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Kona Grill, Inc. (NASDAQ:KONA)

Q2 2009 Earnings Call

July 28, 2009 5:00 pm ET

Executives

Mark S. Robinow - Chief Financial Officer

Mark L. Bartholomay - Interim Chief Executive Officer and Chief Operating Officer

Analysts

Robert Brown - Craig-Hallum Capital

Brad Ludington - KeyBanc Capital Markets

Mark Smith - Feltl & Company

Justin Bennett - Clarke Bennett

Thomas Lynch – Mill Road Capital

Justin Jacobs – Mill Road Capital

Presentation

Operator

Welcome to the Kona Grill second quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the conference call over to Mr. Mark Robinow, Chief Financial Officer.

Mark S. Robinow

Thank you and good afternoon everyone. By now you should all have access to our second quarter earnings release. It may also be found on our Web site at konagrill.com under the Investor Relations section.

Before we begin formal remarks, I need to remind everyone that part of our discussion today may include forward-looking statements. These statements are not guarantees of future performance and therefore undue reliance should not be placed upon them. We refer all of you to our recent filings with the SEC for a more detailed discussion of the risks that could impact our future operating results and financial conditions.

With that, I'd like to turn the call over to Mark Bartholomay, our Chief Executive Officer.

Mark L. Bartholomay

Thank all of you for joining us today. To start, I would like to introduce myself as I've not had the chance to speak with many of you before this call. I've been with the company since May 2007, initially serving as Senior Vice President of Development and then Chief Operating Officer. I also served as a Director of the company from January 2006 until I joined the company in 2007.

Previously I served as restaurant and franchise executive and held senior development and operations positions at Famous Dave's and Rainforest Café, two other publicly traded restaurant companies.

We would like to cover several items during this call. First, I'll open with some brief thoughts and comments on the second quarter. Mark will then discuss in detail our financial results as well as our guidance for Q3. I will then wrap up the call with some final thoughts before the call over for Q&A. And with that I would like to begin.

Second quarter sales were $21.5 million, or at the high end of our guidance. Same store sales declined 9.5% during the second quarter, a disappointing figure but it's reflective of the current economy and the local markets in which we operate.

Loss from continuing operations was $0.11 per share, which was within our guided range.

For the quarter, restaurant operating profit was 18.4% compared to 19.3% last year. In this tough sales environment we believe that the best way we can maintain our margins is through managing costs. During the quarter we were able to achieve savings through better management of our food and our labor costs.

In spite of the same store sales decline, our 15-unit comparable base, which represents over two-thirds of our total operating portfolio generated an impressive operating profit of 21%.

While the overall environment is likely to remain challenging for the foreseeable future, we continue to focus on the things we can control to improve the guest experience and ultimately the bottom line.

During June we rolled out our new menu with enhanced food offerings guided by guest feedback. This menu features new entrees, appetizers, sushi items and desserts. We improved several of our most popular selections and removed others that our sales mix told us did not resonate with our guests. The menu also features a clean, new presentation that is more consistent with our brand image.

The new menu was developed not only from a standpoint of affordability and value for the guest, but was also engineered to benefit our bottom line. We were able to hold you pricing flat and use the new selections with favorable food costs to preserve our overall margins.

We were pleased with the initial guest feedback and we plan to continue updating our menu periodically to keep our offerings fresh and exciting. This past week we continued the update program by adjusting our Perfect Pairing luncheon offering, happy hour and adult beverage menus as well.

We are also working on sales-building initiatives to drive guest traffic, improve training programs and structural changes in restaurant-level staffing to enhance service levels, and cost containment efforts to further protect our margins.

We are committed to a schedule of many changes for the next 16 months but we expect to increase guest frequency and our staffing changes will be fully implemented by August 15. We will also continue to negotiate with our key vendors on more favorable terms in our principal contract.

And with that, I will turn the call over to Mark Robinow, our Chief Financial Officer.

Mark S. Robinow

For the second quarter ended June 30, 2009, restaurant sales increased 9.1% to $21.5 million, reflecting additional revenue from five restaurants opened since last June.

Second quarter sales comparisons were negatively impacted by the challenging economic environment and reduced traffic at most mall locations. Overall, same store sales declined 9.5%, inclusive of a 2% increase in pricing year-over-year. This compares to a 5.6% decline in same store sales for the same period in 2008.

