UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

______________

 

FORM 10-Q

 

 

☒

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2015

 

or

 

 

☐

TRANSITION REPORT P URSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission File Number 001-34082
____________

 

Kona Grill , Inc.
(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

20-0216690

   

(State or   other jurisdiction of i ncorporation or organization )

(I.R.S. Employer Identification No.)

   

7150 East Camelback Road, Suite 333
Scottsdale, Arizona 85251
(480) 922-8100
(Address, including zip code, and telephone number, including area code, of principal executive offices)

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒      No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐

Accelerated filer ☒

Non-accelerated filer ☐ (Do not check if a smaller reporting company)

Smaller reporting company ☐

        

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes ☐      No ☒

 

 

As of July 31, 2015, there were 11,276,853 shares of the registrant’s common stock outstanding.

 

 

 
 
 

 

KONA GRILL, INC.

 


TABLE OF CONTENTS

 

 

 

Page

 

PART I.

FINANCIAL INFORMATION

 
     

Item 1.

Financial Statements

 
 

Condensed Consolidated Balance Sheets as of June 30, 2015 (Unaudited) and December 31, 2014

2

 

Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2015 and 2014 (Unaudited)

3

 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2015 and 2014 (Unaudited)

4

 

Notes to Condensed Consolidated Financial Statements

5

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

10

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

22

Item 4.

Controls and Procedures

23

     
     

PART II.

OTHER INFORMATION

 
     

Item 1.

Legal Proceedings

23

Item 1A.

Risk Factors

23

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

23

Item 3.

Defaults Upon Senior Securities

24

Item 4.

Mine Safety Disclosures

24

Item 5.

Other Information

24

Item 6.

Exhibits

24

 

 
1
 

   

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

 

KONA GRILL, INC.

CONDENSED CONSO LIDATED BALANCE SHEETS

(in thousands, except share data)

 

   

June 30,

   

December 31,

 
   

20 15

   

20 14

 

ASSETS

 

(Unaudited)

   

(Note 1)

 

Current assets:

               

Cash and cash equivalents

  $ 27,532     $ 36,578  

Short-term investments

    178       178  

Receivables

    1,640       387  

Other current assets

    1,985       2,122  

Total current assets

    31,335       39,265  

Other assets

    1,200       1,171  

Property and equipment, net

    66,593       53,934  

Total assets

  $ 99,128     $ 94,370  
                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

               

Current liabilities:

               

Accounts payable

  $ 2,680     $ 3,205  

Accrued expenses

    11,846       9,042  

Total current liabilities

    14,526       12,247  

Deferred rent

    18,996       16,697  

Total liabilities

    33,522       28,944  
                 

Commitments and contingencies (Note 10)

               
                 

Stockholders’ equity:

               

Preferred stock, $0.01 par value, 2,000,000 shares authorized, none issued

    —       —  

Common stock, $0.01 par value, 30,000,000 shares authorized, 11,393,053 shares issued and 11,276,853 shares outstanding at June 30, 2015; 11,325,338 shares issued and 11,209,138 shares outstanding at December 31, 2014

    114       113  

Additional paid-in capital

    97,619       96,422  

Accumulated deficit

    (31,127 )     (30,109 )

Treasury stock, at cost, 116,200 shares at June 30, 2015 and December 31, 2014

    (1,000 )     (1,000 )

Total stockholders’ equity

    65,606       65,426  

Total liabilities and stockholders’ equity

  $ 99,128     $ 94,370  

 

 

See accompanying notes to condensed consolidated financial statements.

 

 
2
 

 

KONA GRILL, INC.

CONDENSED CONSO LIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands, except per share data)

(unaudited)

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

201 5

   

201 4

   

2015

   

201 4

 
                                 

Restaurant sales

  $ 36,225     $ 29,886     $ 69,032     $ 57,502  

Costs and expenses:

                               

Cost of sales

    9,678       8,210       18,740       15,720  

Labor

    12,396       9,900       23,784       19,326  

Occupancy

    2,501       2,001       4,858       3,844  

Restaurant operating expenses

    4,978       4,023       9,586       7,871  

General and administrative

    3,143       2,443       6,426       5,019  

Preopening expense

    1,106       509       1,923       899  

Depreciation and amortization

    2,290       1,717       4,474       3,404  

Other expenses

    161       —       161       —  

Total costs and expenses

    36,253       28,803       69,952       56,083  

Income (loss) from operations

    (28 )     1,083       (920 )     1,419  

Interest expense, net

    46       64       91       124  

Income (loss) before income taxes

    (74 )     1,019       (1,011 )     1,295  

Income tax expense

    19       —       7       25  

Net income (loss)

  $ (93 )   $ 1,019     $ (1,018 )   $ 1,270  
                                 
                                 

Net income (loss) per share:

                               

Basic

  $ (0.01 )   $ 0.12     $ (0.09 )   $ 0.15  

Diluted

  $ (0.01 )   $ 0.11     $ (0.09 )   $ 0.14  
                                 
                                 

Weighted average shares used in computation:

                               

Basic

    11,271       8,770       11,253       8,690  

Diluted

    11,271       9,081       11,253       9,022  
                                 
                                 

Comprehensive income (loss)

  $ (93 )   $ 1,019     $ (1,018 )   $ 1,270  

 

See accompanying notes to condensed consolidated financial statements.

 

 
3
 

 

KONA GRILL, INC.

CONDENSED CONSO LIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

   

Six Months Ended June 30,

 
   

20 15

   

20 14

 

Operating activities

               

Net income (loss)

  $ (1,018

)

  $ 1,270  

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

               

Depreciation and amortization

    4,474       3,404  

Stock-based compensation

    663       418  

Amortization of deferred financing costs

    40       53  

Change in operating assets and liabilities:

               

Receivables

    (1,253

)

    241  

Other current assets

    137       (140

)

Accounts payable

    (469

)

    (493

)

Accrued expenses

    48       759  

Deferred rent

    2,299       2,552  

Net cash provided by operating activities

    4,921       8,064  
                 

Investing activities

               

Purchase of property and equipment

    (14,433

)

    (9,536

)

Change in other assets

    (69

)

    (40

)

Net cash used in investing activities

    (14,502

)

    (9,576

)

                 

Financing activities

               

Debt repayments

    —       (3,500

)

Proceeds from issuance of common stock, net of issuance costs

    —       41,085  

Proceeds from issuance of common stock under the Employee Stock Purchase Plan and exercise of stock options

    535       66  

Net cash provided by financing activities

    535       37,651  
                 

Net increase (decrease) in cash and cash equivalents

    (9,046

)

    36,139  

Cash and cash equivalents at the beginning of the period

    36,578       5,881  

Cash and cash equivalents at the end of the period

  $ 27,532     $ 42,020  
                 

Supplemental disclosure of cash flow information

               

Cash paid for interest, net of capitalized interest

  $ 54     $ 99  

Cash paid for income taxes, net of refunds

  $ 32     $ 110  
                 

Noncash investing activities

               

Accounts payable and accruals related to property and equipment

  $ 4,760     $ 1,218  

 

 

 

See accompanying notes to condensed consolidated financial statements.

   

 
4
 

   

  KONA GRILL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1 .

Basis of Presentation

 

Kona Grill, Inc., including its wholly-owned subsidiaries, (referred to herein as the “Company” or “we,” “us,” and “our”) develops, owns and operates upscale casual dining restaurants under the name “Kona Grill.” Our restaurants feature a diverse selection of American favorites and award-winning sushi that are prepared fresh daily. As of June 30, 2015, we owned and operated 33 restaurants in 19 states and Puerto Rico.

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements. In our opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.

 

The consolidated balance sheet at December 31, 2014 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements. Accordingly, these financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2014.

 

The Company has evaluated subsequent events and transactions for potential recognition or disclosure in the financial statements through the day the financial statements are issued.

 

In April 2015, the Financial Accounting Standards Board issued Accounting Standards Update 2015-03, Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. This guidance requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying value of that debt liability. The recognition and measurement guidance for debt issuance costs are not affected by this new guidance. We do not expect the adoption of this guidance, effective for us in the first quarter of 2016, to have a material impact on our consolidated financial statements, although it will require retrospective application reducing the amount of debt reflected on our historical consolidated balance sheets .

 

2 .

Fair Value Measurements

 

The carrying value for certain of our financial instruments, including cash and cash equivalents, accounts receivable and accounts payable approximates fair value because of their short-term nature. Our investments represent certificates of deposit and are considered available-for-sale securities that are valued using market observable inputs (Level 2).

 

3.

Net Income (Loss) Per Share

 

Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share includes the dilutive effect of potential stock option exercises, calculated using the treasury stock method.

   

 
5
 

 

The following table sets forth the computation of basic and diluted net income (loss) per share:

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2015

   

2014

   

2015

   

2014

 
   

(In thousands, except per share data)

 

Numerator:

                               

Net income (loss)

  $ (93 )   $ 1,019     $ (1,018 )   $ 1,270  

Denominator:

                               

Weighted average shares — Basic

    11,271       8,770       11,253       8,690  

Effect of dilutive stock options

    —       311       —       332  

Weighted average shares — Diluted

    11,271       9,081       11,253       9,022  

Net income (loss) per share:

                               

Basic

  $ (0.01 )   $ 0.12     $ (0.09 )   $ 0.15  

Diluted

  $ (0.01 )   $ 0.11     $ (0.09 )   $ 0.14  

 

Stock options outstanding that were not included in the dilutive earnings per share calculation because the effect would have been anti-dilutive were 357,000 and none, respectively, for the three months ended June 30, 2015 and 2014, and 285,000 and 178,000, respectively, for the six months ended June 30, 2015 and 2014.

 

4.

Property and Equipment

 

Property and equipment consisted of the following (in thousands):

 

   

June 30 ,

201 5

   

December 31,

201 4

 

Leasehold improvements

  $ 78,067     $ 69,643  

Equipment

    21,769       19,378  

Furniture and fixtures

    8,315       6,950  
      108,151       95,971  

Less accumulated depreciation and amortization

    (50,034

)

    (46,860

)

      58,117       49,111  

Construction in progress

    8,476       4,823  

Total property and equipment, net

  $ 66,593     $ 53,934  

 

5.

Accrued Expenses

 

Accrued expenses consisted of the following (in thousands):

 

   

June 30,

   

December 31,

 
   

2015

   

20 14

 

Accrued payroll and benefits

  $ 3,584     $ 3,280  

Accrued construction and remodel costs (1)

    3,822       1,067  

Gift card liability

    1,499       1,961  

Sales taxes

    1,443       1,354  

Accrued occupancy

    435       399  

Other

    1,063       981  
Total accrued expenses    $ 11,846     $ 9,042  

(1)     Balance is attributable to property additions for our new restaurants and remodels.

 

6.

Debt and Credit Agreements

 

On April 19, 2013, we entered into a Credit Agreement for a $20 million revolving line of credit maturing on April 19, 2017 with KeyBank National Association (“KeyBank”) and Stearns Bank National Association (“Stearns Bank”). On November 7, 2014, we entered into an Amended and Restated Credit Agreement (the “Amended Credit Agreement”) with KeyBank to (i) increase the credit facility from $20 million to $35 million, and (ii) extend the maturity date of the credit facility to November 7, 2019. The credit facility is secured by our personal property and assets. Certain of our wholly owned subsidiaries have also guaranteed the credit facility. The entire $35 million under the credit facility was available at June 30, 2015.

 

The interest rate under the Amended Credit Agreement is KeyBank’s prime rate or LIBOR, at our option, plus an applicable margin depending on our leverage ratio. The LIBOR margins range from 1.5% to 2.5% and the base rate margins range from 0.5% to 1.5%. Payments on the credit facility are interest only, payable quarterly with respect to each base rate loan and at varying times with respect to LIBOR rate loans, with outstanding principal and interest due at maturity. Prepayment is permitted at any time without penalty, subject to certain restrictions on the order of repayment or prepayment. We are obligated to pay a commitment fee at an annual rate of 0.175% to 0.350%, depending on our leverage ratio, times the unused total revolving commitment of the credit facility based on the average daily amount outstanding under the credit facility for the previous quarter. The commitment fee is payable quarterly in arrears.

   

 
6
 

 

During the three months ended June 30, 2015 and 2014, we incurred gross interest expense of $49,000 and $64,000, consisting primarily of loan fee amortization of $21,000 and $26,000, respectively, and commitment fees of $22,000 and $21,000, respectively. During the six months ended June 30, 2015 and 2014, we incurred gross interest expense of $94,000 and $126,000, consisting primarily of loan fee amortization of $40,000 and $53,000, respectively, and commitment fees of $44,000 and $41,000, respectively. We capitalized $29,000 of interest costs during the six months ended June 30, 2014.

 

Unamortized loan fees of $363,000 at June 30, 2015 are being amortized over the life of the credit facility and are included in other assets in the consolidated balance sheet.

 

The credit facility also requires us to comply with certain covenants, including (a) a fixed charge coverage ratio of not less than 1.50 and (b) a maximum leverage ratio of 5.0 to 1.0 through March 31, 2016 and 4.75 to 1.0 from April 1, 2016 through the maturity date. We were in compliance with all covenants at June 30, 2015.

 

7.     Income Taxes

 

We recorded an income tax expense of $19,000 during the three months ended June 30, 2015 associated with state income tax for which no state net operating loss carryforwards or other credit exist. We recognized no income tax expense during the three months ended June 30, 2014 based upon the projected net operating loss position resulting from our tax planning strategies conducted in 2014. Income tax expense of $7,000 and $25,000 for the six months ended June 30, 2015 and 2014 primarily related to state income tax expense for which no state net operating loss carryforwards or other credits exist. Income tax expense for the six months ended June 30, 2015 also includes refunds primarily associated with prior year federal income tax.

 

At June 30, 2015, we had approximately $17 million in deferred tax assets primarily related to state net operating loss carryforwards and federal business tax credit carryforwards. We have a full valuation allowance for these carryforwards due to the uncertainty surrounding their future utilization. The realization of our deferred tax assets ultimately depends on the existence of sufficient taxable income in the appropriate taxing jurisdictions in future periods. We have analyzed, and will continue to analyze, the positive and negative evidence to support our conclusion regarding the appropriate amount of our valuation allowance. The valuation allowance could be reduced in a subsequent period if there is sufficient evidence to support a conclusion that it is more likely than not that the state net operating loss carryforwards and/or the federal business tax credit carryforwards will be realized. Future changes in our valuation allowance could have a material effect on our results of operations in the period recorded.

 

8.      Stock-Based Compensation

 

The fair value of stock options granted during the six months ended June 30, 2015 and 2014 was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

 

   

Six Months Ended June 30,

 
   

2015

   

20 14

 

Expected volatility

    40.7

%

    36.9

%

Risk-free interest rate

    0.9

%

    0.7

%

Expected option life (in years)

    3.0       2.9  

Dividend yield

    0.0

%

    0.0

%

Weighted average fair value per option granted

  $ 6.74     $ 4.13  

   

 
7
 

   

The following table summarizes our stock option activity for the six months ended June 30, 2015:

 

   

Options

   

Weighted

Average Exercise Price

   

Weighted Average

Remaining Contractual Term (years)

   

Aggregate Intrinsic Value

 

Outstanding options at December 31, 2014

    740,250     $ 10.66                  

Granted

    362,868       23.49                  

Forfeited

    (15,400

)

    20.02                  

Exercised

    (66,450

)

    7.65                  

Outstanding options at June 30, 2015

    1,021,268     $ 15.27       3.3     $ 5,668,000  

Exercisable at June 30, 2015

    347,463     $ 10.54       2.5     $ 3,162,000  

 

We recognized stock-based compensation expense of $362,000 and $217,000 during the three months ended June 30, 2015 and 2014, respectively, and $663,000 and $418,000 during the six months ended June 30, 2015 and 2014, respectively. As of June 30, 2015, there was $2.6 million of unrecognized stock-based compensation expense related to unvested stock-based compensation awards, which is expected to be recognized over a weighted average period of 2.8 years.

 

In April 2015, our shareholders approved an increase of 1.5 million common shares reserved for issuance under our 2012 Stock Award Plan. The total shares of common stock reserved for issuance were 3.7 million, of which 1.5 million shares were available for grant as of June 30, 2015.

 

9.      Common Stock

 

On April 30, 2015, our shareholders approved an amendment to our certificate of incorporation to increase the number of authorized shares of common stock from 15 million to 30 million.

 

Stock Purchase and Retirement Program  

 

In May 2012, our Board of Directors authorized a stock repurchase and retirement program of up to $5,000,000 of our outstanding common stock. The authorization of the program does not have an expiration date and it does not require us to purchase a specific dollar amount of shares. This authorization may be modified, suspended or terminated at any time. The timing and number of shares purchased pursuant to the share purchase authorization are subject to a number of factors, including current market conditions, legal constraints and available cash.

 

As of June 30, 2015, we repurchased and retired $3.2 million, or 387,109 shares under the 2012 authorization. We did not repurchase any shares during 2014 or 2015.

