Sonnet BioTherapeutics Holdings, Inc. - Quarter Report: 2018 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended: September 30, 2018

Commission File Number: 001-35570

CHANTICLEER HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

7621 Little Avenue, Suite 414, Charlotte, NC 28226

(Address of principal executive offices) (zip code)

(704) 366-5122

(Registrant’s telephone number, including area code)

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

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

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

Large accelerated filer [  ] Accelerated filer [  ]

Non-accelerated filer [X] Smaller reporting company [X]

 Emerging growth company [  ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

The number of shares outstanding of registrant’s common stock, par value $.0001 per share, as of November 9, 2018 was 3,715,404 shares.

Chanticleer Holdings, Inc. and Subsidiaries

INDEX

Part I: FINANCIAL INFORMATION

Item 1: FINANCIAL StatemenTS

Chanticleer Holdings, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

See accompanying notes to unaudited condensed consolidated financial statements.

Chanticleer Holdings, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Operations

See accompanying notes to unaudited condensed consolidated financial statements.

Chanticleer Holdings, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Comprehensive Loss

See accompanying notes to unaudited condensed consolidated financial statements.

Chanticleer Holdings, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows

See accompanying notes to unaudited condensed consolidated financial statements.

Chanticleer Holdings, Inc. and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows, continued

See accompanying notes to unaudited condensed consolidated financial statements.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. Nature of Business

Organization

Chanticleer Holdings, Inc. and its subsidiaries (together, the “Company”) are in the business of owning, operating and franchising fast casual dining concepts domestically and internationally.

The consolidated financial statements include the accounts of Chanticleer Holdings, Inc. and its subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.

GENERAL

The accompanying condensed consolidated financial statements included in this report have been prepared by the Company pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for interim reporting and include all adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation. These condensed consolidated financial statements have not been audited. The results of operations for the nine-month periods ended September 30, 2018 are not necessarily indicative of the operating results for the full year.

Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles of the United States (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations for interim reporting. The Company believes that the disclosures contained herein are adequate to make the information presented not misleading. However, these financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 filed with the SEC on March 30, 2018. Certain amounts for the prior year have been reclassified to conform to the current year presentation.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2018, our cash balance was $1.1 million, our working capital was negative $14.3 million and we have significant near-term commitments and contractual obligations. The level of additional cash needed to fund operations and our ability to conduct business for the next twelve months will be influenced primarily by the following factors:

We have typically funded our operating costs, acquisition activities, working capital requirements and capital expenditures with proceeds from the issuances of our common stock and other financing arrangements, including convertible debt, lines of credit, notes payable, capital leases, and other forms of external financing.

Our operating plans for the next twelve months contemplate opening seven to ten additional company owned stores as well as growing our franchising businesses at Little Big Burger and BGR. We have contractual commitments related to current store construction of approximately $0.7 million, of which we expect approximately $0.2 million to be funded by private investors and approximately $0.5 million will be funded internally by the Company. We also have $9.3 million of debt obligations due on demand or within the next 3 months plus interest. In addition, if our lenders were to assess default interest and penalties, our obligations could be accelerated and additional interest and penalties of approximately $1.3 million could potentially be assessed. We expect to be able to extend or refinance our current debt obligations and are also exploring the sale of certain assets to reduce debt. In May 2018, the Company completed the sale of 403,214 shares of common stock at a price of $3.50 per common share for proceeds of $1.4 million. In January 2018, the Company received net proceeds of $290,000 from the exercise of 100,000 common stock warrants. During the first nine months of 2018, the Company also received $0.8 million in contributions from non-controlling interests for new store construction. However, we cannot provide assurance that we will be able to refinance our long-term debt, sell assets or raise additional capital.

As we execute our growth plans over the next 12 months, we intend to carefully monitor the impact of growth on our working capital needs and cash balances relative to the availability of cost-effective debt and equity financing. In the event that capital is not available or we are unable to refinance our debt obligations or obtain waivers, we may then have to scale back or freeze our organic growth plans, sell assets on less than favorable terms, reduce expenses, and/or curtail future acquisition plans to manage our liquidity and capital resources. We may also incur financial penalties or other negative actions from our lenders if we are not able to refinance or otherwise extend or repay our current obligations or obtain waivers. These factors raise substantial doubt about our ability to continue as a going concern.

The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

2. SIGNIFICANT ACCOUNTING POLICIES

There have been no material changes to our significant accounting policies previously disclosed in the Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

USE OF ESTIMATES

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant estimates include the valuation of the investments in portfolio companies, deferred tax asset valuation allowances, valuing options and warrants using the Binomial Lattice and Black Scholes models, intangible asset valuations and useful lives, depreciation and uncollectible accounts and reserves. Actual results could differ from those estimates.

