##### 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 September 30, 2005
 Commission file number 000-51491
 KONA GRILL, INC.
  Delaware
(State or other jurisdiction
of incorporation or organization)
    
    20-0216690
(I.R.S. Employer
Identification No.)
 
 
 o þ
 o þ
 o þ




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TABLE OF CONTENTS
 ITEM
    
    PagePART IFINANCIAL INFORMATION1. Unaudited Consolidated Financial StatementsConsolidated Balance Sheets as of September 30, 2005 and December 31, 2004
    
    
    2Consolidated Statements of Operations for the Three and Nine
Months Ended September 30, 2005 and 2004
    
    
    3Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004
    
    
    4Notes to Unaudited Consolidated Financial Statements
    
    
    52. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    113. Quantitative and Qualitative Disclosures About Market Risk
    
    
    204. Controls and Procedures
    
    
    21PART IIOTHER INFORMATION1. Legal Proceedings
    
    
    222. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    223. Defaults Upon Senior Securities
    
    
    224. Submission of Matters to a Vote of Security Holders
    
    
    225. Other Information
    
    
    236. Exhibits
    
    
    23Exhibit 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)
 September 30,
    
    
    December 31,2005
    
    
    2004(Unaudited)
    
    
    (Note 1)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    3,494
    
    
    $
    3,098Investments
    
    
    23,900
    
    
    
    Receivables, primarily due from landlords
    
    
    853
    
    
    
    1,344Inventories
    
    
    397
    
    
    
    336Prepaids and other
    
    
    331
    
    
    
    109Total current assets
    
    
    28,975
    
    
    
    4,887Other assets
    
    
    369
    
    
    
    344Notes receivable
    
    
    101
    
    
    
    141Property and equipment, net
    
    
    22,056
    
    
    
    17,041Total assets
    
    $
    51,501
    
    
    $
    22,413LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    798
    
    
    $
    2,786Accrued expenses
    
    
    2,208
    
    
    
    1,767Current portion of notes payable
    
    
    716
    
    
    
    595Total current liabilities
    
    
    3,722
    
    
    
    5,148Long-term notes payable:Related party, net
    
    
    
    
    
    
    2,657Equipment
notes
    
    
    3,508
    
    
    
    2,984Deferred rent
    
    
    7,250
    
    
    
    5,493Total liabilities
    
    
    14,480
    
    
    
    16,282Stockholders equity:Series A convertible preferred stock,
$0.01 par value, aggregate liquidation
preference of $10,000,000, no shares
authorized, issued, or outstanding at
September 30, 2005 and 4,166,666
shares authorized, issued and
outstanding at December 31, 2004
    
    
    
    
    
    
    42Series B convertible preferred stock,
$0.01 par value, no shares authorized,
issued or outstanding at September 30,
2005 and 15,000,000 authorized, no
shares issued or outstanding at
December 31, 2004
    
    
    
    
    
    
    Common stock, $0.01 par value,
40,000,000 shares authorized, 5,676,810
and 1,463,199 shares issued and
outstanding at September 30, 2005 and
December 31, 2004 , respectively
    
    
    57
    
    
    
    15Additional paid-in capital
    
    
    40,229
    
    
    
    8,904Accumulated deficit
    
    
    (3,265
    )
    
    
    (2,830
    )Total stockholders equity
    
    
    37,021
    
    
    
    6,131Total liabilities and stockholders equity
    
    $
    51,501
    
    
    $
    22,413
  2




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KONA GRILL, INC.
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(Unaudited)Restaurant sales
    
    $
    9,455
    
    
    $
    6,566
    
    
    $
    26,385
    
    
    $
    17,428Costs and expenses:Cost of sales
    
    
    2,699
    
    
    
    1,949
    
    
    
    7,588
    
    
    
    5,136Labor
    
    
    2,873
    
    
    
    2,009
    
    
    
    7,940
    
    
    
    5,194Occupancy
    
    
    600
    
    
    
    464
    
    
    
    1,773
    
    
    
    1,238Restaurant operating expenses
    
    
    1,195
    
    
    
    873
    
    
    
    3,202
    
    
    
    2,283General and administrative
    
    
    1,019
    
    
    
    530
    
    
    
    3,410
    
    
    
    1,280Preopening expense
    
    
    462
    
    
    
    79
    
    
    
    569
    
    
    
    206Depreciation
    
    
    602
    
    
    
    332
    
    
    
    1,651
    
    
    
    868Total costs and expenses
    
    
    9,450
    
    
    
    6,236
    
    
    
    26,133
    
    
    
    16,205Income from operations
    
    
    5
    
    
    
    330
    
    
    
    252
    
    
    
