Item 2.
Properties
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Properties
We currently operate 53 restaurants across 24 states and the District of Columbia. We currently lease all of our restaurants, except for one Del Frisco’s restaurant. The majority of our leases provide for minimum annual rents with some containing percentage-of-sales rent provisions, against which the minimum rent may be applied. Typically, our lease terms are 5 to 15 years at initiation, with 2 to 4 5-year extension options. None of our restaurant leases can be terminated early by the landlord other than as is customary in the context of a breach or default under the applicable lease.
			
		
Opening Date
City
State
Lease/Own
Sullivan’s Steakhouse (cont.)
						
						
						
						
						
						
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December 1998
Naperville
Illinois
Lease
January 1999
Palm Desert
California
Lease
June 1999
Chicago
Illinois
Lease
August 1999
Raleigh
North Carolina
Lease
December 2000
Tucson
Arizona
Lease (4)
July 2007
Omaha
Nebraska
Lease
July 2008
Leawood
Kansas
Lease
November 2008
Lincolnshire
Illinois
Lease
February 2009
Baltimore
Maryland
Lease
June 2010
Seattle
Washington
Lease
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(1)
Current lease term expires on November 30, 2017. We have three remaining five-year option periods available that have not yet been exercised.
(2)
The relocation of the Dallas Del Frisco’s Double Eagle location was treated as a new restaurant opening.
(3)
Current lease term expires on August 31, 2017. We have one remaining five-year option period available that has not yet been exercised.
(4)
Current lease term expires on September 30, 2017. We have two remaining five-year option periods available that have not yet been exercised.
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Our corporate headquarters is located in Southlake, Texas. We lease the property for our corporate headquarters.
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﻿Item 3.
Item 6.
Selected Financial Data
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The following table sets forth certain of our historical financial data. We have derived the selected historical consolidated financial data for fiscal years 2012 through 2016 from our audited consolidated financial statements and the related notes. Not all periods shown below are discussed in this Annual Report on Form 10-K. You should read this information together with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and the related notes to those statements included elsewhere in this Annual Report on Form 10-K. Historical results are not necessarily indicative of future performance.
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(1)
We utilize a 52- or 53-week accounting period which ends on the last Tuesday of December. The fiscal year ended December 31, 2013 had 53 weeks. The fiscal years ended December 25, 2012, December 30, 2014, December 29, 2015 and December 27, 2016 each had 52 weeks.
(2)
Defined as total current assets minus total current liabilities.
(3)
We consider a restaurant to be comparable in the first full fiscal quarter following the eighteenth month of operations. Changes in comparable restaurant sales reflect changes in sales for the comparable group of restaurants over a specified period of time.
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Item 7.
Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Overview
Del Frisco’s Restaurant Group, Inc. develops, owns and operates three contemporary, high-end, complementary restaurants: Del Frisco’s Double Eagle Steak House, Sullivan’s Steakhouse, and Del Frisco’s Grille. We currently operate 53 restaurants in 24 states and the District of Columbia. Of the 53 restaurants we operated as of the end of the period covered by this report, there are 12 Del Frisco’s restaurants, 18 Sullivan’s restaurants and 23 Grille restaurants. During fiscal 2016, we relocated a Del Frisco’s in Dallas, Texas and opened Grilles in Long Island, New York, Nashville, Tennessee and Brentwood, Tennessee.
Our Growth Strategies and Outlook. Our growth model is comprised of the following three primary drivers:
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Pursue Disciplined Restaurant Growth. We believe that there are significant opportunities to grow our concepts on a nationwide basis in both existing and new markets, where we believe we can generate attractive unit-level economics. We are presented with many development opportunities, and we carefully evaluate each opportunity to determine that sites selected for development have a high probability of meeting our return on investment targets. Our disciplined growth strategy includes accepting only those sites that we believe present attractive rent and tenant allowance structures as well as reasonable construction costs given the sales potential of the site. We believe our concepts’ complementary market positioning and ability to coexist in the same markets, coupled with our flexible unit models, will allow us to expand each of our three concepts into a greater number of locations.
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Grow Existing Revenue. We will continue to pursue opportunities to increase the sales at our existing restaurants, pursue targeted local marketing efforts and evaluate operational initiatives, including growth in private and group dining, designed to increase restaurant unit volumes.
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Maintain Margins Throughout Our Growth. We will continue to aggressively protect our margins using economies of scale, including marketing and purchasing synergies between our concepts and leveraging our corporate infrastructure as we continue to open new restaurants.
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We believe there are opportunities to open five to seven restaurants annually, generally composed of one to two Del Frisco’s and four to six Sullivan’s and/or Grilles, with new openings of our Grille concept likely serving as the primary driver of new unit growth in the near term. During fiscal 2017, we expect to open one Grille and one Del Frisco’s. We are also currently evaluating the possibility of expanding the Sullivan’s brand through a franchising model. See Item 1, Business for a discussion of our targeted average cash investment for each concept and other information regarding the opening of a new location.
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Performance Indicators. We use the following key metrics in evaluating the performance of our restaurants:
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Comparable Restaurant Sales Growth. We consider a restaurant to be comparable during the first full fiscal quarter following the eighteenth month of operations. Changes in comparable restaurant sales reflect changes in sales for the comparable group of restaurants over a specified period of time. Changes in comparable sales reflect changes in customer count trends as well as changes in average check. Our comparable restaurant base consisted of 41 and 37 restaurants at December 27, 2016 and December 29, 2015, respectively.
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Average Check. Average check is calculated by dividing total restaurant sales by customer counts for a given time period. Average check is influenced by menu prices and menu mix. Management uses this indicator to analyze trends in customers’ preferences, the effectiveness of menu changes and price increases and per customer expenditures.
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Average Unit Volume. Average unit volume, or AUV, consists of the average sales of our restaurants over a certain period of time. This measure is calculated by dividing total restaurant sales within a period by the number of restaurants operating during the relevant period. This indicator assists management in measuring changes in customer traffic, pricing and development of our concepts.
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Customer Counts. Customer counts are measured by the number of entrées ordered at our restaurants over a given time period.
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Adjusted EBITDA Margin. Adjusted EBITDA margin represents net income before interest, income taxes and depreciation and amortization plus the sum of certain non-operating expenses, including pre-opening costs, impairment charges, lease termination and closing costs, third-party lease guarantee payments, public offering transaction bonuses and secondary public offering costs, as a percentage of our revenues. By monitoring and controlling our adjusted EBITDA margins, we can gauge the overall profitability of our company.
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Restaurant-Level EBITDA Margin. Restaurant-level EBITDA margin represents net income before interest expense, income taxes, other expense, net, pre-opening costs, general and administrative expenses, lease termination and closing costs, secondary public offering costs, impairment charges and depreciation and amortization, as a percentage of our revenues. By monitoring and controlling our restaurant-level EBITDA margins, we can gauge the overall profitability of our core restaurant operations. See note 12 in the notes to our consolidated financial statements for a reconciliation of restaurant-level EBITDA to net income.
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Our business is subject to seasonal fluctuations. Historically, the percentage of our annual revenues earned during the first and fourth fiscal quarters has been higher due, in part, to increased gift card redemptions and increased private dining during the year-end holiday season, respectively. In addition, we operate on a 52- or 53-week fiscal year ending the last Tuesday of each December, and our first, second and third quarters each contain 12 operating weeks with the fourth quarter containing 16 or 17 operating weeks. As many of our operating expenses have a fixed component, our operating income and operating income margin have historically varied significantly from quarter to quarter. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year.
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Key Financial Definitions
Revenues. Revenues consist primarily of food and beverage sales at our restaurants, net of any discounts, such as management meals and employee meals, associated with each sale. Additionally, revenues are net of the cost of loyalty points earned associated with sales made to customers in our loyalty program. Revenues also include breakage income associated with gift cards. In fiscal 2016, food comprised 68% of food and beverage sales with beverage comprising the remaining 32%. Revenues are directly influenced by the number of operating weeks in the relevant period and comparable restaurant sales growth. Comparable restaurant sales growth reflects the change in year-over-year sales for the comparable restaurant base. Comparable restaurant sales growth is primarily influenced by the number of customers eating in our restaurants, which is influenced by the popularity of our menu items, competition with other restaurants in each market, our customer mix and our ability to deliver a high quality dining experience, and the average check, which is driven by menu mix and pricing.
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Cost of Sales. Cost of sales is comprised primarily of food and beverage expenses. We measure food and beverage expenses by tracking cost of sales as a percentage of revenues. Food and beverage expenses are generally influenced by the cost of food and beverage items, distribution costs and menu mix. The components of cost of sales are variable in nature, increase with revenues, are subject to increases or decreases based on fluctuations in commodity costs, including beef prices, and depend in part on the controls we have in place to manage costs of sales at our restaurants.
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Restaurant Operating Expenses. We measure restaurant operating expenses as a percentage of revenues. Restaurant operating expenses include the following:
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Labor expenses, which comprise restaurant management salaries, hourly staff payroll and other payroll-related expenses, including management bonus expenses, vacation pay, payroll taxes, fringe benefits and health insurance expenses and are measured by tracking hourly and total labor as a percentage of revenues;
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Occupancy expenses, which comprise all occupancy costs other than pre-opening rent expense, consisting of both fixed and variable portions of rent, common area maintenance charges, real estate property taxes and other related occupancy costs and are measured by tracking occupancy as a percentage of revenues; and
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Other operating expenses, which comprise repairs and maintenance, utilities, operating supplies and other restaurant-level related operating expenses and are measured by tracking other operating expenses as a percentage of revenues.
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Marketing and Advertising Costs. Marketing and advertising costs include all media, production and related costs for both local restaurant advertising and national marketing. We measure the efficiency of our marketing and advertising expenditures by tracking these costs as a percentage of total revenues. We have historically spent approximately 1.5% to 2.5% of total revenues on marketing and advertising and expect to maintain this level in the near term.
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Pre-opening Costs. Pre-opening costs are costs incurred prior to opening a restaurant, and primarily consist of manager salaries, relocation costs, recruiting expenses, employee payroll and related training costs for new employees, including rehearsal of service activities, as well as non-cash lease costs incurred prior to opening. In addition, pre-opening expenses include marketing costs incurred prior to opening as well as meal expenses for entertaining local dignitaries, families and friends. We currently target pre-opening costs per restaurant at $0.8 million for a Del Frisco’s and a Grille and $0.6 million for a Sullivan’s.
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General and Administrative Expenses. General and administrative expenses are comprised of costs related to certain corporate and administrative functions that support development and restaurant operations and provide an infrastructure to support future company growth. These expenses reflect management, supervisory and staff salaries and employee benefits, travel, information systems, training, corporate rent, professional and consulting fees, technology and market research. We measure general and administrative
			
