##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
 For the quarterly period ended March 31, 2006
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
 Commission File Number 000-51491
 
 Kona Grill, Inc.
 (Exact Name of Registrant as Specified in Its Charter)
 Delaware
    
    20-0216690(State of Incorporation)
    
    (I.R.S. Employer Identification No.)
 7150 East Camelback Road, Suite 220
Scottsdale, Arizona 85251
(480) 922-8100  (Address, including zip code, and telephone number, including area code, of principal executive offices)
 þ o
  Large accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer þ
 o þ




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##### 



TABLE OF CONTENTS
 PART IFINANCIAL INFORMATIONPageItem 1.
    
    Unaudited Consolidated Financial StatementsConsolidated Balance Sheets as of March 31, 2006 and December 31, 2005
    
    
    2Consolidated Statements of Operations for the Three Months Ended March 31, 2006 and 2005
    
    
    3Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and 2005
    
    
    4Notes to Consolidated Financial Statements
    
    
    5Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    19Item 4.
    
    Controls and Procedures
    
    
    19PART IIOTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    20Item 1A.
    
    Risk Factors
    
    
    20Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    20Item 3.
    
    Defaults Upon Senior Securities
    
    
    20Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    20Item 5.
    
    Other Information
    
    
    20Item 6.
    
    Exhibits
    
    
    20Exhibit 10.15Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  1




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Unaudited Consolidated Financial Statements
 KONA GRILL, INC.
 
 CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 PART I
 March 31,
    
    
    December 31,2006
    
    
    2005(Unaudited)
    
    (Note 1)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    1,646
    
    
    $
    4,466Investments
    
    
    24,173
    
    
    
    24,200Receivables
    
    
    488
    
    
    
    97Inventories
    
    
    398
    
    
    
    403Prepaids and other
    
    
    360
    
    
    
    161Total current assets
    
    
    27,065
    
    
    
    29,327Other assets
    
    
    384
    
    
    
    387Notes receivable
    
    
    73
    
    
    
    87Property and equipment, net
    
    
    26,657
    
    
    
    22,617Total assets
    
    $
    54,179
    
    
    $
    52,418LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    3,735
    
    
    $
    1,599Accrued expenses
    
    
    2,654
    
    
    
    2,327Current portion of equipment notes
    
    
    692
    
    
    
    729Total current liabilities
    
    
    7,081
    
    
    
    4,655Equipment notes
    
    
    3,164
    
    
    
    3,313Deferred rent
    
    
    7,320
    
    
    
    7,139Total liabilities
    
    
    17,565
    
    
    
    15,107Commitments and contingenciesStockholders equity:Preferred stock, $0.01 par value, 20,000,000 shares authorized, none issued
    
    
    
    
    
    
    Common stock, $0.01 par value, 40,000,000 shares authorized, 5,793,119
and 5,706,420 shares issued and outstanding at March 31, 2006 and December
31, 2005, respectively
    
    
    58
    
    
    
    57Additional paid-in capital
    
    
    40,672
    
    
    
    40,467Accumulated deficit
    
    
    (4,101
    )
    
    
    (3,213
    )Accumulated other comprehensive loss
    
    
    (15
    )
    
    
    Total stockholders equity
    
    
    36,614
    
    
    
    37,311Total liabilities and stockholders equity
    
    $
    54,179
    
    
    $
    52,418
  2




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KONA GRILL, INC.
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
 Three Months Ended March 31,2006
    
    
    2005(Unaudited)Restaurant sales
    
    $
    10,194
    
    
    $
    8,011Costs and expenses:Cost of sales
    
    
    2,895
    
    
    
    2,335Labor
    
    
    3,153
    
    
    
    2,509Occupancy
    
    
    706
    
    
    
    582Restaurant operating expenses
    
    
    1,446
    
    
    
    975General and administrative
    
    
    2,014
    
    
    
    1,214Preopening expense
    
    
    291
    
    
    
    7Depreciation and amortization
    
    
    730
    
    
    
    511Total costs and expenses
    
    
    11,235
    
    
    
