,984 at September 30, 2018.
The loan accrues
interest at a rate of 6% per annum and is payable on demand
.
On August 30, 2018,
the Company entered into a secured convertible promissory note with Seenu G. Kasturi pursuant to which the Company borrowed $622,929
to help finance the Fat Patty’s Acquisition. All principal and accrued but unpaid interest is due and payable by the Company
in full on the earlier of (i) the fifth (5
th
) anniversary of the date of the note, or (ii) the date that Mr. Kasturi
demands repayment in full by providing written notice thereof to the Company. Interest accrues at the rate of six percent (6%)
per annum and is payable in full on the maturity date. Mr. Kasturi has the right, at any time during the term of the note and from
time to time, to convert all of any portion of the outstanding principal of the note, together with accrued and unpaid interest
payable thereon, into shares of the Company’s common stock at a conversion rate of $1.36 per share. The note is secured by
all of the assets of the Company. At the date of the financing, because the effective conversion rate of the convertible note was
less than the market value of the Company’s common stock, a beneficial conversion feature of $155,732 was recorded as a discount
to the convertible note and an increase to additional paid in capital.
The carrying value
of the Company’s outstanding promissory notes, net of unamortized discount of $153,136 and excluding capital lease obligations,
was $523,777 and $30,503 at September 30, 2018 and December 31, 2017, respectively.
Note 13. Capital Stock
The Company’s
authorized capital consisted of 100,000,000 shares of Class A common stock, par value $0.01 per share, at September 30, 2018 and
December 31, 2017, of which 6,524,427 and 6,950,869 shares of common stock were outstanding at September 30, 2018 and December
31, 2017, respectively, and consisted of 1,000,000 and -0- shares of Series A convertible preferred stock, par value $0.01 per
share, at September 30, 2018 and December 31, 2017, respectively, of which
449,581 and -0- shares
were
outstanding at September 30, 2018 and December 31, 2017, respectively.
On January 1, 2018, Mr. Kasturi earned
9,337 shares of the Company’s common stock pursuant to the terms of his employment agreement with the Company.
The
Company recognized $147 of stock compensation expense during the nine-month period ended September 30, 2018 in connection with
the vesting of the shares of common stock earned by Mr. Kasturi on January 1, 2018. The Company also recognized $13,500 of stock
compensation expense during the nine-month period ended September 30, 2018, respectively, in connection with the vesting of 9,660
shares of common stock earned by Mr. Kasturi on April 1, 2018 pursuant to the terms of his employment agreement with the Company,
and recognized $148 and $13,500 of stock compensation expense during the three- and nine-month periods ended September 30, 2018,
respectively, in connection with the vesting of 7,064 shares of common stock to be earned by Mr. Kasturi on July 1, 2018 pursuant
to the terms of his employment agreement with the Company.
The Company also recognized $13,353 of stock compensation expense
during the three- and nine-month periods ended September 30, 2018
in connection with the
vesting of 7,414 shares of common stock earned by Mr. Kasturi on October 1, 2018.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
In
January 2018, the Company issued a total of 5,625 shares of its common stock to certain of its franchisees as incentive compensation.
The shares were valued at a price per share equal to the closing price of the Company’s common stock on the OTCQB on the
date of grant. The Company recognized $9,000 of stock compensation expense in connection therewith during the nine-month period
ended September 30, 2018
.
In June 2018, the Company’s
Board of Directors created Series A convertible preferred stock and authorized 1,000,000 shares of Series A convertible preferred
stock, par value $0.01 per share, for issuance. Each share of Series A convertible preferred stock is entitled to 100 votes per
share and is convertible into one share of the Company’s common stock at a conversion price of $0.75 per share of common
stock. The conversion price may be paid in cash, through a reduction in the number of shares of common stock received, or by other
methods approved by the Board of Directors. In the event any shares of the Series A convertible preferred stock are transferred
by the holder thereof, such shares immediately and automatically convert into shares of common stock with the conversion price
being paid by the recipient through a reduction in the number of shares of common stock received. The Series A convertible preferred
stock is treated
pari passu
with the common stock in all other respects.