 

Common Stock Offering  

 

On June 25, 2014, we completed a public offering of 2,645,000 shares of our common stock at an offering price of $18.50 per share. We sold an aggregate of 2,345,000 shares, of which 345,000 shares were sold pursuant to the underwriters’ exercise of their option to purchase additional shares. The remaining 300,000 shares were sold by certain selling stockholders. The aggregate net proceeds received for the offering totaled $40.9 million, reflecting gross proceeds of $43.4 million, less underwriting expenses of $2.2 million and other offering costs of $0.3 million. Net proceeds from the offering are being used for new unit expansion, capital expenditures and general corporate purposes.

 

10.      Commitments and Contingencies

 

We are engaged in various legal actions, which arise in the ordinary course of our business. Although there can be no assurance as to the ultimate disposition of these matters, it is the opinion of our management, based upon the information available at this time, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the results of operations or financial condition of our company.

   

 
8
 

 

On February 10, 2014, Kona Grill Macadamia, Inc., a wholly-owned subsidiary of the Company (“Macadamia”), filed a Motion to Set Aside Default Judgment in the Circuit Court of Jackson County, Kansas City Missouri relating to a default judgment of approximately $3.5 million entered on December 18, 2013 against Macadamia. The underlying personal injury claim, Frank Neal Goss v. Kona Macadamia, Inc. and Anthony DeAngelo, revolves around a fight that two alleged restaurant patrons had outside of the Company’s Kansas City restaurant on March 1, 2011, which is claimed to have resulted in physical injury to the plaintiff. Following the hearing held on April 3, 2014, the Circuit Court issued a written order on April 7, 2014 granting Macadamia’s Motion to Set Aside Default Judgment. The underlying personal injury case is proceeding in the Circuit Court. The court established a deadline of August 17, 2015 for summary judgment motions and scheduled the matter for trial in December 2015. We believe that we have a strong defense to the claim asserted by the plaintiff and insurance coverage for the claim.

   

 
9
 

 

I tem 2 .      Management ’ s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in Item 1 of Part I of this Form 10-Q and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2014 contained in our 2014 Annual Report on Form 10-K.

 

Certain information included in this discussion contains forward-looking statements that involve known and unknown risks and uncertainties, such as statements relating to our future economic performance, plans and objectives for future operations, expectations, intentions and other financial items that are based on our beliefs as well as assumptions made by and information currently available to us. Factors that could cause actual events or results to differ materially from those indicated by these forward-looking statements may include the matters under Item 1A, “Risk Factors” in this report, our Annual Report on Form 10-K for the year ended December 31, 2014 and other reports filed from time to time with the SEC.

 

Overview

 

We currently own and operate 33 restaurants located in 19 states and Puerto Rico. We offer freshly prepared food, attentive service, and a contemporary ambiance that create a satisfying yet affordable dining experience that we believe exceeds the experience at many traditional casual dining restaurants with which we compete. Our high-volume polished casual restaurants feature a diverse selection of flavorful American favorites with an international influence and award-winning sushi items. Our menu items are freshly prepared and incorporate over 40 signature sauces and dressings that we make from scratch at each restaurant location, creating broad-based appeal for the lifestyle and taste trends of a diverse group of customers. We believe that our diverse menu and generous portions, combined with an average check of approximate ly $25 per person, offer our customers an attractive price-value proposition.

 

We plan to grow organically through unit expansion, with a goal of 20% unit growth annually over the next several years. We achieved a unit growth rate of 20% for 2014, with five openings during the year. We expect a 23% unit growth for 2015, with seven restaurants scheduled to open during the year, including our San Juan, Puerto Rico restaurant that opened in the first quarter of 2015 and our Plano, Texas and Arlington, Virginia restaurants that opened during the second quarter of 2015. We currently have five signed leases for new restaurant openings in 2016 and beyond and continue working diligently to build our pipeline for future growth.

 

In May 2015, we also commenced a major remodel of our Denver restaurant to conform to our new design. We expect to re-open this location in August 2015.

 

In addition, we are exploring expansion into international markets. Given the strength our concept has enjoyed thus far in the U.S. and the increased demand for polished casual dining concepts overseas, we believe there is a significant opportunity to expand our concept in Latin America, the Middle East and beyond. Similar to other brands with international expansion, we plan to utilize a franchise model for development outside the U.S. Under this model, we will provide training and operational support to our partners without committing or putting our capital at risk in these international markets. We are developing marketing materials, obtaining trademarks in the requisite markets and incurring incremental travel and networking expenses in order to build the right foundation for our growth. We have started to identify potential franchise partners and negotiate franchise agreements. Once a franchise agreement is signed, our partners will need to find quality real estate and construct the restaurants. We will then need to train the local team on our food and hospitality standards to ensure a successful execution of our strategy. We expect the first international location to open by the end of 2016.

 

Our same-store sales increased 1.0% year over year, with a 2.3% growth in average check offset by a 1.3% decrease in customer traffic partially due to rainy weather in the state of Texas and to a lesser degree, social unrest in Baltimore during the second quarter of 2015. The 1.0% same-store sales growth in the second quarter of 2015 compares to a 3.2% increase in same-store sales in the second quarter of 2014. We have generated positive same-store sales in each of the last nine quarters and in 19 out of the last 20 quarters.

   

 
10
 

 

We continue to focus on growing sales and successfully opening new restaurants. The average unit volume of our comparable base restaurants increased to $1,183,000 in the second quarter of 2015 compared to $1,160,000 in the second quarter of 2014. We generated a small loss from operations in the second quarter of 2015 compared to income from operations of $1,083,000 in the second quarter of 2014. Our net loss was $93,000 in the second quarter of 2015 compared to net income of $1,019,000 in the second quarter of 2014. In each case, as described in more detail under “Three Months Ended June 30, 2015 Compared with Three Months Ended June 30, 2014,” a significant part of the year over year change was driven by preopening expense related to our growth strategy, incremental operating costs for new restaurant locations, higher depreciation and amortization resulting from new restaurants and remodeling activities and higher general and administrative expenses in support of our accelerated unit growth and international business development.

 

Our restaurant operating profit, defined as restaurant sales minus cost of sales, labor, occupancy, and restaurant operating expenses, increased $0.9 million to $6.7 million, or 16.0% from $5.8 million in the second quarter of 2014. Restaurant operating profit as a percentage of restaurant sales of 18.4% in the second quarter of 2015 included new restaurant operating inefficiencies for the ten locations that opened since the fourth quarter of 2013 compared to the 19.2% in the second quarter of 2014 which included new restaurant operating inefficiencies for the four locations opened since the fourth quarter of 2013. Our Adjusted EBITDA, defined as income from operations plus depreciation and amortization, preopening expense and stock-based compensation, increased 10.4% to $3.9 million from $3.5 million in the second quarter of 2014. Adjusted EBITDA as a percentage of restaurant sales was 10.7% in the second quarter of 2015 compared to 11.8% in the same prior year period, reflecting our investment in human capital to accelerate our unit growth and start-up costs for international business development. See “Key Measures” and “Financial Performance Overview” below for further information on restaurant operating profit and Adjusted EBITDA, including a reconciliation to our income (loss) from operations.

 

Our cost of sales, labor, and other operating expenses for our restaurants open at least 12 months generally trend consistently with restaurant sales, and we analyze those costs as a percentage of restaurant sales. Our typical new restaurants experience gradually increasing unit volumes as customers discover our concept and we generate market awareness. We anticipate that our new restaurants will take approximately six to twelve months to achieve the majority of operating efficiencies as a result of challenges typically associated with opening and operating new restaurants, including lack of market recognition and the need to hire and sufficiently train employees, as well as other factors. We expect cost of sales and labor expenses as a percentage of restaurant sales to be higher when we open a new restaurant, but to decrease as a percentage of restaurant sales as the restaurant matures and as the restaurant management and employees become more efficient in operating that unit. Occupancy and a portion of restaurant operating expenses are fixed. As a result, the volume and timing of newly opened restaurants had, and is expected to continue to have, an impact on cost of sales, labor, occupancy, and restaurant operating expenses measured as a percentage of restaurant sales which we expect will continue until these restaurants mature.

 

Our general and administrative costs are expected to increase in fiscal 2015 compared to the prior year level as we make investments in development and operations personnel and infrastructure to accelerate new unit growth and incur start-up costs for our international business franchising development. The 2015 year to date increase as compared to the same period in the prior year also reflected higher stock-based compensation expenses. Over the longer term, we expect our general and administrative spending to generally decrease as a percentage of restaurant sales as we leverage these investments and realize the benefits of higher sales volumes.

 

We incurred preopening expense of $1,106,000 in the second quarter of 2015 primarily attributable to our Plano, Texas restaurant that opened in May 2015, our Arlington, Virginia restaurant that opened at the end of June 2015 and in preparation for the remaining restaurants scheduled to open in the second half of 2015. We expect to open seven new restaurants in 2015, including the San Juan, Plano and Arlington locations opened in the first half of 2015. Although the actual preopening expenses for a particular location depend upon numerous factors, we expect cash preopening expenses of approximately $425,000 per location, and non-cash preopening rent expense ranging from $50,000 to $100,000 per location. Accordingly, we expect the opening of new units to reduce our profitability as significant preopening expenses are incurred while operating profit from the new restaurants will likely not be significant in the first few months of each new restaurant’s operation as a result of challenges typically associated with opening new restaurants.

 

 
11
 

 

Key Measures We Use to Evaluate Our Company

 

Key measures we use to evaluate and assess our business include the following:

 

Number of Restaurant Openings. Number of restaurant openings reflects the number of restaurants opened during a particular reporting period.

 

Same-Store Sales Percentage Change. Same-store sales percentage change reflects the periodic change in restaurant sales for the comparable restaurant base. In calculating the percentage change in same-store sales, we include a restaurant in the comparable restaurant base after it has been in operation for more than 18 months. We adjust the sales included in the same-store sales calculation for restaurant closures, primarily as a result of remodels, so that the periods will be comparable. Same-store sales growth can be generated by an increase in customer traffic counts or by increases in the per person average check amount. Menu price changes and the mix of menu items sold can affect the per person average check amount.

 

Average Weekly Sales. Average weekly sales represent the average of restaurant sales for the comparable restaurant base measured over consecutive Monday through Sunday time periods.

 

Average Unit Volume. Average unit volume represents the average restaurant sales for the comparable restaurant base.

 

Restaurant Operating Profit. Restaurant operating profit is defined as restaurant sales minus cost of sales, labor, occupancy, and restaurant operating expenses. Restaurant operating profit does not include general and administrative expenses, depreciation and amortization, or preopening expenses. We believe restaurant operating profit is an important component of financial results because it is a widely used metric within the restaurant industry to evaluate restaurant-level productivity, efficiency, and performance prior to application of corporate overhead. We use restaurant operating profit as a percentage of restaurant sales as a key metric to evaluate our restaurants’ financial performance compared with our competitors. This measure provides useful information regarding our financial condition and results of operations and allows investors to better determine future financial results driven by growth and to compare restaurant level profitability.

 

Adjusted EBITDA . Adjusted EBITDA is defined as income from operations plus depreciation and amortization, preopening expense, stock-based compensation and unusual or non-recurring items. Adjusted EBITDA is presented because: (i) we believe it is a useful measure for investors to assess the operating performance of our business without the effect of non-cash items such as depreciation and amortization expenses and stock-based compensation as well as the costs of opening new restaurants; (ii) we believe that investors will find these measures useful in assessing our ability to service or incur indebtedness; and (iii) we use Adjusted EBITDA internally as a benchmark to evaluate our operating performance and compare our performance to that of our competitors.

 

Key Financial Definitions

 

Restaurant Sales. Restaurant sales include gross food and beverage sales, net of promotions and discounts.

 

Cost of Sales. Cost of sales consists of food and beverage costs and related delivery fees.

 

Labor. Labor includes all direct and indirect labor costs incurred in operations.

 

Occupancy. Occupancy includes all rent payments associated with the leasing of real estate, including base, percentage and straight-line rent, property taxes, and common area maintenance expense. We record tenant improvement allowances as a reduction of occupancy expense over the term of the lease.

   

 
12
 

 

Restaurant Operating Expenses. Restaurant operating expenses consist of all other restaurant-level operating costs, the major components of which are utilities, credit card fees, advertising, supplies, marketing, repair and maintenance, and other expenses. Other operating expenses contain both variable and fixed components.

 

General and Administrative. General and administrative includes all corporate and administrative functions that support operations and provide infrastructure to facilitate our future growth. Components of this category include management and staff salaries, bonuses, stock-based compensation and related employee benefits, travel, information systems, human resources, training, corporate rent, professional and consulting fees, and corporate insurance costs.

 

Preopening Expense. Preopening expense consists of costs incurred prior to opening a new restaurant and is comprised principally of manager salaries and relocation, payroll and related training costs for new employees, including food and beverage costs associated with practice and rehearsal of service activities, and rent expense incurred from the date we obtain possession of the property until opening. We expense restaurant preopening expenses as incurred. We expect preopening expenses to commence six to eight months prior to a restaurant opening. Although the actual preopening expenses for a particular location depend upon numerous factors, our historical cash preopening expenses average approximately $425,000 per location, and non-cash preopening rent expense that typically ranges from $50,000 to $100,000 per location. Our preopening costs will fluctuate from period to period depending upon the number of restaurants opened, the timing of new restaurant openings, the location of the restaurants, and the complexity of the staff hiring and training process.

 

Depreciation and Amortization . Depreciation and amortization expense consists of the depreciation of property and equipment. Depreciation and amortization expense also includes accelerated depreciation expense and gains or losses on the disposal of fixed assets, primarily associated with remodel activities.

 

Interest Expense, net. Interest expense consists primarily of the cost of servicing our debt obligations, the amortization of debt issuance costs and commitment fees on the line of credit. Interest expense is offset by interest earned on investment balances. We capitalize interest incurred on borrowings for restaurant construction.

 

Income Tax Expense. Income tax expense reflects management’s best estimate of the effective tax rate expected to be applicable for the full fiscal year. This estimate will be re-evaluated by management each quarter based on the Company’s estimated income tax expense for the year.

 

 
13
 

 

Financial Performance Overview

 

The following table sets forth certain information regarding our financial performance for the three and six months ended June 30, 2015 and 2014.    

 

   

Three Months Ended June 30,

    Six Months Ended June 30,  
   

20 15

   

2014

   

20 15

   

2014

 

Restaurant sales growth

    21.2

%

    15.9

%

    20.1

%

    16.7

%

Same-store sales percentage change (1)

    1.0

%

    3.2

%

    1.6

%

    4.6

%

Average weekly sales – comparable restaurant base

  $ 91,000     $ 89,300     $ 90,800     $ 87,000  

Average weekly sales – non-comparable restaurant base

  $ 89,200     $ 81,900     $ 85,200     $ 80,900  

Average unit volume (in thousands) (2)

  $ 1,183     $ 1,160     $ 2,294     $ 2,250  

Sales per square foot (2)

  $ 165     $ 164     $ 320     $ 319  

Restaurant operating profit (in thousands) (3)

  $ 6,672     $ 5,752     $ 12,064     $ 10,741  

Restaurant operating profit as a percentage of sales (3)

    18.4

%

    19.2

%

    17.5

%

    18.7

%

Adjusted EBITDA (in thousands) (4 )

  $ 3,891     $ 3,526     $ 6,301     $ 6,140  

Adjusted EBITDA as a percentage of sales ( 4 )

    10.7

%

    11.8

%

    9.1

%

    10.7

%

 

 

 

(1)

Same-store sales percentage change reflects the periodic change in restaurant sales for the comparable restaurant base compared to the prior year. In calculating the percentage change for same-store sales, we include a restaurant in the comparable restaurant base after it has been in operation for more than 18 months. We remove restaurants from the comparable base for periods in which they are closed, primarily related to remodel activities.

 

(2)

Includes only those restaurants in the comparable restaurant base.

 

(3)

Restaurant operating profit is not a financial measurement determined in accordance with U.S. generally accepted accounting principles (see reconciliation below) and should not be considered in isolation or as an alternative to income from operations. Restaurant operating profit may not be comparable to the same or similarly titled measures computed by other companies. We believe restaurant operating profit is an important component of financial results because it is a widely used metric within the restaurant industry to evaluate restaurant-level productivity, efficiency, and performance. We use restaurant operating profit as a percentage of restaurant sales as a key metric to evaluate our restaurants’ financial performance compared with our competitors.

 

(4)

Adjusted EBITDA is not a financial measure determined in accordance with U.S. generally accepted accounting principles (see reconciliation below) and should not be considered in isolation or as an alternative to income from operations. Adjusted EBITDA is defined as income from operations plus depreciation and amortization, preopening expense, stock-based compensation and unusual or non-recurring items. Adjusted EBITDA is presented because: (i) we believe it is a useful measure for investors to assess the operating performance of our business without the effect of non-cash items such as depreciation and amortization expenses and stock-based compensation as well as the costs of opening new restaurants; (ii) we believe that investors will find these measures useful in assessing our ability to service or incur indebtedness; and (iii) we use Adjusted EBITDA internally as a benchmark to evaluate our operating performance and compare our performance to that of our competitors.

 

 
14
 

   

The following tables set forth our reconciliation of Adjusted EBITDA and restaurant operating profit to our income (loss) from operations, the most comparable U.S. GAAP measure.