    8,133Loss from operations
    
    
    (1,041
    )
    
    
    (122
    )Nonoperating income (expense):Interest income
    
    
    237
    
    
    
    2Interest expense
    
    
    (79
    )
    
    
    (184
    )Loss before provision for income taxes
    
    
    (883
    )
    
    
    (304
    )Provision for income taxes
    
    
    5
    
    
    
    Net loss
    
    $
    (888
    )
    
    $
    (304
    )Net loss per share:Basic
    
    $
    (0.16
    )
    
    $
    (0.21
    )Diluted
    
    $
    (0.16
    )
    
    $
    (0.21
    )Weighted average shares used in computation:Basic
    
    
    5,731
    
    
    
    1,463Diluted
    
    
    5,731
    
    
    
    1,463
  3




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KONA GRILL, INC.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 Three Months Ended March 31,2006
    
    
    2005(Unaudited)Operating activitiesNet loss
    
    $
    (888
    )
    
    $
    (304
    )Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:Depreciation and amortization
    
    
    730
    
    
    
    511Compensation expense for issuance of stock options and accelerated vesting of stock options
    
    
    191
    
    
    
    197Amortization of debt discount
    
    
    
    
    
    
    34Change in operating assets and liabilities:Receivables
    
    
    (391
    )
    
    
    545Inventories
    
    
    5
    
    
    
    25Prepaids and other current assets
    
    
    (199
    )
    
    
    33Accounts payable
    
    
    789
    
    
    
    (972
    )Accrued expenses
    
    
    326
    
    
    
    (80
    )Deferred rent
    
    
    181
    
    
    
    (90
    )Net cash provided by (used in) operating activities
    
    
    744
    
    
    
    (101
    )Investing activitiesPurchase of property and equipment
    
    
    (3,423
    )
    
    
    (1,430
    )Repayment of notes receivable
    
    
    14
    
    
    
    13Decrease (increase) in other assets
    
    
    3
    
    
    
    (7
    )Net proceeds on purchase and sale of short-term investments
    
    
    12
    
    
    
    Net cash used in investing activities
    
    
    (3,394
    )
    
    
    (1,424
    )Financing activitiesProceeds from issuance of notes payable
    
    
    
    
    
    
    525Repayments of notes payable
    
    
    (186
    )
    
    
    (132
    )Proceeds from issuance of common stock
    
    
    16
    
    
    
    Net cash (used in) provided by financing activities
    
    
    (170
    )
    
    
    393Net decrease in cash and cash equivalents
    
    
    (2,820
    )
    
    
    (1,132
    )Cash and cash equivalents at the beginning of the period
    
    
    4,466
    
    
    
    3,098Cash and cash equivalents at the end of the period
    
    $
    1,646
    
    
    $
    1,966Supplemental disclosures of cash flow informationCash paid for interest
    
    $
    79
    
    
    $
    133Noncash investing activitiesIncrease (decrease) in accounts payable related to property and equipment additions
    
    $
    1,347
    
    
    $
    (945
    )
  4




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KONA GRILL, INC.
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 1. Basis of Presentation
    2. Summary of Significant Accounting Policies
 Cash
  Deferred Rent
  5




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KONA GRILL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 Accounting
for Rental Costs Incurred During a Construction Period
 Preopening Expenses
  Net Income (Loss) Per Share
 Earnings Per Share
 Three Months EndedMarch 31,2006
    
    
    2005(in thousands, except forper share data)Numerator:Net loss
    
    $
    (888
    )
    
    $
    (304
    )Denominator:Weighted average shares  basic
    
    
    5,731
    
    
    
    1,463Effect of dilutive securities:Stock options and warrants
    
    
    
    
    
    
    Weighted average shares  diluted
    
    
    5,731
    
    
    
    1,463Net loss per share:Basic
    
    $
    (0.16
    )
    
    $
    (0.21
    )Diluted
    
    $
    (0.16
    )
    