In
May 2018, the
Company issued a stock option to an employee that is exercisable into 30,000 shares of common stock. The shares
were valued on the date of grant by using the Black-Scholes pricing model. The Company recognized $3,752 and $5,628 of stock compensation
expense during the three- and nine-month periods ended September 30, 2018 in connection with the vesting of the option.
In
May 2018, the Company provided an employee with the right to receive $33,000 in cash or 20,000 shares of shares of the Company’s
common stock on May 15, 2021. The shares were valued at a price per share equal to the closing price of the Company’s common
stock on the OTCQB on the date of grant and remeasured as of September 30, 2018. In accordance with
ASC Topic 718,
Compensation – Stock Compensation
, as the employee is able to settle the right in
either cash or common stock, the Company recognized $2,501 and $3,752 of stock compensation expense in connection therewith during
the three- and nine-month periods ended September 30, 2018 and recorded a corresponding liability which has been recorded in accounts
payable and accrued expenses within the Company’s condensed consolidated balance sheets
.
In June 2018, the Company
entered into a securities purchase agreement with Seenu G. Kasturi pursuant to which the Company issued Mr. Kasturi 449,581 shares
of Series A convertible preferred stock in exchange for 449,581 shares of common stock held by Mr. Kasturi. Upon receipt of the
shares of common stock from Mr. Kasturi, the shares were retired and restored to the status of authorized and unissued shares of
common stock. Accordingly, the number of shares of common stock outstanding immediately after the transaction was completed decreased
from 6,974,008 shares to 6,524,427 shares. No expense was recognized by the Company during the nine-month period ended September
30, 2018 in connection with the transaction.
In
August 2018, the Company entered into an agreement with a firm to provide investor relations services to the Company. Under the
terms of the agreement, the Company agreed to pay the firm $12,250 and issue 3,500 shares of common stock to the firm upon the
execution of the agreement as compensation for services to be performed during the months of August and September 2018. The Company
agreed to pay the firm $7,000 and issue 3,500 shares of common stock each month thereafter during the remainder of the term of
the agreement. The Company recognized $5,250 of stock compensation expense during the three- and nine-months periods ended September
30, 2018 in connection with the issuance of the shares 3,500 shares.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
In
September 2018, the Company entered into an agreement with Maxim Group LLC (“Maxim”) to provide investment banking
and mergers and acquisition services to the Company for a term of one year. Under the terms of the agreement, the Company agreed
to pay Maxim $7,500 per month during the term of the agreement and issue 125,000 shares of common stock to Maxim upon the execution
of the agreement. The Company recognized $240,625 of stock compensation expense during the three- and nine-months periods ended
September 30, 2018 in connection with the issuance of the shares.
The
Company recognized a total of $265,629 and $303,503 for stock compensation expense during the three- and nine-month periods ended
September 30, 2018, respectively, and recognized a total of
$26,889 and $233,740
for stock
compensation expense during the three- and nine-month periods ended September 30, 2017, respectively. The Company had a total of
$290,603 and $26,853 of stock subscription payable outstanding at September 30, 2018 and December 31, 2017, respectively.
Note 14. Stock Options and Warrants
The Company issued
one stock option during the nine-month period ended September 30, 2018. The stock option is exercisable into 30,000 shares of common
stock at an exercise price of $1.49 and vests in three equal annual installments commencing on the first anniversary of the date
of issuance. The shares were valued on the date of grant by using the Black-Scholes pricing model in accordance with the provisions
of ASC Topic 718,
Compensation – Stock Compensation
. This stock option was the only stock option outstanding at September
30, 2018. The Company did not issue any warrants exercisable into shares of the Company’s common stock during the three-
and nine-month periods ended September 30, 2018, no warrants were exercised during the three- and nine-month periods ended September
30, 2018, and there were no warrants outstanding at September 30, 2018.