Same store comps, excluding states severely affected by the housing and economic crisis, being Arizona, Nevada, and Michigan, were down 6.8%. It's worth noting that even though our same store sales base experienced negative comps, these 15 restaurants contributed over $3.2 million in restaurant operating profit during the quarter.

Cost of sales as a percentage of restaurant sales decreased 190 basis points to 25.4% during the second quarter from 27.3% last year, as we continue to experience operational efficiencies from the implementation of our automated food costs and inventory management system.

The roll out was completed during July 2008 so while we have already lapped some of the initial benefits of this implementation, we also realized savings from lowered cost of protein and produce.

Labor expenses as a percentage of restaurant sales increased 150 basis points to 33.9% during the second quarter from 32.4% last year. The higher labor costs are mostly attributable to a greater percentage of restaurant operating weeks for our new stores as labor expenses are typically higher than normal during the first several months of operation, as well as some deleveraging of fixed salaries due to the decline in same store sales.

We expect labor as a percentage of sales to flatten out as we realize the benefits of recently implemented labor staffing schedules, partially offset by the July federal minimum wage increase.

Occupancy expenses as a percentage of restaurant sales increased 90% to 7.2% during the quarter compared to 6.3% last year as these costs are largely fixed. Restaurant operating expenses increased 40 basis points as a percentage of restaurant sales as a result of higher utilities, printing costs associated with our new menu, and deleveraging of fixed operating costs.

Combining these four line items, restaurant operating profit was $4.0 million, or 18.4% of restaurant sales compared to $3.8 million, or 19.3% of restaurant sales last year.

Preopening expenses were $352,000 in the second quarter compared to $541,000 last year. The majority of these costs relate to the April opening of our Woodbridge, New Jersey, restaurant. A cash cost for preopening expenses remains approximately $400,000 per restaurant.

Depreciation expense as a percentage of restaurant sales increased 40 basis points to 8.4% of restaurant sales during the second quarter from 8% last year. The increase reflects decreased leverage on the top line partially offset by a reduction of depreciation expense due to the asset impairment charge we took in the fourth quarter of 2008 for our Lincolnshire, Illinois, restaurant.

General and administrative expenses increased $600,000 during the quarter due to $900,000 of special charges, including $400,000 for severance and related benefits for the resignation of our former CEO, $300,000 in legal and evaluation fees associated with activist shareholder activities, including responding to an unsolicited offer to purchase the company, and the write-down of approximately $200,000 in architectural and permit costs associated with amending the lease for our Baltimore, Maryland, site.

Net loss for the quarter was $214,000, or $0.03 per share, on a weighted average share base of $8.3 million shares. The net loss includes a one-time $700,000 gain from discontinued operations as we settle the lease obligation for our closed Naples, Florida, restaurant at a lower amount than previously estimated.

In the absence of the $900,000 special charges included in G&A and the $700,000 gain, results for the second quarter would have been break even. Last year we posted a net loss of $535,000, or $0.07 per share on a weighted average share base of 8.1 million shares.

We ended the quarter with $12.0 million in cash and investments, $6.6 million of this amount is held in student loan-backed auction rate securities which we have borrowed against up to our limit. Including net proceeds of $2.0 million from the rights offering completed in June, approximately $5.4 million of cash and investments are available to fund capital investment and operations.

Based on our current financial projections, cash on hand plus cash flow from operations is sufficient to fund committed restaurant development through 2010 and beyond. We will continue to pursue equipment leases and lines of credit to provide additional growth capital.

During the second quarter net cash provided by operating activities was $1.7 million. We spent $3.3 million on capital expenditures during the quarter for new restaurants.

For our third quarter guidance we are forecasting sales of $20.0 million to $21.0 million and a loss of $.6 million to $1.1 million, or $0.07 to $0.12 per diluted share on 9.1 million weighted shares.

Our forecast reflects continued weakness in the economy and uncertainty of when traffic trends will start to improve. We currently expect Eden Prairie to open the last week of September and Tampa to open late November.

I will now turn the call back to Mark Bartholomay before we go to Q&A.

Mark L. Bartholomay

As we state in the earnings release, our board of directors recently hired HVS Executive Search to source candidates for the open position of CEO. The board and HVS will evaluate all qualified internal and external candidates and I have submitted my name for consideration.