    $
    (0.21
    )
  6




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KONA GRILL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 Recently Adopted Accounting Pronouncements
 Share-Based
Payment Accounting for Stock-Based Compensation Accounting for Stock Issued to Employees
 Determining
the Amortization Period for Leasehold Improvements
 3. Investments
  GrossAdjusted
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Losses
    
    
    Fair ValueAuction rate municipal securities
    
    $
    18,650
    
    
    $
    
    
    
    $
    18,650Government bonds
    
    
    3,000
    
    
    
    (10
    )
    
    
    2,990Corporate securities
    
    
    2,538
    
    
    
    (5
    )
    
    
    2,533$
    24,188
    
    
    $
    (15
    )
    
    $
    24,173
  4. Accrued Expenses
  March 31,
    
    
    December 31,2006
    
    
    2005Accrued payroll
    
    $
    758
    
    
    $
    798Severance and related costs
    
    
    436
    
    
    
    Gift cards
    
    
    315
    
    
    
    395Sales tax
    
    
    298
    
    
    
    299Accrued rent
    
    
    88
    
    
    
    126Other
    
    
    759
    
    
    
    709$
    2,654
    
    
    $
    2,327
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KONA GRILL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 5. Stock-Based Compensation
  Accounting for Stock Issued to Employees Accounting for
Stock-Based Compensation.
  Three MonthsEnded March 31,2005Net loss, as reported
    
    $
    (304
    )Add: Stock-based compensation
expense included in reported
earnings, net of related tax
effect(a)
    
    
    151Deduct: Total stock-based
compensation expense determined
under fair value based method for
all awards, net of related tax
effects(a)
    
    
    (337
    )Pro forma net loss
    
    $
    (490
    )Net loss per share:Basic, as reported
    
    $
    (0.21
    )Basic, pro forma
    
    $
    (0.33
    )Diluted, as reported
    
    $
    (0.21
    )Diluted, pro forma
    
    $
    (0.33
    )
 
 (a)
    
    Income taxes have been offset by a
valuation allowance. See Note 7 of Notes to Consolidated
Financial Statements. Share-Based Payment,
 8




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KONA GRILL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
   Three Months EndedMarch 31, 2006Dividend yield
    
    
    0.0
    %Expected volatility
    
    
    46.4
    %Risk-free interest rate
    
    
    4.6
    %Expected life (in years)
    
    
    5
  WeightedWeighted
    
    
    AverageShares
    
    
    Average
    
    
    Remaining
    
    
    AggregateUnder
    
    
    Exercise
    
    
    Contractual
    
    
    IntrinsicOption
    
    
    Price
    
    
    Term
    
    
    ValueOutstanding options at December 31, 2005
    
    
    475,879
    
    
    $
    5.56Granted
    
    
    88,000
    
    
    
    8.35Forfeited
    
    
    (97,564
    )
    
    
    5.05Exercised
    
    
    (85,158
    )
    
    
    5.00Outstanding options at March 31, 2006
    
    
    381,157
    
    
    $
    6.46
    
    
    7.12 years
    
    $
    1,787,000Exercisable
    
    
    341,407
    
    
    $
    6.24
    
    
    7.38 years
    
    $
    1,676,000
  9




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KONA GRILL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 6. Comprehensive Income (Loss)
  Three Months Ended March 31,2006
    
    
    2005Net loss
    
    $
    (888
    )
    
    $
    (304
    )Net unrealized losses on available-for-sale securities
    
    
    (15
    )
    
    
    Total comprehensive loss
    
    $
    (903
    )
    
    $
    (304
    )
 7. Income Taxes
  8. Commitments and Contingencies
  10




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  Overview
    11




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Key Measures We Use to Evaluate Our Company
  Number of Restaurant Openings.
 Same Store Sales Growth.
 Average Unit Volume.
 Restaurant Operating Profit.
 Sales Per Square Foot.
 Key Financial Definitions
 Restaurant Sales.
 Restaurant Cost of Sales.
 Restaurant Labor.
 Restaurant Occupancy.
 Restaurant Operating Expenses.
 General and Administrative.
 Preopening Expense.
 12