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2015

   

20 14

   

20 15

   

2014

 
   

(In thousands)

 

Income (loss) from operations

  $ (28 )   $ 1,083     $ (920 )   $ 1,419  

Depreciation and amortization

    2,290       1,717       4,474       3,404  

Preopening expense

    1,106       509       1,923       899  

Stock-based compensation

    362       217       663       418  

Other expenses

    161       —       161       —  

Adjusted EBITDA

  $ 3,891     $ 3,526     $ 6,301     $ 6,140  

General and administrative

    3,143       2,443       6,426       5,019  

Stock-based compensation

    (362 )     (217 )     (663 )     (418 )

Restaurant operating profit

  $ 6,672     $ 5,752     $ 12,064     $ 10,741  

 

 

 

   

Percentage of Restaurant Sales

   

Percentage of Restaurant Sales

 
   

Three Months Ended June 30 ,

   

Six Months Ended June 30 ,

 
   

2015

   

2014

   

2015

   

20 14

 

Income (loss) from operations

    (0.1 )%     3.6 %     (1.3 )%     2.5 %

Depreciation and amortization

    6.3       5.7       6.5       5.8  

Preopening expense

    3.1       1.7       2.8       1.6  

Stock-based compensation

    1.0       0.7       1.0       0.7  

Other expenses

    0.4       —       0.2       —  

Adjusted EBITDA

    10.7       11.8       9.1       10.7  

General and administrative

    8.7       8.2       9.3       8.8  

Stock-based compensation

    (1.0 )     (0.7 )     (1.0 )     (0.7 )

Restaurant operating profit

    18.4 %     19.2 %     17.5 %     18.7 %

 

Certain amounts may not sum due to rounding.

   

 
15
 

 

  Results of Operations

 

The following tables set forth, for the periods indicated, certain items from our financial statements and the percentage of restaurant sales for those items:

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2015

   

20 14

   

20 15

   

2014

 
   

(In thousands)

 

Restaurant sales

  $ 36,225     $ 29,886     $ 69,032     $ 57,502  

Costs and expenses:

                               

Cost of sales

    9,678       8,210       18,740       15,720  

Labor

    12,396       9,900       23,784       19,326  

Occupancy

    2,501       2,001       4,858       3,844  

Restaurant operating expenses

    4,978       4,023       9,586       7,871  

General and administrative

    3,143       2,443       6,426       5,019  

Preopening expense

    1,106       509       1,923       899  

Depreciation and amortization

    2,290       1,717       4,474       3,404  

Other expenses

    161       —       161       —  

Total costs and expenses

    36,253       28,803       69,952       56,083  

Income (loss) from operations

    (28 )     1,083       (920 )     1,419  

Interest expense, net

    46       64       91       124  

Income (loss) before income taxes

    (74 )     1,019       (1,011 )     1,295  

Income tax expense

    19       —       7       25  

Net income (loss)

  $ (93 )   $ 1,019     $ (1,018 )   $ 1,270  

 

 

   

Three Months Ended June 3 0,

    Six Months Ended June 30,  
   

2015

   

2014

   

20 15

   

20 14

 
                                 

Restaurant sales

    100.0 %     100.0 %     100.0 %     100.0 %

Costs and expenses:

                               

Cost of sales

    26.7       27.5       27.1       27.3  

Labor

    34.2       33.1       34.5       33.6  

Occupancy

    6.9       6.7       7.0       6.7  

Restaurant operating expenses

    13.7       13.5       13.9       13.7  

General and administrative

    8.7       8.2       9.3       8.7  

Preopening expense

    3.1       1.7       2.8       1.6  

Depreciation and amortization

    6.3       5.7       6.5       5.9  

Other expenses

    0.4       —       0.2       —  

Total costs and expenses

    100.1       96.4       101.3       97.5  

Income (loss) from operations

    (0.1 )     3.6       (1.3 )     2.5  

Interest expense, net

    0.1       0.2       0.1       0.2  

Income (loss) before income taxes

    (0.2 )     3.4       (1.5 )     2.3  

Income tax expense

    0.1       0.0       0.0       0.0  

Net income (loss)

    (0.3 )%     3.4 %     (1.5 )%     2.2 %

 

Certain amounts may not sum due to rounding.

   

 
16
 

   

Three Months Ended June 30, 2015 Compared with Three Months Ended June 30, 2014

 

Restaurant Sales. Restaurant sales increased $6.3 million, or 21.2%, to $36.2 million during the second quarter of 2015 from $29.9 million in the second quarter of 2014. Of the total increase, $6.7 million related to incremental sales primarily from our seven restaurants opened since June 2014 partially offset by lower sales at our Denver restaurant that was closed for nine weeks during the quarter for a remodel. Our same-store sales increased 1.0% year over year, with a 2.3% growth in average check resulting from a 1.5% menu price increase in April 2015 partially offset by a 1.3% decrease in customer traffic. The decrease in traffic during the quarter was partially attributable to inclement weather in Texas and to a lesser degree, civil unrest in Baltimore. The 1.0% same-store sales growth in the second quarter of 2015 compares to a 3.2% increase in same-store sales in the second quarter of 2014.

 

Cost of Sales . Cost of sales increased $1.5 million, or 17.9% to $9.7 million in the second quarter of 2015 compared to $8.2 million in the same prior year period. New locations opened since June 2014 primarily accounted for $1.9 million of the total increase. As a percentage of restaurant sales, cost of sales was 26.7% compared to 27.5% in the prior year quarter, primarily reflecting improved kitchen efficiencies for our non-comparable restaurants and favorable commodity pricing on chicken, pork and shrimp compared to last year.

 

Labor . Labor costs increased $2.5 million, or 25.2%, to $12.4 million year over year compared to $9.9 million during the prior year same quarter. Of the total increase, $2.4 million was attributable to the seven restaurants opened since June 2014. Labor expenses as a percentage of restaurant sales increased to 34.2% from 33.1% in the same prior year period, reflecting primarily the labor inefficiencies of our newly opened locations. We expect labor cost as a percentage of sales to typically trend higher upon opening and gradually improve as our new restaurant management and employees become more efficient in operating their restaurants .

 

Occupancy . Occupancy expenses increased $0.5 million or 25.0% to $2.5 million in the second quarter of 2015 from $2.0 million in the prior year same quarter, primarily associated with base rent and common area maintenance charges for new locations. Occupancy expenses as a percentage of restaurant sales were 6.9% in the second quarter of 2015 compared to 6.7% in the second quarter of 2014.

 

Restaurant Operating Expenses . Restaurant operating expenses increased $1.0 million, or 23.7%, to $5.0 million in the second quarter of 2015 compared to $4.0 million in the second quarter of 2014. Restaurant operating expenses as a percentage of restaurant sales were 13.7% and 13.5% in the second quarter of 2015 and 2014, respectively. Of the total increase, $0.9 million is attributable to the additional operating expenses associated with our non-comparable base restaurants.

 

General and Administrative . General and administrative expenses were $3.1 million and $2.4 million in the second quarter of 2015 and 2014, respectively. As a percentage of sales, general and administrative expenses increased 50 basis points to 8.7% in the second quarter of 2015 compared to 8.2% in the prior year same quarter. The increased costs reflect human capital investment and additional travel costs to support our unit growth expansion and start-up efforts for our international business development, as well as higher stock-based compensation expense.

 

Preopening Expense . Preopening expense of $1.1 million in the second quarter of 2015 was primarily attributable to the Plano and Arlington restaurants which opened in May and June of 2015, respectively, and expenses for restaurants scheduled to open later this year. Preopening expense of $0.5 million in the second quarter of 2014 was primarily attributable to the El Paso restaurant which opened in June of 2014.

 

Depreciation and Amortization . Depreciation and amortization expense increased $0.6 million or 33.4% to $2.3 million year over year. Incremental depreciation expense associated with the seven new restaurants opened since June 2014 accounted for $0.6 million of the total increase. Depreciation and amortization expense as a percentage of restaurant sales was 6.3% and 5.7% of restaurant sales in the second quarter of 2015 and 2014, respectively.

   

 
17
 

 

Other Expenses. We recognized $0.2 million of expenses in the second quarter of 2015 related to an expected settlement of a state use tax audit which has been ongoing for several years.

 

Interest Expense , Net . Net interest expense is attributable to the amortization of deferred loan fees and the commitment fees associated with the KeyBank credit facility partially offset by interest income earned from cash and investment balances. Interest expense decreased in the second quarter of 2015 as compared to the prior year period due to the repayment of all outstanding borrowings under the KeyBank credit facility in June 2014.

 

Income Tax Expense . We recorded an income tax expense of $19,000 primarily relating to state income tax expense for which no net operating loss carryforwards or other credits exist during the three months ended June 30, 2015. We did not recognize any income tax expense during the second quarter of 2014 due to projected net operating loss carryforwards expected to be generated from tax planning strategies and available credits to offset taxable income.

 

Six Months Ended June 30, 2015 Compared with Six Months Ended June 30, 2014

 

Restaurant Sales. Restaurant sales increased 20.1% to $69.0 million during the first half of 2015 from $57.5 million in the first half of 2014. Of the $11.5 million increase year over year, $11.4 million was attributable to incremental sales from our eight new restaurants opened since the first quarter of 2014. The remaining increase was driven by comparable sales growth of 1.6% resulting mainly from the average check increase in the first half of 2015.   

 

Cost of Sales . Cost of sales increased $3.0 million, or 19.2% to $18.7 million during the first half of 2015 compared to $15.7 million during the same period in the prior year. New locations opened since the first quarter of 2014 accounted for $3.2 million of the total increase. As a percentage of restaurant sales, cost of sales was 27.1% compared to 27.3% during the same prior year period, primarily reflecting improved kitchen efficiencies for our non-comparable restaurants and decreased commodity pricing for chicken, pork and shrimp year over year.

 

Labor. Labor costs in the first half of 2015 grew 23.1% to $23.8 million compared to $19.3 million in the comparable prior year period. Incremental labor costs for new locations accounted for $4.0 million of the total increase. Labor expenses as a percentage of restaurant sales increased to 34.5% compared to 33.6% in the prior year period driven mainly by inefficiencies associated with our newer non-comparable base units, staffing challenges associated with a tight labor market and increased benefit costs year over year due to the Affordable Care Act.

 

Occupancy . Occupancy expenses increased $1.1 million or 26.4% to $4.9 million in the first half of 2015 compared to $3.8 million in the prior year period. Base rent and common area maintenance charges associated with the new locations accounted for $0.9 million of the total year over year increase. Occupancy expenses as a percentage of restaurant sales were 7.0% in the first half of 2015 compared to 6.7% in the first half of 2014.

 

Restaurant Operating Expenses . Restaurant operating expenses increased $1.7 million, or 21.8%, to $9.6 million during the first half of 2015 compared to $7.9 million in the same period in 2014. Restaurant operating expenses as a percentage of restaurant sales were 13.9% during the first half of 2015 compared to 13.7% in the first half of 2014. Of the total increase, $1.5 million is attributable to the additional operating expenses associated with our non-comparable base restaurants.

 

General and Administrative . General and administrative expenses increased by $1.4 million, or 28.0% to $6.4 million from $5.0 million year over year. General and administrative expenses increased as a percentage of sales by 60 basis points to 9.3% in the first half of 2015 compared to 8.7% in the prior year period. Increased costs associated with additional headcount investment to support our unit growth expansion and start-up efforts for our international franchising strategy, higher travel costs for increased real estate development activities and increased stock-based compensation expense contributed to the year over year increase.

   

 
18
 

 

Preopening Expense . Preopening expense was $1.9 million and $0.9 million in the first half of 2015 and 2014, respectively. Preopening expense in year to date 2015 was primarily attributable to the San Juan, Puerto Rico restaurant which opened in March of 2015 as well as the Plano, Texas and Arlington, Virginia restaurants which opened in May and June of 2015, respectively. Preopening expense during the first half of 2014 primarily related to the Fort Worth and El Paso, Texas restaurants which opened in February and June of 2014, respectively.

 

Depreciation and Amortization . Depreciation and amortization expense increased $1.1 million or 31.4% to $4.5 million year over year, primarily attributable to the eight new restaurants opened since the first quarter of 2014 and accelerated depreciation expense associated with the remodel of our Denver restaurant. Depreciation and amortization expense as a percentage of restaurant sales was 6.5% and 5.9% of restaurant sales in the first half of 2015 and 2014, respectively.

 

Other Expenses. Other expenses of $0.2 million in the first half of 2015 primarily related to an expected settlement of a state use tax audit which has been ongoing for several years.

 

Interest Expense. Interest expense decreased in the first half of 2015 as compared to the prior year period, primarily due to the repayment of all outstanding borrowings under the KeyBank credit facility in June 2014.

 

Income Tax Expense . We recorded income tax expense of $7,000 and $25,000 in 2015 and 2014 year to date, respectively. The income tax expense in year to date 2015 relates to state income tax expense for which no net operating loss carryforwards or other credits exist partially offset by refunds primarily associated with prior year federal income tax. Income tax expense during the first half of 2014 consists of state tax expenses for which no state net operating losses and other credits exist.

 

Potential Fluctuations in Quarterly Results and Seasonality

 

Our quarterly operating results may fluctuate significantly as a result of a variety of factors, including the following:

 

 

●

timing of new restaurant openings and related expenses;

 

●

fluctuations in commodity and food protein prices;

 

●

preopening costs for our newly-opened restaurants and operating costs for those locations, which are often materially greater during the first several months of operation than thereafter;

 

●

timing of restaurant remodels and potential lost sales associated with remodel closure;

 

●

labor availability and costs for hourly and management personnel;

 

●

profitability of our restaurants, especially in new markets;

 

●

increases and decreases in comparable restaurant sales;

 

●

impairment of long-lived assets and any loss on restaurant closures;

 

●

changes in borrowings and interest rates;

 

●

general economic conditions;

 

●

weather conditions or natural disasters;

 

●

timing of certain holidays;

 

●

changes in government regulations;

 

●

settlements, damages and legal costs associated with litigation;

 

●

new or revised regulatory requirements and accounting pronouncements; and

 

●

changes in consumer preferences and competitive conditions.

 

Our business is also subject to seasonal fluctuations. Historically, sales in most of our restaurants have been higher during the spring and summer months and winter holiday season. Consequently, our quarterly and annual operating results and comparable restaurant sales may fluctuate significantly as a result of seasonality and the factors discussed above. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year and comparable restaurant sales for any particular future period may decrease. In the future, operating results may fall below the expectations of our investors. In that event, the price of our common stock would likely be impacted.

   

 
19
 

   

Liquidity and Capital Resources

 

Currently, our primary capital requirements are for new restaurant development and remodeling of existing restaurants. Similar to many restaurant companies, we utilize operating lease arrangements for all of our restaurant locations. We believe that our operating lease arrangements provide appropriate leverage for our capital structure in a financially efficient manner. We are typically required to expend cash for leasehold improvements, furniture, fixtures and equipment to construct and equip each restaurant. We also require capital resources to maintain our existing base of restaurants, including remodeling, and to further expand and strengthen the capabilities of our corporate and information technology infrastructures.

 

The following tables set forth, as of the dates and for the periods indicated, a summary of our key liquidity measurements (amounts in thousands):

   

June 30,

2015

   

December 31,

2014

 

Cash and short-term investments

  $ 27,710     $ 36,756  

Net working capital

  $ 16,809     $ 27,018  

 

 

   

Six Months Ended June 30,

 
   

2015

   

2014

 

Cash provided by operating activities

  $ 4,921     $ 8,064  

Capital expenditures

  $ 14,433     $ 9,536  

 

F uture Capital Requirements

 

Our capital requirements, including development costs related to the opening of new restaurants, have historically been significant. Over the past year, we funded development of new restaurants and remodels primarily from cash flows from operations and proceeds from our June 2014 equity offering. Our future cash requirements and the adequacy of available funds will depend on many factors, including the operating performance of our current restaurants, the pace of expansion and remodels, real estate markets, site locations, the nature of the arrangements negotiated with landlords and the capital market accessibility.

 

We plan to grow organically through unit expansion, with a goal of 20% unit growth annually over the next several years. We achieved a unit growth rate of 20% for 2014, with five openings during the year. We expect 23% unit growth for 2015, with seven restaurants scheduled to open during the year, including our San Juan, Puerto Rico restaurant that opened in the first quarter of 2015 and our Plano, Texas and Arlington, Virginia restaurants opened during the second quarter of 2015. We plan to remodel certain restaurants during 2015 and incur maintenance capital expenditures for existing restaurants and our corporate office. We also are diligently working on our real estate pipeline and expect to incur capital expenditures during 2015 for restaurants scheduled to open during the first half of 2016. We expect to spend approximately $40 million in capital expenditures in 2015, exclusive of tenant improvement allowances, for the planned construction and remodel scheduled during 2015 and to certain extent, planned construction scheduled for early 2016.

 

As of June 30, 2015, we had working capital of $16.8 million and no borrowings under the credit facility. We believe existing cash and short-term investments of $27.7 million, the ability to draw on our $35 million credit facility and cash flow from operations will be sufficient to fund property additions for new restaurants and planned remodel of existing restaurants over the next several years.