    1,223Nonoperating expenses:Interest expense, net of interest income of $91
and $0 in the three months ended September 30,
2005 and 2004, respectively, and $96 and $1 for
the nine months ended September 30, 2005 and
2004, respectively
    
    
    305
    
    
    
    119
    
    
    
    663
    
    
    
    213(Loss) income from operations before provision for
income taxes
    
    
    (300
    )
    
    
    211
    
    
    
    (411
    )
    
    
    1,010Provision for income taxes
    
    
    6
    
    
    
    20
    
    
    
    24
    
    
    
    40Net (loss) income
    
    $
    (306
    )
    
    $
    191
    
    
    $
    (435
    )
    
    $
    970Net (loss) income per share :Basic
    
    $
    (0.09
    )
    
    $
    0.13
    
    
    $
    (0.20
    )
    
    $
    0.66Diluted
    
    $
    (0.09
    )
    
    $
    0.10
    
    
    $
    (0.20
    )
    
    $
    0.37Weighted average shares used in computation:Basic
    
    
    3,570
    
    
    
    1,460
    
    
    
    2,165
    
    
    
    1,460Diluted
    
    
    3,570
    
    
    
    2,794
    
    
    
    2,165
    
    
    
    2,807
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KONA GRILL, INC.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 Nine Months EndedSeptember 30,2005
    
    
    2004(Unaudited)Operating activitiesNet (loss) income
    
    $
    (435
    )
    
    $
    970Adjustments to reconcile (loss) income from operations to net cash
provided by operating activities:Depreciation
    
    
    1,651
    
    
    
    868Compensation expense for issuance of common stock and stock options
and accelerated vesting of stock options
    
    
    197
    
    
    
    Amortization of debt discount
    
    
    343
    
    
    
    24Change in operating assets and liabilities:Receivables
    
    
    491
    
    
    
    (1,458
    )Inventories
    
    
    (61
    )
    
    
    (14
    )Prepaids and other current assets
    
    
    (222
    )
    
    
    (86
    )Accounts payable
    
    
    (819
    )
    
    
    64Accrued expenses
    
    
    441
    
    
    
    159Deferred rent
    
    
    1,757
    
    
    
    2,141Net cash provided by operating activities
    
    
    3,343
    
    
    
    2,668Investing activitiesPurchase of property and equipment
    
    
    (7,835
    )
    
    
    (5,877
    )Repayment of notes receivable
    
    
    40
    
    
    
    45Increase in other assets
    
    
    (25
    )
    
    
    (54
    )Purchase of investments
    
    
    (23,900
    )
    
    
    Net cash used in investing activities
    
    
    (31,720
    )
    
    
    (5,886
    )Financing activitiesProceeds from issuance of notes payable
    
    
    1,094
    
    
    
    4,982Repayments of notes payable
    
    
    (449
    )
    
    
    (1,450
    )Proceeds from the exercise of stock options and warrants
    
    
    38
    
    
    
    Proceeds from issuance of common stock, net of issuance costs
    
    
    28,090
    
    
    
    Net cash provided by financing activities
    
    
    28,773
    
    
    
    3,532Net increase in cash and cash equivalents
    
    
    396
    
    
    
    314Cash and cash equivalents at the beginning of the period
    
    
    3,098
    
    
    
    3,107Cash and cash equivalents at the end of the period
    
    $
    3,494
    
    
    $
    3,421Supplemental disclosures of cash flow informationCash paid for interest
    
    $
    416
    
    
    $
    215Noncash investing and financing activitiesDecrease in accounts payable related to property and equipment additions
    
    
    (1,169
    )
    
    
    (218
    )Beneficial conversion feature and detachable warrants on convertible note
    
    
    
    
    
    
    400Conversion of convertible promissory note to preferred stock
    
    
    3,000
    
    
    
    
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KONA GRILL, INC.
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 1. Basis of Presentation
    2. Summary of Significant Accounting Policies
 Reverse Stock Split
  Stock-Based Compensation
 Accounting for Stock Issued to Employees
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KONA GRILL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 Accounting for Stock-Based Compensation
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Net (loss) income, as reported
    
    $
    (306
    )
    
    $
    191
    
    
    $
    (435
    )
    
    $
    970Stock-based compensation income (expense), net of tax effect
    
    
    6
    
    
    
    (9
    )
    
    
    (190
    )
    
    
    (66
    )Pro forma net (loss) income
    
    $
    (300
    )
    
    $
    182
    
    
    $
    (625
    )
    
    $
    904Net (loss) income per share:Basic, as reported
    
    $
    (0.09
    )
    
    $
    0.13
    
    
    $
    (0.20
    )
    