REVENUE RECOGNITION

The Company accounts for revenue in accordance with Accounting Standards Update (“ASU”) No. 2014-09 “Revenue from Contracts with Customers”.

Restaurant Net Sales and Food and Beverage Costs

The Company records revenue from restaurant sales at the time of sale, net of discounts, coupons, employee meals, and complimentary meals and gift cards. Sales tax, value added tax (“VAT”) and goods and services tax (“GST”) collected from customers and remitted to governmental authorities are presented on a net basis within revenue in our consolidated statements of operations and comprehensive loss. Restaurant cost of sales primarily includes the cost of food, beverages, and merchandise and disposable paper and plastic goods used in preparing and selling our menu items, and exclude depreciation and amortization. Vendor allowances received in connection with the purchase of a vendor’s products are recognized as a reduction of the related food and beverage costs as earned.

Management Fee Income

The Company receives revenue from management fees from certain non-affiliated companies, including from managing its investment in Hooters of America which are generally earned and recognized upon receipt.

Gaming Income

The Company receives revenue from operating a gaming facility adjacent to its Hooters restaurant in Jantzen Beach, Oregon. Revenue from gaming is recognized as earned from gaming activities, net of payouts to customers, taxes and government fees. These fees are recognized as they are earned based on the terms of the agreements.

Franchise Income

The Company grants franchises to operators in exchange for initial franchise license fees and continuing royalty payments. The license granted for each restaurant or area is considered a performance obligation. All other obligations (such as providing assistance during the opening of a restaurant) are combined with the license and were determined to be a single performance obligation. Accordingly, the total transaction price (comprised of the restaurant opening and territory fees) is allocated to each restaurant expected to be opened by the licensee under the contract. There are significant judgments regarding the estimated total transaction price, including the number of stores expected to be opened. We recognize the fee allocated to each restaurant as revenue on a straight-line basis over the restaurant’s license term, which generally begins upon the signing of the contract for area development agreements and upon the signing of a store lease for franchise agreements. The payments for these upfront fees are generally received upon contract execution. Continuing fees, which are based upon a percentage of franchisee revenues and are not subject to any constraints, are recognized on the accrual basis as those sales occur. The payments for these continuing fees are generally made on a weekly basis.

Revenue recognized for the three and nine-month periods ended September 30, 2018 under ASC-606 and revenue that would have been recognized had ASC-605 been applied is as follows:

Prior to the adoption of ASC-606, the Company’s initial fees were recorded as deferred revenue when received and proportionate amounts were recognized as revenue when certain milestones such as completion of employee training, lease signing and store opening were met with the adoption of ASC 606, such initial fees are deferred and recognized over the franchise license term.

LOSS PER COMMON SHARE

The Company is required to report both basic earnings per share, which is based on the weighted-average number of shares outstanding, and diluted earnings per share, which is based on the weighted-average number of common shares outstanding plus all potentially diluted shares outstanding. The following table summarizes the number of common shares potentially issuable upon the exercise of certain warrants and convertible notes payable as of September 30, 2018 and 2017 that have been excluded from the calculation of diluted net loss per common share since the effect would be antidilutive.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09 “Revenue from Contracts with Customers”. The FASB has also issued additional related standards (ASU’s 2015-14, 2016-08, 2016-10, 2016-12, 2016-20) all of which superseded the existing revenue recognition guidance and provides a new framework for recognizing revenue. The core principle of the new standard is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. The new standard also requires significantly more comprehensive disclosures than the existing standard. Guidance subsequent to ASU 2014-09 has been issued to clarify various provisions in the standard, including principal versus agent considerations, identifying performance obligations, licensing transactions, as well as various technical corrections and improvements. This standard may be adopted using either a retrospective or modified retrospective method. Early adoption is permitted.

The Company adopted the new revenue standard effective January 1, 2018 utilizing the modified retrospective approach. The adoption did not have a significant effect on restaurant sales, gaming income or management fees or to sales-based royalty revenue.

However, the pattern and timing of revenue recognition related to the fixed fees associated with our franchise agreements (such as restaurant opening and development area fees) are significantly different from period prior to adoption. Effective for franchise agreements entered into after January 1, 2018, and for existing agreements with terms extending beyond January 1, 2018, the license granted for each restaurant is considered a performance obligation. All other promises (such as providing assistance during the opening of a restaurant) are combined with the license and considered as a single performance obligation. Accordingly, the total transaction price (comprised of the restaurant opening and territory fees) is allocated to each restaurant expected to be opened by the licensee under the contract. We recognize the fee allocated to each restaurant as revenue on a straight-line basis over the restaurant’s license term, which generally begins upon the signing of the license/franchise agreement for area development agreements and upon signing of a store lease for franchise agreements.