 

Any reduction of our cash flow from operations or an inability to draw on our credit facility may cause a delay or cancellation of future restaurant development or remodels of existing restaurants. Financing to construct new restaurants or remodels for amounts in excess of the line of credit availability may not be available on acceptable terms, or at all, and our failure to raise capital when needed could impact our growth plans, financial condition, and results of operations. Additional equity financing may result in dilution to current stockholders and debt financing, if available, may involve significant cash payment obligations or financial covenants and ratios that may restrict our ability to operate our business.

   

 
20
 

 

Debt and Credit Agreements

 

On April 19, 2013, we entered into a Credit Agreement for a $20 million revolving line of credit maturing on April 19, 2017 with KeyBank National Association (“KeyBank”) and Stearns Bank National Association (“Stearns Bank”). On November 7, 2014, we entered into an Amended and Restated Credit Agreement (the “Amended Credit Agreement”) with KeyBank to (i) increase the credit facility from $20 million to $35 million, and (ii) extend the maturity date of the credit facility to November 7, 2019. The credit facility is secured by our personal property and assets. Certain of our wholly owned subsidiaries have also guaranteed the credit facility. The entire $35 million under the credit facility was available at June 30, 2015.

 

The interest rate under the Amended Credit Agreement is KeyBank’s prime rate or LIBOR, at our option, plus an applicable margin depending on our leverage ratio. The LIBOR margins range from 1.5% to 2.5% and the base rate margins range from 0.5% to 1.5%. Payments on the credit facility are interest only, payable quarterly with respect to each base rate loan and at varying times with respect to LIBOR rate loans, with outstanding principal and interest due at maturity. Prepayment is permitted at any time without penalty, subject to certain restrictions on the order of repayment or prepayment. We are obligated to pay a commitment fee at an annual rate of 0.175% to 0.350%, depending on our leverage ratio, times the unused total revolving commitment of the credit facility based on the average daily amount outstanding under the credit facility for the previous quarter. The commitment fee is payable quarterly in arrears.

 

During the three months ended June 30, 2015 and 2014, we incurred gross interest expense of $49,000 and $64,000, consisting primarily of loan fee amortization of $21,000 and $26,000, respectively, and commitment fees of $22,000 and $21,000, respectively. During the six months ended June 30, 2015 and 2014, we incurred gross interest expense of $94,000 and $126,000, consisting primarily of loan fee amortization of $40,000 and $53,000, respectively, and commitment fees of $44,000 and $41,000, respectively. We capitalized $29,000 of interest costs during the six months ended June 30, 2014.

 

Unamortized loan fees of $363,000 at June 30, 2015 are being amortized over the life of the credit facility and are included in other assets in the consolidated balance sheet.

 

The credit facility also requires us to comply with certain covenants, including (a) a fixed charge coverage ratio of not less than 1.50 and (b) a maximum leverage ratio of 5.0 to 1.0 through March 31, 2016 and 4.75 to 1.0 from April 1, 2016 through the maturity date. We were in compliance with all covenants at June 30, 2015.

 

Cash Flows

 

      The following table summarizes our primary sources and uses of cash during the periods presented (in thousands).

   

Six Months Ended June 30,

 
   

2015

   

2014

 

Net cash provided by (used in):

               

Operating activities

  $ 4,921     $ 8,064  

Investing activities

    (14,502

)

    (9,576

)

Financing activities

    535       37,651  

Net increase (decrease) in cash and cash equivalents

  $ (9,046

)

  $ 36,139  

 

Operating Activities. Our cash flows from operating activities provided $4.9 million and $8.1 million of net cash during the first half of 2015 and 2014, respectively. The net change in cash from operating activities year over year is primarily due to lower net income and timing of payments and receipt of tenant allowance reimbursements.

   

 
21
 

 

Investing Activities. Capital expenditures for the six months ended June 30, 2015 were $14.4 million, primarily associated with our San Juan, Plano and Arlington restaurants opened during the first half of 2015, our Denver remodel as well as architecture, design and construction-related costs associated with our four new restaurants scheduled for the second half of 2015. Capital expenditures for the six months ended June 30, 2014 were $9.5 million, primarily associated with our Fort Worth and El Paso restaurants opened during the first half of 2014 and architecture, design and construction-related costs associated with our other three restaurants opened in the second half of 2014.

 

Financing Activities. Net cash provided by financing activities during the first half of 2015 consisted primarily of proceeds from stock option exercises. Net cash provided by financing activities during the first half of 2014 was $37.7 million and consisted primarily of $41.1 million in proceeds, net of issuance costs, from our equity offering, and $0.1 million from employee stock option exercises. This increase in cash was partially offset by the $3.5 million repayment of all borrowings under the Credit Facility.

 

Off-Balance Sheet Arrangements

 

As of June 30, 2015, we had no off-balance sheet arrangements or obligations.

 

Critical Accounting Policies and Estimates

 

Critical accounting policies and estimates are those that we believe are both significant and that require us to make difficult, subjective or complex judgments, often because we need to estimate the effect of inherently uncertain matters. We base our estimates and judgments on historical experiences and various other factors that we believe to be appropriate under the circumstances. Actual results may differ from these estimates, and we might obtain different estimates if we used different assumptions or conditions. We had no significant changes in our critical accounting policies and estimates since our last annual report. Our critical accounting policies and estimates are identified and described in our annual report on Form 10-K for the year ended December 31, 2014.

 

Item 3.      Quantitative and Qualitative Disclosures About Market Risk

 

Commodity Price Risk

 

Our primary market risk exposure is commodity costs. Many of the food products purchased by us can be subject to volatility due to changes in weather, production, availability, seasonality, international demand, and other factors outside our control. Substantially all of our food and supplies are available from several sources, which help to diversify our overall commodity cost risk. We also believe that we have the ability to increase certain menu prices in response to food commodity price increases.

 

Inflation

 

The primary inflationary factors affecting our operations are food, labor costs, energy costs and labor and materials used in the construction of new restaurants. Increases in minimum wages could directly affect our labor costs. Many of our leases require us to pay taxes, maintenance, repairs, insurance, and utilities, all of which are generally subject to inflationary adjustments. These increases could impact our operating results to the extent that such increases cannot be passed along through higher menu prices. Over the past five years, inflation has not significantly affected our operating results.

 

Interest Rate Risk

 

We may also face market risk exposure due to the variable interest rates on the credit line obtained from KeyBank. Interest on the loans is subject to adjustment based on changes to the LIBOR rate. Interest rate fluctuations may adversely impact our financial condition or results of operations.

   

 
22
 

   

Item 4.      Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

As of June 30, 2015, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

 

There were no changes during the three months ended June 30, 2015 in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

I tem 1.     Legal Proceedings

 

We are engaged in various legal actions, which arise in the ordinary course of our business. Although there can be no assurance as to the ultimate disposition of these matters, it is the opinion of our management, based upon the information available at this time, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the results of operations or financial condition of our company.

 

On February 10, 2014, Kona Grill Macadamia, Inc., a wholly-owned subsidiary of the Company (“Macadamia”), filed a Motion to Set Aside Default Judgment in the Circuit Court of Jackson County, Kansas City Missouri relating to a default judgment of approximately $3.5 million entered on December 18, 2013 against Macadamia. The underlying personal injury claim, Frank Neal Goss v. Kona Macadamia, Inc. and Anthony DeAngelo, revolves around a fight that two alleged restaurant patrons had outside of the Company’s Kansas City restaurant on March 1, 2011, which is claimed to have resulted in physical injury to the plaintiff. Following the hearing held on April 3, 2014, the Circuit Court issued a written order on April 7, 2014 granting Macadamia’s Motion to Set Aside Default Judgment. The underlying personal injury case is proceeding in the Circuit Court. The court established a deadline of August 17, 2015 for summary judgment motions and scheduled the matter for trial in December 2015. We believe that we have a strong defense to the claim asserted by the plaintiff and insurance coverage for the claim.

 

Item 1A. Risk Factors

 

There have been no material changes in our risk factors since our annual report on Form 10-K for the year ended December 31, 2014. A description of the risk factors associated with our business is contained in Part I, Item 1A, “Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2014. These cautionary statements are to be used as a reference in connection with any forward-looking statements. The factors, risks, and uncertainties identified in these cautionary statements are in addition to those contained in any other cautionary statements, written or oral, which may be made or otherwise addressed in connection with a forward-looking statement or contained in any of our subsequent filings with the SEC.

 

I tem 2.     Unregistered Sales of Equity Securities and Use of Proceeds

 

Not applicable.

 

 
23
 

 

I tem 3.     Defaults Upon Senior Securities

 

Not applicable.

 

I tem 4.      Mine Safety Disclosures

 

Not applicable.

 

Item 5.     Other Information

 

Not applicable.

 

I tem 6.     Exhibits

 

Exhibit
Number

Exhibit  

3.1

Certificate of Incorporation, as amended on April 30, 2015.

10.1

Amended and Restated 2012 Stock Award Plan, as amended on April 30, 2015.

31.1

Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.

31.2

Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.

32.1

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  

101

Interactive data files pursuant to Rule 405 of Regulation S-T (i) the Condensed Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014, (ii) the Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2015 and 2014, (iii) the Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014 and (iv) the notes to the Unaudited Condensed Consolidated Financial Statements.

_____________

 

 
24
 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

   

 

 

KONA GRILL , INC .

 

 

 

 

 

       

 

 

/s/  Berke Bakay

 

 

 

Berke Bakay

 

 

 

President, Chief Executive Officer and Director

 

    (Principal Executive Officer)  
       
    /s/ Christi Hing  
    Christi Hing  
    Chief Financial Officer  
   

(Principal Accounting and Financial Officer)

 
       
Date: August 4, 2015      

 

 

25

Exhibit 10.1

 

KONA GRILL, inc.

 

2012 STOCK AWARD PLAN

 

              As amended through April 30, 2015

 

      1. Purpose . The purpose of this 2012 Stock Award Plan (the "Plan") is to assist Kona Grill, Inc., a Delaware corporation (the "Company"), and its Related Entities in attracting, motivating, retaining, and rewarding high-quality Employees, officers, Directors, and Consultants by enabling such persons to acquire or increase a proprietary interest in the Company in order to strengthen the mutuality of interests between such persons and the Company's stockholders, and providing such persons with annual and long-term performance incentives to expend their maximum efforts in the creation of stockholder value. The Plan is intended to qualify certain compensation awarded under the Plan for tax deductibility under Section 162(m) of the Code (as hereafter defined) to the extent deemed appropriate by the Committee (or any successor committee) of the Board.

 

      2. Definitions . For purposes of the Plan, the following terms shall be defined as set forth below, in addition to such terms defined in Section 1 hereof.

 

            (a) "2005 Plan" means the Company's 2005 Stock Plan.

 

            (b) "Applicable Laws" means the requirements relating to the administration of equity compensation plans under U.S. state corporate laws, U.S. federal and state securities laws, the Code, the rules and regulations of any stock exchange upon which the Common Stock is listed, and the applicable laws of any foreign country or jurisdiction where Awards are granted under the Plan.

 

            (c) "Award" means any award granted pursuant to the terms of this Plan including, an Option, Stock Appreciation Right, Restricted Stock, Stock Units, Stock granted as a bonus or in lieu of another award, Dividend Equivalent, Other Stock-Based Award, or Performance Award, together with any other right or interest, granted to a Participant under the Plan.

 

            (d) "Beneficiary" means the person, persons, trust, or trusts which have been designated by a Participant in his or her most recent written beneficiary designation filed with the Committee to receive the benefits specified under the Plan upon such Participant's death or to which Awards or other rights are transferred if and to the extent permitted under Section 10(b) hereof. If, upon a Participant's death, there is no designated Beneficiary or surviving designated Beneficiary, then the term Beneficiary means the person, persons, trust, or trusts entitled by will or the laws of descent and distribution to receive such benefits.

 

            (e) "Beneficial Owner," "Beneficially Owning," and "Beneficial Ownership" shall have the meanings ascribed to such terms in Rule 13d-3 under the Exchange Act and any successor to such Rule.

 

            (f) "Board" means the Company's Board of Directors.

   

 
 
 

 

            (g) "Cause" shall, with respect to any Participant, have the equivalent meaning (or the same meaning as "cause" or "for cause") set forth in any employment agreement between the Participant and the Company or a Related Entity or, in the absence of any such agreement, such term shall mean (i) the failure by the Participant to perform his or her duties as assigned by the Company (or a Related Entity) in a reasonable manner, (ii) any violation or breach by the Participant of his or her employment agreement with the Company (or a Related Entity), if any, (iii) any violation or breach by the Participant of his or her confidential information and invention assignment agreement with the Company (or a Related Entity), if any, (iv) any act by the Participant of dishonesty or bad faith with respect to the Company (or a Related Entity), (v) any material violation or breach by the Participant of the Company's or a Related Entity's policy for employee conduct, if any, (vi) any act by the Participant of dishonesty or bad faith with respect to the Company (or a Related Entity), (vii) use of alcohol, drugs, or other similar substances affecting the Participant's work performance, or (viii) the commission by the Participant of any act, misdemeanor, or crime reflecting unfavorably upon the Participant or the Company. The good faith determination by the Committee of whether the Participant's Continuous Service was terminated by the Company for "Cause" shall be final and binding for all purposes hereunder.

 

            (h) "Change in Control" means and shall be deemed to have occurred on the earliest of the following dates:

 

                  (i) the date on which any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) obtains "beneficial ownership" (as defined in Rule 13d-3 of the Exchange Act) or a pecuniary interest in more than fifty percent (50%) of the combined voting power of the Company's then outstanding securities ("Voting Stock");

 

                  (ii) the consummation of a merger, consolidation, reorganization, or similar transaction other than a transaction: (1) (a) in which substantially all of the holders of Company's Voting Stock hold or receive directly or indirectly fifty percent (50%) or more of the voting stock of the resulting entity or a parent company thereof, in substantially the same proportions as their ownership of the Company immediately prior to the transaction; or (2) in which the holders of Company's capital stock immediately before such transaction will, immediately after such transaction, hold as a group on a fully diluted basis the ability to elect at least a majority of the directors of the surviving corporation (or a parent company);

 

                  (iii) there is consummated a sale, lease, exclusive license, or other disposition of all or substantially all of the consolidated assets of the Company and its Subsidiaries, other than a sale, lease, license, or other disposition of all or substantially all of the consolidated assets of the Company and its Subsidiaries to an entity, more than fifty percent (50%) of the combined voting power of the voting securities of which are owned by stockholders of the Company in substantially the same proportions as their ownership of the Company immediately prior to such sale, lease, license, or other disposition; or

 

                  (iv) individuals who, on the date this Plan is adopted by the Board, are Directors (the "Incumbent Board") cease for any reason to constitute at least a majority of the Directors; provided, however, that if the appointment or election (or nomination for election) of any new Director was approved or recommended by a majority vote of the members of the Incumbent Board then still in office, such new member shall, for purposes of this Plan, be considered as a member of the Incumbent Board.

 

      For purposes of determining whether a Change in Control has occurred, a transaction includes all transactions in a series of related transactions, and terms used in this definition but not defined are used as defined in the Plan. The term Change in Control shall not include a sale of assets, merger, or other transaction effected exclusively for the purpose of changing the domicile of the Company.

 

      Notwithstanding the foregoing or any other provision of this Plan, the definition of Change in Control (or any analogous term) in an individual written agreement between the Company and the Participant shall supersede the foregoing definition with respect to Awards subject to such agreement (it being understood, however, that if no definition of Change in Control or any analogous term is set forth in such an individual written agreement, the foregoing definition shall apply).

 

            (i) "Code" means the Internal Revenue Code of 1986, as amended from time to time, including regulations thereunder and successor provisions and regulations thereto.

 

 
 
 

 

            (j) "Committee" means a committee designated by the Board to administer the Plan with respect to at least a group of Employees, Directors, or Consultants.

 

            (k) "Consultant" means any person (other than an Employee or a Director, solely with respect to rendering services in such person's capacity as a director) who is engaged by the Company or any Related Entity to render consulting or advisory services to the Company or such Related Entity.

 

            (l) "Continuous Service" means uninterrupted provision of services to the Company as an Employee, a Director, or a Consultant. Continuous Service shall not be considered to be interrupted in the case of (i) any approved leave of absence, (ii) transfers among the Company, any Related Entities, or any successor entities, as either an Employee, a Director, or a Consultant, or (iii) any change in status as long as the individual remains in the service of the Company or a Related Entity as either an Employee, a Director, or a Consultant (except as otherwise provided in the Option Agreement). An approved leave of absence shall include sick leave, military leave, or any other authorized personal leave.

 

            (m) "Corporate Transaction" means the occurrence, in a single transaction or in a series of related transactions, of any one or more of the following events:

 

                  (i) a sale, lease, exclusive license, or other disposition of all or substantially all, as determined by the Board in its discretion, of the consolidated assets of the Company and its Subsidiaries;

 

                  (ii) a merger, consolidation, reorganization, or similar transaction, whether or not the Company is the surviving corporation.

 

            (n) "Covered Employee" means an Eligible Person who is a Covered Employee as specified in Section 7(d) of the Plan.