In my nearly four years involvement with the company, I've never been more excited with then opportunities and futures here at Kona Grill.

As Mark indicated, our cash flow from operations, along with the proceeds of our Rights offering, allows us to complete construction of the Eden Prairie, Minnesota, and Tampa, Florida, restaurants this year, and complete the construction of the Baltimore, Maryland, restaurant in 2010.

We will consider signing additional leases if the opportunity can provide significant economic opportunity and we have the availability of affordable debt capital or sufficient cash flow from operations to fund that expansion.

In the meantime, we are updating and renovating our older restaurants to stay ahead of the competition surrounding them. Most importantly, the Kina Grill brand is well positioned with strong personnel committed to that success. I and my team are working to bring guest service to a new level to continue to improve the quality and guest perception of value in our food and beverage offerings and to protect our margins in the current environment.

We would now be happy to answer any questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Robert Brown - Craig-Hallum Capital.

Robert Brown - Craig-Hallum Capital

Could you just give a little more color on your guidance, what comp expectation do you have for Q3 and what are the trends you've seen thus far in the quarter?

Mark S. Robinow

Our guidance for Q3 anticipates same store sales down about 9% as we have seen here in this quarter. So basically with what we're seeing now, and frankly, in July we were seeing same store sales trend a little worse than what we saw in our second quarter and down low double digits at this point.

Robert Brown - Craig-Hallum Capital

Could you just give me some information on the menu redesign? How much of that margin helped to impact Q2? Did you get a full quarter's worth of impact there or do you think you'll see more of that in Q3?

Mark L. Bartholomay

We'll see more of that in Q3. That menu didn't come out until June and it encompasses about 8 or 10 new items and then just the reformatting of a lot of side dishes and stuff for presentation and value purposes.

So we started to see, we saw a couple of weeks of the new items but I'm not sure that that's going to make a huge impact by itself. It's more an intermediate to long term thing to get to see that we're making changes on a regular basis.

But the new menu items have been received very well.

Robert Brown - Craig-Hallum Capital

Could you just give an update on your thoughts on capex for the year, considering you're doing remodeling. Is that going to increase capex or is that part of your original plan and what are your thoughts for the year?

Mark S. Robinow

We're trending towards between $11.0 million and $12.0 million in total capex for the year and that would be gross, before tenant improvement allowances. So we've got basically remodel costs built into that number for the restaurants that we know we are going to be remodeling this year.

Robert Brown - Craig-Hallum Capital

And how many do you plan to remodel this year?

Mark S. Robinow

Three.

Operator

Your next question comes from Brad Ludington - KeyBanc Capital Markets.

Brad Ludington - KeyBanc Capital Markets

I wanted to start off with the charges, the $200,000 charge for the write-down on the architecture and other costs, is that a non-cash charge? As a write-down?

Mark S. Robinow

It's a non-cash charge in this period. We had actually spent that money several periods before.

Brad Ludington - KeyBanc Capital Markets

When you take that $900,000 out you're at G&A of about $1.5 million or $1.6 million. Is that a run rate we should look at or is it just would have been lower this quarter because of certain issues?

Mark S. Robinow

That's a pretty good run rate but you have to also consider that we are going to have search costs, which are an unusual item, in the third and fourth quarter this year. But other than that, at this point, we're not anticipating any other unusual charges.

Brad Ludington - KeyBanc Capital Markets

You talked about one of the strains on opex being the printing cost of the menus. Was that significant? Like a 10 basis point or 20 basis point impact and something that maybe we should expect in future quarters?

Mark S. Robinow

As Mark Bartholomay said, we're going to be updating our menu more frequently so I would say we're going to experience those a couple of times a year.

Brad Ludington - KeyBanc Capital Markets

Since you didn't take any price, what should we expect in the back half for price increases [inaudible] roll offs occur?

Mark L. Bartholomay

We're going to study it again but right now we're anticipating that we will probably take some price at that point in time. We haven't looked at it a lot. I guess most of the people out there are doing anywhere from 1 to 4 a year. We felt that it was very important at this time to keep it flat but we are not going to be afraid of that come fall, we don't think.

Operator

Your next question comes from Mark Smith - Feltl & Company.

Mark Smith - Feltl & Company

Can you just walk through some of the regions and how some particular restaurants did in the quarter, particularly your restaurants in Arizona, and also curious about West Palm Beach and Lincolnshire, if you have seen any tick or is things have gotten worse.