The adoption resulted in a decrease to retained earnings of approximately $1.1 million on the transition date with a corresponding increase of $1.1 million in deferred revenue. The Company recognized an additional $21 thousand and $62 thousand in franchise income for the three months and nine months ended September 30, 2018, respectively, as a result of the change in accounting policy.

In February 2016, the FASB issued ASU No. 2016-02 “Leases,” which supersedes ASC 840 “Leases” and creates a new topic, ASC 842 “Leases.” This update requires lessees to recognize a lease liability and a lease asset for all leases, including operating leases, with a term greater than 12 months on its balance sheet. The update also expands the required quantitative and qualitative disclosures surrounding leases. This update is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, with earlier adoption permitted. This update will be applied using a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements.

The Company is currently evaluating the impact this standard will have on its consolidated financial statements and are in process of accumulating and analyzing the leases to be recognized as right to use assets and liabilities on the Company’s consolidated balance sheet upon adoption. The Company has not completed its evaluation or quantified the impact that adoption of ASU 2016-02 will have on its consolidated financial statements. However, management does expect there to be a material increase in both assets and liabilities reflected on its consolidated balance sheets as a result of adoption on January 1, 2019 with the majority of leases currently classified as operating being reflected as right to use assets and capital lease obligations on the consolidated balance sheet under the new standard.

In January 2017, the FASB issued ASU No. 2017-04 “Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” The new guidance simplifies the test for goodwill impairment. Currently, the fair value of the reporting unit is compared with the carrying value of the reporting unit (identified as “Step 1”). If the fair value of the reporting unit is lower than its carrying amount then, the implied fair value of goodwill is calculated. If the implied fair value of goodwill is lower than the carrying value of goodwill an impairment is recognized (identified as “Step 2”). The new standard eliminates Step 2 from the impairment test; therefore, a goodwill impairment will be recognized as the difference of the fair value and the carrying value of the reporting unit. The new standard becomes effective on January 1, 2020 with early adoption permitted. The Company adopted ASU 2017-04 effective January 1, 2018 and it did not have any effect on the Company’s condensed consolidated financial statements.

In August 2018, the Securities and Exchange Commission (the “SEC”) adopted the final rule under SEC Release No. 33-10532, “Disclosure Update and Simplification,” amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders’ equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders’ equity presented in the balance sheet must be provided in a note or separate statement. The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed. The final rule is effective for all filings made on and after November 5, 2018. Given the effective date and proximity to most filers’ quarterly reports, the SEC is not objecting to filers deferring the presentation of changes in stockholders’ equity in their quarterly reports on Forms 10-Q until the quarter that begins after November 5, 2018. The Company anticipates its first presentation of changes in stockholders’ equity will be included in its quarterly report on Form 10-Q for the quarter ended March 31, 2019.

There are several other new accounting pronouncements issued by FASB, which are not yet effective. Each of these pronouncements has been or will be adopted, as required, by the Company. At September 30, 2018, other than the adoption of ASU No. 2016-02 “Leases,” none of these pronouncements are expected to have a material effect on the financial position, results of operations or cash flows of the Company.

3. ACQUISITIONS

On March 7, 2018, the Company entered into an agreement to purchase two BGR franchise locations in Maryland. The Company closed on the purchase of the Annapolis, MD location in the first quarter of 2018 and the results of that store are included in the accompanying condensed consolidated financial statements. The Company closed on the Colombia, MD location as of October 1, 2018, subsequent to the date of the accompanying condensed consolidated financial statements.

Total consideration consisted of $30,000 in cash paid and a seller note of $9,580 upon the closing of the first location (reflected in the accompanying condensed consolidated financial statements) and $20,000 in cash and a seller note of $186,767 upon closing of the second location in October (not reflected in the accompanying condensed consolidated financial statements as of September 30, 2018).

The Company allocates the purchase price as of the date of acquisition based on the estimated fair value of the acquired assets and assumed liabilities. The purchase accounting for the Annapolis location was considered preliminary as of September 30, 2018 and is expected to be finalized in the fourth quarter in connection with completion of the transaction to purchase the Colombia location. No proforma information was included as the proforma impact of the acquisition is not material to the condensed consolidated financial statements as of September 30, 2018.