 

             (o) "Deferred Compensation" means any Award under this Plan that provides for the “deferral of compensation” under a “nonqualified deferred compensation plan” (as those terms are defined under Code Section 409A and the regulations promulgated thereunder) and that would be subject to the taxes specified in Code Section 409A(a)(1) if and to the extent that the Plan and the agreement evidencing the Incentive do not meet or are not operated in compliance with the requirements of Code Section 409A(a)(2), (3) and (4) and the regulations promulgated thereunder. Deferred Compensation shall not include any amount that is otherwise exempt from the requirements of Code Section 409A and the regulations promulgated thereunder.

 

            (p) "Director" means a member of the Board or the board of directors of any Related Entity.

 

            (q) "Disability" means a permanent and total disability (within the meaning of Section 22(e) of the Code), as determined by a medical doctor satisfactory to the Committee.

 

            (r) "Dividend Equivalent" means a right, granted to a Participant under Section 6(g) hereof, to receive cash, Stock, other Awards, or other property equal in value to dividends paid with respect to a specified number of Shares, or other periodic payments.

 

            (s) "Effective Date" means the effective date of this Plan, which shall be the date this Plan is adopted by the Board, subject to the approval of the stockholders of the Company.

   

 
 
 

 

            (t) "Eligible Person" means all Employees (including officers), Directors, and Consultants of the Company or of any Related Entity. The foregoing notwithstanding, only employees of the Company, the Parent, or any Subsidiary shall be Eligible Persons for purposes of receiving any Incentive Stock Options. An Employee on leave of absence may be considered as still in the employ of the Company or a Related Entity for purposes of eligibility for participation in the Plan.

 

            (u) "Employee" means any person, including an officer or Director, who is an employee of the Company or any Related Entity. The Payment of a director's fee by the Company or a Related Entity shall not be sufficient to constitute "employment" by the Company.

 

            (v) "Exchange Act" means the Securities Exchange Act of 1934, as amended from time to time, including rules thereunder and successor provisions and rules thereto.

 

            (w) "Executive Officer" means an executive officer of the Company as defined under the Exchange Act.

 

            (x) "Fair Market Value" means the fair market value of Stock, Awards, or other property as determined by the Plan Administrator, or under procedures established by the Plan Administrator. Unless otherwise determined by the Plan Administrator, the Fair Market Value of Stock as of any given date, after which the Stock is publicly traded on a stock exchange or market, shall be the closing sale price per share reported on a consolidated basis for stock listed on the principal stock exchange or market on which Stock is traded on the date as of which such value is being determined or, if there is no sale on that date, then on the last previous day on which a sale was reported.

 

            (y) "Incentive Stock Option" means any Option intended to be designated as an incentive stock option within the meaning of Section 422 of the Code or any successor provision thereto.

 

            (z) "Non-Employee Director" means a Director of the Company who is not an Employee.

 

            (aa) "Option" means a right granted to a Participant under Section 6(b) hereof, to purchase Stock or other Awards at a specified price during specified time periods.

 

            (bb) "Other Stock-Based Awards" means Awards granted to a Participant pursuant to Section 6(h) hereof.

 

            (cc) "Parent" means any corporation (other than the Company), whether now or hereafter existing, in an unbroken chain of corporations ending with the Company, if each of the corporations in the chain (other than the Company) owns stock possessing 50 percent or more of the combined voting power of all classes of stock in one of the other corporations in the chain.

 

            (dd) "Participant" means a person who has been granted an Award under the Plan which remains outstanding, including a person who is no longer an Eligible Person.

 

            (ee) "Performance Award" means a right, granted to an Eligible Person under Section 7 hereof, to receive Awards based upon performance criteria specified by the Plan Administrator.

 

            (ff) "Person" has the meaning ascribed to such term in Section 3(a)(9) of the Exchange Act and used in Sections 13(d) and 14(d) thereof, and shall include a "group" as defined in Section 12(d) thereof.

 

            (gg) "Plan Administrator" means the Board or any Committee delegated by the Board to administer the Plan.

   

 
 
 

 

            (hh) "Related Entity" means any Parent, Subsidiary, and any business, corporation, partnership, limited liability company, or other entity in which the Company, a Parent, or a Subsidiary, directly or indirectly, holds a substantial ownership interest.

 

            (ii) "Restricted Stock" means Stock granted to a Participant under Section 6(d) hereof, that is subject to certain restrictions and to a risk of forfeiture.

 

            (jj) "Rule 16b-3" and "Rule 16a-1(c)(3)" means Rule 16b-3 and Rule 16a-1(c)(3), as from time to time in effect and applicable to the Plan and Participants, promulgated by the Securities and Exchange Commission under Section 16 of the Exchange Act.

 

            (kk) "Shares" means the shares of the Company's Common Stock, and the shares of such other securities as may be substituted (or resubstituted) for Stock pursuant to Section 10(c) hereof.

 

            (ll) "Stock" means the Company's Common Stock, and such other securities as may be substituted (or resubstituted) for the Company's Common Stock pursuant to Section 10(c) hereof.

 

            (mm) "Stock Appreciation Right" means a right granted to a Participant pursuant to Section 6(c) hereof.

 

            (nn) "Stock Unit" means a right, granted to a Participant pursuant to Section 6(e) hereof, to receive Shares, cash or a combination thereof at the end of a specified period of time.

 

            (oo) "Subsidiary" means any corporation (other than the Company), whether now or hereafter existing, in an unbroken chain of corporations beginning with the Company, if each of the corporations other than the last corporation in the unbroken chain owns stock possessing 50 percent or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

 

      3. Administration .

 

            (a) Administration by Board. The Board shall administer the Plan unless and until the Board delegates administration to a Committee, as provided in Section 3(c).

 

            (b) Powers of Board. The Board shall have the power, subject to, and within the limitations of, the express provisions of the Plan:

 

                  (i) To determine from time to time which of the persons eligible under the Plan shall be granted Awards; when and how each Award shall be granted; what type or combination of types of Award shall be granted; the provisions of each Award granted (which need not be identical), including the time or times when a person shall be permitted to receive Shares pursuant to an Award; and the number of Shares with respect to which an Award shall be granted to each such person.

 

                  (ii) To construe and interpret the Plan and Awards granted under it, and to establish, amend, and revoke rules and regulations for its administration. The Board, in the exercise of this power, may correct any defect, omission, or inconsistency in the Plan or in any Stock Award Agreement, in a manner and to the extent it shall deem necessary or expedient to make the Plan fully effective.

 

                  (iii) To amend the Plan or an Award as provided in Section 10(e).

 

                  (iv) To terminate or suspend the Plan as provided in Section 10(e).

   

 
 
 

 

                  (v) To effect, at any time and from time to time, with the consent of any adversely affected Participant, (1) the reduction of the exercise price of any outstanding Award under the Plan, if any, (2) the cancellation of any outstanding Award and the grant in substitution therefor of (A) a new Award under the Plan or another equity plan of the Company covering the same or a different number of Shares, (B) cash and/or (C) other valuable consideration (as determined by the Board, in its sole discretion), or (3) any other action that is treated as a repricing under generally accepted accounting principles.

 

                  (vi) Generally, to exercise such powers and to perform such acts as the Board deems necessary or expedient to promote the best interests of the Company and that are not in conflict with the provisions of the Plan.

 

            (c) Delegation to Committee .

 

                  (i) General . The Board may delegate administration of the Plan to a Committee or Committees of two (2) or more members of the Board, and the term "Committee" shall apply to any person or persons to whom such authority has been delegated. If administration is delegated to a Committee, the Committee shall have, in connection with the administration of the Plan, the powers theretofore possessed by the Board, including the power to delegate to a subcommittee any of the administrative powers the Committee is authorized to exercise (and references in this Plan to the Board shall thereafter be to the Committee or subcommittee), subject, however, to such resolutions, not inconsistent with the provisions of the Plan, as may be adopted from time to time by the Board. The Board may abolish the Committee at any time and revest in the Board the administration of the Plan.

 

                  (ii) Section 162(m) and Rule 16b-3 Compliance . In the discretion of the Board, the Committee may consist solely of two or more "Outside Directors", in accordance with Section 162(m) of the Code, and/or solely of two or more "Non-Employee Directors", in accordance with Rule 16b-3. In addition, the Board or the Committee may delegate to a committee of two or more members of the Board the authority to grant Awards to eligible persons who are either (a) not then Covered Employees and are not expected to be Covered Employees at the time of recognition of income resulting from such Award, (b) not persons with respect to whom the Company wishes to comply with Section 162(m) of the Code, or (c) not then subject to Section 16 of the Exchange Act.

 

            (d) Effect of Board's Decision . All determinations, interpretations, and constructions made by the Board in good faith shall not be subject to review by any person and shall be final, binding, and conclusive on all persons.

 

            (e) Arbitration . Any dispute or claim concerning any Award granted (or not granted) pursuant to the Plan or any disputes or claims relating to or arising out of the Plan shall be fully, finally, and exclusively resolved by binding and confidential arbitration conducted pursuant to the rules of Judicial Arbitration and Mediation Services, Inc. ("JAMS") in Phoenix, Arizona. The Company shall pay all arbitration fees. In addition to any other relief, the arbitrator may award to the prevailing party recovery of its attorneys' fees and costs. By accepting an Award, the Participant and the Company waive their respective rights to have any such disputes or claims tried by a judge or jury.

 

            (f) Limitation of Liability . The Committee and the Board, and each member thereof, shall be entitled to, in good faith, rely or act upon any report or other information furnished to him or her by any officer or Employee, the Company's independent auditors, Consultants or any other agents assisting in the administration of the Plan. Members of the Committee and the Board, and any officer or Employee acting at the direction or on behalf of the Plan Administrator, shall not be personally liable for any action or determination taken or made in good faith with respect to the Plan, and shall, to the extent permitted by law, be fully indemnified and protected by the Company with respect to any such action or determination.

 

 
 
 

 

      4. Stock Subject to Plan .

 

            (a) Limitation on Overall Number of Shares Subject to Awards . Subject to adjustment as provided in Section 10(c) hereof, the total number of Shares reserved and available for delivery in connection with Awards under the Plan shall be 2,250,000. In addition, as of the date this Plan is first approved by the stockholders, any shares available in the reserve of the 2005 Plan shall be added to the Plan share reserve and be available for issuance under the Plan. Any Shares delivered under the Plan may consist, in whole or in part, of authorized and unissued shares or treasury shares.

 

            (b) Availability of Shares Not Delivered under Awards .

 

                  (i) If any Shares subject to an Award or subject to an award under the 2005 Plan are forfeited, expire or otherwise terminate without issuance of such Shares, or any Award is settled for cash or otherwise does not result in the issuance of all or a portion of the Shares subject to such Award, the Shares shall, to the extent of such forfeiture, expiration, termination, cash settlement or non-issuance, again be available for Awards under the Plan, subject to Section 4(b)(iv) below.

 

                  (ii) If any Shares issued pursuant to an Award or an award under the 2005 Plan are forfeited back to or repurchased by the Company, including, but not limited to, any repurchase or forfeiture caused by the failure to meet a contingency or condition required for the vesting of such shares, then such forfeited or repurchased Shares shall revert to and again become available for issuance under the Plan, subject to Section 4(b)(iv) below.

 

                  (iii) In the event that any Option or other Award granted hereunder or under the 2005 Plan is exercised through the tendering of Shares (either actually or by attestation) or by the withholding of Shares by the Company, or withholding tax liabilities arising from such Option, other Award or other award are satisfied by the tendering of Shares (either actually or by attestation) or by the withholding of Shares by the Company, then only the net number of Shares actually issued to the Participant shall be counted as issued for purposes of determining the maximum number of Shares available for grant under the Plan, subject to Section 4(b)(iv) below.

 

                  (iv) Notwithstanding anything in this Section 4(b) to the contrary and solely for purposes of determining whether Shares are available for the grant of Incentive Stock Options, the maximum aggregate number of shares that may be granted under this Plan shall be determined without regard to any Shares restored pursuant to this Section 4(b) that, if taken into account, would cause the Plan, for purposes of the grant of Incentive Stock Options, to fail the requirement under Code Section 422 that the Plan designate a maximum aggregate number of shares that may be issued.

 

            (c) Application of Limitations . The limitation contained in this Section 4 shall apply not only to Awards that are settled by the delivery of Shares but also to Awards relating to Shares but settled only in cash (such as cash-only Stock Appreciation Rights). The Plan Administrator may adopt reasonable counting procedures to ensure appropriate counting, avoid double counting (as, for example, in the case of tandem or substitute awards) and make adjustments if the number of Shares actually delivered differs from the number of shares previously counted in connection with an Award.

 

      5. Eligibility . Awards may be granted under the Plan only to Eligible Persons.

   

 
 
 

 

      6. Terms of Awards .

 

            (a) General . Awards may be granted on the terms and conditions set forth in this Section 6. In addition, the Plan Administrator may impose on any Award or the exercise thereof, at the date of grant or thereafter (subject to Section 10(e)), such additional terms and conditions, not inconsistent with the provisions of the Plan, as the Plan Administrator shall determine, including but not limited to terms requiring forfeiture of Awards in the event of termination of Continuous Service by the Participant and terms permitting a Participant to make elections relating to his or her Award. The Plan Administrator shall retain full power and discretion to accelerate, waive, or modify, at any time, any term or condition of an Award that is not mandatory under the Plan.

 

            (b) Options . The Plan Administrator is authorized to grant Options to Participants on the following terms and conditions:

 

                  (i) Stock Option Agreement . Each grant of an Option shall be evidenced by a Stock Option Agreement. Such Stock Option Agreement shall be subject to all applicable terms and conditions of the Plan and may be subject to any other terms and conditions which are not inconsistent with the Plan and which the Plan Administrator deems appropriate for inclusion in a Stock Option Agreement. The provisions of the various Stock Option Agreements entered into under the Plan need not be identical.

 

                  (ii) Number of Shares . Each Stock Option Agreement shall specify the number of Shares that are subject to the Option and shall provide, either explicitly or pursuant to general incorporation of the Plan by reference into such Stock Option Agreement, for the adjustment of such number in accordance with Section 10(c) hereof. The Stock Option Agreement shall also specify whether the Stock Option is an Incentive Stock Option or a Non-Qualified Stock Option.

 

                  (iii) Exercise Price .

 

                        (A) In General . Each Stock Option Agreement shall state the price at which Shares subject to the Option may be purchased (the "Exercise Price"), which shall be, with respect to Incentive Stock Options, not less than 100% of the Fair Market Value of the Stock on the date of grant. In the case of Non-Qualified Stock Options, the Exercise Price shall be determined in the sole discretion of the Plan Administrator.

 

                        (B) Ten Percent Stockholder . If a Participant owns or is deemed to own (by reason of the attribution rules applicable under Section 424(d) of the Code) more than 10% of the combined voting power of all classes of stock of the Company or any Related Entity, any Incentive Stock Option granted to such Participant must have an Exercise Price per share of at least 110% of the Fair Market Value of a share of Stock on the date of grant.

 

                  (iv) Time and Method of Exercise . The Plan Administrator shall determine the time or times at which or the circumstances under which an Option may be exercised in whole or in part (including based on achievement of performance goals and/or future service requirements). The Plan Administrator may also determine the time or times at which Options shall cease to be or become exercisable following termination of Continuous Service or upon other conditions. The Board or the Committee may determine the methods by which such exercise price may be paid or deemed to be paid (including, in the discretion of the Plan Administrator, a cashless exercise procedure), the form of such payment, including, without limitation, cash, Stock, other Awards or awards granted under other plans of the Company or a Related Entity, or other property (including notes or other contractual obligations of Participants to make payment on a deferred basis), and the methods by or forms in which Stock will be delivered or deemed to be delivered to Participants.

 

 
 
 

 

                  (v) Incentive Stock Options . The terms of any Incentive Stock Option granted under the Plan shall comply in all respects with the provisions of Section 422 of the Code. Anything in the Plan to the contrary notwithstanding, no term of the Plan relating to Incentive Stock Options (including any Stock Appreciation Rights in tandem therewith) shall be interpreted, amended, or altered, nor shall any discretion or authority granted under the Plan be exercised, so as to disqualify either the Plan or any Incentive Stock Option under Section 422 of the Code, unless the Participant has consented in writing to the change that will result in such disqualification. If and to the extent required to comply with Section 422 of the Code, Options granted as Incentive Stock Options shall be subject to the following special terms and conditions:

 

                        (1) the Option shall not be exercisable more than ten years after the date such Incentive Stock Option is granted; provided, however, that if a Participant owns or is deemed to own (by reason of the attribution rules of Section 424(d) of the Code) more than 10% of the combined voting power of all classes of stock of the Company or any Parent Corporation and the Incentive Stock Option is granted to such Participant, the term of the Incentive Stock Option shall be (to the extent required by the Code at the time of the grant) for no more than five years from the date of grant; and

 

                        (2) If the aggregate Fair Market Value (determined as of the date the Incentive Stock Option is granted) of the Shares with respect to which Incentive Stock Options granted under the Plan and all other option plans of the Company, its Parent or any Subsidiary are exercisable for the first time by a Participant during any calendar year exceeds $100,000, then such Participant's Incentive Stock Option(s) or portions thereof that exceed such $100,000 limit shall be treated as Non-statutory Stock Options (in the reverse order in which they were granted, so that the last Incentive Stock Option will be the first treated as a Non-statutory Stock Option). This paragraph shall only apply to the extent such limitation is applicable under the Code at the time of the grant.