    $
    0.66Basic, pro forma
    
    $
    (0.08
    )
    
    $
    0.12
    
    
    $
    (0.29
    )
    
    $
    0.62Diluted, as reported
    
    $
    (0.09
    )
    
    $
    0.10
    
    
    $
    (0.20
    )
    
    $
    0.37Diluted, pro forma
    
    $
    (0.08
    )
    
    $
    0.07
    
    
    $
    (0.29
    )
    
    $
    0.32
  Net Income (Loss) Per Share
 Earnings Per Share
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KONA GRILL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(In thousands, except per share data)Numerator:Net (loss) income available to common stockholders
    
    $
    (306
    )
    
    $
    191
    
    
    $
    (435
    )
    
    $
    970Interest and amortization expense related to
convertible subordinated promissory note, net of
tax
    
    
    
    
    
    
    77
    
    
    
    
    
    
    
    77$
    (306
    )
    
    $
    268
    
    
    $
    (435
    )
    
    $
    1,047Denominator:Weighted average shares  Basic
    
    
    3,570
    
    
    
    1,460
    
    
    
    2,165
    
    
    
    1,460Effect of dilutive securities:Stock options and warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13Convertible shares
    
    
    
    
    
    
    1,334
    
    
    
    
    
    
    
    1,334Weighted average shares  Diluted
    
    
    3,570
    
    
    
    2,794
    
    
    
    2,165
    
    
    
    2,807Net (loss) income per share:Basic
    
    $
    (0.09
    )
    
    $
    0.13
    
    
    $
    (0.20
    )
    
    $
    0.66Diluted
    
    $
    (0.09
    )
    
    $
    0.10
    
    
    $
    (0.20
    )
    
    $
    0.37
  Cash and Cash Equivalents
  Investments
 Accounting for Certain Investments in Debt and Equity Securities
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KONA GRILL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
  Recent Accounting Pronouncements
 Share-Based Payment Accounting for Stock-Based Compensation
 Earnings Per Share
 Determining the Amortization Period for
Leasehold Improvements
 Inventory Cost
 Accounting Changes and Error Corrections: a
replacement of APB Opinion No. 20 and FASB Statement No. 3.
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KONA GRILL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 Accounting for Rental Costs
Incurred During a Construction Period
 3. Convertible Subordinated Promissory Note
  4. Accrued Expenses
  September 30,
    
    
    December 31,2005
    
    
    2004Accrued payroll
    
    $
    924
    
    
    $
    537Gift cards
    
    
    233
    
    
    
    304Sales tax
    
    
    253
    
    
    
    234Accrued rent
    
    
    181
    
    
    
    183Other
    
    
    617
    
    
    
    509Total
    
    $
    2,208
    
    
    $
    1,767
 5. Income Tax
  6. Stockholders Equity
 Preferred Stock
  9




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KONA GRILL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 Warrants
  Conversion of Series Preferred A and Series Preferred B to Common Stock
   7. Commitments and Contingencies
  10




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 You should read the following discussion and analysis in conjunction with our unaudited
consolidated financial statements and related notes contained elsewhere in this report. This
discussion contains forward-looking statements that involve risks, uncertainties, and assumptions.
Our actual results may differ materially from those anticipated in these forward-looking statements
as a result of a variety of factors, including those set forth under Risk Factors under our
Registration Statement on Form S-1 (Reg. No. 333-125506) filed with the Securities Exchange
Commission and elsewhere in this report.
 Overview
   Key Measures We Use to Evaluate Our Company
  Number of Restaurant Openings.
 Same Store Sales Growth.
 11




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Average Unit Volume.
 Key Financial Definitions
 Restaurant Sales.
 Restaurant Cost of Sales.
 Restaurant Labor.
 Restaurant Occupancy.
 Restaurant Operating Expenses.
 General and Administrative.
 Preopening Expense.
 Depreciation.
 Interest Expense, Net.
 Sales Per Square Foot.
 12




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Financial Performance Overview
  Nine Months EndedSeptember 30,2005
    
    
    2004Restaurant sales growth
    
    
    51.4
    %
    
    
    54.3
    %Same store sales growth (1)
    
    
    4.6
    %
    
    
    9.6
    %Average restaurant sales (in thousands) (2)
    
    $
    3,917
    
    
    $
    4,106
 
 (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. Nine Months Ended
    
    Year EndedSeptember 30, 2005
    

December 31, 2004Store GrowthBeginning Restaurants
    
    
    7
    
    
    
    4Openings
    
    
    2
    
    
    
    3Closings
    
    
    
    
    
    
    Total
    
    
    9
    
    
    