		
costs by tracking general and administrative expenses as a percentage of revenues. These expenses are expected to increase as a result of costs related to our anticipated growth, including substantial training costs and significant investments in infrastructure. As we are able to leverage these investments made in our people and systems, we expect these expenses to decrease as a percentage of total revenues over time.
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Depreciation and Amortization. Depreciation and amortization includes depreciation of fixed assets and certain definite-life intangible assets. We depreciate capitalized leasehold improvements over the shorter of the total expected lease term or their estimated useful life. As we accelerate our restaurant openings, depreciation and amortization is expected to increase as a result of our increased capital expenditures.
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Results of Operations
The following table sets forth certain statements of income data for the periods indicated:
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Fiscal Year Ended December 27, 2016 (52 weeks) Compared to Fiscal Year Ended December 29, 2015 (52 weeks)
The following tables show our operating results by operating segment, as well as our operating results as a percentage of revenues, for the fiscal years ended December 27, 2016 and December 29, 2015.
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Revenues. Consolidated revenues increased $20.1 million, or 6.1%, to $351.7 million in fiscal 2016 from $331.6 million in fiscal 2015. This increase was due to 151 net additional operating weeks in fiscal 2016 resulting from three Grille openings in fiscal 2016 and the full year impact of one Del Frisco’s and six Grille openings in fiscal 2015. This increase was partially offset by the closing of one Sullivan’s location and two Grille locations in fiscal 2015, the temporary closing of the Dallas Del Frisco’s during its relocation in fiscal 2016 and by a 0.8% decrease in total comparable restaurant sales, comprised of a 0.8% decrease in customer counts.
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Del Frisco’s revenues increased $5.1 million, or 3.1%, to $166.9 million in fiscal 2016 from $161.8 million in fiscal 2015. This increase was primarily due to 33 additional operating weeks resulting from the full year impact of the Orlando, Florida Del Frisco’s, which opened in August 2015. This increase was partially offset by the temporary closing of the Dallas Del Frisco’s during its relocation in fiscal 2016 and a 1.2% decrease in total comparable restaurant sales, comprised of a 1.6% decrease in customer counts, partially offset by a 0.4% increase in average check.
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Sullivan’s revenues decreased $1.2 million, or 1.5%, to $77.8 million in fiscal 2016 from $79.0 million in fiscal 2015. This decrease was primarily due to the closing of one Sullivan’s location in May 2015, as well as a 0.2% decrease in total comparable restaurant sales, comprised of a 0.8% decrease in customer counts, partially offset by a 0.6% increase in average check.
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The Grille’s revenues increased $16.2 million, or 17.8%, to $107.0 million in fiscal 2016 from $90.8 million in fiscal 2015. This increase was driven by 143 net additional operating weeks resulting from three Grille openings during fiscal 2016 and the full year impact of six Grille openings during fiscal 2015. This increase was partially offset by a 0.7% decrease in total comparable restaurant
			
		
sales, comprised of a 0.8% decrease in average check, partially offset by a 0.1% increase in customer counts, as well as the closure of two Grille locations in fiscal 2015.
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Cost of Sales. Consolidated cost of sales increased $3.2 million, or 3.4%, to $99.2 million in fiscal 2016 from $96.0 million in fiscal 2015. This increase was primarily due to an additional 151 net operating weeks in fiscal 2016, as discussed above. As a percentage of consolidated revenues, consolidated cost of sales decreased to 28.2% in fiscal 2016 from 28.9% in fiscal 2015.
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As a percentage of revenues, Del Frisco’s cost of sales decreased to 29.3% during fiscal 2016 from 30.0% in fiscal 2015. This decrease in cost of sales, as a percentage of revenues, was primarily due to lower beef costs, partially offset by higher seafood and wine costs.
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As a percentage of revenues, Sullivan’s cost of sales decreased to 29.4% during fiscal 2016 from 30.0% in fiscal 2015. This decrease in cost of sales, as a percentage of revenues, was primarily due to lower beef and seafood costs.
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As a percentage of revenues, the Grille’s cost of sales decreased to 25.6% during fiscal 2016 from 26.2% in fiscal 2015. This decrease in cost of sales, as a percentage of revenues, was primarily due to lower beef, seafood and wine costs.
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Restaurant Operating Expenses. Consolidated restaurant operating expenses increased $13.0 million, or 8.3%, to $169.3 million in fiscal 2016 from $156.3 million in fiscal 2015. This increase was primarily due to an additional 151 net operating weeks in fiscal 2016, as discussed above. As a percentage of consolidated revenues, consolidated restaurant operating expenses increased to 48.1% in fiscal 2016 from 47.1% in fiscal 2015.
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As a percentage of revenues, Del Frisco’s restaurant operating expenses increased to 40.6% during fiscal 2016 from 40.0% in fiscal 2015. This increase in restaurant operating expenses, as a percentage of revenues, was due to higher occupancy costs and other restaurant operating costs.
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As a percentage of revenues, Sullivan’s restaurant operating expenses increased to 51.8% during fiscal 2016 from 50.5% in fiscal 2015. This increase in restaurant operating expenses, as a percentage of revenues, was due to higher labor costs, other restaurant operating costs and occupancy costs.
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As a percentage of revenues, the Grille’s restaurant operating expenses increased to 57.3% during fiscal 2016 from 57.0% in fiscal 2015. This increase in restaurant operating expenses, as a percentage of revenues, was due to higher labor costs, partially offset by lower occupancy costs and other restaurant operating expenses.
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Marketing and Advertising Costs. Consolidated marketing and advertising costs increased $0.5 million, or 6.6%, to $8.3 million in fiscal 2016 from $7.7 million in fiscal 2015. As a percentage of consolidated revenues, consolidated marketing and advertising costs remained flat at 2.3% in fiscal 2016 compared to fiscal 2015.
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As a percentage of revenues, Del Frisco’s marketing and advertising costs increased to 2.0% in fiscal 2016 from 1.7% in fiscal 2015. The increase in marketing and advertising costs, as a percentage of revenues, was primarily due to higher digital and print advertising, partially offset by lower broadcast media costs.
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As a percentage of revenues, Sullivan’s marketing and advertising costs increased to 3.2% in fiscal 2016 from 3.0% in fiscal 2015. The increase in marketing and advertising costs, as a percentage of revenues, was primarily due to higher digital and print advertising, partially offset by lower broadcast media costs.
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As a percentage of revenues, the Grille’s marketing and advertising costs decreased to 2.3% in fiscal 2016 from 2.9% in fiscal 2015. This decrease in marketing and advertising costs, as a percentage of revenues, was due to lower broadcast media and other advertising, partially offset by higher digital advertising and print production costs.
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Pre-opening Costs. Pre-opening costs decreased by $1.8 million to $3.4 million in fiscal 2016 from $5.2 million in fiscal 2015. One new Del Frisco’s and three new Grilles were opened in fiscal 2016 compared to one new Del Frisco’s and six new Grilles in fiscal 2015. The relocated Dallas Del Frisco’s was treated as a new restaurant opening and incurred customary pre-opening expenses in preparation for the opening of the restaurant.
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General and Administrative Expenses. General and administrative expenses increased $2.8 million, or 12.2%, to $25.9 million in fiscal 2016 from $23.1 million in fiscal 2015. This increase was primarily related to additional compensation costs related to growth in the number of restaurant support center and regional management-level personnel to support recent and anticipated growth, as well as increased legal expenses and $0.8 million in reorganization severance expenses. As a percentage of revenues, general and administrative expenses increased to 7.4% in fiscal 2016 from 7.0% in fiscal 2015. General and administrative costs are expected to continue to increase as a result of costs related to our anticipated growth, including further investments in our infrastructure. As we are
			
		
able to leverage these investments made in our people and systems, we expect these expenses to decrease as a percentage of total revenues over time.
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Lease termination and closing costs. During the fourth quarter of fiscal 2016, we decided to close the Seattle Sullivan’s location by March 31, 2017. In conjunction with this anticipated closing, we incurred $0.9 million in lease termination costs, as well as $0.1 million in closing costs from prior year closures. In fiscal 2015, we incurred $1.4 million in lease termination and closing costs due to the closing of two Grille locations in the fourth quarter of fiscal 2015.
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Impairment Charges. During the fourth quarter of fiscal 2016, we determined that the carrying value of two Sullivan’s locations exceeded their estimated future cash flows, due in part by our determination to close these locations, and recognized a combined $0.6 million impairment charge. This charge was based on the difference between the carrying value of the restaurant assets and the estimated value of leasehold improvements, furniture and restaurant equipment that may be transferred to other restaurant locations. During the third quarter of fiscal 2015, we determined that the carrying value of one Grille location exceeded its estimated future cash flows and recognized a $3.2 million impairment charge. This charge was based on the difference between the carrying value of the restaurant assets and the estimated value of furniture and restaurant equipment that may be transferred to future Grille locations.
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Depreciation and Amortization. Depreciation and amortization increased $2.1 million, or 12.5%, to $18.9 million in fiscal 2016 from $16.8 million in fiscal 2015. The increase in depreciation and amortization expense primarily resulted from new assets related to seven restaurants opened in fiscal 2015 and four restaurants opened in fiscal 2016, as well as for existing restaurants that were remodeled during fiscal 2015 and fiscal 2016.
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Interest Expense. Interest expense decreased to $70,000 in 2016, net of capitalized interest of $19,000, from $77,000 in 2015.
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Provision for Income Taxes. The effective income tax rate was 27.7% and 25.6% in fiscal 2016 and fiscal 2015, respectively. The factors that cause the effective tax rates to vary from the federal statutory rate of 35% include the impact of FICA tip and other credits, state income taxes and certain non-deductible or non-taxable expenses. The increase in the effective tax rate was primarily attributable to increased state tax expense, and a higher taxable income without a corresponding increase in tax credits.
			
