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GCFB > SEC Filings for GCFB > Form 10-K on 19-Mar-2014All Recent SEC Filings

Show all filings for GRANITE CITY FOOD & BREWERY LTD.

Form 10-K for GRANITE CITY FOOD & BREWERY LTD.


19-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statement Disclaimer

This Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties. The statements contained in this Annual Report that are not purely historical are forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements include, without limitation, statements relating to future economic conditions in general and statements about our future:

† Strategy and business;

† Development plans and growth;

† Sales, earnings, income, expenses, operating results, profit margins, capital resource needs and competition; and

† Ability to obtain and protect intellectual property and proprietary rights.

All of these forward-looking statements are based on information available to us on the date of filing this Annual Report. Our actual results could differ materially. The forward-looking statements contained in this Annual Report, and other written and oral forward-looking statements made by us from time to time, are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated in the forward- looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in Item 1A of this report under the caption "Risk Factors."

Overview

We operate two casual dining concepts under the names Granite City Food & Brewery® and Cadillac Ranch All American Bar & Grill®. As of March 11, 2014, we operated 30 Granite City restaurants and five Cadillac Ranch restaurants in 16 states. The Granite City restaurant theme is upscale casual dining with a wide variety of menu items that are prepared fresh daily, including Granite City's award-winning signature line of hand-crafted beers finished on-site. The extensive menu features moderately priced favorites served in generous portions. Granite City's attractive price point, high service standards, and great food and beer combine for a memorable dining experience. Cadillac Ranch restaurants feature freshly prepared, authentic, All-American cuisine in a fun, dynamic environment. Patrons enjoy a warm, Rock N' Roll inspired atmosphere, with plenty of room for friends, music and dancing. The Cadillac Ranch menu is diverse with offerings ranging from homemade meatloaf to pasta dishes, all freshly prepared using quality ingredients.


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Additionally, we operate a centralized beer production facility which facilitates the initial stages of our brewing process. The product produced at our beer production facility is then transported to the fermentation vessels at each of our Granite City restaurants where the brewing process is completed. We believe that this brewing process improves the economics of microbrewing as it eliminates the initial stages of brewing and storage at multiple locations. We have been granted patents by the United States Patent and Trademark Office for our brewing process and for an apparatus for distributed production of beer.

Our industry can be significantly affected by changes in economic conditions, discretionary spending patterns, consumer tastes, and cost fluctuations. In recent years, consumers have been under increased economic pressures and as a result, many have changed their discretionary spending patterns. We believe trends in consumer spending within the casual dining sector will continue to fluctuate, and we continue to see many consumers dining out less frequently than in the past and/or decreasing the amount they spend on meals while dining out. These changes have affected guest counts in the overall casual dining industry, including our concepts. To help offset the negative impact of these trends, we have implemented marketing initiatives designed to increase brand awareness and help drive guest traffic, including focusing on local marketing and social media initiatives, as well as growing our "Mug Club" loyalty program.

We believe that our operating results will fluctuate significantly because of several factors, including the operating results of our restaurants, changes in food and labor costs, increases or decreases in comparable restaurant sales, general economic conditions, consumer confidence in the economy, changes in consumer preferences, nutritional concerns and discretionary spending patterns, competitive factors, the skill and the experience of our restaurant-level management teams, the maturity of each restaurant, adverse weather conditions in our markets, and the timing of future restaurant openings and related expenses.

We use a 52/53-week fiscal year ending on the last Tuesday of December to account for our operations. All references to "2013" and "2012" within the following discussion represent the fiscal years ended December 31, 2013 and December 25, 2012, respectively. Fiscal year 2013 consisted of 53 weeks while fiscal year 2012 consisted of 52 weeks. Our fiscal year ended December 31, 2013 included 1,827 operating weeks, which is the sum of the actual number of weeks each restaurant operated. Our fiscal year ended December 25, 2012 included 1,675 restaurant weeks. We provide the statistical measure of restaurant weeks to enhance the comparison of revenue from period to period as changes occur in the number of restaurants we are operating.