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Interest Income:
 Interest Expense:
 Depreciation and Amortization
 Financial Performance Overview
  Three Months EndedMarch 31,2006
    
    2005Restaurant sales
growth
    
    
    27.2
    %
    
    
    52.0
    %Same store sales
growth(1)
    
    
    6.2
    %
    
    
    6.9
    %Average unit volume (in
thousands)(2)
    
    $
    1,214
    
    
    $
    1,358Sales per square foot
(2)
    
    $
    174
    
    
    $
    193Restaurant operating profit
(in thousands) (3)
    
    $
    1,994
    
    
    $
    1,610Restaurant operating profit
as a percentage of sales (3)
    
    
    19.6
    %
    
    
    20.1
    %
 
 (1)
    
    Same store sales growth reflects the periodic change in restaurant sales for the
comparable restaurant base. In calculating same store sales growth, we include a
restaurant in the comparable restaurant base after it has been in operation for more
than 18 months.(2)
    
    Includes only those restaurants open for at least 12 months before the beginning
of the period measured.(3)
    
    Restaurant operating profit is not a financial measurement determined in
accordance with generally accepted accounting principles and should not be considered in
isolation or as an alternative to income from operations. Restaurant operating profit
may not be comparable to the same or similarly titled measures computed by other
companies. The table below sets forth our calculation of restaurant operating profit and
a reconciliation to loss from operations, the most comparable GAAP measure. Three Months EndedMarch 31,2006
    
    
    2005(In thousands)Restaurant sales
    
    $
    10,194
    
    
    $
    8,011Costs and expenses:Cost of sales
    
    
    2,895
    
    
    
    2,335Labor
    
    
    3,153
    
    
    
    2,509Occupancy
    
    
    706
    
    
    
    582Restaurant operating expenses
    
    
    1,446
    
    
    
    975Restaurant operating profit
    
    
    1,994
    
    
    
    1,610Deduct  other costs and expensesGeneral and administrative
    
    
    2,014
    
    
    
    1,214Preopening expense
    
    
    291
    
    
    
    7Depreciation and amortization
    
    
    730
    
    
    
    511Loss from operations
    
    $
    (1,041
    )
    
    $
    (122
    )
 13




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Percentage ofRestaurant SalesThree Months Ended March 31,2006
    
    2005Restaurant sales
    
    
    100.0
    %
    
    
    100.0
    %Costs and expenses:Cost of sales
    
    
    28.4
    
    
    
    29.1Labor
    
    
    30.9
    
    
    
    31.3Occupancy
    
    
    6.9
    
    
    
    7.3Restaurant operating expenses
    
    
    14.2
    
    
    
    12.2Restaurant operating profit
    
    
    19.6
    
    
    
    20.1Deduct  other costs and expensesGeneral and administrative
    
    
    19.7
    
    
    
    15.1Preopening expense
    
    
    2.9
    
    
    
    0.1Depreciation and amortization
    
    
    7.2
    
    
    
    6.4Loss from operations
    
    
    (10.2
    )%
    
    
    (1.5
    )%
 Three Months
    
    Year EndedEnded March 31,
    
    December 31,2006
    
    2005Store Growth ActivityBeginning Restaurants
    
    
    9
    
    
    
    7Openings
    
    
    
    
    
    
    2Closings
    
    
    
    
    
    
    Total
    
    
    9
    
    
    
    9
 Critical Accounting Policies and Estimates
  Accounting for Stock Options
 Share-Based Payment,
  14




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Results of Operations
  Three Months EndedMarch 31,2006
    
    2005Restaurant sales
    
    
    100.0
    %
    
    
    100.0
    %Costs and expenses:Cost of sales
    
    
    28.4
    
    
    
    29.1Labor
    
    
    30.9
    
    
    
    31.3Occupancy
    
    
    6.9
    
    
    
    7.3Restaurant operating expenses
    
    
    14.2
    
    
    
    12.2General and administrative
    
    
    19.7
    
    
    