The Company did not
issue any stock options or warrants exercisable into shares of the Company’s common stock during the three- and nine-month
periods ended September 30, 2017, and no stock options or warrants were exercised during the three- and nine-month periods ended
September 30, 2017. There were no stock options or warrants outstanding at September 30, 2017.
Note 15. Commitments and Contingencies
Operating Leases
Company Headquarters
In January 2015, the
Company entered into a lease with Crescent Hill Office Park for its corporate headquarters located at
6327-4
Argyle Forest Boulevard, Jacksonville, Florida pursuant to which the Company leases approximately
1,500 square feet of space.
The lease provides for an initial monthly rent payment of $1,806 and expired on December 31, 2017, at which time it converted to
a month-to-month lease.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
In January 2018, the
Company entered into a new lease with Crescent Hill Office Park for its corporate headquarters located at
6327-4
Argyle Forest Boulevard, Jacksonville, Florida pursuant to which the Company leases approximately
1,500 square feet of space.
The lease provides for an initial monthly rent payment of $2,063 and continues in place on a month-to-month basis until either
party provides 60 days advance written notice of their intent to terminate the lease.
Nocatee
Restaurant
In
October 2013,
DWG Acquisitions entered into a triple net shopping center lease with NTC-REG, LLC (“NTC-REG) for the
Nocatee Restaurant pursuant to which DWG Acquisitions leased approximately 2,900 square feet of space. The lease provides for an
initial monthly rent payment of $1,100 and an additional annual rent payment equal to the amount by which 6% of the restaurant’s
annual gross sales exceeds the aggregate monthly rent payments accrued during the applicable year. The lease has an initial term
of 53 months and provides DWG Acquisitions with an option to extend the lease by an additional term of 60 months. The lease was
assumed by Seediv when Seediv acquired all of the assets and liabilities associated with the Nocatee and Youngerman Circle Restaurants
from DWG Acquisitions pursuant to the terms of that certain Asset Purchase Agreement, dated December 1, 2016, by and between Seediv
and DWG Acquisitions (the “Asset Purchase Agreement”).
On April 1, 2017, DWG
Acquisitions, Seediv and NTC-REG entered into an assignment and assumption & first modification to lease agreement for the
Nocatee Restaurant. Under the agreement, DWG Acquisitions assigned all of its right, title, interest and claim in and to the Nocatee
Lease, and Seediv assumed the payment and performance of all obligations, liabilities and covenants of DWG Acquisitions under the
lease for the Nocatee Restaurant. In addition, the parties amended certain terms of the lease to state that the lease covers approximately
3,400 square feet of space, to extend the term of the lease for a 60-month period commencing on April 1, 2018 and expiring March
31, 2023, and to change the rent payments to an initial monthly rent payment of $6,830 without an additional annual rent payment.
Youngerman Circle Restaurant
In
May 2014,
DWG Acquisitions entered into a triple net lease with Raceland QSR, which is a related party, for the Youngerman
Circle Restaurant pursuant to which DWG Acquisitions leased approximately 6,500 square feet of space. The lease provides for a
monthly rent payment equal to 7% of the restaurant’s monthly net sales. The lease has an initial term of 10 years and renews
automatically for additional one-year terms unless prior written notice is provided by either party. The lease was assumed by Seediv
when Seediv acquired all of the assets and liabilities associated with the Nocatee and Youngerman Circle Restaurants from DWG Acquisitions
pursuant to the terms of the Asset Purchase Agreement.