4. ASSETS HELD FOR SALE

The Company entered into Letters of Intent for the sale of its Hooters Nottingham and Hooters Tacoma locations in the first quarter of 2018 and the assets of those operations were reclassified to Assets Held for Sale with impairment charges recognized totaling $1.7 million recognized in the first six months of 2018. The impairment charges primarily consisted of impairment of goodwill and reversal of approximately $720 thousand of foreign exchange losses previously classified in Other Comprehensive loss.

As of September 30, 2018, the letters of intent for Hooters Nottingham and Hooters Tacoma have expired. Management is continuing to explore potential to sell both locations, however there is not a specific program underway currently to locate a buyer or that would otherwise indicate that a disposal is imminent. Accordingly, as of September 30, 2018, management determined that it was appropriate to reclassify those locations from held for sale to operating assets. Management believes that the carrying amount of the assets, following the $1.7 million impairment charge recorded during the nine months ended September 30, 2018, continues to reflect the net realizable value of the properties and that no additional impairment adjustment is warranted at this time.

5. PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

Depreciation and amortization expense was $0.4 million and $1.2 million for the three and nine months ended September 30, 2018 and $0.6 million and $1.6 million for the three and nine months ended September 30, 2017, respectively.

6. GOODWILL AND OTHER INTANGIBLE ASSETS, NET

Goodwill consists of the following:

Other intangible assets, consisting of franchise costs, trademarks and tradenames, is summarized by location as follows:

Amortization expense was $0.4 million and $0.2 million for the nine months ended September 30, 2018 and 2017, respectively.

7. LONG-TERM DEBT AND NOTES PAYABLE

Long-term debt and notes payable are summarized as follows:

For the nine months ended September 30, 2018 and 2017 amortization of debt discount was $0.9 million and $0.5 million respectively.

a) On May 4, 2017, pursuant to a Securities Purchase Agreement, the Company issued 8% non-convertible secured debentures in the principal amount of $6,000,000 and warrants to purchase 1,200,000 shares of common stock (as adjusted for the Company’s subsequent one-for-ten reverse stock split) to accredited investors. The debentures bear interest at a rate of 8% per annum, payable in cash quarterly in arrears. The debentures mature on December 31, 2018 and contain customary financial and other covenants, including a requirement to maintain positive annual earnings before interest, taxes, depreciation and amortization. The debentures are secured by a second priority security interest on the Company’s assets and the obligation is guaranteed by the Company’s subsidiaries. The debentures contain a mandatory redemption provision that is triggered by an asset sale. Sale of greater than 33% of the Company’s assets will also trigger an event of default. Upon any event of default, in addition to other customary remedies, the holders have the right, at their sole option, to purchase Little Big Burger from the Company, for an aggregate purchase price of $6,500,000, or demand repayment at 108% of the outstanding principal balance and any outstanding accrued interest. The warrants have an exercise price of $3.50 (as adjusted for the reverse stock split on May 19, 2017) and a ten-year term. Warrants to purchase 800,000 shares include a beneficial ownership limit upon exercise of 4.99% of the number of shares of the common stock outstanding immediately after giving effect to the issuance of shares of common stock issuable upon exercise of the warrant; warrants to purchase the remaining 400,000 shares were amended to increase the beneficial ownership limit upon exercise to 19.99%.

The $6 million debentures are due and payable on December 31, 2018. The Company is in discussions with its lenders regarding the terms of an extension or new debenture to replace the expiring debenture. Those discussions are continuing and are expected to be final by the end of the year. Management cannot provide any assurance that it will be successful in negotiating an extension or a new loan or provide any assurance as to the terms and conditions of any new or extended debentures.

b) The Company has two term loans with Paragon Bank (previously three loans, one of which was paid in full in September 2018), all of which are collateralized by all assets of the Company and personally guaranteed by our Chief Executive Officer. The outstanding balance, interest rate and contractual maturity date of each loan is as follows:

c) The Company has a promissory note payable on demand in the amount of $75,000 with 800 shares of restricted Company common stock to be paid to the lender each month while the note is outstanding.

d) During February 2017, in consideration for proceeds of $330,000, the Company agreed to make payments of $1,965 per day for 210 days. As of October 2017, the daily payment amount was modified to $1,200 per day and the term was extended to February 2018, with total remittance over the life of the loan unchanged. Also, during March 2017 in consideration for proceeds of $150,000, the Company agreed to make payments of $856 per day for 240 days. The Company granted a security interest in the credit card receivables of the specified restaurants in connection with the Receivables Financing Agreements

As of September 30, 2018, the Company has $49 thousand outstanding under these facilities.

The Company’s various loan agreements contain financial and non-financial covenants and provisions providing for cross-default. The evaluation of compliance with these provisions is subject to interpretation and the exercise of judgment.