		
Fiscal Year Ended December 29, 2015 (52 weeks) Compared to Fiscal Year Ended December 30, 2014 (52 weeks)
The following tables show our operating results by operating segment, as well as our operating results as a percentage of revenues, for the fiscal years ended December 29, 2015 and December 30, 2014.
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Revenues. Consolidated revenues increased $29.8 million, or 9.9%, to $331.6 million in fiscal 2015 from $301.8 million in fiscal 2014. This increase was due to 321 net additional operating weeks resulting from one Del Frisco’s and six Grille openings in fiscal 2015 and the full year impact of one Del Frisco’s and five Grille openings in fiscal 2014. This increase was partially offset by the closing of one Sullivan’s location and two Grille locations in fiscal 2016 and by a 0.6% decrease in total comparable restaurant sales, comprised of a 2.6% decrease in customer counts, which was partially offset by a 2.0% increase in average check.
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Del Frisco’s revenues increased $10.7 million, or 7.1%, to $161.8 million in fiscal 2015 from $151.1 million in fiscal 2014. This increase was primarily due to 57 additional operating weeks resulting from the Orlando, Florida Del Frisco’s opening in August 2015 and the full year impact of the Washington, D.C. Del Frisco’s, which opened in September 2014, as well as a 0.1% increase in total comparable restaurant sales, comprised of a 2.9% increase in average check, partially offset by a 2.8% decrease in customer counts.
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Sullivan’s revenues decreased $1.9 million, or 2.4%, to $79.0 million in fiscal 2015 from $80.9 million in fiscal 2014. This decrease was primarily due to the closing of one Sullivan’s location in May 2015. This decrease was partially offset by a 0.2% increase in total comparable restaurant sales, comprised of a 3.4% increase in average check, partially offset by a 3.2% decrease in customer counts.
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The Grille’s revenues increased $21.1 million, or 30.2%, to $90.8 million in fiscal 2015 from $69.8 million in fiscal 2014. This increase was provided by 294 additional operating weeks resulting from six Grille openings during fiscal 2015 and five Grille openings during fiscal 2014. This increase was partially offset by a 4.1% decrease in total comparable restaurant sales, comprised of a 2.5% decrease in average check and a 1.6% decrease in customer counts, as well as the closure of two Grille locations in fiscal 2015.
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Cost of Sales. Consolidated cost of sales increased $5.0 million, or 5.5%, to $96.0 million in fiscal 2015 from $91.0 million in fiscal 2014. This increase was primarily due to 321 net additional operating weeks in fiscal 2015, as discussed above. As a percentage of consolidated revenues, consolidated cost of sales decreased to 28.9% in fiscal 2015 from 30.1% in fiscal 2014.
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As a percentage of revenues, Del Frisco’s cost of sales decreased to 30.0% during fiscal 2015 from 31.4% in fiscal 2014. This decrease in cost of sales, as a percentage of revenues, was primarily due to lower wine and protein costs, primarily for our prime beef and seafood.
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As a percentage of revenues, Sullivan’s cost of sales increased to 30.0% during fiscal 2015 from 29.9% in fiscal 2014. This increase in cost of sales, as a percentage of revenues, was primarily due to higher beef, liquor and wine costs, partially offset by lower seafood and dairy costs.
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As a percentage of revenues, the Grille’s cost of sales decreased to 26.2% during fiscal 2015 from 27.7% in fiscal 2014. The decrease in cost of sales, as a percentage of revenues, was due primarily to lower liquor, wine and protein costs, primarily for our prime beef and seafood.
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Restaurant Operating Expenses. Consolidated restaurant operating expenses increased $18.6 million, or 13.5%, to $156.3 million in fiscal 2015 from $137.7 million in fiscal 2014. This increase was primarily due to 321 net additional operating weeks in fiscal 2015, as discussed above. As a percentage of consolidated revenues, consolidated restaurant operating expenses increased to 47.1% in fiscal 2015 from 45.6% in fiscal 2014.
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As a percentage of revenues, Del Frisco’s restaurant operating expenses increased to 40.0% during fiscal 2015 from 38.6% in fiscal 2014. This increase in restaurant operating expenses, as a percentage of revenues, was due to higher direct labor and benefits costs, operating and occupancy costs due in part to new opening inefficiencies of the Orlando, Florida location and the comparable restaurant growth insufficient to offset increases in certain expenses.
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As a percentage of revenues, Sullivan’s restaurant operating expenses decreased to 50.5% during fiscal 2015 from 50.6% in fiscal 2014. This decrease in restaurant operating expenses, as a percentage of revenues, was due to lower other restaurant operating costs, related to strategic cost savings initiatives, partially offset by higher labor cost.
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As a percentage of revenues, the Grille’s restaurant operating expenses increased to 57.0% during fiscal 2015 from 55.2% in fiscal 2014. This increase in restaurant operating expenses, as a percentage of revenues, was due primarily to higher occupancy and new opening inefficiencies related to the six openings in fiscal 2015 and two openings in late fiscal 2014, as well as diminished operations at the two Grille locations that closed during the fourth quarter of fiscal 2015. Additionally, the decline in comparable restaurant sales resulted in deleveraging against certain fixed costs.
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Marketing and Advertising Costs. Consolidated marketing and advertising costs increased $1.6 million, or 25.5%, to $7.7 million in fiscal 2015 from $6.2 million in fiscal 2014. As a percentage of consolidated revenues, consolidated marketing and advertising costs increased to 2.3% in fiscal 2015 from 2.0% in fiscal 2014.
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As a percentage of revenues, Del Frisco’s marketing and advertising costs increased to 1.7% in fiscal 2015 from 1.6% in fiscal 2014. The increase in marketing and advertising costs, as a percentage of revenues, was primarily due to higher digital and outdoor advertising.
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As a percentage of revenues, Sullivan’s marketing and advertising costs remained flat at 3.0% in fiscal 2015 compared to fiscal 2014.
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As a percentage of revenues, the Grille’s marketing and advertising costs increased to 2.9% in fiscal 2015 from 2.0% in fiscal 2014. This increase in marketing and advertising costs, as a percentage of revenues, was due to higher digital, broadcast and print media spending.
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Pre-opening Costs. Pre-opening costs increased by $0.5 million to $5.2 million in fiscal 2015 from $4.7 million in fiscal 2014. One new Del Frisco’s and six new Grilles were opened in fiscal 2015 compared to five new Grilles in fiscal 2014.
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General and Administrative Expenses. General and administrative expenses increased $2.6 million, or 12.5%, to $23.1 million in fiscal 2015 from $20.5 million in fiscal 2014. This increase was primarily related to additional compensation costs related to growth in the number of restaurant support center and regional management-level personnel to support recent and anticipated growth, as well as $0.7 million in increased restaurant management training expenses. In addition, we incurred an additional $0.3 million in non-cash
			