Mark S. Robinow

We continue to see, I mean, Arizona continues to be flattened out at a weaker level. We don't see that going down anymore. West Palm Beach did take a tick down, probably due to the economy but we weren't open at this time last year so we don't have any comparison. And we know that that restaurant itself is going to be below and then Lincolnshire actually is, a restaurant, is pretty stable, at a lower volume but not going down.

Mark Smith - Feltl & Company

With the menu and also just looking at consumer trends during the quarter, have you seen any shift in alcohol sales?

Mark S. Robinow

No, we continue to see alcohol sales between 32% and 33% of revenues, very consistent with prior periods. Within the alcohol mix, for several quarters now, we have seen a shift from basically mixed drinks and wine to beer, probably because it's a little less expensive. But that's within the overall alcohol mix and as a percentage of total sales it's remained pretty constant.

Mark Smith - Feltl & Company

Have you set any time table or the board's talked about any time table on naming a permanent CEO?

Mark L. Bartholomay

The board just got done hiring HVS and the process has just gotten underway, so they are committed to moving forward as quickly as they can but they want to make sure they leave enough time to get the right candidate. So you know how these things go. Certainly I suspect it would be more toward the end of the year before it would be any time before then, that's for sure. But they really haven't set a schedule. They're just underway.

Operator

Your next question comes from Justin Bennett - Clarke Bennett.

Justin Bennett - Clarke Bennett

I just want to go over the balance sheet very quickly. It was $12.0 million in total cash, $6.6 million in student loans, and $5.4 million of cash. Is that right?

Mark S. Robinow

That's correct.

Justin Bennett - Clarke Bennett

And those student loans are still borrowed at 90%, is that correct?

Mark S. Robinow

Yes, the student loans are borrowed up, up to our limit. We have no more borrowing power against those, so what we said in the script is we have $5.4 million basically of net cash available to fund capex.

Justin Bennett - Clarke Bennett

And then you have $11.0 million to $12.0 million left in the year of capex, or was that total for the year?

Mark S. Robinow

No, that's total for the year and we're at about $7.6 million year-to-date.

Justin Bennett - Clarke Bennett

Okay, so you have $3.0 million to $4.0 million net left to go?

Mark S. Robinow

Correct.

Justin Bennett - Clarke Bennett

Also, the payment to the former CEO, was that $400,000? Did I hear that correctly?

Mark S. Robinow

That is the severance accrual, correct.

Justin Bennett - Clarke Bennett

And he resigned and he's paid that even if he resigned?

Mark S. Robinow

Yes.

Justin Bennett - Clarke Bennett

And are there any investigations with his resigning?

Mark S. Robinow

No.

Operator

Your next question comes from Thomas Lynch – Mill Road Capital.

Thomas Lynch – Mill Road Capital

The first area I would like to start with is operations. I notice your same store sales are pretty weak, weaker than any restaurant chain that has reported so far. I know everyone is facing a difficult, tough environment but our numbers are 12 out of 12 so far.

Can you discuss why Kona's performance has been so weak and specific steps you're taking to turn the situation around?

Mark L. Bartholomay

As you know, it's difficult to predict when you can get that done and we're all up under the pressure of the economy. I think we've been impacted more so because of our position in the marketplace. We're away from McCormick & Schmick's and some of the other kind of fine casual kind of dining. Obviously the fine dining is getting terribly massacred and we're not in that category.

What we hear from our customers, intermittently, is that they feel that we are "expensive." I think some of that is due to our physical structure and that is part of the reason that we did not take any menu price increase recently here. In fact, we re-engineered some of the product so that we could offer it at a lower price.

I think there are a lot of things that go into same store sales. We have our managers' meeting next week, we will be hitting very hard there on the guest service function. We have put in some new food items. We've got a menu strategy. We will have a plan to roll out menu changes regularly so that we can get some variety to our customers. I personally think we've gotten a little bit complacent in our changing, up until probably six, seven months ago. We had become, frankly, somewhat comfortable with our successes of the past. So we didn't get here in three months, we're not going to get out of here in three months.

But it's all the little things. It's getting good food, providing good value, putting forth great service, and having the right people in the right buildings at the right time. And then also, just about a year ago to right now, we actually hired a marketing and advertising company to help us establish and position our brand. The impacts of that are just starting to come through now. And I think we're getting a lot more continuity in the various pieces of the pieces of the business that the guests see.