Our restaurant revenue is comprised almost entirely of the sales of food and beverages. We also obtain a small percentage of revenue from cover charges, banquet or private dining room rentals and the sale of retail items. Such sales make up approximately one percent of total revenue. Product costs include the costs of food, beverages and retail items. Labor costs include direct hourly and management wages, taxes and benefits for restaurant employees. Direct and occupancy costs include restaurant supplies, marketing costs, rent, utilities, real estate taxes, repairs and maintenance and other related costs. Pre-opening costs consist of direct costs related to hiring and training the initial restaurant workforce, the salaries and related costs of our new restaurant opening team, cash and non-cash rent costs incurred during the construction period and certain other direct costs associated with opening new restaurants. General and administrative expenses are comprised of expenses associated with all corporate and administrative functions that support existing operations, which include management and staff salaries, employee benefits, travel, information systems, training, market research, professional fees, supplies and corporate rent. Acquisition costs are expenses related to due diligence performed as part of the acquisition of assets. Depreciation and amortization includes depreciation on capital expenditures at the restaurant and corporate levels and amortization of intangibles that do not have indefinite lives. Interest expense represents the cost of interest expense on debt and capital leases and the change in fair value of our interest rate swap, net of interest income on invested assets.


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Results of Operations as a Percentage of Sales

The following table sets forth results of our operations expressed as a percentage of sales for fiscal years 2013 and 2012:

                                 53 Weeks Ended       52 Weeks Ended
                                December 31, 2013    December 25, 2012

Restaurant revenue                          100.0 %              100.0 %

Cost of sales:
Food, beverage and retail                    27.6                 27.1
Labor                                        32.6                 32.9
Direct restaurant operating                  15.7                 15.0
Occupancy                                     8.3                  8.3
Cost of sales and occupancy                  84.2                 83.3

General and administrative                    7.0                  8.0
Depreciation and amortization                 6.0                  6.1
Pre-opening                                   1.2                  0.9
Acquisition costs                             0.3                  0.6
Loss on disposal of assets                    0.5                  0.4
Exit or disposal activities                  (0.3 )                0.1

Total costs and expenses                     98.9                 99.3
Operating income                              1.1                  0.7

Interest:
Income                                        0.0                  0.0
Expense                                      (3.7 )               (4.1 )
Net interest expense                         (3.7 )               (4.1 )

Net loss                                     (2.6 )%              (3.4 )%

Certain percentage amounts do not sum due to rounding.

Critical Accounting Policies

This discussion and analysis is based upon our consolidated financial statements, which were prepared in conformity with generally accepted accounting principles. These principles require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We believe our estimates and assumptions are reasonable; however, actual results and the timing of the recognition of such amounts could differ from those estimates. We have identified the following critical accounting policies and estimates utilized by management in the preparation of our financial statements:

Property and Equipment

The cost of property and equipment is depreciated over the estimated useful lives of the related assets ranging from three to 20 years. The cost of leasehold improvements is depreciated over the initial term of the


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related lease, which is generally 10 to 30 years. Depreciation is computed on the straight-line method for financial reporting purposes and accelerated methods for income tax purposes. Amortization of assets acquired under capital lease is included in depreciation expense. We review property and equipment, including leasehold improvements, for impairment when events or circumstances indicate these assets might be impaired pursuant the Financial Accounting Standards Board's ("FASB") accounting guidance on accounting for the impairment or disposal of long-lived assets. We base this assessment upon the carrying value versus the fair market value of the asset and whether or not that difference is recoverable. Such assessment is performed on a restaurant-by-restaurant basis and includes other relevant facts and circumstances including the physical condition of the asset.

Our accounting policies regarding property and equipment include certain management judgments regarding the estimated useful lives of such assets and the determination as to what constitutes enhancing the value of or increasing the life of existing assets. These judgments and estimates may produce materially different amounts of depreciation and amortization expense than would be reported if different assumptions were used.

We continually reassess our assumptions and judgments and make adjustments when significant facts and circumstances dictate. Historically, actual results have not been materially different than the estimates we have made.