		
stock compensation expense in fiscal 2015 compared to fiscal 2014. These increases were partially offset by lower incentive compensation during fiscal 2015. As a percentage of revenues, general and administrative expenses increased to 7.0% in fiscal 2015 from 6.8% in fiscal 2014. General and administrative costs are expected to continue to increase as a result of costs related to our anticipated growth, including further investments in our infrastructure. As we are able to leverage these investments made in our people and systems, we expect these expenses to decrease as a percentage of total revenues over time.
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Lease Termination and Closing Costs. In conjunction with the closing of two Grille locations in the fourth quarter of fiscal 2015, we incurred $1.4 million in lease termination and closing costs. No such costs were incurred in fiscal 2014.
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Impairment Charges. During the third quarter of fiscal 2015, we determined that the carrying value of one Grille location exceeded its estimated future cash flows and recognized a $3.2 million impairment charge. This charge was based on the difference between the carrying value of the restaurant assets and the estimated value of furniture and restaurant equipment that may be transferred to future Grille locations. During the fourth quarter of fiscal 2014, we determined that the carrying value of one Grille location exceeded its estimated future cash flows and recognized a $3.5 million impairment charge. This charge was based on the difference between the carrying value of the restaurant assets and the estimated value of furniture and restaurant equipment that may be transferred to future Grille locations.
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Depreciation and Amortization. Depreciation and amortization increased $3.2 million, or 23.4%, to $16.8 million in fiscal 2015 from $13.6 million in fiscal 2014. The increase in depreciation and amortization expense primarily resulted from new assets related to six restaurants opened in fiscal 2014 and seven restaurants opened in fiscal 2015 as well as for existing restaurants that were remodeled during fiscal 2014 and fiscal 2015.
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Interest Expense. Interest expense decreased to $77,000 in fiscal 2015, net of capitalized interest of $115,000, from $113,000 in fiscal 2014.
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Provision for Income Taxes. The effective income tax rate was 25.6% and 31.8% in fiscal 2015 and fiscal 2014, respectively. The factors that cause the effective tax rates to vary from the federal statutory rate of 35% include the impact of the FICA tip and other credits, state income taxes and certain non-deductible or non-taxable expenses. The decrease in the effective tax rate was primarily attributable to increased tax credits against a lower taxable income and the settlement of uncertain tax positions during fiscal 2015. This decrease was partially offset by higher effective state tax rate and higher non-deductible stock compensation expense, which lowered income from continuing operations before income tax, but were not deductible for certain state and local taxes.
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Liquidity and Capital Resources
We believe that net cash provided by operating activities and available borrowings under our credit facility will be sufficient to fund currently anticipated working capital, planned capital expenditures and debt service requirements for the next 24 months. We regularly review acquisitions and other strategic opportunities, which may require additional debt or equity financing.
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Our principal liquidity requirements are our lease obligations and our working capital and capital expenditure needs and any principal and interest obligations on our debt. Subject to our operating performance, which, if significantly adversely affected, would adversely affect the availability of funds, we expect to finance our operations for at least the next several years, including costs of opening currently planned new restaurants, through cash provided by operations and existing borrowings available under our credit facility discussed below. We cannot be sure that these sources will be sufficient to finance our operations, however, and we may seek additional financing in the future. As of December 27, 2016, we had cash and cash equivalents of approximately $14.6 million.
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Our operations have not required significant working capital and, like many restaurant companies, we may at times have negative working capital. Revenues are received primarily in cash or by credit card, and restaurant operations do not require significant receivables or inventories, other than our wine inventory. In addition, we receive trade credit for the purchase of food, beverages and supplies, thereby reducing the need for incremental working capital to support growth.
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Cash Flows
The following table summarizes the statement of cash flows for the fiscal years ended December 27, 2016, December 29, 2015 and December 30, 2014:
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Operating Activities. Net cash flows provided by operating activities increased $3.9 million during fiscal 2016 as compared to fiscal 2015, primarily due to a $6.2 million net increase in cash related to income taxes and a $3.4 million net increase in cash related to deferred rent obligations, partially offset by a $5.5 million net decrease in cash related to accounts payable and other net changes in certain operating assets and liabilities (as noted in the consolidated statement of cash flows). Net cash flows provided by operating activities increased $3.1 million during fiscal 2015 as compared to fiscal 2014 primarily due to a $3.2 million increase in depreciation and amortization, as well as other net changes in certain operating assets and liabilities (as noted in the consolidated statement of cash flows). Cash flows from operating activities was $42.8 million in fiscal 2014, consisting primarily of net income of $16.6 million, adjustments for depreciation, amortization, deferred income taxes and other non-cash charges totaling $19.6 million, a net increase in cash of $3.8 million resulting from a decrease in lease incentives receivable and $10.5 million from an increase in other liabilities and deferred rent obligations. These cash inflows were partially offset by increases in inventories, other current assets and income taxes receivable of $7.7 million.
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Investing Activities. Net cash used in investing activities in fiscal 2016 was $34.2 million, consisting primarily of purchases of leasehold improvements, property and equipment, as well as a trade name acquisition (see note 3 to the consolidated financial statements for information related to the trade name acquisition). These purchases were primarily related to construction of three Grilles and one Del Frisco’s during fiscal 2016, as well as remodel activity at existing restaurants. Net cash used in investing activities in fiscal 2015 was $46.5 million, consisting primarily of purchases of leasehold improvements, property and equipment. These purchases were primarily related to construction of six Grilles and one Del Frisco’s during fiscal 2015, as well as remodel activity at existing restaurants. Net cash used in investing activities in fiscal 2014 was $48.0 million, consisting primarily of purchases of property and equipment. These purchases were primarily related to construction of five Grilles and one Del Frisco’s during fiscal 2014, as well as the purchase of a land and building site related to a fiscal 2015 opening and remodel activity at existing restaurants.
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Financing Activities. Net cash used in financing activities in fiscal 2016 was $6.2 million, which was comprised of $4.5 million in net payments toward the outstanding balance under our credit facility and $4.8 million in share repurchases, offset by $3.2 million in proceeds from the exercise of stock options. Net cash provided by financing activities in fiscal 2015 was $2.3 million, which was comprised of $4.5 million in net proceeds from borrowings on the credit facility and $0.8 million in proceeds from the exercise of stock options, partially offset by $3.0 million in share repurchases. Net cash used in financing activities in fiscal 2014 was $5.0 million, which was comprised of $6.3 million in share repurchases, partially offset by $1.3 million in proceeds from the exercise of stock options.
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Capital Expenditures
We typically target an average cash investment of approximately $7.0 million to $9.0 million per restaurant for a Del Frisco’s restaurant and $3.0 million to $4.5 million for a Sullivan’s or a Grille, in each case net of landlord contributions and equipment financing and including pre-opening costs. In addition, we are currently “refreshing” a number of our Sullivan’s and Del Frisco’s locations to, among other things, add additional seating, private dining space and patio seating. During fiscal 2016, we completed a refresh of one Sullivan’s and one Del Frisco’s. Looking forward, we expect to complete two to four refreshes each year at an approximate cost of $0.5 million to $1.0 million per location. These capital expenditures will primarily be funded by cash flows from operations and, if necessary, by the use of our credit facility, depending upon the timing of expenditures.
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Credit Facility
On October 15, 2012, we entered into a credit facility that provides for a three-year unsecured revolving credit facility of up to $25 million. Borrowings under the credit facility bear interest at LIBOR plus 1.50%. We are required to pay a commitment fee equal to 0.25% per annum on the available but unused revolving loan facility. The credit facility is guaranteed by certain of our subsidiaries. On June 30, 2015, we entered into a Second Amendment to the credit facility. The amendment, among other things, extended the termination date of the credit facility to October 15, 2017 and modified the revolving credit commitment to $15 million, with such amount subject to increases in increments of $5 million at our request, up to a maximum amount of $30 million. On December 21, 2016, we entered into a Third Amendment to the credit facility. The amendment, among other things, extended the termination date of the credit facility to October 15, 2019 and modifies the revolving credit commitment to $10 million, with such amount subject to increases in increments of $5 million at our request, up to a maximum amount of $30 million.
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The credit facility contains various financial covenants, including a maximum leverage ratio of total indebtedness to EBITDA (as defined in the credit facility), and minimum fixed charge coverage ratio. Specifically, we are required to have a leverage ratio of less than 1.00 and a fixed charge coverage ratio of greater than 2.00. As of December 27, 2016, we were in compliance with each of these tests. The credit facility also contains covenants restricting certain corporate actions, including asset dispositions, acquisitions, the payment of dividends, the incurrence of indebtedness and providing financing or other transactions with affiliates.
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As of December 27, 2016, there was no outstanding balance under the credit facility. Under the revolving loan commitment, we had approximately $28.8 million of borrowings available, net of $1.2 million in letter of credit commitments.
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Contractual Obligations
The following table summarizes our contractual obligations as of December 27, 2016:
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Inflation
Over the past five years, inflation has not significantly affected our operations. However, the impact of inflation on labor, food and occupancy costs could, in the future, significantly affect our operations. We pay many of our employees hourly rates related to the applicable federal or state minimum wage. We have been impacted by recent increases in minimum wage laws, such as the 15% increase in the minimum wage on January 1, 2017 in Seattle, Washington to $15.00 per hour or the 17% increase in minimum wage in California to $10.50. Food costs as a percentage of revenues have been somewhat stable due to procurement efficiencies and menu price adjustments, although no assurance can be made that our procurement will continue to be efficient or that we will be able to raise menu prices in the future. Costs for construction, taxes, repairs, maintenance and insurance all impact our occupancy costs. We believe that our current strategy, which is to seek to maintain operating margins through a combination of menu price increases, cost controls, careful evaluation of property and equipment needs, and efficient purchasing practices, has been an effective tool for dealing with inflation. There can be no assurance, however, that future inflationary or other cost pressure will be effectively offset by this strategy.
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Critical Accounting Policies and Estimates
Our discussion and analysis of results of operations and financial condition are based upon our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements is based on our critical accounting policies that require us to make estimates and judgments that affect the amounts reported in those consolidated financial statements. Our significant accounting policies, which may be affected by our estimates and assumptions, are more fully described in the notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Critical accounting policies are those that we believe are most important to portraying
			
		
our financial condition and results of operations and also require the greatest amount of subjective or complex judgments by management. Judgments or uncertainties regarding the application of these policies may result in materially different amounts being reported under different conditions or using different assumptions. We consider the following policies to be the most critical in understanding the judgments that are involved in preparing the consolidated financial statements.
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Goodwill and Other Intangible Assets. We account for our goodwill and intangible assets in accordance with Accounting Standards Codification, or ASC, Topic 350, Intangibles-Goodwill and Other. In accordance with ASC Topic 350, goodwill and intangible assets, primarily trade names, which have indefinite useful lives, are not being amortized. However, both goodwill and trade names are subject to annual impairment testing in accordance with ASC Topic 350. Currently, we define the reporting units as the Del Frisco’s and Sullivan’s concepts.
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The impairment evaluation for goodwill is conducted annually using a two-step process. In the first step, the fair value of each reporting unit is compared with the carrying amount of the reporting unit, including goodwill. The estimated fair value of the reporting unit is generally determined on the basis of discounted future cash flows and a market-based approach. We make assumptions regarding future profits and cash flows, expected growth rates, terminal value, and other factors which could significantly impact the fair value calculations. If the estimated fair value of the reporting unit is less than the carrying amount of the reporting unit, then a second step must be completed in order to determine the amount of the goodwill impairment that should be recorded. In the second step, the implied fair value of the reporting unit’s goodwill is determined by allocating the reporting unit’s fair value to all of its assets and liabilities other than goodwill in a manner similar to a purchase price allocation. The resulting implied fair value of the goodwill that results from the application of this second step is then compared to the carrying amount of the goodwill and an impairment charge is recorded for the difference.
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The evaluation of the carrying amount of other intangible assets with indefinite lives is made annually by comparing the carrying amount of these assets to their estimated fair value. The estimated fair value is determined on the basis of existing market-based conditions as well as discounted future cash flow or the royalty-relief method for trade names. If the estimated fair value is less than the carrying amount, an impairment charge is recorded to reduce the asset to its estimated fair value.
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The valuation approaches used to determine fair value of each reporting unit and other intangible assets are subject to key judgments and assumptions about revenue growth rates, operating margins, weighted average cost of capital and comparable company and acquisition market multiples. When developing these key judgments and assumptions, which are sensitive to change, management considers economic, operational and market conditions that could impact the fair value. The judgments and assumptions used are consistent with what management believes hypothetical market participants would use. However, estimates are inherently uncertain and represent only reasonable expectations regarding future developments.
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The fair value of our restaurant concepts were in excess of the carrying value as of our fiscal 2016 goodwill and other intangible impairment test that was performed at year-end.
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Property and Equipment. We assess recoverability of property and equipment in accordance with ASC Topic 360, Property, Plant and Equipment. Our assessment of recoverability of property and equipment is performed on a restaurant-by-restaurant basis. Certain events or changes in circumstances may indicate that the recoverability of the carrying amount of property and equipment should be assessed. These events or changes may include a significant decrease in market value, a significant change in the business climate in a particular market, or a current-period operating or cash flow loss combined with historical losses or projected future losses. If an event occurs or changes in circumstances are present, we estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. Additionally, we periodically review assets for changes in circumstances which may impact their useful lives.
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Our assessments of undiscounted cash flows represent our best estimate as of the time of the impairment review and are consistent with our internal planning. If different cash flows had been estimated in the current period, the property and equipment balances could have been materially impacted. Furthermore, our accounting estimates may change from period to period as conditions change, and this could materially impact our results in future periods. Factors that we must estimate when performing impairment tests include sales volume, prices, inflation, marketing expense, and capital expenses.
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In fiscal 2016, we recognized impairment charges of long-lived assets of $0.6 million. This impairment charge was related to our determination that the carrying amount of long-lived assets at two Sullivan’s locations exceeded their estimated undiscounted future cash flows, due in part by our determination to close these locations. The estimated fair value was based on an estimated sales price of leasehold improvements, furniture and restaurant equipment for this location.
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In fiscal 2015, we recognized impairment charges of long-lived assets of $3.2 million. This impairment charge was related to our determination that the carrying amount of long-lived assets at one Grille location exceeded its estimated undiscounted future cash flows. The estimated fair value was based on an estimated value of the furniture and equipment that we may transfer to future Grille locations.
			