 

                  (vi) Repurchase Rights . The Committee and the Board shall have the discretion to grant Options that are exercisable for unvested shares of Common Stock. Should the Participant's Continuous Service cease while holding such unvested shares, the Company shall have the right to repurchase any or all of those unvested shares, at either (a) the exercise price paid per share, (b) the fair market value, or (c) the lower of the exercise price paid per share and the fair market value. The terms upon which such repurchase right shall be exercisable (including the period and procedure for exercise and the appropriate vesting schedule for the purchased shares) shall be established by the Plan Administrator and set forth in the document evidencing such repurchase right.

 

(vii) Limitation on Awards . During any one fiscal year, no Person shall receive Options and Stock Appreciation Rights that exceed, in the aggregate, 300,000 Shares.

 

            (c) Stock Appreciation Rights . The Plan Administrator is authorized to grant Stock Appreciation Rights to Participants on the following terms and conditions:

 

                  (i) Right to Payment . A Stock Appreciation Right shall confer on the Participant to whom it is granted a right to receive, upon exercise thereof, the excess of (A) the Fair Market Value of one share of stock on the date of exercise over (B) the grant price of the Stock Appreciation Right as determined by the Plan Administrator.

 

                  (ii) Other Terms . The Plan Administrator shall determine at the date of grant or thereafter, the time or times at which and the circumstances under which a Stock Appreciation Right may be exercised in whole or in part (including based on achievement of performance goals and/or future service requirements), the time or times at which Stock Appreciation Rights shall cease to be or become exercisable following termination of Continuous Service or upon other conditions, the method of exercise, method of settlement, form of consideration payable in settlement, method by or forms in which Stock will be delivered or deemed to be delivered to Participants, whether or not a Stock Appreciation Right shall be in tandem or in combination with any other Award, and any other terms and conditions of any Stock Appreciation Right. Stock Appreciation Rights may be either freestanding or in tandem with other Awards.

   

 
 
 

 

            (d) Restricted Stock . The Plan Administrator is authorized to grant Restricted Stock to Participants on the following terms and conditions:

 

                  (i) Grant and Restrictions . Restricted Stock shall be subject to such restrictions on transferability, risk of forfeiture, and other restrictions, if any, as the Plan Administrator may impose, or as otherwise provided in this Plan. The restrictions may lapse separately or in combination at such times, under such circumstances (including based on achievement of performance goals and/or future service requirements), in such installments or otherwise, as the Plan Administrator may determine at the date of grant or thereafter. Except to the extent restricted under the terms of the Plan and any Award agreement relating to the Restricted Stock, a Participant granted Restricted Stock shall have all of the rights of a stockholder, including the right to vote the Restricted Stock and the right to receive dividends thereon (subject to any mandatory reinvestment or other requirement imposed by the Plan Administrator). During the restricted period applicable to the Restricted Stock, subject to Section 10(b) below, the Restricted Stock may not be sold, transferred, pledged, hypothecated, margined, or otherwise encumbered by the Participant.

 

                  (ii) Forfeiture . Except as otherwise determined by the Plan Administrator at the time of the Award, upon termination of a Participant's Continuous Service during the applicable restriction period, the Participant's Restricted Stock that is at that time subject to restrictions shall be forfeited and reacquired by the Company; provided that the Plan Administrator may provide, by rule or regulation or in any Award agreement, or may determine in any individual case, that restrictions or forfeiture conditions relating to Restricted Stock shall be waived in whole or in part in the event of terminations resulting from specified causes, and the Plan Administrator may in other cases waive in whole or in part the forfeiture of Restricted Stock.

 

                  (iii) Certificates for Stock . Restricted Stock granted under the Plan may be evidenced in such manner as the Plan Administrator shall determine. If certificates representing Restricted Stock are registered in the name of the Participant, the Plan Administrator may require that such certificates bear an appropriate legend referring to the terms, conditions, and restrictions applicable to such Restricted Stock, that the Company retain physical possession of the certificates, that the certificates be kept with an escrow agent and that the Participant deliver a stock power to the Company, endorsed in blank, relating to the Restricted Stock.

 

                  (iv) Dividends and Splits . As a condition to the grant of an Award of Restricted Stock, the Plan Administrator may require that any cash dividends paid on a share of Restricted Stock be automatically reinvested in additional shares of Restricted Stock or applied to the purchase of additional Awards under the Plan. Unless otherwise determined by the Plan Administrator, Stock distributed in connection with a Stock split or Stock dividend, and other property distributed as a dividend, shall be subject to restrictions and a risk of forfeiture to the same extent as the Restricted Stock with respect to which such Stock or other property has been distributed.

 

            (e) Stock Units . The Plan Administrator is authorized to grant Stock Units to Participants, which are rights to receive Stock, cash, or a combination thereof at the end of a specified time period, subject to the following terms and conditions:

 

                  (i) Award and Restrictions . Satisfaction of an Award of Stock Units shall occur upon expiration of the time period specified for such Stock Units by the Plan Administrator (or, if permitted by the Plan Administrator, as elected by the Participant). In addition, Stock Units shall be subject to such restrictions (which may include a risk of forfeiture) as the Plan Administrator may impose, if any, which restrictions may lapse at the expiration of the time period or at earlier specified times (including based on achievement of performance goals and/or future service requirements), separately or in combination, in installments or otherwise, as the Plan Administrator may determine. Stock Units may be satisfied by delivery of Stock, cash equal to the Fair Market Value of the specified number of Shares covered by the Stock Units, or a combination thereof, as determined by the Plan Administrator at the date of grant or thereafter. Prior to satisfaction of an Award of Stock Units, an Award of Stock Units carries no voting or dividend or other rights associated with share ownership.

   

 
 
 

 

                  (ii) Forfeiture . Except as otherwise determined by the Plan Administrator, upon termination of a Participant's Continuous Service during the applicable time period thereof to which forfeiture conditions apply (as provided in the Award agreement evidencing the Stock Units), the Participant's Stock Units (other than those Stock Units subject to deferral at the election of the Participant) shall be forfeited; provided that the Plan Administrator may provide, by rule or regulation or in any Award agreement, or may determine in any individual case, that restrictions or forfeiture conditions relating to Stock Units shall be waived in whole or in part in the event of terminations resulting from specified causes, and the Plan Administrator may in other cases waive in whole or in part the forfeiture of Stock Units.

 

                  (iii) Dividend Equivalents . Unless otherwise determined by the Plan Administrator at date of grant, any Dividend Equivalents that are granted with respect to any Award of Stock Units shall be either (A) paid with respect to such Stock Units at the dividend payment date in cash or in shares of unrestricted Stock having a Fair Market Value equal to the amount of such dividends, or (B) deferred with respect to such Stock Units and the amount or value thereof automatically deemed reinvested in additional Stock Units, other Awards or other investment vehicles, as the Plan Administrator shall determine or permit the Participant to elect.

 

            (f) Bonus Stock and Awards in Lieu of Obligations . The Plan Administrator is authorized to grant Stock as a bonus, or to grant Stock or other Awards in lieu of Company obligations to pay cash or deliver other property under the Plan or under other plans or compensatory arrangements, provided that, in the case of Participants subject to Section 16 of the Exchange Act, the amount of such grants remains within the discretion of the Committee to the extent necessary to ensure that acquisitions of Stock or other Awards are exempt from liability under Section 16(b) of the Exchange Act. Stock or Awards granted hereunder shall be subject to such other terms as shall be determined by the Plan Administrator.

 

            (g) Dividend Equivalents . The Plan Administrator is authorized to grant Dividend Equivalents to a Participant entitling the Participant to receive cash, Stock, other Awards, or other property equal in value to dividends paid with respect to a specified number of Shares, or other periodic payments. Dividend Equivalents may be awarded on a free-standing basis or in connection with another Award. The Plan Administrator may provide that Dividend Equivalents shall be paid or distributed when accrued or shall be deemed to have been reinvested in additional Stock, Awards, or other investment vehicles, and subject to such restrictions on transferability and risks of forfeiture, as the Plan Administrator may specify.

 

            (h) Other Stock-Based Awards . The Plan Administrator is authorized, subject to limitations under applicable law, to grant to Participants such other Awards that may be denominated or payable in, valued in whole or in part by reference to, or otherwise based on, or related to, Stock, as deemed by the Plan Administrator to be consistent with the purposes of the Plan, including, without limitation, convertible or exchangeable debt securities, other rights convertible or exchangeable into Stock, purchase rights for Stock, Awards with value and payment contingent upon performance of the Company or any other factors designated by the Plan Administrator, and Awards valued by reference to the book value of Stock or the value of securities of or the performance of specified Related Entities or business units. The Plan Administrator shall determine the terms and conditions of such Awards. Stock delivered pursuant to an Award in the nature of a purchase right granted under this Section 6(h) shall be purchased for such consideration (including without limitation loans from the Company or a Related Entity), paid for at such times, by such methods, and in such forms, including, without limitation, cash, Stock, other Awards or other property, as the Plan Administrator shall determine. The Plan Administrator shall have the discretion to grant such other Awards which are exercisable for unvested shares of Common Stock. Should the Participant's Continuous Service cease while holding such unvested shares, the Company shall have the right to repurchase, at a price determined by the Administrator at the time of grant, any or all of those unvested shares. The terms upon which such repurchase right shall be exercisable (including the period and procedure for exercise and the appropriate vesting schedule for the purchased shares) shall be established by the Plan Administrator and set forth in the document evidencing such repurchase right. Cash awards, as an element of or supplement to any other Award under the Plan, may also be granted pursuant to this Section 6(h).

   

 
 
 

 

      7. Performance Awards .

 

            (a) Performance Conditions . The right of a Participant to exercise or receive a grant or settlement of any Award, and the timing thereof, may be subject to such performance conditions as may be specified by the Plan Administrator. The Plan Administrator may use such business criteria and other measures of performance as it may deem appropriate in establishing any performance conditions, and may exercise its discretion to reduce the amounts payable under any Award subject to performance conditions, except as limited under Section 7(b) hereof in the case of a Performance Award intended to qualify under Code Section 162(m). If and to the extent required under Code Section 162(m), any power or authority relating to a Performance Award intended to qualify under Code Section 162(m), shall be exercised by the Committee as the Plan Administrator and not the Board.

 

            (b) Performance Awards Granted to Designated Covered Employees . If and to the extent that the Committee determines that a Performance Award to be granted to an Eligible Person who is designated by the Committee as likely to be a Covered Employee should qualify as "performance-based compensation" for purposes of Code Section 162(m), the grant, exercise, and/or settlement of such Performance Award shall be contingent upon achievement of pre-established performance goals and other terms set forth in this Section 7(b).

 

                  (i) Performance Goals Generally . The performance goals for such Performance Awards shall consist of one or more business criteria and a targeted level or levels of performance with respect to each of such criteria, as specified by the Committee consistent with this Section 7(b). Performance goals shall be objective and shall otherwise meet the requirements of Code Section 162(m) and regulations thereunder including the requirement that the level or levels of performance targeted by the Committee result in the achievement of performance goals being "substantially uncertain." The Committee may determine that such Performance Awards shall be granted, exercised, and/or settled upon achievement of any one performance goal or that two or more of the performance goals must be achieved as a condition to grant, exercise, and/or settlement of such Performance Awards. Performance goals may differ for Performance Awards granted to any one Participant or to different Participants.

 

                  (ii) Business Criteria . One or more of the following business criteria for the Company, on a consolidated basis, and/or specified Related Entities or business units of the Company, shall be used exclusively by the Committee in establishing performance goals for such Performance Awards that are intended to qualify as “performance-based” compensation within the meaning of Section 162(m) of the Code: earnings per share, operating income or profit, net income, gross or net sales, expenses, expenses as a percentage of net sales, inventory turns, cash flow (including, but not limited to, operating cash flow, free cash flow, cash flow return on equity, and cash flow return on investment), gross profit, margins, working capital, earnings before interest and tax (EBIT), earnings before interest, tax, depreciation and amortization (EBITDA), return measures (including, but not limited to, return on assets, capital, invested capital, equity, sales, or revenue), revenue growth, share price (including, but not limited to, growth measures and total shareholder return), operating efficiency, productivity ratios, market share, economic value added and safety (or any of the above criteria as compared to the performance of a group of comparator companies, or published or special index that the Plan Administrator, in its sole discretion, deems appropriate, or the Committee may select criteria based on the Company’s share price as compared to various stock market indices. The Plan Administrator, in its sole discretion, may modify the performance goals if it determines that circumstances have changed and modification is required to reflect the original intent of the Performance Goals; provided, however, that no such change or modification may be made to the extent it increases the amount of compensation payable to any Participant who is a Covered Employee” within the meaning of Code Section 162(m).

   

 
 
 

 

                  (iii) Performance Period; Timing For Establishing Performance Goals . Achievement of performance goals in respect of such Performance Awards shall be measured over a performance period of up to ten (10) years, as specified by the Committee. Performance goals shall be established not later than ninety (90) days after the beginning of any performance period applicable to such Performance Awards, or at such other date as may be required or permitted for "performance-based compensation" under Code Section 162(m).

 

                  (iv) Performance Award Pool . The Committee may establish a Performance Award pool, which shall be an unfunded pool, for purposes of measuring Company performance in connection with Performance Awards. The amount of such Performance Award pool shall be based upon the achievement of a performance goal or goals based on one or more of the business criteria set forth in Section 7(b)(ii) hereof during the given performance period, as specified by the Committee in accordance with Section 7(b)(iii) hereof. The Committee may specify the amount of the Performance Award pool as a percentage of any of such business criteria, a percentage thereof in excess of a threshold amount, or as another amount which need not bear a strictly mathematical relationship to such business criteria.

 

                  (v) Settlement of Performance Awards; Other Terms . Settlement of such Performance Awards shall be in cash, Stock, other Awards or other property, in the discretion of the Committee. The Committee may, in its discretion, reduce the amount of a settlement otherwise to be made in connection with such Performance Awards. The Committee shall specify the circumstances in which such Performance Awards shall be paid or forfeited in the event of termination of Continuous Service by the Participant prior to the end of a performance period or settlement of Performance Awards.

 

            (c) Written Determinations . All determinations by the Committee as to the establishment of performance goals, the amount of any Performance Award pool or potential individual Performance Awards and as to the achievement of performance goals relating to Performance Awards under Section 7(b), shall be made in writing in the case of any Award intended to qualify under Code Section 162(m). The Committee may not delegate any responsibility relating to such Performance Awards if and to the extent required to comply with Code Section 162(m).

 

            (d) Status of Performance Awards Under Code Section 162(m) . It is the intent of the Company that Performance Awards under this Section 7 hereof granted to persons who are designated by the Committee as likely to be Covered Employees within the meaning of Code Section 162(m) and regulations thereunder shall, if so designated by the Committee, constitute "qualified performance-based compensation" within the meaning of Code Section 162(m) and regulations thereunder. Accordingly, the terms of Sections 7(b), (c) and (d), including the definitions of Covered Employee and other terms used therein, shall be interpreted in a manner consistent with Code Section 162(m) and regulations thereunder. The foregoing notwithstanding, because the Committee cannot determine with certainty whether a given Participant will be a Covered Employee with respect to a fiscal year that has not yet been completed, the term Covered Employee as used herein shall mean only a person designated by the Committee, at the time of grant of Performance Awards, as likely to be a Covered Employee with respect to that fiscal year. If any provision of the Plan or any agreement relating to such Performance Awards does not comply or is inconsistent with the requirements of Code Section 162(m) or regulations thereunder, such provision shall be construed or deemed amended to the extent necessary to conform to such requirements.

   

 
 
 

 

      8. Certain Provisions Applicable to Awards or Sales .

 

            (a) Stand-Alone, Additional, Tandem, and Substitute Awards . Awards granted under the Plan may, in the discretion of the Plan Administrator, be granted either alone or in addition to, in tandem with, or in substitution or exchange for, any other Award or any award granted under another plan of the Company, any Related Entity, or any business entity to be acquired by the Company or a Related Entity, or any other right of a Participant to receive payment from the Company or any Related Entity. Such additional, tandem, and substitute or exchange Awards may be granted at any time. If an Award is granted in substitution or exchange for another Award or award, the Plan Administrator shall require the surrender of such other Award or award in consideration for the grant of the new Award. In addition, Awards may be granted in lieu of cash compensation, including in lieu of cash amounts payable under other plans of the Company or any Related Entity.

 

            (b) Form and Timing of Payment Under Awards; Deferrals . Subject to the terms of the Plan and any applicable Award agreement, payments to be made by the Company or a Related Entity upon the exercise of an Option or other Award or settlement of an Award may be made in such forms as the Plan Administrator shall determine, including, without limitation, cash, other Awards or other property, and may be made in a single payment or transfer, in installments, or on a deferred basis. The settlement of any Award may be accelerated, and cash paid in lieu of Stock in connection with such settlement, in the discretion of the Plan Administrator or upon occurrence of one or more specified events (in addition to a Change in Control). Installment or deferred payments may be required by the Plan Administrator (subject to Section 10(g) of the Plan) or permitted at the election of the Participant on terms and conditions established by the Plan Administrator. Payments may include, without limitation, provisions for the payment or crediting of a reasonable interest rate on installment or deferred payments or the grant or crediting of Dividend Equivalents or other amounts in respect of installment or deferred payments denominated in Stock.