Leasing Activities

We have entered into various leases for our buildings and for ground leases. At the inception of a lease, we evaluate it to determine whether the lease will be accounted for as an operating or capital lease pursuant to the FASB guidance on accounting for leases.

Our lease term used for straight-line rent expense is calculated from the date we take possession of the leased premises through the termination date. There is potential for variability in our "rent holiday" period which begins on the date we take possession of the leased premises and ends on the date the restaurant opens, during which no cash rent payments are typically due. Factors that may affect the length of the rent holiday period generally relate to construction related delays. Extension of the rent holiday period due to delays in restaurant opening will result in greater pre-opening rent expense recognized during the rent holiday period.

Certain leases contain provisions that require additional rent payments based upon restaurants sales volume ("contingent rentals"). Contingent rentals are accrued each period as the liabilities are incurred.

Management makes judgments regarding the probable term for each restaurant property lease which can impact the classification and accounting for a lease as capital or operating. These judgments may produce materially different amounts of depreciation, rent expense and interest expense than would be reported if different assumptions were made.

Stock-Based Compensation

We have granted stock options to certain employees and non-employee directors. We account for stock-based compensation in accordance with the FASB fair value recognition guidance. Stock-based compensation is measured at the grant date based on the value of the award and is recognized as an expense over the vesting period. Under the Black-Scholes option-pricing model, we determine the fair value of stock-based compensation at the grant date. This requires judgment, including but not limited to judgment concerning the expected volatility and forfeiture of our stock. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.

Revenue Recognition

Revenue is derived from the sale of prepared food and beverage and select retail items and is recognized at the time of sale. Revenue derived from gift card sales is recognized at the time the gift card is redeemed. Until the redemption of gift cards occurs, the outstanding balances on such cards are included in accrued expenses in


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the accompanying consolidated balance sheets. When we determine there is no legal obligation to remit the value of unredeemed gift cards to the relevant jurisdictions, we periodically recognize gift card breakage which represents the portion of our gift card obligation for which management believes the likelihood of redemption by the customer is remote, based upon historical redemption patterns. Such amounts are included as a reduction to general and administrative expense. We arrive at this amount using certain management judgments and estimates. Such judgments and estimates may produce different amounts of breakage than would be reported if different assumptions were used.

Recently Issued Accounting Standards

We reviewed all significant newly-issued accounting pronouncements and concluded that they either are not applicable to our operations or that no material effect is expected on our consolidated financial statements as a result of future adoption.

Results of Operations for the Fiscal Years Ended December 31, 2013 and December 25, 2012

Revenue

We generated $134,163,349 and $120,931,643 of revenue during fiscal years 2013 and 2012, respectively, an increase of 10.9%. Such increase was the result of the additional fiscal week in the first quarter of 2013 as well as having three additional locations in operation in 2013 compared to 2012. Comparable restaurant revenue, which includes restaurants we have operated for over 18 months, increased 0.5% from fiscal year 2012 to fiscal year 2013 due in part to a menu price increase.

We expect that restaurant revenue will vary from quarter to quarter. Continued seasonal fluctuations in restaurant revenue are due in part to increased outdoor seating and weather conditions. Due to the honeymoon effect that periodically occurs with the opening of a restaurant, we expect the timing of any future restaurant openings to cause fluctuations in restaurant revenue. Additionally, other factors outside of our control, such as timing of holidays, consumer confidence in the economy and changes in consumer preferences may affect our future revenue.

Restaurant Costs

Food and beverage

Our food and beverage costs, as a percentage of revenue, increased 0.5% to 27.6% in 2013 from 27.1% in 2012. While we experienced some cost decreases in bottled beer, liquor and some dairy and proteins, such decreases were more than offset by increases in tap beer, soft drinks, wine, steak, chicken breasts, cheese and retail products. While pricing negotiations with our suppliers have reduced our exposure to commodity price increases, we do expect that our food and beverage costs will continue to vary going forward due to numerous variables, including seasonal changes in food and beverage costs for certain products for which we do not have contracted pricing, fluctuations within commodity-priced goods and guest preferences. We periodically create new menu offerings and introduce new craft brewed beers based upon guest preferences. During the second quarter of 2013, the Granite City concept rolled out a new menu which we believe caused a temporary increase in our food costs. We have, however, been able to offset a portion of such increase with our feature items which provide variety and value to our guests. Our varieties of craft brewed beer, which we produce at a lower cost than beers we purchase for resale, also enable us to keep our food and beverage costs low while fulfilling guest requests and building customer loyalty. Based on industry information, we anticipate commodity prices to increase in 2014. However, we intend to continue to seek to offset such increases with pricing, new menu offerings and specials.