So when that will all come together magically and start getting things better, I don't know. We were obviously disappointed in the second quarter but we are optimistic at least that the second quarter is now worse, and in fact, just a little bit better than the first quarter, when most of the people were seeing or having a worse second quarter than first.

So it seems we might be fighting a little bit of our way back but it will be a battle for a while.

Thomas Lynch – Mill Road Capital

All this points to one area where we're really quite concerned about and maybe you could help me out a little bit further and it also relates to operation.

I look at your numbers, your food and labor margins have materially improved. And especially your food margin is at 25.4% is a very, very low number. However, when we go to the units, here's what we're seeing. We're seeing decline portion size, lower food quality, less freshness, and a lower standard of service. And as we walk around the restaurant, customers who we talk to are showing increasing dissatisfaction. And I've got to tell you, we're concerned that dissatisfaction is quantified in the weak same store sales numbers.

So taking the question another way, can you give me some steps that you're taking to improve the customer experience and turn around the situation and specifically I mean improving food quality, increasing portion size, increasing training, improving staffing levels. I mean, we've talked a lot about cuts, but it seems like these cuts are hurting us more on the top line than helping us on the bottom line.

Mark L. Bartholomay

First off let me address one thing you say there. We did, in our new menu roll out, we did diminish the portion of one or two items but we took those prices down considerably and the response from the guests that we've heard, both empirically and through our comment line, has been that that has been much appreciated.

The biggest example of that would taking our hamburger from 12 ounces to 8 ounces, which, frankly, some of our managers were very concerned about. They’ve all now come back with a positive recognition that it's selling better, the guest are happier because they can order it and eat it all without having to walk out. I guess nobody really needed a ¾ pound burger.

Other than that, the portion size is taken down on one sandwich. So there are only two things that had a smaller portion. There are no more smaller portions.

There are some smaller portions on the side dishes. The potatoes, the beans. We did hear on one side, for a little bit at the beginning on the potatoes, but realistically we made the quality better from the way we made them. We left the skin on, we used some more expensive ingredients. That got, frankly, that overwhelmed the negative of the size and frankly, we're seeing anywhere from a 1 to a 4 garbage bag difference that we're taking out every day because both of those came back. I mean, we put a lot of credence in what people don't eat, we don't anticipate they like so we go in and adjust it.

So there's been no change in product, there's been no change in freshness, there's been no change in ordering or any of that stuff. The real impact on the menu has been really somewhat of a mix, either it went more to lower priced items on our menu, and frankly we make more money—we have lower cost on the lower priced items than we do on the higher priced items.

And the other thing that's helped our margin a little bit has been the Perfect Pairings lunch special that we put out. Frankly, we thought people would be going more toward the sandwiches and the sushi. They've been going for salads and soup, which we all know have a significantly lower food cost. So that's become over 10% of our lunch sales so that helped a lot, too.

So really, the food side of it, it's a long story, I guess, the food side of it hasn't changed. The quality has actually been upgraded. We will continue to upgrade that quality. I don't think you'll see our portion sizes going up. That was one of our largest guest complaints was portion size was too big. Most of the complaints were from the female side and the idea was that all of our appetizers were fried, all or our portions were big, we were the best men's sports bar of the 1980s that anybody had ever seen. So we actually are trying to address a broader breadth of people there.

As far as service goes, that's where we're really going at it. We have completely adjusted the way new store training goes. We have made a shift in staffing, not from a reduction from an increase, but also focusing on a training kind of team approach to serving the guests that will be rolled out next week at our general managers' meeting, but we've tested it in three restaurants now for about six weeks. It seems to have gone well.

We are also focused on retention. We are going to shift around some our recommended tip sharing in our restaurants to attempt to get more compensation for the front line people that are there really interacting with the guests. And we think those two are going to have a big difference.

Also it is, but in fairness to our managers and everybody else, we will be making it, and we haven't made it obvious in the past, that—and we thought we had, frankly but obviously the communication was not correct on my part—we are going to make sure that they're aware that profitability is in the back seat and guest service is in the front seat.

They seem to have, for several reasons, I can't disagree with you that that service appears to have, I mean, we can't empirically see anything in any data that we have, but we have the same feeling that the guest service, especially in the last two or three months has really kind of drifted down. So we're going to put it on the top of the highlight just from an overall at the management level standpoint.