 

            (c) Exemptions from Section 16(b) Liability . It is the intent of the Company that this Plan comply in all respects with applicable provisions of Rule 16b-3 or Rule 16a-1(c)(3) to the extent necessary to ensure that neither the grant of any Awards to nor other transaction by a Participant who is subject to Section 16 of the Exchange Act is subject to liability under Section 16(b) thereof (except for transactions acknowledged in writing to be non-exempt by such Participant). Accordingly, if any provision of this Plan or any Award agreement does not comply with the requirements of Rule 16b-3 or Rule 16a-1(c)(3) as then applicable to any such transaction, such provision will be construed or deemed amended to the extent necessary to conform to the applicable requirements of Rule 16b-3 or Rule 16a-1(c)(3) so that such Participant shall avoid liability under Section 16(b).

 

(d) No Option Repricing . Other than for capitalization adjustment pursuant to Section 10(c), without approval of the Company’s stockholders, the Plan Administrator shall not be permitted to (A) lower the exercise price per Share of an Option after it is granted, (B) cancel an Option when the exercise price per Share exceeds the Fair Market Value of the underlying Shares in exchange for another Award or cash, or (C) take any other action with respect to an Option that may be treated as a repricing under the federal securities laws or Generally Accepted Accounting Principles.

   

 
 
 

 

      9. Change in Control; Corporate Transaction .

 

            (a) Change in Control .

 

                  (i) The Plan Administrator may, in its discretion, accelerate the vesting, exercisability, lapsing of restrictions, or expiration of deferral of any Award, including upon the occurrence of a Change in Control. In addition, the Plan Administrator may provide in an Award agreement that the performance goals relating to any Performance Award will be deemed to have been met upon the occurrence of any Change in Control.

 

                  (ii) In addition to the terms of Section 9(a)(i) above, the effect of a "Change in Control," may be provided (1) in an employment, compensation, or severance agreement, if any, between the Company or any Related Entity and the Participant, relating to the Participant's employment, compensation, or severance with or from the Company or such Related Entity, or (2) in the agreement evidencing the Award.

 

            (b) Corporate Transactions . In the event of a Corporate Transaction, any surviving corporation or acquiring corporation may either (i) assume or continue any or all Awards outstanding under the Plan, or (ii) substitute similar stock awards for outstanding Awards (it being understood that similar awards include, but are not limited to, awards to acquire the same consideration paid to the stockholders or the Company, as the case may be, pursuant to the Corporate Transaction). In the event that any surviving corporation or acquiring corporation does not assume or continue any or all such outstanding Awards or substitute similar stock awards for such outstanding Awards, then with respect to Awards that have been not assumed, continued, or substituted, then such Awards shall terminate if not exercised (if applicable) at or prior to such effective time (contingent upon the effectiveness of the Corporate Transaction). The Administrator, in its discretion and without the consent of any Participant, may (but is not obligated to) either (i) accelerate the vesting of all Awards (and, if applicable, the time at which such Awards may be exercised) in full or as to some percentage of the Award to a date prior to the effective time of such Corporate Transaction as the Administrator shall determine (contingent upon the effectiveness of each Corporate Transaction) or (ii) provide for a cash payment in exchange for the termination of an Award or any portion thereof where such cash payment is equal to the Fair Market Value of the Shares that the Participant would receive if the Award were fully vested and exercised (if applicable) as of such date (less any applicable exercise price). The Administrator, in its sole discretion, shall determine whether each Award is assumed, continued, substituted, or terminated.

 

                  With respect to Restricted Stock and any other Award granted under the Plan that the Company has any reacquisition or repurchase rights, the reacquisition or repurchase rights for such Awards may be assigned by the Company to the successor of the Company (or the successor's parent company) in connection with such Corporate Transaction. In addition, the Administrator, in its discretion, may (but is not obligated to) provide that any reacquisition or repurchase rights held by the Company with respect to such Awards shall lapse in whole or in part (contingent upon the effectiveness of the Corporate Transaction).

 

            (c) Dissolution or Liquidation . In the event of a dissolution or liquidation of the Company, then all outstanding Awards shall terminate immediately prior to the completion of such dissolution or liquidation, and shares of Common Stock subject to the Company's repurchase option may be repurchased by the Company notwithstanding the fact that the holder of such stock is still in Continuous Service.

 

 
 
 

 

      10. General Provisions .

 

            (a) Compliance With Legal and Other Requirements . The Company may, to the extent deemed necessary or advisable by the Plan Administrator, postpone the issuance or delivery of Stock or payment of other benefits under any Award until completion of such registration or qualification of such Stock or other required action under any federal or state law, rule, or regulation, listing or other required action with respect to any stock exchange or automated quotation system upon which the Stock or other Company securities are listed or quoted, or compliance with any other obligation of the Company, as the Plan Administrator, may consider appropriate, and may require any Participant to make such representations, furnish such information, and comply with or be subject to such other conditions as it may consider appropriate in connection with the issuance or delivery of Stock or payment of other benefits in compliance with applicable laws, rules, and regulations, listing requirements, or other obligations. The foregoing notwithstanding, in connection with a Change in Control, the Company shall take or cause to be taken no action, and shall undertake or permit to arise no legal or contractual obligation, that results or would result in any postponement of the issuance or delivery of Stock or payment of benefits under any Award or the imposition of any other conditions on such issuance, delivery, or payment, to the extent that such postponement or other condition would represent a greater burden on a Participant than existed on the 90th day preceding the Change in Control.

 

            (b) Limits on Transferability; Beneficiaries .

 

                  (i) General . Except as provided in the Award agreement, a Participant may not assign, sell, transfer, or otherwise encumber or subject to any lien any Award or other right or interest granted under this Plan, in whole or in part, other than by will or by operation of the laws of descent and distribution, and such Awards or rights that may be exercisable shall be exercised during the lifetime of the Participant only by the Participant or his or her guardian or legal representative.

 

                  (ii) Permitted Transfer of Option . The Plan Administrator, in its sole discretion, may permit the transfer of an Option (but not an Incentive Stock Option, or any other right to purchase Stock other than an Option) as follows: (A) by gift to a member of the Participant's Immediate Family or (B) by transfer by instrument to a trust providing that the Option is to be passed to beneficiaries upon death of the Participant. For purposes of this Section 10(b)(ii), "Immediate Family" shall mean the Participant's spouse (including a former spouse subject to terms of a domestic relations order); child, stepchild, grandchild, child-in-law; parent, stepparent, grandparent, parent-in-law; sibling and sibling-in-law, and shall include adoptive relationships. If a determination is made by counsel for the Company that the restrictions contained in this Section 10(b)(ii) are not required by applicable federal or state securities laws under the circumstances, then the Committee or Board, in its sole discretion, may permit the transfer of Awards (other than Incentive Stock Options and Stock Appreciation Rights in tandem therewith) to one or more Beneficiaries or other transferees during the lifetime of the Participant, which may be exercised by such transferees in accordance with the terms of such Award, but only if and to the extent permitted by the Plan Administrator pursuant to the express terms of an Award agreement (subject to any terms and conditions which the Plan Administrator may impose thereon, and further subject to any prohibitions and restrictions on such transfers pursuant to Rule 16b-3). A Beneficiary, transferee, or other person claiming any rights under the Plan from or through any Participant shall be subject to all terms and conditions of the Plan and any Award agreement applicable to such Participant, except as otherwise determined by the Plan Administrator, and to any additional terms and conditions deemed necessary or appropriate by the Plan Administrator.

 

             (c) Adjustments .

 

                  (i) Adjustments to Awards . In the event that any dividend or other distribution (whether in the form of cash, Stock, or other property), recapitalization, forward or reverse split, reorganization, merger, consolidation, spin-off, combination, repurchase, share exchange, liquidation, dissolution, or other similar corporate transaction or event affects the Stock and/or such other securities of the Company or any other issuer such that a substitution, exchange, or adjustment is determined by the Plan Administrator to be appropriate, then the Plan Administrator shall, in such manner as it may deem equitable, substitute, exchange, or adjust any or all of (A) the number and kind of Shares which may be delivered in connection with Awards granted thereafter, (B) the number and kind of Shares by which annual per-person Award limitations are measured under Section 5 hereof, (C) the number and kind of Shares subject to or deliverable in respect of outstanding Awards, (D) the exercise price, grant price, or purchase price relating to any Award and/or make provision for payment of cash or other property in respect of any outstanding Award, and (E) any other aspect of any Award that the Plan Administrator determines to be appropriate.

 

 
 
 

 

                  (ii) Other Adjustments . The Committee (and the Board if and only to the extent such authority is not required to be exercised by the Committee to comply with Code Section 162(m)) is authorized to make adjustments in the terms and conditions of, and the criteria included in, Awards (including Performance Awards and performance goals and performance goals relating thereto) in recognition of unusual or nonrecurring events (including, without limitation, acquisitions and dispositions of businesses and assets) affecting the Company, any Related Entity or any business unit, or the financial statements of the Company or any Related Entity, or in response to changes in applicable laws, regulations, accounting principles, tax rates, and regulations or business conditions or in view of the Committee's assessment of the business strategy of the Company, any Related Entity or business unit thereof, performance of comparable organizations, economic and business conditions, personal performance of a Participant, and any other circumstances deemed relevant; provided that no such adjustment shall be authorized or made if and to the extent that such authority or the making of such adjustment would cause Options, Stock Appreciation Rights, Performance Awards granted under Section 7(b) hereof to Participants designated by the Committee as Covered Employees and intended to qualify as "performance-based compensation" under Code Section 162(m) and the regulations thereunder to otherwise fail to qualify as "performance-based compensation" under Code Section 162(m) and regulations thereunder.

 

            (d) Taxes . The Company and any Related Entity are authorized to withhold from any Award granted, any payment relating to an Award under the Plan, including from a distribution of Stock, or any payroll or other payment to a Participant, amounts of withholding and other taxes due or potentially payable in connection with any transaction involving an Award, and to take such other action as the Plan Administrator may deem advisable to enable the Company and Participants to satisfy obligations for the payment of withholding taxes and other tax obligations relating to any Award. This authority shall include authority to withhold or receive Stock or other property and to make cash payments in respect thereof in satisfaction of a Participant's tax obligations, either on a mandatory or elective basis in the discretion of the Committee.

 

            (e) Changes to the Plan and Awards . The Board may amend, alter, suspend, discontinue, or terminate the Plan, or the Committee's authority to grant Awards under the Plan, without the consent of stockholders or Participants. Any amendment or alteration to the Plan shall be subject to the approval of the Company's stockholders if such stockholder approval is deemed necessary and advisable by the Board. However, without the consent of an affected Participant, no such amendment, alteration, suspension, discontinuance, or termination of the Plan may materially and adversely affect the rights of such Participant under any previously granted and outstanding Award. The Plan Administrator may waive any conditions or rights under, or amend, alter, suspend, discontinue, or terminate any Award theretofore granted and any Award agreement relating thereto, except as otherwise provided in the Plan; provided that, without the consent of an affected Participant, no such action may materially and adversely affect the rights of such Participant under such Award.

 

            (f) Limitation on Rights Conferred Under Plan . Neither the Plan nor any action taken hereunder shall be construed as (i) giving any Eligible Person or Participant the right to continue as an Eligible Person or Participant or in the employ of the Company or a Related Entity; (ii) interfering in any way with the right of the Company or a Related Entity to terminate any Eligible Person's or Participant's Continuous Service at any time, (iii) giving an Eligible Person or Participant any claim to be granted any Award under the Plan or to be treated uniformly with other Participants and Employees, or (iv) conferring on a Participant any of the rights of a stockholder of the Company unless and until the Participant is duly issued or transferred Shares in accordance with the terms of an Award.

   

 
 
 

 

            (g) Unfunded Status of Awards; Creation of Trusts . The Plan is intended to constitute an "unfunded" plan for incentive and deferred compensation. With respect to any payments not yet made to a Participant or obligations to deliver Stock pursuant to an Award, nothing contained in the Plan or any Award shall give any such Participant any rights that are greater than those of a general creditor of the Company; provided that the Committee may authorize the creation of trusts and deposit therein cash, Stock, other Awards or other property, or make other arrangements to meet the Company's obligations under the Plan. Such trusts or other arrangements shall be consistent with the "unfunded" status of the Plan unless the Committee otherwise determines with the consent of each affected Participant. The trustee of such trusts may be authorized to dispose of trust assets and reinvest the proceeds in alternative investments, subject to such terms and conditions as the Plan Administrator may specify and in accordance with applicable law.

 

            (h) Nonexclusivity of the Plan . Neither the adoption of the Plan by the Board nor its submission to the stockholders of the Company for approval shall be construed as creating any limitations on the power of the Board or a committee thereof to adopt such other incentive arrangements as it may deem desirable including incentive arrangements and awards which do not qualify under Code Section 162(m).

 

            (i) Fractional Shares . No fractional Shares shall be issued or delivered pursuant to the Plan or any Award. The Plan Administrator shall determine whether cash, other Awards, or other property shall be issued or paid in lieu of such fractional shares or whether such fractional shares or any rights thereto shall be forfeited or otherwise eliminated.

 

            (j) Governing Law . The validity, construction, and effect of the Plan, any rules and regulations under the Plan, and any Award agreement shall be determined in accordance with the laws of the state of Delaware without giving effect to principles of conflicts of laws, and applicable federal law.

 

            (k) Plan Effective Date and Stockholder Approval; Termination of Plan . The Plan shall become effective on the Effective Date, subject to subsequent approval within twelve (12) months of its adoption by the Board by stockholders of the Company eligible to vote in the election of directors, by a vote sufficient to meet the requirements of Code Sections 162(m) (if applicable) and 422, Rule 16b-3 under the Exchange Act (if applicable), applicable NASDAQ requirements, and other laws, regulations, and obligations of the Company applicable to the Plan. Awards may be granted subject to stockholder approval, but may not be exercised or otherwise settled in the event stockholder approval is not obtained. The Plan shall terminate no later than ten (10) years from the date of the later of (x) the Effective Date and (y) the date an increase in the number of shares reserved for issuance under the Plan is approved by the Board (so long as such increase is also approved by the stockholders).

 

            (l) 2005 Plan . Notwithstanding the adoption of this Plan by the Board and its approval by the stockholders, the 2005 Plan shall remain in effect, and all grants and awards made under the 2005 Plan shall be governed by the terms of the 2005 Plan. Upon approval of the Plan by the stockholders of the Company, no further Awards will be granted under the 2005 Plan.

 

            (m) Code Section 409A Provisions; Deferred Compensation .

 

                  (i) Except to the extent such acceleration or deferral is permitted or complies with the requirements of Code Section 409A and the regulations promulgated thereunder, neither the Plan Administrator nor a Participant may accelerate or defer the time or schedule of any payment of, or the amount scheduled to be paid under, an Award that constitutes Deferred Compensation; provided, however, that payment shall be permitted if it is in accordance with a fixed date or schedule or on account of “separation from service,” “disability,” death, “change in control” or “ unforeseeable emergency” as those terms are defined under Code Section 409A and the regulations promulgated thereunder.

   

 
 
 

 

                  (ii) Notwithstanding anything in the Plan, unless the agreement evidencing the Award specifically provides otherwise, the Company may not make payment to a Specified Employee (as determined under Code Section 409A by the Plan Administrator in good faith) of any Award that constitutes Deferred Compensation, earlier than 6 months following the Participant’s “separation from service” as defined for purposes of Code Section 409A (or if earlier, upon the Specified Employee’s death), except as permitted under Code Section 409A and the regulations promulgated thereunder. Any payments that otherwise would be payable to the Specified Employee during the foregoing 6 month period will be accumulated and payment delayed until the first date after the 6 month period. The Plan Administrator may specify in the Award agreement, that the amount of the Deferred Compensation delayed shall accumulate interest, earnings or Dividend Equivalents (as applicable) during the period of such delay.

 

                  (iii) The Plan Administrator may, however, reform any provision in an Award intended to comply with (or be exempt from) Code Section 409A to maintain to the maximum extent practicable the original intent of the applicable provision without violating the provisions of Code Section 409A and the regulations promulgated thereunder.

 

Exhibit 3.1

 

AMENDED AND RESTATED

CERTIFICATE OF INCORPORATION

OF

KONA GRILL, INC.

As Amended on April 30, 2015

 

Kona Grill, Inc., a corporation organized and existing under the laws of the State of Delaware (the "CORPORATION"), hereby certifies as follows:

 

1.

The name of the corporation is Kona Grill, Inc. The original Certificate of Incorporation of the Corporation was filed with the Secretary of State of the State of Delaware on April 10, 2002.

 

2.

Pursuant to Sections 242 and 245 and in accordance with Sections 141(f) and 228(a) of the General Corporation Law of the State of Delaware, this Amended and Restated Certificate of Incorporation restates and amends the provisions of the Certificate of Incorporation of the Corporation.

 

3.