    7
 Critical Accounting Policies and Estimates
   Property and Equipment
   13




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Leasing Activities
    Income Taxes
   Accounting for Stock Options
 Accounting for Stock Issued to Employees
 14




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Accounting for Stock-Based Compensation FASB Share-Based Payment
 Acceleration of Vesting of Outstanding Options
    Results of Operations
  Three Months
    
    Nine MonthsEnded September 30,
    
    Ended September 30,2005
    
    2004
    
    2005
    
    2004Restaurant sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Costs and expenses:Cost of sales
    
    
    28.5
    
    
    
    29.7
    
    
    
    28.8
    
    
    
    29.5Labor
    
    
    30.4
    
    
    
    30.6
    
    
    
    30.1
    
    
    
    29.8Occupancy
    
    
    6.3
    
    
    
    7.0
    
    
    
    6.7
    
    
    
    7.1Restaurant operating expenses
    
    
    12.6
    
    
    
    13.3
    
    
    
    12.1
    
    
    
    13.1General and administrative
    
    
    10.8
    
    
    
    8.1
    
    
    
    12.9
    
    
    
    7.3Preopening expense
    
    
    4.9
    
    
    
    1.2
    
    
    
    2.1
    
    
    
    1.2Depreciation
    
    
    6.4
    
    
    
    5.1
    
    
    
    6.3
    
    
    
    5.0Total costs and expenses
    
    
    99.9
    
    
    
    95.0
    
    
    
    99.0
    
    
    
    93.0Income from operations
    
    
    0.1
    
    
    
    5.0
    
    
    
    1.0
    
    
    
    7.0Nonoperating expenses:Interest expense, net
    
    
    3.2
    
    
    
    1.8
    
    
    
    2.5
    
    
    
    1.2(Loss) income from
operations before
provision for income taxes
    
    
    (3.1
    )
    
    
    3.2
    
    
    
    (1.5
    )
    
    
    5.8Provision for income taxes
    
    
    0.1
    
    
    
    0.3
    
    
    
    0.1
    
    
    
    0.2Net (loss) income
    
    
    (3.2
    )%
    
    
    2.9
    %
    
    
    (1.6
    )%
    
    
    5.6
    %
 15




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Three Months Ended September 30, 2005 Compared with Three Months Ended September 30, 2004
 Restaurant Sales
 Cost of Sales
 Labor
 Occupancy
 Restaurant Operating Expenses
 General and Administrative
 Preopening Expense
 Depreciation
 16




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Interest Expense, Net
 Provision for Income Taxes.
 Nine Months Ended September 30, 2005 Compared with Nine Months Ended September 30, 2004
 Restaurant Sales
 Cost of Sales
 Labor
 Occupancy
 Restaurant Operating Expenses
 General and Administrative
 Preopening Expense
 17




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Depreciation
 Interest Expense, Net
 Provision for Income Taxes
 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
 18




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
    
    fluctuations in commodity prices.
  Liquidity and Capital Resources
  Equipment Loans
  Cash Flows
  Operating Activities
 Investing activities
 19




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Financing Activities
 Off-Balance Sheet Arrangements
  Impact of Inflation
  
 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
  20




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ITEM 4. Controls and Procedures
  21




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PART II  OTHER INFORMATION
 
 ITEM 1. Legal Proceedings
  
 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
  22




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For
    
    
    Against
    
    
    Abstain1. Proposal to approve and ratify our 2005
Stock Award Plan
    
    
    6,993,482
    
    
    
    835,834
    
    
    
    2. Proposal to approve and ratify our 2005
Employee Stock Purchase Plan
    
    
    6,993,482
    
    
    
    2,500
    
    
    
    3. Proposal to approve our proposed 1-for-5
reverse stock split of our common stock
    
    
    6,816,982
    
    
    
    149,000
    
    
    
    4. Ratification of the election of two
directors
(C. Donald Dempsey and Anthony J. Winczewski)
to serve as Class II members of our Board of
Directors for a term expiring in 2007
    
    
    6,994,982
    
    
    
    
    
    
    
    1,000
  
 ITEM 5. Other Information
  
 ITEM 6. Exhibits
  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 amended31.2
    
    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 amended32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 23




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SIGNATURES
  KONA GRILL, INC.
 Signature
    
    Capacity
    
    Date/s/ C. Donald Dempsey

C. Donald Dempsey
    
    President, Chief Executive
Officer, and Director
(Principal Executive Officer)
    
    November 14, 2005/s/ Mark S. Robinow

Mark S. Robinow
    
    Executive Vice President,
Chief Financial Officer, and
Secretary (Principal
Accounting and Financial
Officer)
    
    November 14, 2005
 24




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##### Table of Contents



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 amended31.2
    
    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 amended32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002