    15.1Preopening expense
    
    
    2.9
    
    
    
    0.1Depreciation and amortization
    
    
    7.2
    
    
    
    6.4Total costs and expenses
    
    
    110.2
    
    
    
    101.5Loss from operations
    
    
    (10.2
    )
    
    
    (1.5
    )Nonoperating income (expense):Interest income
    
    
    2.3
    
    
    
    Interest expense
    
    
    (0.8
    )
    
    
    (2.3
    )Loss before provision for income taxes
    
    
    (8.7
    )
    
    
    (3.8
    )Provision for income taxes
    
    
    
    
    
    
    Net loss
    
    
    (8.7
    )%
    
    
    (3.8
    )%
 Three Months Ended March 31, 2006 Compared with Three Months Ended March 31, 2005
 Restaurant Sales.
 Cost of Sales
 15




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Labor
 Occupancy
 Restaurant Operating Expenses
 General and Administrative
 Preopening Expense Accounting for Rental Costs Incurred
During a Construction Period.
 Depreciation and Amortization
 Interest Income.
 Interest Expense.
 Provision for Income Taxes
 16




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Potential Fluctuations in Quarterly Results and Seasonality
  
    
    timing of new restaurant openings and related expenses;
    
    restaurant operating costs and preopening costs for our newly-opened restaurants, which
are often materially greater during the first several months of operation than thereafter;
    
    labor availability and costs for hourly and management personnel;
    
    profitability of our restaurants, especially in new markets;
    
    increases and decreases in comparable restaurant sales;
    
    impairment of long-lived assets and any loss on restaurant closures;
    
    changes in borrowings and interest rates;
    
    general economic conditions;
    
    weather conditions or natural disasters;
    
    timing of certain holidays;
    
    new or revised regulatory requirements and accounting pronouncements;
    
    changes in consumer preferences and competitive conditions; and
    
    fluctuations in commodity prices.
  Liquidity and Capital Resources
  17




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Equipment Loans
  Cash Flows
  Three Months EndedMarch 31,2006
    
    
    2005Net cash provided by (used in):Operating activities
    
    $
    744
    
    
    $
    (101
    )Investing activities
    
    
    (3,394
    )
    
    
    (1,424
    )Financing activities
    
    
    (170
    )
    
    
    393Net decrease in cash and cash equivalents
    
    $
    (2,820
    )
    
    $
    (1,132
    )
  Operating Activities.
 Investing activities.
 Financing Activities.
 Off-Balance Sheet Arrangements
  18




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Item 3. Quantitative and Qualitative Disclosures about Market Risk
 Derivative Financial Instruments, Other Financial Instruments, and Derivative Commodity
Instruments
 Disclosure About Fair Value of Financial Investments
 Primary Market Risk Exposures
  Inflation
  
 Item 4. Controls and Procedures
  19




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PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. Exhibits
 (a)
    
    Exhibits
 10.15
    
    Form of Stock Option Agreement (2005 Stock Award Plan)31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a), promulgated under the Securities Exchange Act of
1934, as amended.31.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a), promulgated under the Securities Exchange Act of
1934, as amended.32.1
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
 20




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##### Table of Contents



SIGNATURES
  Kona Grill, Inc./s/ Marcus E. JundtMarcus E. JundtChairman of the Board, Interim
President, and Chief Executive
Officer/s/ Mark S. RobinowMark S. RobinowExecutive Vice President, Chief
Financial Officer, and Secretary
(Principal Accounting and Financial
Officer)Date: May 8, 2006
 21




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##### Table of Contents



Exhibit Index
 ExhibitNumber
    
    Description10.15
    
    Form of Stock Option Agreement (2005 Stock Award Plan)31.1
    
    Certification of Chief Executive Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a), promulgated under the
Securities Exchange Act of 1934, as amended.31.2
    
    Certification of Chief Financial Officer pursuant to Rule
13a-14(a) and Rule 15d-14(a), promulgated under the
Securities Exchange Act of 1934, as amended.32.1
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 22