The Certificate of Incorporation is hereby restated and amended to read in its entirety as follows:

 

ARTICLE 1

 

The name of the Corporation is Kona Grill, Inc.

 

ARTICLE 2

 

The address of the registered office of the Corporation in the State of Delaware is 1209 Orange Street, Wilmington, Delaware 19801, located in New Castle County. The registered agent of the Corporation at that address is The Corporation Trust Company.

 

ARTICLE 3

 

The purpose of the Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware.

 

ARTICLE 4

 

The Corporation shall have the authority to issue an aggregate of 30,000,000 shares of Common Stock, each with a par value of $.01 per share (the "COMMON STOCK"), and an aggregate of 2,000,000 shares of preferred stock, each with a par value of $.01 per share, undesignated as to terms and preferences (the "PREFERRED STOCK").

 

 
 
 

 

The designations and the voting powers, preferences and relative, participating, optional or other special rights, and the qualifications, limitations or restrictions thereof, of the Common Stock that are fixed by this Amended and Restated Certificate of Incorporation and the express grant of authority to the Board of Directors to fix by resolution or resolutions the designations and the voting powers, preferences and relative, participating, optional or other special rights, and the qualifications, limitations or restrictions thereof, of the Preferred Stock that are not fixed by this Amended and Restated Certificate of Incorporation are as follows and as elsewhere set forth herein:

 

1.

ISSUANCE OF PREFERRED STOCK. The Preferred Stock may be issued at any time or from time to time in any amount as Preferred Stock of one or more series, as hereinafter provided. Each share of any one series of Preferred Stock shall be identical in all respects except as to the date from which dividends thereon may be cumulative, each series of Preferred Stock shall be distinctly designated by letter or descriptive words, and all series of Preferred Stock shall rank equally and be identical in all respects except as permitted by the provisions of Section 2 of this Article 4. Shares of Preferred Stock shall be issued only as fully paid and nonassessable shares.

 

2.

POWERS, PREFERENCES AND OTHER RIGHTS. Authority is hereby expressly granted to and vested in the Board of Directors at any time or from time to time, without action by or approval of the stockholders, to issue the Preferred Stock as Preferred Stock of one or more series, to fix by resolution or resolutions providing for the issuance of shares of any series the designations and the voting powers, preferences and relative, participating, optional or other special rights, and the qualifications, limitations or restrictions thereof, of such series so far as not inconsistent with the provisions of this Article 4 applicable to all series of Preferred Stock, and to the full extent now or hereafter permitted by the laws of the State of Delaware, including the following:

 

 

(a)

the distinctive designation of such series and the number of shares that shall constitute such series, which number may be increased (except where otherwise provided by the Board of Directors in creating such series) or decreased (but not below the number of shares thereof then outstanding) from time to time by action of the Board of Directors;

 

 

(b)

the rate or rates of dividends payable on shares of such series, whether dividends shall be cumulative and, if so, the date or dates from which dividends shall be cumulative on the shares of such series, the preferences, restrictions, limitations and conditions upon the payment of dividends, and the dates on which dividends, if declared, shall be payable;

 

 

(c)

whether shares of such series shall be redeemable and, if so, the terms and provisions of such redemption, including the date or dates upon or after which they shall be redeemable, the amount per share payable in case of redemption, which amount may vary under different conditions and at different redemption dates, and the manner of selecting shares for redemption;

 

 

(d)

the rights of the shares of such series in the event of voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Corporation, and the relative rights of priority, if any, of payment of shares of such series;

 

 

(e)

whether shares of such series shall have a purchase, retirement or sinking fund for the purchase, retirement or redemption of shares of such series and, if so, the terms and provisions thereof;

 

 
 
 

   

 

(f)

whether shares of such series shall have conversion privileges and, if so, the terms and provisions thereof, including provisions for adjustment of the conversion rate in such events as the Board of Directors shall determine;

 

 

(g)

whether shares of such series shall have voting rights, in addition to voting rights provided by law, and, if so, the terms and provisions thereof; and

 

 

(h)

any other preferences and relative, participating, optional or other special rights, and the qualifications, limitations or restrictions thereof.

 

3.

DIVIDENDS. The holders of the Preferred Stock of each series shall be entitled to receive such dividends, when and as declared by the Board of Directors, out of funds legally available therefor, as they may be entitled to in accordance with the resolution or resolutions adopted by the Board of Directors providing for the issuance of such series, payable on such dates as may be fixed in such resolution or resolutions. Subject to the foregoing and to any further limitations prescribed in accordance with the provisions of Section 2 of this Article 4, the Board of Directors may declare, out of funds legally available therefor, dividends upon the then-outstanding shares of Common Stock, and shares of Preferred Stock of any series shall not be entitled to participate therein.

 

4.

LIQUIDATING DISSOLUTION. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Corporation, the holders of the Preferred Stock of each series shall be entitled to receive, out of the assets of the Corporation available for distribution to its stockholders, before any distribution of assets shall be made to the holders of the Common Stock, the amount per share provided by the Board of Directors pursuant to Section 2 of this Article 4, which may include an amount equal to any cumulative dividends thereon to the date of final distribution to the holders of the Preferred Stock. If upon any liquidation, dissolution or winding up of the Corporation the assets available for distribution shall be insufficient to pay the holders of all outstanding shares of Preferred Stock the full amounts to which they respectively shall be entitled, unless otherwise provided by the Board of Directors pursuant to Section 2 of this Article 4, the holders of shares of Preferred Stock of all series shall participate ratably in any distribution of assets according to the respective amount that would be payable in respect to the shares of Preferred Stock held by them upon such distribution if all amounts payable in respect of the Preferred Stock of all series were paid in full. Neither a statutory merger nor consolidation of the Corporation into or with any other corporation into or with any other corporation, nor a statutory merger or consolidation of any other corporation, into or with the Corporation, nor a sale, transfer or exchange or lease of all or any part of the assets of the Corporation, shall be deemed to be a liquidation, dissolution or winding up of the Corporation within the meaning of this Section 4.

 

5.

REDEMPTION. The Corporation, at the option of the Board of Directors, may redeem the whole or any part of the Preferred Stock of any series at the price or prices and on the terms and conditions provided in the resolution or resolutions of the Board of Directors providing for the issuance of such series.

   

 
 
 

 

6.

GENERAL PROVISIONS.

 

 

(a)

 Anything herein or in any resolution or resolutions of the Board of Directors providing for the issuance of any series of Preferred Stock to the contrary notwithstanding, the rights of holders of all classes and series of capital stock of the Corporation in respect of dividends and purchase, retirement or sinking funds, if any, shall at all times be subject to the power of the Board of Directors from time to time to set aside such reserves and to make such other provisions, if any, as the Board of Directors shall deem to be necessary or advisable for working capital, for expansion of the Corporation's business (including the acquisition of real and personal property for that purpose) and for any other purpose of the Corporation.

 

   (b) Except as otherwise provided by law or by this Certificate of Incorporation or by the resolution or resolutions of the Board of Directors providing for the issuance of any series of Preferred Stock, the vote of the holders of all or any portion of any class or series of capital stock, as a class or series, shall not be required for an action to be taken or authorized by the stockholders of the Corporation, including any amendment of this Certificate of Incorporation. Without limiting the foregoing, the number of authorized shares of Common Stock or any series thereof may be increased or decreased (but not below the number of shares thereof then outstanding by the affirmative vote of the holders of a majority of the stock o the Corporation entitled to vote, without regard for the provisions of Section 242(b) of the General Corporation Law of the State of Delaware. Except as otherwise provided by law or by this Certificate of Incorporation, each holder of shares of Common Stock shall be entitled to one vote for each share of Common Stock held by such holder.

 

 

(c)

Except as otherwise provided by law or by this Certificate of Incorporation or by the resolution or resolutions of the Board of Directors providing for the issuance of any series of Preferred Stock or by the instrument governing the security, obligation, warrant, option or right, no holder of shares of any class or series of capital stock of the Corporation or of any security or obligation convertible into, or of any warrant, option or right to subscribe for, purchase or otherwise acquire, shares of any class or series of capital stock of the Corporation, whether now or hereafter authorized, shall, as such holder, have any preemptive right to subscribe for, purchase or otherwise acquire shares of any class or series of capital stock of the Corporation or any security or obligation convertible into, or any warrant, option or right to subscribe for, purchase or otherwise acquire, shares of any class or series of capital stock of the Corporation, whether now or hereafter authorized.

 

 
 
 

   

 

(d)

Authority is hereby expressly granted to and vested in the Board of Directors at any time and from time to time, without action by or approval of the stockholders, to declare, create and issue, with respect to shares of any class or series of capital stock of the Corporation, dividends or distributions in, or options or rights to acquire, shares of any class or series of capital stock of the Corporation, or other securities, and to fix by resolution or resolutions providing for the declaration, creation and issuance of any such dividend, distribution, option or right the terms, provisions, rights, qualifications, limitations or restrictions thereof so far as not inconsistent with the provisions of this Article 4, and to the full extent now or hereafter permitted by the laws of the State of Delaware, including (a) provisions for the adjustment thereof upon an acquisition of shares, reorganization, merger, consolidation, sale of assets, business combination or other event, and (b) provisions that prevent the holder of a specified percentage of outstanding shares of any class or series of capital stock of the Corporation, including transferees of such holder, from exercising rights thereunder.

 

ARTICLE 5

 

1.

BOARD OF DIRECTORS. The business and affairs of the Corporation shall be managed by or under the direction of a Board of Directors.

 

2.

CLASSIFICATION, TERM. The directors shall be divided into three classes, as nearly equal in number as possible. The term of one class shall expire at the first annual meeting of stockholders, the term of a second class shall expire at the second annual meeting of stockholders, and the term of a third class shall expire at the third annual meeting of stockholders. At each succeeding annual meeting of stockholders beginning in 2003, successors to the class of directors whose term expires at that annual meeting shall be elected for a three-year term. If the number of directors is changed, any increase or decrease shall be apportioned among the classes so as to maintain the number of directors in each class as nearly equal as possible, and any additional director of any class elected to fill a vacancy resulting from an increase in such class shall hold office for a term that shall coincide with the remaining term of that class. In no case will a decrease in the number of directors shorten the term of any incumbent director. The number of directors in the class to be elected at an annual meeting of stockholders shall be determined by the Board of Directors prior to such meeting or, in the absence of such determination, by the stockholders at such meeting. Notwithstanding the foregoing, whenever the holders of any one or more classes of preferred or preference stock issued by the corporation shall have the right, voting separately by class or series, to elect directors at an annual or special meeting of stockholders, the election, term of office, filling of vacancies and other features of such directorships shall be governed by or pursuant to the applicable terms of this Certificate of Incorporation or of the certificate of designation or other instrument creating such class or series of preferred stock, and such directors so elected shall not be divided into classes pursuant to this Section 2 unless expressly provided by such terms.

 

3.

VACANCY. In the event of a vacancy occurring in any class, the Board of Directors may reduce the number of directors in such class to eliminate the vacancy, but in no case may the number of directors in such class be less than one. In the event of a vacancy occurring in any class or a newly created directorship resulting from an increase in the number of directors in any class, the Board of Directors may fill such vacancy or newly created directorship for the remainder of the unexpired term by vote of the majority of the remaining directors, though less than a quorum. The directors of each class shall hold office for the term for which elected and until the successors to such class are elected, and nothing herein shall prevent any retiring director from being eligible for re-election.

   

 
 
 

   

4.

REMOVAL. The stockholders shall have the right to remove any directors upon the affirmative vote of at least 75% of the votes entitled to be cast by the holders of all outstanding shares of capital stock entitled to vote generally in the election of directors of the Corporation, voting together as a single class.

 

5.

WRITTEN BALLOT. Elections of directors need not be by written ballot unless the Bylaws of the Corporation so provide.

 

6.

LIABILITY. A director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty by the director as a director; provided, however, that this Section 6 shall not eliminate or limit the liability of a director to the extent provided by applicable law (a) for any breach of the duty of loyalty of the director to the Corporation or its stockholders, (b) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (c) for any unlawful action under Section 174 of the General Corporation Law of the State of Delaware or (d) for any transaction from which the director derived an improper personal benefit. No amendment to or repeal of this Section 6 shall apply to or have any effect on the liability or alleged liability of any director of the Corporation for or with respect to any acts or omissions of the director occurring prior to such amendment or repeal. If the laws of the State of Delaware are hereafter changed to permit further elimination or limitation of the liability of directors, then the liability of each director of the Corporation shall thereupon be eliminated or limited to the fullest extent then permitted by law.

 

7.

AMENDMENT OF THE BYLAWS. The Board of Directors shall have concurrent power with the stockholders to adopt, alter, amend or repeal the Bylaws of the Corporation. The Board of Directors may so adopt or change the Bylaws upon the affirmative vote of the number of directors which shall constitute, under the provisions of the Bylaws, the action of the Board of Directors. The stockholders may not so adopt or change the Bylaws except upon the affirmative vote of at least 75% of the votes entitled to be cast by the holders of all outstanding shares of stock entitled to vote, voting together as a single class.

 

8.

GENERAL PROVISIONS.

 

 

(a)

When considering a merger, consolidation, sale of assets, business combination or other transaction, the Board of Directors and any committee thereof, the directors and the officers of the Corporation may, in considering the best interests of the Corporation and its stockholders, consider the interests of and the effects of such transaction upon the employees, customers and suppliers of the Corporation and its subsidiaries and upon communities in which the Corporation and its subsidiaries are located or do business.

 

 
 
 

   

 

(b)

The Board of Directors may from time to time determine whether, to what extent, at what times and places and under what conditions and regulations the accounts, books and records of the Corporation, or any of them, shall be open to the inspection of the stockholders, and no stockholder shall have any right to inspect any account, book or document of the Corporation except as and to the extent expressly provided by law or expressly authorized by resolution of the Board of Directors.

 

 

(c)

In addition to the powers and authority herein or by law expressly conferred upon them, the directors are hereby empowered to exercise all such powers and do all such acts and things as may be exercised or done by the Corporation, subject, nevertheless, to the provisions of the laws of the State of Delaware, this Amended and Restated Certificate of Incorporation and any Bylaws adopted by the stockholders; provided, however, that no Bylaws hereafter adopted by the stockholders shall invalidate any prior act of the directors that would have been valid if such Bylaws had not been adopted.

 

 

(d)

No action shall be taken by the stockholders of the Corporation except at an annual or special meeting of the stockholders, and the right of stockholders to act by written consent in lieu of a meeting is specifically denied. Unless otherwise specifically provided by law or this Amended and Restated Certificate of Incorporation, a special meeting of shareholders, for any purpose or purposes, may be called only by the Chairman, the Chief Executive Officer, the President or the Secretary and shall be called by any such officer at the request in writing of a majority of the Board of Directors. Such request shall state the purpose or purposes of the meeting.

 

ARTICLE 6

 

Subject to the provisions of this Amended and Restated Certificate of Incorporation, the Corporation reserves the right to alter, amend or repeal any provision contained in this Amended and Restated Certificate of Incorporation, in the manner now or hereafter prescribed by law, and all rights of stockholders or others hereunder are subject to such reservation.

 

IN WITNESS WHEREOF, Kona Grill, Inc. has caused this Amended and Restated Certificate of Incorporation to be executed this 30th day of April, 2015 .

 

 

 

 

 

/s/ Christi Hing

 

 

 

Christi Hing, Chief Financial Officer

 

 

 

 

 

 

Exhibit 31.1

 

CERTIFICATION

 

I, Berke Bakay, certify that:

 

1.

I have reviewed this quarterly report on Form 10-Q of Kona Grill, Inc.;

 

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

 

a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

 

b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;    

 

 

c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

 

d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

 

a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize, and report financial information; and

 

 

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

 

 

 Date: August 4, 2015

 

/s/  Berke Bakay

 

 

 

Berke Bakay

 

 

 

Chief Executive Officer

 

 

 

 

E xhibit 31.2

 

CERTIFICATION

 

I, Christi Hing, certify that:

 

1.

I have reviewed this quarterly report on Form 10-Q of Kona Grill, Inc.;

 

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

 

a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

 

b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;     

 

 

c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

 

d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

 

a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize, and report financial information; and

 

 

b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

 

 

 Date: August 4, 2015

 

/s/ Christi Hing

 

 

 

Christi Hing

 

 

 

Chief Financial Officer

 

 

Exhibit 32.1

 

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report on Form 10-Q of Kona Grill, Inc. (the “Company”) for the period ended June 30, 2015, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Berke Bakay, Chief Executive Officer of the Company, certify, to my best knowledge and belief, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

 

 

(1)

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and

 

 

(2)

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

 

 

 

/s/  Berke Bakay

 

 

 

  Berke Bakay

 

 

 

  Chief Executive Officer

 

       
August 4, 2015      

 

Exhibit 32.2

 

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report on Form 10-Q of Kona Grill, Inc. (the “Company”) for the period ended June 30, 2015, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Christi Hing, Chief Financial Officer of the Company, certify, to my best knowledge and belief, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

 

 

(1)

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and

 

 

(2)

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

 

 

By:

/s/  Christi Hing

 

 

 

Christi Hing

 

 

 

Chief Financial Officer

 

       
August 4, 2015