While the Company has not been notified by its lenders of any specific asserted defaults, management concluded that conditions exist that represent events of technical default under one or more of its note or convertible note obligations. The existence of a technical default in one loan agreement would also trigger cross default provisions applicable to other loan agreements. Management quantified the potential penalties and default interest that could be assessed in the event the loans were deemed by its lenders to be in default. Accordingly, the Company recorded a liability for potential default interest and penalties of $1.3 million as accrued interest in the accompanying consolidated financial statements of September 30, 2018.

8. cONVERTIBLE NOTEs PAYABLE

Convertible notes payable are summarized as follows:

(a) On August 2, 2013, the Company entered into an agreement with seven individual accredited investors, whereby the Company issued separate 6% Secured Subordinate Convertible Notes for a total of $3,000,000 in a private offering and is collateralized by the assets of the Hooters Nottingham restaurant and a subordinate position to all other assets of the Company.

In connection with the Company’s agreement to conduct a capital raise in 2016, the lenders agreed to waive certain existing defaults and extended the original note maturity by eighteen months from December 31, 2016 to June 30, 2018. The Note holders were to receive 10%, pro rata, of the net profit of the Nottingham, England Hooters restaurant, paid quarterly, and 10% of the net proceeds should the location be sold.

The Company entered into a letter of intent for the sale of the Hooters Nottingham facility from which the Company planned to settle a portion of the convertible note. However, the letter of intent has expired. Management is evaluating other alternatives to market the property for sale. (See Note 4 - Assets Held for sale).

Principal and interest under the convertible notes are payable on demand following the maturity on June 30, 2018 are classified as current liabilities on the accompanying condensed consolidated balance sheets.

As of November 13, 2018, the lenders have not demanded payment of principal or unpaid interest, asserted defaults or indicated any imminent action for collection. Management is in discussions with the lenders and intends to enter into an extension or new agreement, but cannot provide assurance that it will be successful in negotiating an extension or new loan or the terms of any new or extended debt.

(b) On February 22, 2018, $200,000 of the Company’s convertible debt was converted into 66,667 shares of Company common stock in accordance with the terms of the convertible debt agreements.

9. accounts payable and accrued expenses

Accounts payable and accrued expenses are summarized as follows:

To date, approximately $1.6 million of employee and employer taxes have been accrued but not remitted to certain taxing authorities by the Company for cash compensation paid. As a result, the Company is liable for such payroll taxes and any related penalties and interest.

10. Stockholders’ Equity

The Company has 45,000,000 shares of its $0.0001 par value common stock authorized at both September 30, 2018 and December 31, 2017. The Company had 3,706,563 and 3,045,809 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively.

The Company has 5,000,000 shares of its no par value preferred stock authorized at both September 30, 2018 and December 31, 2017. The Company had 62,876 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively. Holders of the preferred shares are entitled to receive cumulative dividends out of legally available funds at the rate of 9% per year for a term of seven years, payable quarterly on the last day of March, June, September and December in each year in cash or registered common stock at the election of the Company. Shares of common stock issued as dividends are issued at a 10% discount to the five-day volume weighted average price per share of common stock prior to payable date. The preferred shares are non-voting, have a liquidation preference of $13.50 per share and contain a required redemption at $13.50 plus any accrued but unpaid dividends upon maturity in 2023.

Options and Warrants

The Company’s shareholders have approved the Chanticleer Holdings, Inc. 2014 Stock Incentive Plan (the “2014 Plan”), authorizing the issuance of options, stock appreciation rights, restricted stock awards and units, performance shares and units, phantom stock and other stock-based and dividend equivalent awards. Pursuant to the approved 2014 Plan, 400,000 shares have been approved for grant.

As of September 30, 2018, the Company had issued 91,029 restricted and unrestricted shares on a cumulative basis under the plan pursuant to compensatory arrangements with employees, board members and outside consultants. No employee stock options have been issued or are outstanding. The Company issued 15,000 restricted stock units to employees in 2016 and none since that date. Approximately 293,971 shares remain available for grant under the plan.

The Company also has issued warrants to investors in connection with financing transactions. Fair value of any warrant issuances is valued utilizing the Black-Scholes model. The model includes subjective input assumptions that can materially affect the fair value estimates. The expected stock price volatility for the Company’s warrants was determined by the average of the historical volatilities for the Company’s common stock.

A summary of the warrant activity is presented below:

The Company accepted subscriptions to purchase 403,214 shares of common stock at a purchase price of $3.50 per Share, for a total gross purchase price of approximately $1,411,249 pursuant to a Securities Purchase Agreement dated May 3, 2018 with institutional and accredited investors in a registered direct offering.