		
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In fiscal 2014, we recognized impairment charges of long-lived assets of $3.5 million. This impairment charge was related to our determination that the carrying amount of long-lived assets at one Grille location exceeded its estimated undiscounted future cash flows. The estimated fair value was based on an estimated value of the furniture and equipment that we may transfer to future Grille locations.
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Leases. We currently lease all but one of our restaurant locations. We evaluate each lease to determine its appropriate classification as an operating or capital lease for financial reporting purposes. All of our leases are classified as operating leases. We record the minimum lease payments for our operating leases on a straight-line basis over the lease term, including option periods which in the judgment of management are reasonably assured of renewal. The lease term commences on the date that the lessee obtains control of the property, which is normally when the property is ready for tenant improvements. Contingent rent expense is recognized as incurred and is usually based on either a percentage of restaurant sales or as a percentage of restaurant sales in excess of a defined amount. Our lease costs will change based on the lease terms of our lease renewals as well as leases that we enter into with respect to our new restaurants.
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Leasehold improvements financed by the landlord through tenant improvement allowances are capitalized as leasehold improvements with the tenant improvement allowances recorded as deferred lease incentives. Deferred lease incentives are amortized on a straight-line basis over the lease term, including option periods which in the judgment of management are reasonably assured of renewal (same term that is used for related leasehold improvements) and are recorded as a reduction of occupancy expense. As part of the initial lease terms, we negotiate with our landlords to secure these tenant improvement allowances. There is no guarantee that we will receive tenant improvement allowances for any of our future locations, which would result in additional occupancy expenses.
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In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) which provides for a comprehensive set of changes in accounting for leases. The lease accounting model is a “right of use” model that assumes that each lease creates an asset (the lessee’s right to use the leased asset) and a liability (the future rent payment obligations) which should be reflected on a lessee’s balance sheet to fairly represent the lease transaction and the lessee’s related financial obligations. All of our leases are accounted for as operating leases, with no related assets and liabilities on our balance sheet. However, changes in lease accounting rules or their interpretation, or changes in underlying assumptions, estimates or judgments by us could significantly change our reported or expected financial performance.
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Income Taxes. We have accounted for, and currently account for, income taxes in accordance with ASC Topic 740, Accounting for Income Taxes. This statement requires an asset and liability approach for financial accounting and reporting of income taxes. Under ASC Topic 740, income taxes are accounted for based upon the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carry-forwards. Income taxes are one of our critical accounting policies and estimates and therefore involve a certain degree of judgment. We use an estimate of our annual effective tax rate at each interim period based on the facts and circumstances available at that time while the actual effective tax rate is calculated at year-end.
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The realization of tax benefits of deductible temporary differences will depend on whether we will have sufficient taxable income of an appropriate character to allow for utilization of the deductible amounts.
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We record a liability for unrecognized tax benefits resulting from tax positions taken, or expected to be taken, in an income tax return. We recognize any interest and penalties related to unrecognized tax benefits in income tax expense. Significant judgment is required in assessing, among other things, the timing and amounts of deductible and taxable items. Tax reserves are evaluated and adjusted as appropriate, while taking into account the progress of audits of various taxing jurisdictions.
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Self-Insurance Reserves. We maintain various insurance policies including workers’ compensation and general liability. Pursuant to those policies, we are responsible for losses up to certain limits and are required to estimate a liability that represents our ultimate exposure for aggregate losses below those limits. This liability is based on management’s estimates of the ultimate costs to be incurred to settle known claims and claims not reported as of the balance sheet date. Our estimated liability is not discounted and is based on a number of assumptions and factors, including historical trends, actuarial assumptions, and economic conditions. If actual trends, including the severity or frequency of claims, differ from our estimates, our financial results could be impacted.
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Recent Accounting Pronouncements
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The information regarding recent accounting pronouncements materially affecting our consolidated financial statements is included in
Note 2 to our consolidated financial statements in Item 15 of this Annual Report on Form 10-K.
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Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
The inherent risk in market risk sensitive instruments and positions primarily relates to potential losses arising from adverse changes in interest rates.
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We are exposed to market risk from fluctuations in interest rates. For fixed rate debt, interest rate changes affect the fair market value of the debt but do not impact earnings or cash flows. Conversely for variable rate debt, including borrowings under our credit facility, interest rate changes generally do not affect the fair market value of the debt, but do impact future earnings and cash flows, assuming other factors are held constant. At December 27, 2016, we had no outstanding debt on our revolving credit facility. Assuming a full drawdown on the revolving credit facility, and holding other variables constant, such as foreign exchange rates and debt levels, a hypothetical immediate one percentage point change in interest rates would be expected to have an impact on pre-tax earnings and cash flows of approximately $0.3 million over the course of 12 months.
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Commodity Price Risk
We are exposed to market price fluctuations in beef, seafood, produce and other food product prices. Given the historical volatility of beef, seafood, produce and other food product prices, these fluctuations can materially impact our food and beverage costs. While we have taken steps to qualify multiple suppliers who meet our standards as suppliers for our restaurants and enter into agreements with suppliers for some of the commodities used in our restaurant operations, there can be no assurance that future supplies and costs for such commodities will not fluctuate due to weather and other market conditions outside of our control. We currently do not contract for some of our commodities, such as fresh seafood and certain produce, for periods longer than one week. Consequently, such commodities can be subject to unforeseen supply and cost fluctuations. Dairy costs can also fluctuate due to government regulation. Because we typically set our menu prices in advance of our food product prices, our menu prices cannot immediately take into account changing costs of food items. To the extent that we are unable to pass the increased costs on to our customers through price increases, our results of operations would be adversely affected. We do not use financial instruments to hedge our risk to market price fluctuations in beef, seafood, produce and other food product prices at this time.
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Item 8.
Item 8. Financial Statements and Supplementary Data
Our consolidated financial statements and notes thereto and the reports of KPMG LLP, our independent registered public accounting firm, are set forth in the Index to Financial Statements under Item 15, Exhibits and Financial Statement Schedules, and are incorporated herein by reference.
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Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
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Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
We carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.
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The design of any system of disclosure controls and procedures is based upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated objectives under all future events, no matter how remote, or that the degree of compliance with the policies or procedures may not deteriorate. Because of its inherent limitations, disclosure controls and procedures may not prevent or detect all misstatements. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.
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Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act. Management, with the participation of our Chief Executive Officer and Chief Financial Officer, has assessed the effectiveness of our internal control over financial reporting as of the end of the period covered by this report based on the framework established in “Internal Control-Integrated Framework (2013 framework)”, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management has concluded that our internal control over financial reporting was effective as of the end of the period covered by this report.
Our system of internal control over financial reporting was designed to provide reasonable assurance regarding the preparation and fair presentation of published financial statements in accordance with accounting principles generally accepted in the United States.
			
		
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
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Because we are an “emerging growth company” under the JOBS Act, our independent registered public accounting firm, KPMG LLP, is not required to issue an attestation report on our internal control over financial reporting.
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Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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Item 9B.
Item 9B. Other Information
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None.
			
		
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PART III
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Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information required under this Item is incorporated herein by reference to our definitive proxy statement to be filed with the SEC no later than 120 days after the close of our fiscal year ended December 27, 2016. The information with respect to our executive officers required under this Item is set forth in Item 1, Business and incorporated herein by reference.
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Item 11.
Item 11. Executive Compensation
The information required under this Item is incorporated herein by reference to our definitive proxy statement to be filed with the SEC no later than 120 days after the close of our fiscal year ended December 27, 2016.
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Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
All information, except the equity compensation plans table below, required under this Item is incorporated herein by reference to our definitive proxy statement to be filed with the SEC no later than 120 days after the close of our fiscal year ended December 27, 2016.
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Equity Compensation Plans
The following table sets forth information as of December 27, 2016, with respect to our equity compensation plans under which our equity securities are authorized for issuance:
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Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required under this Item is incorporated herein by reference to our definitive proxy statement to be filed with the SEC no later than 120 days after the close of our fiscal year ended December 27, 2016.
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Item 14.
Item 14. Principal Accountant Fees and Services
The information required under this item is incorporated herein by reference to our definitive proxy statement to be filed with the SEC no later than 120 days after the close of our fiscal year ended December 27, 2016.
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PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
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(a)
Financial Statements and Financial Statement Schedules
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See Index to Consolidated Financial Statements appearing on page. All schedules have been omitted because they are not required or applicable or the information is included in the consolidated financial statements or notes thereto.
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(b)
Exhibits
See Exhibit Index appearing on the next page for a list of exhibits filed with or incorporated by reference as part of this Annual Report on Form 10-K.
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Exhibit Index
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10.15#
						
Form of Incentive Stock Option Award Agreement under the Del Frisco’s Restaurant Group 2012 Long-Term Incentive Plan.
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10.16#
						
Form of Restricted Stock Award Agreement under the Del Frisco’s Restaurant Group 2012 Long-Term Incentive Plan.
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10.17#
						
Form of Performance-Based Restricted Stock Unit Award Agreement under the Del Frisco’s Restaurant Group 2012 Long-Term Incentive Plan.
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*
Filed herewith.
#
Denotes management compensatory plan or arrangement.
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SIGNATURES
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused report to be signed on its behalf by the undersigned, thereunto duly authorized.
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Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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﻿Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements -December 27, 2016, December 29, 2015 and December 30, 2014:
						
						
						
﻿Consolidated Balance Sheets
﻿Consolidated Statements of Income and Comprehensive Income
﻿Consolidated Statements of Changes in Stockholders’ Equity
﻿Consolidated Statements of Cash Flows
﻿Notes to Consolidated Financial Statements
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Del Frisco’s Restaurant Group, Inc.:
We have audited the accompanying consolidated balance sheets of Del Frisco’s Restaurant Group, Inc. and subsidiaries (the Company) as of December 27, 2016 and December 29, 2015, and the related consolidated statements of income and comprehensive income, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 27, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
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We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
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In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Del Frisco’s Restaurant Group, Inc. and subsidiaries as of December 27, 2016 and December 29, 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 27, 2016 in conformity with U.S. generally accepted accounting principles.
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/s/ KPMG LLP
Dallas, Texas
February 28, 2017
			
		
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DEL FRISCO’S RESTAURANT GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands)
See accompanying notes.
			