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Labor

Labor expense consists of restaurant management salaries, hourly staff payroll costs, other payroll-related items including management bonuses, and non-cash stock-based compensation expense. Our experience to date has been that staff labor costs associated with a newly opened restaurant, for approximately its first four to six months of operation, are greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenue.

Our labor costs, as a percentage of revenue, decreased 0.3% to 32.6% in 2013 from 32.9% in 2012. Although we experienced increases in some kitchen labor and labor relating to the security and janitorial services we brought in-house at a number of our locations, most of the other labor costs decreased from 2012 to 2013. Non-cash stock-based compensation decreased $55,731 to $72,803 in 2013 from $128,534 in 2012.

We expect that benefit costs will increase as new health insurance regulations are implemented. Additionally, we expect labor costs will vary as minimum wage laws, local labor laws and practices, and unemployment rates vary from state to state, as will hiring and training expenses. We believe that retaining good employees and more experienced staff ensures high quality guest service and may reduce hiring and training costs.

Direct restaurant operating

Operating supplies, repairs and maintenance, utilities, promotions and restaurant-level administrative expense represent the majority of our direct restaurant operating expense, a portion of which is fixed or indirectly variable. Our direct restaurant operating expense, as a percentage of revenue, increased 0.7% to 15.7% in 2013 from 15.0% in 2012. Cost increases in training, maintenance and repair, marketing, utilities and subscriptions were offset in part by decreases in consulting services, paper products and linen and laundry services. Additionally, because we brought janitorial services in-house at many of our locations, we experienced decreases in outside janitorial service costs.

We continue to seek ways to reduce our direct operating costs going forward including additional pricing negotiations with suppliers and the elimination of waste.

Occupancy

As a percentage of revenue, our occupancy costs, which include both fixed and variable portions of rent, common area maintenance charges, property insurance and property taxes, remained consistent at 8.3% in 2013 and 2012. While fixed rent decreased as a percentage of revenue due to the higher revenue base and the additional fiscal week in 2013 compared to 2012, occupancy expense increased $1,147,854 in 2013 due to the additional restaurants in operation. The majority of our leases include a provision for additional rent based upon restaurant sales. As such, with our increased revenue base, our percentage rent has increased as well. In December 2013, we purchased the building and improvements at seven of our restaurants and entered into a sale leaseback agreement for one restaurant. We expect overall lease expense to decrease, although, due to the change in lease classifications from capital to operating, the amount of the lease expense recorded in occupancy will increase, while the amount of lease expense recorded as interest expense and liability reduction will decrease, in 2014.

Pre-opening

Pre-opening costs, which are expensed as incurred, consist of expenses related to hiring and training the initial restaurant workforce, wages and expenses of a new restaurant opening team during periods of expansion, non-cash rental costs incurred during the construction period and certain other direct costs associated with opening new restaurants. The majority of pre-opening costs, excluding construction-period rent, are incurred in the month of, and two months prior to, restaurant opening.


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Our pre-opening costs in 2013 related primarily to the Granite City restaurants we opened in Franklin, Tennessee in February 2013, Indianapolis, Indiana in July 2013, and Lyndhurst, Ohio in November 2013. Such expenses in 2012 related primarily to the Granite City restaurants we opened in Troy, Michigan in May 2012 and Franklin, Tennessee in February 2013. Of the pre-opening cost incurred, we recorded $295,166 and $46,729 of non-cash construction-period rent in 2013 and 2012, respectively.

