Kona Grill and its former CEO go to war

Lawsuits between the chain and former Chief Executive Jim Kuhn paint a picture of a company that grew too fast, then cut too many costs to survive, says RB’s The Bottom Line.
kona grill

The Bottom Line

Kona Grill and James Kuhn, who was promoted to CEO in August and then fired just three months later, are going to war over Kuhn’s unpaid severance payment.

In the process, separate lawsuits by Kona and its former chief executive paint a picture of a company that had grown too fast and then grew desperate to cut costs—only to make matters worse by hurting the chain’s service and quality.

As a result, the company disclosed this week that it might have to file for bankruptcy even if it finds a buyer. Kona Grill missed a debt payment in March, doesn’t believe it can effectively refinance its $33 million in debt and has outstanding leases on unprofitable stores—the landlord of its closed Las Vegas restaurant has sued the company, for instance.

None of this is unique to Kona. Many chains find themselves in dire straits after overaggressive growth. They desperately cut costs, and then sales plunge further as service and quality go downhill. The only thing unusual here is the lawsuits.

Kuhn sued Kona in late January. The chain’s former chief operating officer was promoted to CEO in August. By November, he was asked to resign. In his lawsuit, he claims the firing was unjust and that he is owed severance.

Kona, in its response, denied the claims. And then it filed a lawsuit of its own, claiming a “breach of fiduciary duty” by Kuhn during his time at the company. It largely placed the blame for falling sales directly at Kuhn’s feet.

Berke Bakay, an activist investor and board member, was named CEO of the chain in 2012. Bakay employed an aggressive unit growth strategy, doubling the chain’s size to 46 at one point in 2017.

But same-store sales fell 5.9% in 2017, and the company was clearly struggling. That year, according to a transcript of an earnings call on financial site Sentieo, Kona received a waiver of financial requirements in its lending agreement.

In December 2017, it brought in Kuhn, the former CEO of Genghis Grill parent company Chalak Mitra Group, to be the company’s chief operating officer. Kuhn had also worked with Ignite Restaurant Group, Ruby Tuesday and other chains.

According to his complaint, Kuhn’s “marching orders were to address the plummeting financial condition” of Kona’s business, “and quickly create cost saving measures that would increase the company’s overall profitability.”

Kuhn argues that profitability improved 66% during the first three quarters of 2018, ultimately leading to that August promotion.

Indeed, “Jim has done a remarkable job during his tenure with us at improving the profitability of our restaurants and I’m confident that Kona will thrive under his leadership,” Bakay said in announcing Kuhn’s hiring last year.

But Kona, apparently, didn’t like the results of Kuhn’s cuts.

Kuhn was asked to resign in November. Same-store sales, it seems, were plunging. Average unit volumes that at one point were near $5 million had fallen to $3.5 million.

Same-store sales fell by another 12.3% in 2018—for a cumulative decline of more than 17% over two years.

Kona Grill didn’t hold back in its lawsuit, which it filed in Arizona. It called the same-store sales decline last year “unprecedented” in its history. It said that Kuhn “failed to conduct the business affairs of Kona Grill in a manner that any reasonable person in a like position could possibly believe was in the best interests of the company.”

It said he left stores “woefully understaffed,” which led to long wait times that hurt same-store sales. It said he cut out wasabi and eliminated a popular happy hour promotion. It also said that he stopped paying some invoices, leaving accounts payable at $2.5 million, and also stopped providing pest control services, beer line cleaning and knife sharpening.

The company argued that Kuhn did this to artificially inflate Kona’s adjusted EBITDA, on which his bonus was based.

At the end of the lawsuit, Kona stuck in this charge: “Mr. Kuhn frequently consumed alcohol on the company’s properties, even going so far as to unilaterally close restaurants early so that he could drink at the restaurant bar.”

Jeff Schwaber, Kuhn’s Maryland-based attorney, was apoplectic about the Kona lawsuit, calling it “an outrageous attempt at bullying Mr. Kuhn into dismissing the suit he’d previously filed” to avoid paying him a severance.

As for the drinking, he says, “It was in the limited context of tasting certain wine and cocktail items for quality purposes,” which was part of his job.

To conclude: It appears that Kona, struggling with sales and profits, hired an operator to cut costs, promoted him to CEO on the basis of those cost cuts, fired him three months later, and then sued him for the result of those cuts.

That company is now for sale, and a bankruptcy filing might be required so the company can close some of the stores it should not have opened in the first place.

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