Thomas Lynch – Mill Road Capital

From our perspective we fundamentally think that it is a terrible trade, getting short term margins at the expense of our customers. I know there has been a lot of tumult in the company and it might have limited your ability to get out to a lot of the restaurants as all of this going on, but we are seeing a decline in performance at the restaurant level and as we talk to customers, customer dissatisfaction.

So if you, in the next quarter, put that on the front burner, that would be great.

I would like to just move to CEO for a second.

Mark L. Bartholomay

Sounds like one-to-one. I do appreciate that. And any data you have on particular restaurants, we would love to hear about. But I did make it to I think everything except for six restaurants in the last four months. So we are out there regularly. And obviously our district management staff is our there regularly as well. So, we are seeing it, we're sneaking in, they don't know we're coming. We have secret shopper programs where we're trying to stay on top of it. But if you have any data, we would love to have it.

Thomas Lynch – Mill Road Capital

I'm happy to talk to you off line on that. But going to the CEO role, the $400,000 paid to Marcus Jundt, that's about 20% of your net fund raised from the rights offering. As we read his employment agreement, which was revised on May 11, he wasn't entitled to any severance. Can you give us more color on why he was given 20% of the net proceeds of the rights offering?

Mark L. Bartholomay

He was given a percentage of the rights offering.

Thomas Lynch – Mill Road Capital

He was given $400,000.

Mark L. Bartholomay

That the board has determined and it's really an issue for them and not for us that he was obligated to receive under his employment agreement. There is really not a lot more that we can say about that.

Thomas Lynch – Mill Road Capital

In his employment agreement, section 6.4 says, ". . . resignation . . ." he is entitled to " . . . any base salary earned but unpaid through the date of termination and any other accrued invested payments and/or benefits." But that's all. It's quite clear in section 6.4.

Mark L. Bartholomay

The issue there, as I would—I would love to sound authenticate and knowledgeable on that. The issue is that's really a board issue between the board and the officer and we haven't been really involved in that at all, Mark and myself.

Thomas Lynch – Mill Road Capital

When Justin Bennett asked the question, I want to ask it again because I'm not sure I understood the answer, and the question is was there any ethics investigation conducted in the week prior to Marcus Jundt leaving the company? And ethics investigation related to Marcus Jundt? Did I hear that the answer was no?

Mark S. Robinow

I said no.

Thomas Lynch – Mill Road Capital

Okay. So there was no ethics investigation whatsoever.

Mark S. Robinow

Not that I know of.

Thomas Lynch – Mill Road Capital

Okay, none involving Mark Zesbaugh or the board of directors?

Mark S. Robinow

I can't comment on the board of directors. You're talking to management.

Thomas Lynch – Mill Road Capital

I think there's a shell. I'm little bit surprised that 20% of the rights offering went to the CEO but I understand both of you are in a difficult position. Can we talk about the board for a second. There are a number of vacancies and the board doesn't have a single person with restaurant experience on it or a single person with public company experience on it. I mean, I would imagine someone with those backgrounds would be real helpful to you guys running the company day to day. Is that something you could tell us the company is going to commit to fill the board with people of that type of experience, a). And b) would people with that type of experience be helpful to you?

Mark L. Bartholomay

Number one, I think you're incorrect. I'm not sure [Mark] Zesbaugh worked at a public company but I know that he's had involvement with them, and also Kirk Patterson worked at a public company as a CFO.

Thomas Lynch – Mill Road Capital

I'm sorry, I said board experience. I understand some of them have worked at a public company.

Mark L. Bartholomay

All I can tell you about the board right now is that we're at five members. We need that in NASDAQ requirements. The board is going to decide whether they're going to have more or less people, at which time they decide to have more or less people and it looks like the people [inaudible].

Clearly there has been discussion at the board level and amongst the management and between the two groups as to who people would be if they come on and certainly relevant restaurant industry experience, relevant board experience, relevant experience as a management team, all those things enter into it. I can't tell you what that mix will be when they get to a candidate that they find to fit the best.

But I have confidence that they will do that with the shareholders best interest at heart.

Thomas Lynch – Mill Road Capital

Would you like someone with restaurant experience on the board? Or with public board experience on the board?