		
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DEL FRISCO’S RESTAURANT GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Income and Comprehensive Income
(Dollars in thousands, except per share data)
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See accompanying notes.
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DEL FRISCO’S RESTAURANT GROUP, INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Stockholders’ Equity
(Dollars in thousands)
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See accompanying notes.
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DEL FRISCO’S RESTAURANT GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
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See accompanying notes.
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DEL FRISCO’S RESTAURANT GROUP, INC. AND SUBSIDIARIES
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Notes to Consolidated Financial Statements
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(1) Organization, Business and Basis of Presentation
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Description of Business
Del Frisco’s Restaurant Group, Inc., or the Company, is incorporated in Delaware as a corporation. We own and operate restaurants under the brand names of Del Frisco’s Double Eagle Steak House, Sullivan’s Steakhouse, and Del Frisco’s Grille. As of December 27, 2016, we owned and operated 12 Del Frisco’s, 18 Sullivan’s and 23 Grille restaurants. During fiscal 2016, we relocated one Del Frisco’s in Dallas, Texas and opened Grilles in Long Island, New York, Nashville, Tennessee and Brentwood, Tennessee.
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(2) Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
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Fiscal Year
We operate on a 52- or 53-week fiscal year ending the last Tuesday in December. Fiscal 2016, 2015 and 2014 included 52 weeks of operations.
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Concentrations
We have certain financial instruments exposed to a concentration of credit risk, which consist primarily of cash and cash equivalents. We place cash with high-credit-quality financial institutions, and, at times, such cash may be in excess of the federal depository insurance limit.
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Additionally, we purchased a significant amount of total beef purchases from one supplier during fiscal 2016, 2015 and 2014. Due to the nature of the beef purchases, there are alternative sources of supply available; however, a change in suppliers could potentially cause increased costs.
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Use of Estimates
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
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Cash and Cash Equivalents
Cash and cash equivalents include currency on hand, demand deposits with banks or other financial institutions, credit card receivables, and short-term investments with maturities of three months or less when purchased. Cash and cash equivalents are carried at cost, which approximates fair value.
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Financial Instruments
We consider the carrying amounts of cash and cash equivalents, short-term investments, receivables and accounts payable to approximate fair value based on the short-term nature of these items. Borrowings available under the credit facility at December 27, 2016 have variable interest rates that reflect currently available terms and conditions for similar debt.
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Inventories
Inventories, which primarily consist of food and beverages, are valued at the lower of cost, using the first-in, first-out (FIFO) method, or market.
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Property and Equipment
Property and equipment are stated at cost. Maintenance, repairs, and renewals that do not enhance the value of or increase the lives of the assets are expensed as incurred. Buildings are depreciated using the straight-line method over their estimated useful lives of 20 to 25 years. Leasehold improvements are amortized using the straight-line method over the lesser of the estimated useful lives of the assets of 20 years or the expected term of the lease, including cancelable optional renewal periods when failure to exercise such renewal options would result in an economic penalty to us. Furniture, fixtures, and equipment are depreciated using the straight-line method over three to seven years, which are the estimated useful lives of the assets.
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Interest is capitalized in connection with the construction of restaurant facilities. The capitalized interest is recorded as part of the asset to which it relates and is amortized over the asset’s estimated useful life. Capitalized interest was $19,000, $115,000 and $0 for the fiscal years ended December 27, 2016, December 29, 2015 and December 30, 2014, respectively.
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Operating Leases
We lease all but one of our restaurants under operating leases. The majority of our leases provide for rent escalation clauses, contingent rental expense, and/or tenant improvement allowances.
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Rent expense is recognized on a straight-line basis over the expected term of the lease, which includes cancelable optional renewal periods that are reasonably assured to be exercised and where failure to exercise such renewal options would result in an economic penalty to us.
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Certain of our operating leases contain clauses that provide additional contingent rent based on a percentage of sales greater than certain specified target amounts. We recognize contingent rent expense prior to the achievement of the specified target that triggers the contingent rent, provided achievement of that target is considered probable.
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We record tenant improvement allowances and other landlord incentives as a component of deferred rent which is amortized on a straight-line basis over the expected term of the lease.
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Pre-opening Costs
Pre-opening costs, including rent, labor costs, costs of hiring and training personnel, and certain other costs related to opening new restaurants, are expensed when the costs are incurred.
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Goodwill and Other Intangible Assets
Our intangible assets primarily include goodwill, trade names and licensing agreements. Our trade names include “Del Frisco’s Double Eagle Steak House” and “Sullivan’s Steakhouse,” both of which have indefinite lives and, accordingly, are not subject to amortization. The trade names are used in the advertising and marketing of the restaurants and are widely recognized and accepted by consumers in their respective markets for providing its customers an enjoyable fine-dining experience. Goodwill represents the excess of costs over the fair value of the net assets acquired.
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Goodwill and intangible assets that have indefinite useful lives are not amortized. However, both goodwill and trade names are subject to annual impairment testing, or more frequently if an event or other circumstance indicates that goodwill or the trade names may be impaired. We amortize our finite-lived intangible assets on a straight-line basis over the estimated period of benefit, generally 7 to 17 years. See Note 3 for additional information.
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The impairment evaluation for goodwill is conducted annually using a two-step process. In the first step, the fair value of each reporting unit is compared to the carrying amount of the reporting unit, including goodwill. The estimated fair value of the reporting unit is generally determined using discounted cash flows and a market-based approach. If the estimated fair value of the reporting unit is less than the carrying amount of the reporting unit, then a second step must be completed in order to determine the amount of the goodwill impairment that should be recorded. In the second step, the implied fair value of the reporting unit’s goodwill is determined by allocating the reporting unit’s fair value to all of its assets and liabilities, other than goodwill, in a manner similar to a purchase price allocation. If the resulting implied fair value of the goodwill that results from the application of this second step is less than the carrying amount of the goodwill, an impairment charge is recorded for the difference. Currently, we define the reporting units as the Del Frisco’s and Sullivan’s concepts. We perform its annual impairment test as of its year-end.
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The evaluation of the carrying amount of other intangible assets with indefinite lives is made annually by comparing the carrying amount of these assets to their estimated fair value. The estimated fair value is determined on the basis of existing market-based conditions as well as discounted future cash flow or the royalty-relief method for trade names. If the estimated fair value is less than the carrying amount, an impairment charge is recorded to reduce the asset to its estimated fair value.
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The valuation approaches used to determine fair value of each reporting unit and other intangible assets are subject to key judgments and assumptions about revenue growth rates, operating margins, weighted average cost of capital and comparable company and acquisition market multiples. When developing these key judgments and assumptions, which are sensitive to change, management considers economic, operational and market conditions that could impact the fair value. The judgments and assumptions used are consistent with what management believes hypothetical market participants would use. However, estimates are inherently uncertain and represent only reasonable expectations regarding future developments.
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Loan Costs
Loan costs are stated at cost and amortized using the effective interest method over the life of the related loan.
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Deferred Compensation Plan
In connection with our deferred-compensation plan, we have created a grantor trust to which we contribute amounts equal to employee participants’ qualified deferrals and our matching portion. The plan is informally funded using life insurance policies and mutual funds held by the grantor trust. All assets held by the grantor trust remain the property of us; however, we do not currently intend to use such assets for any purpose other than to fund payments to the participants, pursuant to the terms of the deferred-compensation plan. The assets of the plan consist principally of cash surrender values of the life insurance policies. Because the investment assets of the deferred-compensation plan are our assets and would be subject to general claims by creditors in the event of our insolvency, the accompanying consolidated balance sheets reflect such investments as assets, with a liability for deferred compensation reflected in long-term liabilities for amounts owed to employees.
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Impairment of Long-Lived Assets
Property and equipment and finite-life intangibles are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. We review applicable finite-lived intangible assets and long-lived assets related to each restaurant on a periodic basis. Our assessment of recoverability of property and equipment and finite-lived intangible assets is performed at the component level, which is generally an individual restaurant. When events or changes in circumstances indicate an asset may not be recoverable, we estimate the future cash flows expected to result from the use of the asset. If the sum of the expected undiscounted future cash flows is less than the carrying value of the asset, an impairment loss is recognized. The impairment loss is recognized by measuring the difference between the carrying value of the assets and the estimated fair value of the assets. Our estimates of fair values are based on the best information available and require the use of estimates, judgments, and projections. The actual results may vary significantly from the estimates.
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During fiscal 2016, we determined that the carrying amount of two of our Sullivan’s restaurants were most likely not recoverable. Therefore, we recorded a non-cash impairment charge of $0.6 million, which represents the difference between the carrying value of the restaurant assets and the estimated value of leasehold improvements, furniture and restaurant equipment that may be transferred to other restaurant locations. This amount is included in impairment charges in the consolidated statements of income and comprehensive income.
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During fiscal 2015, we determined that the carrying amount of one of our Grille restaurants was most likely not recoverable. Therefore, we recorded a non-cash impairment charge of $3.2 million, which represents the difference between the carrying value of the restaurant assets and the estimated value of furniture and restaurant equipment that may be transferred to future Grille locations. This amount is included in impairment charges in the consolidated statements of income and comprehensive income.
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During fiscal 2014, we determined that the carrying amount of one of our Grille restaurants was most likely not recoverable. Therefore, we recorded a non-cash impairment charge of $3.5 million, which represents the difference between the carrying value of the restaurant assets and the estimated value of furniture and restaurant equipment that may be transferred to future Grille locations. This amount is included in impairment charges in the consolidated statements of income and comprehensive income.
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Self-Insurance Reserves
We maintain self-insurance programs for our workers’ compensation and general liability insurance programs. In order to minimize the exposure under the self-insurance programs, we have purchased stop-loss coverage both on a per-occurrence and on an aggregate basis. The self-insured losses under the programs are accrued based on our estimate of the ultimate expected liability for both claims incurred and on an incurred but not reported basis. The establishment of such accruals for self-insurance involves certain management judgments and assumptions regarding the frequency or severity of claims, the historical patterns of claim development, and our experience with claim-reserve management and settlement practices. To the extent actual results differ from the assumptions used to develop the accruals, such unanticipated changes may produce significantly different amounts of expense than those estimated under the self-insurance programs.
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Income Taxes
We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. We regularly evaluate the likelihood of realization of tax benefits derived from positions we have taken in various federal and state filings after consideration of all relevant facts, circumstances, and available information. For those tax benefits deemed more likely than not that will be sustained, we recognize the benefit we believe is cumulatively greater than 50% likely to be realized. To the extent we were to prevail in matters for which accruals have been established or be required to pay amounts in excess of recorded reserves, the effective tax rate in a given financial statement period could be materially impacted.
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Advertising Costs
Advertising costs are expensed as incurred. Advertising expense for the fiscal years ended December 27, 2016, December 29, 2015 and December 30, 2014 was $8.3 million, $7.7 million, and $6.2 million, respectively.
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Revenue Recognition
Revenue from restaurant sales is recognized when food and beverage products are sold. Proceeds from the sale of gift cards are recorded as deferred revenue at the time of sale and recognized as revenue when the gift card is redeemed by the holder or the likelihood of redemption becomes remote (gift card breakage) and we determine there is no legal obligation to remit the value of the unredeemed gift cards to governmental agencies. We determine the gift card breakage rate based upon historical redemption patterns. Certain of our gift cards are sold at a discount and the net value (face value to be redeemed less the proceeds received) is deferred until redeemed or breakage is deemed appropriate. We have deemed gift card breakage income immaterial for fiscal years 2016, 2015 and 2014, and it is included in revenues in the consolidated statements of income and comprehensive income. Additionally, revenues are net of the cost of loyalty points earned associated with sales made to customers in our loyalty program. We exclude from revenue any taxes assessed by governmental agencies that are directly imposed on revenue-producing transactions between us and a customer.
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Stock-Based Compensation
In 2012, we adopted the Del Frisco’s Restaurant Group, Inc. 2012 Long-Term Equity Incentive Plan (2012 Plan), which allows our Board of Directors or a committee thereof to grant stock options, restricted stock, restricted stock units, deferred stock units and other equity-based awards to directors, officers, key employees and other key individuals performing services for us. We recognize stock-based compensation in accordance with Compensation-Stock Compensation (ASC Topic 718). Stock-based compensation cost includes compensation cost for all share-based payments granted based on the grant date fair value estimated in accordance with the provisions of Topic 718. Compensation cost is recognized on a straight-line basis, net of estimated forfeitures, over the requisite service period of each award.
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Reclassifications
Certain amounts from the prior years have been reclassified to conform with the fiscal 2016 presentation.
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Recently Issued Accounting Standards
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers which will supersede ASC Topic 605, Revenue Recognition. In August 2015, the FASB deferred the effective date of this new standard by one year. The FASB later issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606) - Principal versus Agent Considerations, in March 2016, ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606) - Identifying Performance Obligations and Licensing, in April 2016, ASU 2016-12, Revenue from Contracts with Customers (Topic 606) - Narrow-Scope Improvements and Practical Expedients, in May 2016, and ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers, in December 2016, all of which further clarified aspects of Topic 606. A core principle of the new guidance is that an entity should measure revenue in connection with its sale of goods and services to a customer based on an amount that depicts the consideration to which the entity expects to be entitled in exchange for each of those goods and services. For a contract that involves more than one performance obligation, the entity must (a) determine or, if necessary, estimate the standalone selling price at inception of the contract for the distinct goods or services underlying each performance obligation and (b) allocate the transaction price to each performance obligation on the basis of the relative standalone selling prices. In addition, under the new guidance, an entity should recognize revenue when (or as) it satisfies each performance obligation under the contract by transferring the promised good or service to the customer. A good or service is deemed transferred when (or as) the customer obtains control of that good or service. The new standard permits the use of either the retrospective or cumulative effect transition method. For public companies, this amendment is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early application is permitted, but no earlier than fiscal years beginning after December 16, 2016. While we have not yet selected a transition method nor determined the effect of the new standard on our consolidated financial statements, through our assessment of these ASUs, we have identified that the primary items affected by these ASUs are our loyalty program liability and the breakage income associated with our gift card program. See the revenue recognition section of this footnote for a description of the accounting policy related to our gift card and loyalty programs.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (ASU 2016-02). ASU 2016-02 is intended to improve the reporting of leasing transactions to provide users of financial statements with more decision-useful information. ASU 2016-02 will require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. We are currently assessing the potential impact of ASU 2016-02 on our consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting. The FASB is issuing this ASU as part of its Simplification Initiative. The amendments in this ASU affect all entities that issue share-based payment awards to their employees. The areas for simplification in this ASU involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification
			