General and Administrative

General and administrative expense includes all salaries and benefits, including non-cash stock-based compensation, associated with our corporate staff that is responsible for overall restaurant quality, financial controls and reporting, restaurant management recruiting, management training, and excess capacity costs related to our beer production facility. Other general and administrative expense includes advertising, professional fees, investor relations, office administration, centralized accounting system costs and travel by our corporate management.

General and administrative expense decreased $262,440 to $9,451,655 in 2013 from $9,714,095 in 2012. As a percentage of revenue, general and administrative expense decreased 1.0% to 7.0% in 2013 from 8.0% in 2012. We incurred increased compensation expense in 2013 due in part to the additional fiscal week and additional personnel, and increased consulting expense related to restaurant sites we discontinued pursuing. These costs were more than offset by a reduction of travel and management training expenses, as well as an increase in gift card breakage which represents the portion of the gift card obligation for which management believes the likelihood of redemption by the customer is remote.

As we seek new ways to build revenue, including restaurant, menu and food upgrades and future restaurant unit growth, we will continue to closely monitor our general and administrative costs and attempt to reduce these expenses as a percentage of revenue while preserving an infrastructure that remains suitable for our current operations. With our growth plans, we will need to recruit additional personnel to provide continued oversight of operations. To the extent our turnover increases above our expectations, additional costs could be incurred in recruiting and training expenses.

Depreciation and Amortization

Depreciation and amortization expense increased $635,927 to $8,041,632 in 2013 from $7,405,705 in 2012. As a percentage of revenue, depreciation and amortization expense decreased 0.1% to 6.0% in 2013 from 6.1% in 2012, indicating that revenue generated from our new locations more than offset the related increase in depreciation expense. We anticipate depreciation expense will increase as we open new restaurants and complete enhancements at selected restaurants including increased seating in the bars, enclosure of patios for year-round service, and the addition of private dining rooms to accommodate private parties and reduce wait times during peak periods.

Exit or Disposal Activities

In the first quarter of fiscal year 2011, we issued a $1.0 million promissory note to Dunham Capital Management, L.L.C. ("DCM"), related to expenses we incurred and recorded as exit and disposal activities when we ceased operations at our Rogers, Arkansas restaurant in August 2008. In December 2013, DCM cancelled the note we issued to DCM in consideration of our cash payment of $433,736. We wrote off the remaining $480,891 balance of such note as a non-cash reduction to exit and disposal activities.

Interest

Net interest expense consists of interest expense on capital leases and long-term debt, net of interest earned from cash on hand. Net interest expense decreased $10,662 to $4,900,763 in 2013 from $4,911,425 in 2012. In 2013 and 2012, $160,836 and $159,421 of interest expense was capitalized as part of the construction of our new restaurants. In the second quarter of 2013, we entered into an interest swap agreement per the terms of


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the Credit Agreement. The decrease in fair value of the swap agreement was $128,557 during 2013 and is recorded as interest expense in the consolidated statements of operations.

Liquidity and Capital Resources

As of December 31, 2013, we had $2,677,090 of cash and a working capital deficit of $10,865,348 compared to $2,566,034 of cash and a working capital deficit of $8,905,723 at December 25, 2012. As of March 11, 2014, we had additional cash availability of $10.5 million under our line of credit facility with the Bank.

During the year ended December 31, 2013, we obtained $8,741,736 of net cash from operating activities and $2,003,357 of net cash through financing activities. The funds from financing activities were made up of $12,069,039 proceeds from the Credit Agreement, $2,869,265 proceeds from the sale lease back of our Olathe, Kansas location, $2,000,000 proceeds from the sale of Redeemable Preferred Stock, and net proceeds from issuance of our common stock of $1,850. Such proceeds were partially offset by payments on our long-term debt and line of credit of $9,479,057, payments on capital lease obligations of $4,702,410, debt issuance costs of $249,075 and payment of cash dividends on our Series A Preferred of $506,255. Our net cash used for investing activities of $10,634,037 was made up of purchases of property and equipment totaling $13,982,242 and other assets consisting primarily of security deposits aggregating $114,595, offset in part by $3,462,800 of cash proceeds from the sale leaseback of our Franklin, Tennessee, Indianapolis, Indiana and Lyndhurst, . . .

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