Mark L. Bartholomay

I've got all kind of mentors that I call up regularly for guidance in the industry. It certainly wouldn't hurt. When I was brought on the board that was one of the reasons I was brought on the board, because I had that experience from my background.

But determination for that is made on an opportunity-by-opportunity basis and as the board gets through, I think their primary function right now, their primary obligation and focus is really to make sure this CEO search goes along correctly and well and gets the best candidate for the company. I'm not sure that right now where board ranks, but I think it's probably behind that.

Thomas Lynch – Mill Road Capital

Can you tell me a little bit about your financing plans. Is there a process in place to raise financing for next year? And do you have the financing to grow the company next year if you don't get any new financing into the company?

Mark L. Bartholomay

We have the financing right now to perform on our obligations as they exist. We are always looking opportunistically if there should be a financing available that we think is a good transaction for the shareholders. We haven't found that. We aren't searching like it's a primary objective, but it's always an objective to look at the strategic opportunities out there relative to the cost of capital. I mean, it's really an ROI kind of situation. Right now we are staying alert on the development side in case we find something that we find to be very exciting, but we haven't come across anything yet so there has been no need for anything to finance.

Thomas Lynch – Mill Road Capital

So you are in the financing market and you have no—I'm just clarifying here—you have no growth plans other than what you've announced, is that right?

Mark L. Bartholomay

We have no growth plans other than what we have announced and we would only be in the financing market if it was what we thought was an opportunistic value for the shareholders.

Thomas Lynch – Mill Road Capital

Just final thoughts, guys, and I know you're both—it has been a difficult position for both of you, probably for all the time you've been in the company. You know, as a shareholder, our concern really is you don't have restaurant experience on the board, you don’t have public experience on the board, we don't have a permanent CEO in the company, and we don't have financing to grow the company. And we just raised $2.0 million and $400,000 of it, or 20%, was given to someone named Jundt. That $400,000 could have been the start of a new unit.

Our sense, as a shareholder, is that if the company's precious capital is going to be given to people with the surname Jundt, people with the surname Jundt ought to own the company and ought to buy it from all shareholders. Otherwise, they ought to turn it over to independent folks with the restaurant experience who are going to turn this into something special. And I know you guys can't comment on it but I bet in your heart of hearts you believe that.

Mark L. Bartholomay

Just to close out a comment for Tom even though he's left, there is no reason to cry for myself or Mr. Robinow. It hasn't been that difficult a time. It's been a great opportunity. It continues to be one. And [inaudible] the future. So what's the next question?

Operator

Your next question comes from Justin Jacobs – Mill Road Capital.

Justin Jacobs – Mill Road Capital

I want to clarify some of the stuff on the units. Looking on your Web site, there's three units that are listed as waiting to open, which are Eden Prairie, Tampa, and Baltimore. Can you give a status on the build out of each and the expected timing?

Mark S. Robinow

As I said in the script, Eden Prairie is expected to open, right now, the very last week of September. And Tampa, Florida, is expected to open mid-to-late November. Baltimore is a spring of 2010 opening. I would say probably middle of the second quarter 2010 would be the best way to look at that right now.

Justin Jacobs – Mill Road Capital

And the status, let's see if it's September of Q3, and we're July, so the hard construction of Eden Prairie hasn't really started yet and that won't really start until August—is that right?

Mark L. Bartholomay

No, it's almost complete.

Justin Jacobs – Mill Road Capital

It's almost complete.

Mark L. Bartholomay

We have a [inaudible] process which is a little shorter than most of our counterparts who are probably in the 20 to 21. So it takes us about four and a half months to get them done. Eden Prairie is well along its way. Tampa is probably about half way along its way.

Justin Jacobs – Mill Road Capital

The right off that was associated with a lease amendment, I'm just reading from the press release. That was related to Baltimore?

Mark S. Robinow

Yes.

Justin Jacobs – Mill Road Capital

And you said it was $200,000. What was that writing off if we're still going to open it up?

Mark L. Bartholomay

What we did was we had already gone through a lot of the city process as well as much of the architectural work relating to our site in the building. We technically, by the terms of the lease, we probably should have—there would be some debate but it probably should have opened September of this year, through our obligation. We went to the landlord to discuss that. It turns out that he had another location in the same building that we thought would actually work better for us physically, in the space. He would have like us to move over there. So it became an opportunity for both us that we were able to delay the opening for about eight months, which given our cash position, seemed very prudent.