The offering was made pursuant to a prospectus supplement filed with the Securities and Exchange Commission on March 8, 2018 and an accompanying prospectus dated October 16, 2017, pursuant to the Company’s shelf registration statement on Form S-3 that was filed with the Securities and Exchange Commission on April 27, 2015, amended on June 3, 2015 and became effective on June 9, 2015.

The Company also agreed to issue unregistered 5 ½ year warrants to purchase up to 403,214 shares of common stock to the investors in a concurrent private placement at an exercise price of $4.50 per share. The Company has agreed to register the resale of the common shares underlying the warrants, which has been completed. The warrants are exercisable for cash in full commencing six months after the issuance date. The warrants qualified for equity accounting.

Larry Spitcaufsky, a director of the Company and greater than 5% shareholder, subscribed for 70,000 Shares and received an equal number of Warrants in the transaction. Michael D. Pruitt, the company’s chairman and Chief Executive Officer also participated in the offering.

On October 1, 2018, the maturity dates for warrants covering 201,974 shares of common stock with strike prices ranging from $55.00 to $70.00 per share were extended from October 1, 2018 to October 1, 2020.

Oak Ridge Financial Services Group, Inc., a registered broker-dealer acted as placement agent for the offering and received, as compensation, 7% of gross proceeds of the amounts subscribed by institutional investors introduced by Oak Ridge, for an aggregate commission of $36,767 and legal expenses in an amount less than $2,500.

11. RELATED PARTY TRANSACTIONS

Due to related parties

The Company has received non-interest bearing, short-term advances from Chanticleer Investors, LLC, a related party, in the amount of $191,226 and $191,580 as of September 30, 2018 and December 31, 2017, respectively. The amount owed to Chanticleer Investors LLC is related to cash distributions received from Chanticleer Investors LLC’s interest in Hooters of America which is payable to the Company’s co-investors in that investment.

Transactions with Board Members

Larry Spitcaufsky, a significant shareholder and member of the Company’s board of directors, is also a lender to the Company for $2 million of the Company’s $6 million in notes payable due December 31, 2018. In connection with this note, the Company made payments of interest to the board member and related entities as required under the notes for the three and nine months ended September 30, 2018 of $40,000 and $120,000, respectively, and $0 during the same periods of 2017.

The Company has also entered into a franchise agreement with entities controlled by Mr. Spitcaufsky providing him with the franchise rights for Little Big Burger in the San Diego area and an option for additional franchise rights in southern California. The Company received royalties of $2,762 and $6,486 during the three and nine months ended September 30, 2018, respectively, and $0 in the same periods of 2017. The Company also received franchise fees of $0 during the three and nine months ended September 30, 2018 and $60,000 for the three and nine month periods of 2017.

12. SEGMENT INFORMATION

The Company is in the business of operating restaurants and its operations are organized by geographic region and by brand within each region. Further, each restaurant location produces monthly financial statements at the individual store level. The Company’s chief operating decision maker reviews revenues and profitability at the group level comprised of: Full Service Hooters, Better Burger Fast Casual, Just Fresh Fast Casual, and Corporate.

The following are revenues and operating income (loss) from continuing operations by segment as of and for the periods presented. The Company does not aggregate or review non-current assets at the segment level.

(1) Note that Operating Income (Loss) includes non-cash impairment charges of $1.7 million and $1.5 for the nine months ended September 30, 2018 and 2017, respectively and $0 and $0.8 million for the three months ended September 30, 2018 and 2017, respectively.

The following are revenues and operating income (loss) from continuing operations and non-current assets by geographic region as of and for the periods presented.

(1) Note that Operating Income (Loss) includes non-cash impairment charges of $1.7 million and $1.5 for the nine months ended September 30, 2018 and 2017, respectively and $0 and $0.8 million for the three months ended September 30, 2018 and 2017, respectively.