On December 20, 2016,
Seediv entered into a new triple net lease with Raceland QSR for the Youngerman Circle Restaurant. The lease provides for rent
payments to be made by the Company for each of 13 rent periods per year, with each rent period comprised of four weeks. The lease
provides for an initial base rent payment equal to the greater of: (i) $10,000 per rent period, or (ii) 7.5% of the Youngerman
Circle Restaurant’s net sales for the applicable rent period. Commencing on the fifth (5
th
) anniversary and continuing
every five years thereafter, the base rent will be equal to the sum of: (i) the average base rent previously in effect for the
preceding five-year period, and (ii) the product of such previous average base rent multiplied by 7.5%. The lease has an initial
term of 20 years and provides the Company with an option to extend the lease for two additional five-year periods. The Company
agreed to guarantee Seediv’s payment and performance of all of its obligations under the lease.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
Rent expense under
the Company’s operating leases was $57,713 and $182,293 during the three- and nine-month periods ended September 30, 2018,
respectively, and was
$98,748 and $205,220 during the three- and nine-month periods ended September
30, 2017, respectively.
Capital Leases
On August 30, 2018,
the Company entered into the Master Lease. The initial term of the lease expires on August 31, 2038. The Company has the option
to extend the term of the lease for four additional successive periods of five years each. The aggregate base annual rent is $876,875
and is subject to annual increases commencing September 1, 2019 in an amount equal to the lesser of: (i) 1.75%, or (ii) 1.25
times the change in the Consumer Price Index. The Company is responsible for all costs and obligations relating to the Properties.
The Company determined
that the Master Lease is a capital lease. The Company recorded a capital lease asset and capital lease obligation of $11,500,000
in its condensed consolidated balance sheets that was equal to the present value of the Company’s future minimum leaseback
payments.
The outstanding balance of the capital lease obligation was
$11,413,326
at September 30, 2018, of which $171,411 represented the short-term portion of the capital lease obligation and $11,241,915 represented
the long-term portion of the capital lease obligation
.
The following table
presents the future annual minimum lease payments to be recognized under the capital lease at September 30, 2018:
Year
|
|
Future
Minimum
Lease
Payments
|
|
2018
|
|
$
|
146,146
|
|
2019
|
|
|
881,990
|
|
2020
|
|
|
897,425
|
|
2021
|
|
|
913,130
|
|
2022
|
|
|
929,110
|
|
Thereafter
|
|
|
16,869,402
|
|
Total
|
|
|
20,637,203
|
|
Less: portion representing interest
|
|
|
(9,223,877
|
)
|
Present value of lease payments
|
|
$
|
11,413,326
|
|
The future annual minimum lease payments
to be recognized for 2018 represent the payments to be recognized during the remainder of the 2018 fiscal year.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
The following table
presents the future obligations under the capital lease at September 30, 2018:
Year
|
|
Lease
Obligation
Recognized
|
|
2018
|
|
$
|
27,416
|
|
2019
|
|
|
175,764
|
|
2020
|
|
|
202,944
|
|
2021
|
|
|
232,148
|
|
2022
|
|
|
263,512
|
|
Thereafter
|
|
|
10,511,542
|
|
Total
|
|
$
|
11,413,326
|
|
The capital lease obligation for 2018 represents
the obligation to be recognized during the remainder of the 2018 fiscal year.
The land, buildings and improvements of
$11,500,000 included within property and equipment in
Note 8. Property and Equipment, Net
at September 30, 2018 consisted
of gross assets acquired on the capital lease.
The gross amount of all future payments under the lease
was $20,637,203 at September 30, 2018, of which $9,223,877 was for interest.
Depreciation
expense and accumulated depreciation were approximately $24,000 during the three- and nine-month periods ended September 30, 3018.
Interest expense was $59,471 during the three- and nine-month periods ended September 30, 2018. No depreciation or interest expense
was recognized during three- and nine-month periods ended September 30, 2017.
Note 16. Related-Party
Transactions
During the year ended
December 31, 2017, the Company borrowed
$372,049 from Blue Victory and repaid $341,546 to
Blue Victory under a separate loan.