And then start work on a space. So the architectural plans are basically at that point moot and we have to go all the way back to the city again. So we wrote all of that off.

From a total cash standpoint, the new space has some advantages over the old space so in an overall case I don't think it's going to cost us any more cash to build it out, even with the change. But that was the deal.

Justin Jacobs – Mill Road Capital

In the press release there's a comment about a bonus element associated with the company's below-market rights offering. What exactly does that mean?

Mark S. Robinow

That's under FASE statement 128. It's really compliance with technical accounting literature. Bonus element does not mean that a bonus was paid, what that is the FASE pronouncement required us to retroactively restate the number of shares outstanding for what the accounting editor defines as a bonus element because the rights offering was done at a below market price, we have to account for it similar to a stock dividend or stock split. And that's what the bonus element means. It's technical accounting literature, no cash associated.

Justin Jacobs – Mill Road Capital

Let me just turn to some cash questions. I'm just confirming some of these numbers. The severance amount of $400,000, was that a lump sum or will it be ongoing?

Mark S. Robinow

Ongoing.

Justin Jacobs – Mill Road Capital

And capex for the quarter was $3.3 million—is that correct?

Mark S. Robinow

Correct.

Justin Jacobs – Mill Road Capital

And you're saying 11 to 12 gross before TIs for capex for all of 2009. So does that assume on a net basis that's kind of 8 to 9 assuming a million a unit.

Mark S. Robinow

Yes, it's a million a unit except for we did not get a TI allowance for the Woodbridge, New Jersey, unit.

Justin Jacobs – Mill Road Capital

Okay, so that's fully spent. So you're talking on a gross basis, 8 to 9, and I guess the 7.6 on the cash flow, that's a gross number as well, right?

Mark S. Robinow

Correct.

Justin Jacobs – Mill Road Capital

Is there any more cash output required for Naples?

Mark S. Robinow

Half of the Naples will be paid over the following year.

Justin Jacobs – Mill Road Capital

What's the dollar amount for that mean?

Mark S. Robinow

$300,000 remaining of the Naples obligation is paid out over the following year, starting in August.

Justin Jacobs – Mill Road Capital

That's paid over the full year?

Mark S. Robinow

Correct.

Justin Jacobs – Mill Road Capital

The cash amount we're showing is 12.2 which includes 6.6 million in student loans, is that correct? And the balance is all in cash?

Mark S. Robinow

Cash and investments.

Operator

Your final question is a follow-up from Justin Bennett - Clarke Bennett.

Justin Bennett - Clarke Bennett

Listening to Tom there from Mill Road, he kind of brought back, why do you guys pursue his financing agreement?

Mark L. Bartholomay

We're not going back over that, Justin.

Justin Bennett - Clarke Bennett

When did we go over it the first time?

Mark S. Robinow

We have completed our financing. It's done and it's not open to further discussion on this call.

Justin Bennett - Clarke Bennett

Are you finding 12% debt anywhere else?

Mark L. Bartholomay

Actually, we didn't end up taking down debt so it wasn't—if we found 12% debt—the question is we found 12% debt today, would we take it? Probably not, given our current cash position and our commitments. I don't think that would be particularly compelling.

Justin Bennett - Clarke Bennett

Okay, so can we have the valuation work that we spent $300,000 on? What sort of valuation did they come to and how did they arrive at a number? We issued equity at $1.35. You're right, we're not paying 12% but we issued equity at $1.35. Can you help us out with the valuation that Piper[?] got to?

Mark L. Bartholomay

That's really a confidential piece between them and the board. The issue is that we issued the stock at $1.35 to existing shareholders so that everyone could benefit from that equally.

Mark S. Robinow

And as I recall, Justin, you were in favor of the rights offering.

Justin Bennett - Clarke Bennett

It's because if we didn't do the rights offering we were toast. We had no other option at that point.

Okay, so 12.5%, that isn't attractive?

Mark L. Bartholomay

Not at this time, no.

Operator

There are no further questions in the queue.

Mark L. Bartholomay

Thank you everyone for being with us today and your interest in Kona Grill. We'll keep our nose to the grindstone out here and continue to make improvements and look forward to talking to you at the end of next quarter.

Operator

This concludes today’s conference call.

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Source: Kona Grill, Inc. Q1 2009 Earnings Call Transcript
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