		
of awards as either equity or liability and classification on the statement of cash flows. Specifically, all excess tax benefits and tax deficiencies should be recognized as income tax expense or benefit in the income statement. The tax effects of exercised or vested awards should be treated as discrete items in the reporting period in which they occur. An entity also should recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. Excess tax benefits should be classified along with other income tax cash flows as an operating activity. An entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur. The threshold to qualify for equity classifications permits withholding up to the maximum statutory tax rates in the applicable jurisdiction. Cash paid by an employer when directly withholding shares for tax-withholding purposes should be classified as a financing activity. For public business entities, the amendments in this ASU are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any entity in any interim or annual period. Amendments related to the timing of when excess tax benefits are recognized, minimum statutory withholding requirements, forfeitures and intrinsic value should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Amendments related to the presentation of employee taxes paid on the statement of cash flows when an employer withholds shares to meet the minimum statutory withholding requirement should be applied retrospectively. Amendments requiring recognition of excess tax benefits and tax deficiencies in the income statement and the practical expedient for estimating expected term should be applied prospectively. An entity may elect to apply the amendments related to the presentation of excess tax benefits on the statement of cash flows using either a prospective transition method or a retrospective transition method. We are adopting this ASU on December 28, 2016. While we do not expect this ASU to have a material impact on our consolidated financial statements, it will introduce an additional element of volatility in our effective tax rate.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments. This ASU is intended to clarify the presentation of cash receipts and payments in specific situations. The amendments in this update are effective for financial statements issued for annual periods beginning after December 15, 2017, including interim periods within those annual periods, and early application is permitted. We currently assessing the impact of this ASU on our consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) - Restricted Cash, which outlines that a statement of cash flows explains the change during the period in total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. ASU 2016-18 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017, and early application is permitted. We are currently assessing the impact of the adoption of this ASU on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment, which removes the second step of the goodwill impairment test and requires an entity to perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and recognize an impairment charge for the amount by which the carrying value exceeds the fair value, not to exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2019, and early application is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We are currently assessing the impact of the adoption of this ASU on our consolidated financial statements.
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(3) Intangible Assets and Goodwill
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The components of intangible assets and goodwill consist of the following:
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Licensing contract rights and favorable lease rights are being amortized using the straight-line method over the estimated lives of the related contracts and agreements, which are 7 to 9 years for favorable leasehold interest and 17 years for licensing contract rights. Liquor licenses that are transferable are carried at cost. Such licenses are reviewed for impairment on an annual basis.
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Goodwill is allocated to the Del Frisco’s and Sullivan’s reporting units, as follows: $43.9 million and $31.4 million at December 27, 2016 and December 29, 2015, respectively.
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We have estimated that annual amortization expense will amount to approximately $0.1 million for 2017, $0.1 million for 2018, $0.1 million for 2019, $0.1 million for 2020, and $0.1 million for 2021.
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Amortization expense was $0.1 million, $0.1 million, and $0.2 million for the years ended December 27, 2016, December 29, 2015 and December 30, 2014, respectively.
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We performed the annual test for impairment of goodwill and indefinite-lived intangible assets and concluded that no impairment existed as of December 27, 2016, December 29, 2015 or December 30, 2014, and accordingly, no impairment losses were recorded.
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On February 1, 2012, we entered into an agreement to terminate a license agreement with the licensee operating a Del Frisco’s in Orlando, Florida effective June 1, 2013. The original licensing agreement has been amortized over the expected term of the agreement, and has a remaining book value of $0.5 million as of December 27, 2016. Under the agreement, in exchange for us surrendering our right to receive licensing fees from January 1, 2012 through June 1, 2013 and making a one-time $25,000 payment to the licensee, we received the rights to open and operate any of our restaurants in the three counties that make up the Orlando metropolitan area no earlier than January 1, 2015. We accounted for this as an exchange of non-monetary assets, for which we have concluded that the fair value of the asset surrendered approximates its book value and therefore no gain or loss has been recorded on the exchange. To determine the fair value of the asset surrendered, we utilized a discounted cash flow method that applied a discount rate of 11.5%, our weighted-average cost of capital, to the future estimated cash flows to be received over the remaining term, including expected renewal, of the license agreement.
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On March 17, 2016, we entered into an agreement to obtain and clarify ownership of all naming rights for Del Frisco’s in certain counties of Kentucky, Indiana and Ohio for aggregate consideration of $0.6 million. Under the terms of the agreement, we made a payments totaling $0.5 million in 2016, with the remaining $0.1 million to be paid on August 1, 2017. This intangible asset has been recorded as a trade name with an indefinite life.
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(4) Leases
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We lease certain facilities under noncancelable operating leases with terms expiring between 2017 and 2036. The leases have renewal options ranging from 5 to 20 years, which are exercisable at our option. In addition, certain leases contain escalation clauses based on a fixed percentage increase and provisions for contingent rentals based on a percentage of gross revenues, as defined. Total
			
		
rental expense amounted to $22.9 million, $21.1 million, and $18.7 million, including contingent rentals of approximately $3.6 million, $3.6 million, and $3.9 million for the fiscal years ended December 27, 2016, December 29, 2015 and December 30, 2014, respectively.
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Future minimum lease payments under noncancelable operating leases include renewal option periods for certain leases when such option periods are included for purposes of calculating straight-line rents. At December 27, 2016, future minimum rentals for each of the next five years and thereafter, and in total, are as follows:
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(5) Income Taxes
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The components of income tax expense consist of the following:
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The difference between the reported income tax expense and taxes determined by applying the applicable U.S. federal statutory income tax rate to income before taxes is reconciled as follows:
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Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. Significant components of deferred tax assets and liabilities are presented below:
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We may, from time to time, be assessed interest or penalties by major tax jurisdictions, although any such assessments historically have been minimal and immaterial to our financial results. In the event we receive an assessment for interest and penalties, it has been classified in the consolidated financial statements as income tax expense. Generally, our federal, state, and local tax returns for years subsequent to 2012 remain open to examination by the major taxing jurisdictions to which we is subject.
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A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
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We do not believe our uncertain tax positions will change materially during the next 12 months. As of December 29, 2015 and December 27, 2016, accrued interest and penalties included in the consolidated balance sheets totaled $0.3 million. The change in interest and penalties associated with our unrecognized tax benefits is included as a component of the Other, net line of the effective tax rate reconciliation.
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(6) Long-Term Debt
On October 15, 2012, we entered into a credit facility that provides for a three-year unsecured revolving credit facility of up to $25 million. Borrowings under the credit facility bear interest at LIBOR plus 1.50%. We are required to pay a commitment fee equal to 0.25% per annum on the available but unused revolving loan facility. The credit facility is guaranteed by certain of our subsidiaries. The credit facility contains various financial covenants, including a maximum leverage ratio of total indebtedness to EBITDA, as defined in the credit agreement, and minimum fixed charge coverage ratio, as defined in the credit agreement. The credit facility also contains covenants restricting certain corporate actions, including asset dispositions, acquisitions, the payment of dividends, changes of control, the incurrence of indebtedness and providing financing or other transactions with affiliates.
On June 30, 2015, we entered into a Second Amendment to the credit facility. The amendment, among other things, extended the termination date of the credit facility to October 15, 2017 and modified the revolving credit commitment to $15 million, with such amount subject to increases in increments of $5 million at our request, up to a maximum amount of $30 million. All other major terms remain unchanged. On December 21, 2016, we entered into a Third Amendment to the credit facility. The amendment, among other things, extended the termination date of the credit facility to October 15, 2019 and modified the revolving credit commitment to $10 million, with such amount subject to increases in increments of $5 million at our request, up to a maximum amount of $30 million.
			