Accordingly, the amount of principal outstanding under the loan was $30,503 at December
31, 2017. The Company borrowed $23,481 under the loan during the nine-month period ended September 30, 2018. Accordingly, the amount
of principal outstanding under the loan was $53,984 at September 30, 2018.
The loan accrues
interest at a rate of 6% per annum and is payable on demand
. Seenu G. Kasturi was appointed President, Chief Financial Officer
and Chairman of the board of directors of the Company in January 2017. He owned approximately 17% of the Company’s common
stock, all of the Company’s Series A convertible preferred stock, and 90% of the equity interests in Blue Victory at September
30, 2018. He also served as the President, Treasurer and Secretary, and as the sole member of the board of directors, of Blue Victory
during the nine-month period ended September 30, 2018 and the year ended December 31, 2017.
The Company generated
a total of $23,256 and $100,994 in royalties and franchise fees through its franchise agreements with DWG Acquisitions during the
three- and nine-month periods ended September 30, 2018, respectively, and generated a total of
$40,285
and $123,343
in royalties and franchise fees through its franchise agreements with DWG Acquisitions during the three-
and nine-month periods ended September 30, 2017, respectively.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
The Company had a total
of $891 and $1,505 of accounts receivable outstanding from DWG Acquisitions at September 30, 2018 and December 31, 2017, respectively,
and had a total of $1,761 and $2,280 of ad funds receivable outstanding from DWG Acquisitions at September 30, 2018 and December
31, 2017, respectively. The Company had a total of $100,892 and $94,150 for accounts payable and accrued expenses outstanding from
DWG Acquisitions and certain of its employees at September 30, 2018 and December 31, 2017, respectively. The outstanding amounts
were primarily for rent owed to DWG Acquisitions and other expenses owed to the employees.
Note 17. Judgments in Legal Proceedings
In October 2009, the
Company initiated a legal proceeding entitled
American Restaurant Concepts, Inc. vs. Cala, et al
was filed in in the United
States District Court for the Middle District of Florida, Jacksonville Division, in Duval County (the “ARC Proceeding”).
In the complaint, the Company alleged damages for trademark infringement. Also on that date, a legal proceeding entitled
Cala
v. Rosenberger et al.
was filed with the Fourth Judicial Circuit Court in and for Duval County, Florida (the “Cala Proceeding”;
together with the ARC Proceeding, the “ARC & Cala Proceedings”). In the complaint, Cala alleged damages for breach
of contract. In January 2010, the parties to each of the actions entered into a settlement agreement with respect to both actions
pursuant to which the Company agreed to pay $250,000 in full settlement of the legal proceedings (the “2010 Settlement Agreement”).
In early 2010, Cala breached the terms of the 2010 Settlement Agreement, relieving the Company of any further obligations under
the agreement. The Company made total payments of $40,000 under the 2010 Settlement Agreement prior to the breach by Cala. Accordingly,
the remaining balance of $210,000 outstanding under the settlement agreement was reflected in settlement agreements payable.
In August 2016, the
Company entered into a full and final settlement and release agreement with Cala. Under the terms of the agreement, the Company
and Cala agreed to release each other from all claims related to the ARC & Cala Proceedings, any and all other lawsuits that
may have been filed by one party against the other, the 2010 Settlement Agreement, and any other matters, causes of action or claims
either party may have had against the other. In consideration for the releases, the Company agreed to pay $15,000 to Cala and issue
35,000 shares of its common stock to Cala. The Company recognized a non-cash gain on settlement of liabilities of $175,449 in connection
therewith during the year ended December 31, 2016. The remaining balance of $210,000 outstanding under the 2010 Settlement Agreement
was debited to settlement agreements payable.