13. COMMITMENTS AND CONTINGENCIES

On March 26, 2013, our South African operations received Notice of Motion filed in the Kwazulu-Natal High Court, Durban, Republic of South Africa, filed against Rolalor (PTY) LTD (“Rolalor”) and Labyrinth Trading 18 (PTY) LTD (“Labyrinth”) by Jennifer Catherine Mary Shaw (“Shaw”). Rolalor and Labyrinth were the original entities formed to operate the Johannesburg and Durban locations, respectively. On September 9, 2011, the assets and the then-disclosed liabilities of these entities were transferred to Tundraspex (PTY) LTD (“Tundraspex”) and Dimaflo (PTY) LTD (“Dimaflo”), respectively. The current entities, Tundraspex and Dimaflo are not parties in the lawsuit. Shaw is requesting that the Respondents, Rolalor and Labyrinth, be wound up in satisfaction of an alleged debt owed in the total amount of R4,082,636 (approximately $480,000). The two Notices were defended and argued in the High Court of South Africa (Durban) on January 31, 2014. Madam Justice Steryi dismissed the action with costs on May 5, 2014. Ms. Shaw appealed this decision and in December 2016, the Court dismissed the Labyrinth case with costs payable to the Company, and allowed the Rolalor case to proceed to liquidation. The Company did not object to the proposed liquidation of Rolalor as the entity has no assets and the Company does not expect there to be any material impact on the Company. No amounts have been accrued as of September 30, 2018 or December 31, 2017 in the accompanying condensed consolidated balance sheets.

From time to time, the Company may be involved in legal proceedings and claims that have arisen in the ordinary course of business. These actions, when ultimately concluded and settled, will not, in the opinion of management, have a material adverse effect upon the financial position, results of operations or cash flows of the company.

The Company has contractual commitments related to store construction of approximately $0.7 million, of which we expect approximately $0.2 million to be funded by private investors and approximately $0.5 million will be funded internally by the Company.

ITEM 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. These statements include projections, predictions, expectations or statements as to beliefs or future events or results or refer to other matters that are not historical facts. Forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from those contemplated by these statements. The forward-looking statements contained in this Annual Report are based on various factors and were derived using numerous assumptions. In some cases, you can identify these forward-looking statements by the words “anticipate”, “estimate”, “plan”, “project”, “continuing”, “ongoing”, “target”, “aim”, “expect”, “believe”, “intend”, “may”, “will”, “should”, “could”, or the negative of those words and other comparable words. You should be aware that those statements reflect only the Company’s predictions. If known or unknown risks or uncertainties should materialize, or if underlying assumptions should prove inaccurate, actual results could differ materially from past results and those anticipated, estimated or projected. You should bear this in mind when reading this Annual Report and not place undue reliance on these forward-looking statements. Factors that might cause such differences include, but are not limited to:

You should also consider carefully the Risk Factors contained in Part II, Item 1A of this Quarterly Report and Item 1A of Part I of our Annual Report filed on Form 10-K for the year ended December 31, 2017, which address additional factors that could cause actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect the Company’s business, operating results and financial condition. The risks discussed in this Quarterly Report and the Annual Report are factors that, individually or in the aggregate, the Company believes could cause its actual results to differ materially from expected and historical results. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider such disclosures to be a complete discussion of all potential risks or uncertainties.

The forward-looking statements are based on information available to the Company as of the date hereof, and, except to the extent required by federal securities laws, the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, the Company cannot assess the impact of each factor on its business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

Management’s Analysis of Business

We are in the business of owning, operating and franchising fast casual and full service dining concepts in the United States and internationally. As of September 30, 2018, our system-wide store count totaled 59 locations, consisting of 43 company-owned locations and 16 franchisee-operated locations as summarized below:

We own, operate and franchise a system-wide total of 46 fast casual restaurants specializing the “Better Burger” category of which 30 are company-owned and 16 are operated by franchisees under franchise agreements. American Burger Company (“ABC”) is a fast-casual dining chain consisting of 7 locations in New York and the Carolinas, known for its diverse menu featuring, customized burgers, milk shakes, sandwiches, fresh salads and beer and wine. BGR: The Burger Joint (“BGR”), consists of 10 company-owned locations in the United States and 13 franchisee-operated locations in the United States and the Middle East. Little Big Burger (“LBB”) consists of 16 locations in Oregon, California and North Carolina, of which 13 are company-owned and 3 are operated by franchisees.

We also own and operate Just Fresh, our healthier eating fast casual concept with 5 company owned locations in Charlotte, North Carolina. Just Fresh offers fresh-squeezed juices, gourmet coffee, fresh-baked goods and premium-quality, made-to-order sandwiches, salads and soups.

We own and operate 8 Hooters full service restaurants in the United States, South Africa, and the United Kingdom. Hooters restaurants are casual beach-themed establishments featuring music, sports on large flat screens, and a menu that includes seafood, sandwiches, burgers, salads, and of course, Hooters original chicken wings and the “nearly world famous” Hooters Girls.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2018 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2017

Our results of operations are summarized below:

* Restaurant cost of sales, operating expenses and pre-opening and closing expense percentages are based on restaurant sales, net.

Other percentages are based on total revenue.

Revenue

Total revenue from continuing operations decreased 5.8% to $10.1 million for the three months ended September 30, 2018 from $10.7 million for the three months ended September 30, 2017.