		
We were in compliance with the financial debt covenants as of December 27, 2016. As of December 27, 2016, there was no outstanding balance on our revolving credit facility. Under the revolving loan commitment, we had approximately $28.8 million of borrowings available, net of $1.2 million in letter of credit commitments.
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(7) Retirement Plans
We provide two retirement benefit plans to participants. The salary-reduction plans are provided through a qualified 401(k) plan and a nonqualified deferred compensation plan (the Plans). Under the Plans, employees who meet minimum service requirements and elect to participate may make contributions of up to 15% of their annual salaries under the 401(k) plan and up to 80% under the deferred-compensation plan. We may make additional contributions at the discretion of the Board of Directors. Expenses related to the Plans for the fiscal years ended December 27, 2016, December 29, 2015 and December 30, 2014 totaled $1.3 million, $2.2 million, and $1.7 million, respectively.
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(8) Litigation
We are involved, from time to time, in litigation arising in the ordinary course of business. We believe the outcome of such matters will not have a material adverse effect on our consolidated financial position or results of operations.
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(9) Stockholders’ Equity
On October 14, 2014, our Board of Directors approved a stock repurchase program authorizing us to repurchase up to $25 million of our common stock over the next three years. On February 15, 2017, our Board of Directors increased this authorization to $50 million. Under this program, we can from time to time purchase outstanding common stock in the open market at management’s discretion, subject to share price, market conditions and other factors. The common stock repurchase program does not obligate us to repurchase any dollar amount or number of shares. As of December 27, 2016, we had repurchased 492,214 shares of our common stock at an aggregate cost of approximately $7.8 million under this program.
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(10) Commitments and Contingencies
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At December 27, 2016, we had outstanding letters of credit of $1.2 million on our revolving credit facility. The letters of credit typically act as guarantee of payment to certain third parties in accordance with specified terms and conditions.
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(11) Fair Value Measurement
Under generally accepted accounting principles in the United States, we are required to measure certain assets and liabilities at fair value, or to disclose the fair value of certain assets and liabilities recorded at cost. Pursuant to these fair value measurement and disclosure requirements, fair value is defined as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value is calculated based on assumptions that market participants would use in pricing the asset or liability, not on assumptions specific to the entity. In addition, the fair value of liabilities includes consideration of non-performance risk, including our own credit risk. Each fair value measurement is reported in one of the following three levels:
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Level 1-valuation inputs are based upon unadjusted quoted prices for identical instruments traded in active markets.
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Level 2-valuation inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
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Level 3-valuation inputs are unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques.
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The following tables present our financial assets and liabilities measured at fair value on a recurring basis at December 27, 2016 and December 29, 2015:
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There were no transfers among levels within the fair value hierarchy during the years ended December 27, 2016 or December 29, 2015. The carrying value of our cash and cash equivalents and restricted cash approximate fair value because of their short term
			
		
nature, and are classified within Level 1 of the fair value hierarchy. The carrying value of our accounts payable approximate fair value because of their short term nature, and are classified within Level 2 of the fair value hierarchy. The fair value of the credit facility at December 27, 2016 approximated its carrying value since it is a variable rate credit facility (Level 2).
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We had no derivative instruments at December 27, 2016 or December 29, 2015.
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(12) Segment Reporting
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We operate the Del Frisco’s, Sullivan’s, and Del Frisco’s Grille brands as operating segments. The concepts operate solely in the U.S. within the full-service dining industry, providing similar products to similar customers. Sales to external customers are derived principally from food and beverage sales, and we do not rely on any major customers as a source of sales. The concepts also possess similar economic characteristics, resulting in similar long-term expected financial performance characteristics. However, as Del Frisco’s restaurants typically have higher revenues, driven by their larger physical presence and higher check average, the Del Frisco’s, Sullivan’s, and Del Frisco’s Grille operating segments have varying operating income and restaurant-level EBITDA margins due to the leveraging of higher revenues on certain fixed operating costs such as management labor, rent, utilities, and building maintenance.
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The following table presents information about reportable segments for fiscal years 2016, 2015, and 2014:
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In addition to using consolidated results in evaluating our performance and allocating our resources, our chief operating decision maker uses restaurant-level EBITDA, which is not a measure defined by GAAP. Restaurant-level EBITDA is defined as net income before interest expense, income taxes, other expense, net, pre-opening costs, general and administrative expenses, lease termination and closing costs, secondary public offering costs, impairment charges and depreciation and amortization. Pre-opening costs are excluded because they vary in timing and magnitude and are not related to the health of ongoing operations. General and administrative expenses are excluded as they are generally not specifically identifiable to individual operating segments as these costs relate to supporting all of our restaurant operations and the extension of our concepts into new markets. Lease termination and closing costs, impairment charges and depreciation and amortization are excluded because they are not ongoing controllable cash expenses and they are not related to the health of ongoing operations. Property and equipment is the only balance sheet measure used by our chief operating decision maker in allocating resources. See the table below for a reconciliation of net income to restaurant-level EBITDA.
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(13) Earnings Per Share
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Basic earnings per share (EPS) data is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS data is computed based on the weighted average number of shares of common stock outstanding, including all potentially issuable shares of common stock. Diluted earnings per share for fiscal 2016, 2015, and 2014 exclude stock options of 632,565, 728,604 and 716,335, respectively, which were outstanding during the period, but were anti-dilutive. Diluted earnings per share for fiscal 2016 exclude restricted stock shares of 106,726, which were outstanding during the period, but were anti-dilutive.
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(14) Stock-Based Employee Compensation
2012 Long-Term Equity Incentive Plan
In connection with the IPO, we adopted the 2012 Plan, which allows our Board of Directors or a committee thereof to grant stock options, restricted stock, restricted stock units, deferred stock units and other equity-based awards to directors, officers, key employees and other key individuals performing services for us. The 2012 Plan provides for granting of options to purchase shares of common stock at an exercise price not less than the fair value of the stock on the date of grant. Outstanding stock options vest at various periods ranging from one to four years from date of grant. Outstanding shares of restricted stock vest over periods ranging from one to four years. The 2012 Plan has 2,232,800 shares authorized for issuance under the plan. There are 927,675 shares of
			
		
common stock issuable upon exercise of currently outstanding options, 145,519 outstanding shares of restricted stock, and 200,000 outstanding performance stock units at December 27, 2016. There are 519,080 shares available for future grants.
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The following table details our total stock based compensation costs during the fiscal years ended December 27, 2016, December 29, 2015 and December 30, 2014, as well as where the costs were expensed:
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The following table summarizes restricted stock activity during fiscal 2016:
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As of December 27, 2016, there was $1.7 million of total unrecognized compensation cost related to non-vested restricted stock. This cost is expected to be recognized over a period of approximately 2.7 years.
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The following table summarizes stock option activity during fiscal 2016:
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The intrinsic value of options exercised during fiscal 2016 was $1.1 million. A summary of the status of non-vested stock options as of December 27, 2016 and changes during fiscal 2016 is presented below:
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As of December 27, 2016, there was $0.7 million of total unrecognized compensation cost related to non-vested stock options. This cost is expected to be recognized over a period of approximately 0.7 years. The total fair value of stock options vested during fiscal 2016 was $2.1 million.
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We issue performance share units, or PSUs, to certain employees that represent shares potentially issuable in the future. During fiscal 2016, we granted 200,000 PSUs to our CEO. The issuance of these shares is based upon our stock price reaching $28.00 per share for five consecutive days and is subject to post vesting holding periods. The fair value of performance share units was calculated using a Monte Carlo simulation model, which requires the use of highly subjective and complex assumptions, including the expected life of the award, the price volatility of the underlying stock and a blended illiquidity discount of 16.9%. The following table summarizes performance stock unit activity during fiscal 2016:
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The expense recognized each period is dependent on our estimate of the number of shares that will ultimately be issued. As of December 27, 2016 there was $1.7 million of total unrecognized compensation cost related to non-vested performance stock units. This cost is expected to be recognized over a period of approximately 2.1 years.
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The following table details the values from and assumptions for the Monte Carlo PSU pricing model for PSUs granted during the fiscal 2016.
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(15) Quarterly Financial Information (Unaudited)
The following tables set forth certain unaudited consolidated financial information for each of the four quarters in fiscal 2016 and fiscal 2015.
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During the fourth fiscal quarter of 2016, we incurred $0.6 in million impairment charges related to two Sullivan’s locations, $0.9 million in lease termination costs associated with one Sullivan’s location and $0.8 million in reorganization severance costs. In the third fiscal quarter of 2016, we incurred $0.4 million in expenses to settle an easement claim related to the sale of the previous Dallas, Texas Del Frisco’s location.
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During the third fiscal quarter of 2015, we incurred a $3.2 million impairment charge related to one Grille location. During the fourth fiscal quarter of 2015, we incurred a $1.4 million charge related to the lease termination and closing costs associated with the closure of two Grille locations.
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In management’s opinion, the unaudited quarterly information shown above has been prepared on the same basis as the audited consolidated financial statements and includes all necessary adjustments that management considers necessary for a fair presentation of the unaudited quarterly results when read in conjunction with the consolidated financial statements and the accompanying notes. We believe that quarter-to-quarter comparisons of our financial results are not necessarily indicative of future performance.
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