On February
25, 2011, a legal proceeding entitled
Duval Station Investment, LLC vs. Hot Wing Concepts, Inc. d/b/a Dick’s Wings
and Grill, and American Restaurant Concepts, Inc.
was filed with the Fourth Judicial Circuit Court in and for Duval
County, Florida. In the complaint, the plaintiff alleged damages for breach of guaranty. On October 4, 2011, a final judgment
was entered by the court in favor of the plaintiff in the amount of $161,747, and on November 11, 2011 a final judgment
for attorneys’ fees and costs was entered in favor of the plaintiff in the amount of $33,000. These judgments,
together with accrued interest of $2,369 thereon, resulted in a total loss from legal proceedings of $197,116 during the year
ended December 25, 2011. The Company had not paid any part of the judgment or the accrued interest thereon. As a result, the
loss was reflected in settlement agreements payable at September 30, 2018 and December 31, 2017. Interest expense in the
amount of $2,841 accrued on the outstanding balance of the settlement agreement payable during the three-month periods ended
September 30, 2018 and 2017, respectively, and interest expense in the amount of $8,431 accrued on the outstanding balance of
the settlement agreement payable during the nine-month periods ended September 30, 2018 and 2017, respectively. The
interest expense was credited to settlement agreements payable. The Company had accrued interest of $78,681 and $70,250
outstanding at September 30, 2018 and December 31, 2017, respectively. The outstanding judgment and legal fees in the amount
of $194,747 along with the accrued interest of $78,681 totaled $273,428 as of September 30, 2018. The outstanding judgment
and legal fees in the amount of $194,747 along with the accrued interest of $70,250 totaled $264,997 at December 31, 2017.
ARC Group, Inc.
Notes to Condensed Consolidated Financial
Statements (Unaudited)
In January 2015, Santander
Bank filed a complaint against the Company in the Circuit Court, Fourth Judicial Circuit in and for Duval County, Florida, seeking
damages of $194,181 plus interest, costs and attorney’s fees for breach of a guaranty of certain obligations of Ritz Aviation,
LLC (“Ritz Aviation”) under a promissory note executed by Ritz Aviation in July 2005. During the Company’s fourth
fiscal quarter of 2016, Santander Bank informed the Company that certain assets of Ritz Aviation had been sold for $82,642 and
that the proceeds from the sale were applied towards the balance of the damages being sought, resulting in an outstanding balance
of damages sought of $111,539. A total of $39,665 and $33,809 of accrued interest, and $10,586 of other expenses, were outstanding
at September 30, 2018 and December 31, 2017, respectively, resulting in an aggregate potential loss of $161,790 and $155,935 at
September 30, 2018 and December 31, 2017, respectively. The potential losses of $161,790 and $155,935 were reflected in accrued
legal contingency at September 30, 2018 and December 31, 2017, respectively. This case is currently pending.
Note 18. Subsequent Events
On October 1, 2018,
Seenu G. Kasturi earned 7,414 shares of the Company’s common stock pursuant to the terms of his employment agreement with
the Company.
On October 30, 2018, the Company entered
into a Membership Interest Purchase Agreement (the “Purchase Agreement”) with SDA Holdings, LLC, a Louisiana limited
liability company (“SDA”), and Fred D. Alexander, an individual, pursuant to which the Company agreed to acquire all
of the issued and outstanding membership interests in SDA for $10.00. SDA is the owner of the
Tilted Kilt Pub & Eatery
®
restaurant franchise. The transactions contemplated by the Purchase Agreement are sometimes referred to herein collectively as
the “Tilted Kilt Acquisition”.
The closing of the
Tilted Kilt Acquisition is conditioned upon SDA, Trustee Services Group (the “Custodian”), Seenu G. Kasturi, Let’s
Eat Incorporated (“Let’s Eat”), the Reilly Group, LLC (the “Reilly Group”) and John Reynauld (Mr.
Reynauld, together with the Custodian, Mr. Kasturi, Let’s Eat, the Reilly Group, the “Parties”) entering into
an amendment to that certain Custodian Agreement, dated June 7, 2018, by an among the Parties to add SDA as a party to the agreement
and remove Mr. Kasturi as a party to the agreement, in which event SDA will be required to deliver to the Custodian a certificate
evidencing 718,563 shares of the Company’s common stock. The closing of the Tilted Kilt Acquisition is also conditioned upon
the Company raising gross proceeds of at least $2,000,000 through the sale of debt or equity securities, as well as other customary
closing conditions. The closing of the Tilted Kilt Acquisition will occur once all of the closing conditions have been satisfied.
SPECIAL NOTE REGARDING FORWARD-LOOKING
STATEMENTS
This report contains
“forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities
Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements
other than statements of historical facts included or incorporated by reference in this report, including, without limitation,
statements regarding our future financial position, business strategy, budgets, projected revenue and costs, and plans and objectives
of management for future operations, are forward-looking statements. In addition, forward-looking statements generally can be identified
by the use of forward-looking terminology such as “may,” “will,” “expects,” “intends,”
“plans,” “projects,” “estimates,” “anticipates,” or “believes” or the
negative thereof or any variation thereon or similar terminology or expressions.
We have based these forward-looking
statements on our current expectations and projections about future events. These forward-looking statements are not guarantees
and are subject to known and unknown risks, uncertainties and assumptions that may cause our actual results to differ materially
from results proposed in such statements. Although we believe that the expectations reflected in such forward-looking statements
are reasonable, we can give no assurance that such expectations will prove to have been correct. Important factors that could cause
actual results to differ materially from our expectations include, but are not limited to:
|
·
|
our ability to fund our future growth and implement our business strategy;
|
|
·
|
market acceptance of our restaurants and products;
|
|
·
|
food safety issues and other health concerns;
|
|
·
|
the cost of food and other commodities;
|
|
·
|
labor shortages and changes in employee compensation costs;
|
|
·
|
shortages or interruptions in the availability and delivery of food and other supplies;
|
|
·
|
our ability to maintain and increase the value of our
Dick’s Wings
®
and
Fat Patty’s
®
brands;
|
|
·
|
changes in consumer preferences;
|
|
·
|
our ability to identify, attract and retain qualified franchisees;
|
|
·
|
our limited control over the activities of our franchisees;
|
|
·
|
the ability of us and our franchisees to identify suitable restaurant sites, open new restaurants
and operate them in a profitable manner;
|
|
·
|
our ability to successfully operate our company-owned restaurants;
|
|
·
|
our ability to identify, acquire and integrate new restaurant brands and businesses;
|
|
·
|
the loss of key members of our management team;
|
|
·
|
the impact of any failure of our information technology system or any breach of our network security;
|
|
·
|
the impact of security breaches of confidential customer information in connection with the electronic
processing of credit/debit card transactions by us and our franchisees;
|
|
·
|
the ability of us and our franchisees to comply with applicable federal, state and local laws and
regulations;
|
|
·
|
our ability to protect our trademarks and other intellectual property;
|
|
·
|
competition and consolidation in the restaurant industry;
|
|
·
|
the effects of litigation on our business;
|
|
·
|
our ability to obtain debt, equity or other financing on favorable terms, or at all;
|
|
·
|
the impact of any decision to record asset impairment charges in the future;
|
|
·
|
the condition of the securities and capital markets generally;
|
|
·
|
economic conditions in the jurisdictions in which we operate and nationally;
|
and statements of assumption
underlying any of the foregoing, as well as any other factors set forth herein under
Item 2. Management’s Discussion and
Analysis of Financial Condition and Results of Operations
below and
Item 1A. Risk Factors
of our Annual Report on Form
10-K for our fiscal year ended December 31, 2017. All subsequent written and oral forward-looking statements attributable to us
or persons acting on our behalf are expressly qualified in their entirety by the foregoing. Except as required by law, we assume
no duty to update or revise our forward-looking statements.