Revenues by concept and revenue type are further summarized below:

Restaurant revenues from continuing operations decreased 6.0% to $9.8 million for the three months ended September 30, 2018 from $10.5 million for the three months ended September 30, 2017.

Gaming revenue from the Company’s US Hooters locations was relatively unchanged, decreasing 3.4% to $111 thousand from $115 thousand for the period.

Management fee revenue was unchanged at $25 thousand for each period. The Company earns management fees for its CEO serving on the Board of Directors of Hooters of America.

Franchise revenue was increased 7.5% to $114 thousand for the three months ended September 30, 2018 from $106 thousand for the three months ended September 30, 2017. Franchise revenue was favorably impacted by change in revenue recognition under the new accounting guidance adopted on January 1, 2018 which increased quarterly franchise revenue by $21 thousand. The prior year period also included upfront franchise fee revenue which would now be recognized over the life of the franchise agreement under the new accounting guidance if the fee had been received in the current period.

Cost of restaurant sales

Cost of restaurant sales decreased 9.6% to $3.3 million for the three months ended September 30, 2018 from $3.6 million for the three months ended September 30, 2017.

Cost of restaurant sales improved to 33.1% of net restaurant revenues for the three months ended September 30, 2018 from 34.4% for the three months ended September 30, 2017. Cost of sales improved from 34.0% to 31.8% for the Better Burger business and from 35.1% to 34.8% at our Hooters locations, while cost of sales increased from 34.2% to 34.7% at Just Fresh. Cost of sales in the Burger business improved largely due to favorable movements in beef prices, combined with expansion of our Little big Burger brand which runs lower costs than BGR and American Burger. Cost of sales in the Better Burger business improved largely due to favorable movements in beef prices, combined with expansion of our Little Big Burger brand which runs lower costs than BGR and American Burger. Costs at our Hooters business improved in our US locations and in South Africa, while costs increased in our UK location as food and alcohol costs increased. The Company is planning menu pricing and procedural changes in the UK in late 2018 to offset the cost increases in the local market.

Restaurant operating expenses

Restaurant operating expenses decreased 5.5% to $5.8 million for the three months ended September 30, 2018 from $6.1 million for the three months ended September 30, 2017.

Our restaurant operating expenses as a percentage of restaurant sales for each region of operations are included in the following table:

As a percent of restaurant revenues, operating expenses increased to 58.7% for the three months ended September 30, 2018 from 58.4% for the three months ended September 30, 2017. Operating expenses benefitted from the closure of underperforming locations in prior periods where rent and occupancy costs were higher than our target levels. Those improvements were offset by increases in personnel costs primarily associated with higher minimum wage rates and increased service charges from third party delivery services.

Restaurant pre-opening and closing expenses

Restaurant pre-opening and closing expenses increased to $113 thousand for the three months ended September 30, 2018 from $34 thousand for the three months ended September 30, 2017. We have more new stores under lease and incurring pre-opening rent and other costs in the current year.

General and Administrative Expense (“G&A”)

G&A was increased 14.6% to $1.1 million for the three months ended September 30, 2018 from $1.0 million for the three months ended September 30, 2017.

Significant components of G&A are summarized as follows:

As a percentage of total revenue, G&A increased to 10.8% for the three months ended September 30, 2018 from 8.9% for the three months ended September 30, 2017.

For the current year, approximately $0.6 million of G&A is attributable to the cost of operating our Corporate office including salaries, travel, audit, legal, professional fees and other public company and transaction related costs. Approximately $0.5 million is attributable to managing the operations of our restaurants, including regional management, franchising operations, marketing, advertising and other expenses within the Better Burger group, Hooters and Just Fresh.

Asset impairment charges

The Company did not incur any asset impairment charges for the three months ended September 30, 2018 as compared with $0.8 million during the three months ended September 30, 2017.

Depreciation and amortization

Depreciation and amortization expense was essentially unchanged at $0.5 million for the three months ended September 30, 2018 and $0.6 million for the three months ended September 30, 2017. Increased depreciation from new stores and increased amortization of franchise right intangibles were more than offset by reduced deprecation from locations that have been closed with related assets written off in the current and prior years.

OTHER INCOME (EXPENSE)

Other income (expense) consisted of the following:

Other expense increased to $0.9 million for the three months ended September 30, 2018 from $0.4 million for the three months ended September 30, 2017. The change in other expenses, net was primarily due to increased accrued penalty interest accrued penalties and interest on payroll taxes combined with an unrealized loss recognized on investments recognized in the current period.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2018 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2017

Our results of operations are summarized below: