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Granite City Food & Brewery 10-Q 2007

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549


FORM 10-Q

 

x                               QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 25, 2007

 

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 000-29643

 

GRANITE CITY FOOD & BREWERY LTD.

(Exact Name of Registrant as Specified in Its Charter)

 

Minnesota

 

41-1883639

(State or Other Jurisdiction

 

(I.R.S. Employer

of Incorporation or Organization)

 

Identification No.)

 

 

 

 

 

 

5402 Parkdale Drive, Suite 101

Minneapolis, Minnesota 55416

(952) 215-0660

(Address of Principal Executive Offices and Issuer’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 period that 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 o

 

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

Large accelerated filer  o        Accelerated filer  o        Non-accelerated filer  x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o     No x

 

As of November 1, 2007, the issuer had outstanding 16,097,335 shares of common stock.

 

 



 

TABLE OF CONTENTS

 

 

 

 

 

 

PART I

FINANCIAL INFORMATION

 

 

 

 

ITEM 1

Financial Statements

 

 

 

 

 

Condensed Consolidated Balance Sheets as of September 25, 2007and December 26, 2006

 

 

 

 

 

Condensed Consolidated Statements of Operations for the Thirteen and Thirty-nine weeks ended September 25, 2007 and September 26, 2006

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Thirty-nine weeks ended September 25, 2007 and September 26, 2006

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

 

 

 

ITEM 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

 

 

 

ITEM 3

Quantitative and Qualitative Disclosures about Market Risk

 

 

 

 

ITEM 4

Controls and Procedures

 

 

 

 

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

 

 

 

 

SIGNATURES

 

 

 

 

 

INDEX TO EXHIBITS

 

 

i



 

PART I          

FINANCIAL INFORMATION

 

 

 

 

ITEM 1  Financial Statements

 

 

 

GRANITE CITY FOOD & BREWERY LTD.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

 

September 25,
2007

 

December 26,
2006

 

ASSETS:

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

6,483,988

 

$

7,671,750

 

Inventory

 

537,138

 

511,146

 

Prepaids and other

 

512,700

 

393,803

 

Total current assets

 

7,533,826

 

8,576,699

 

 

 

 

 

 

 

Prepaid rent, net of current portion

 

459,872

 

503,267

 

Property and equipment, net

 

61,106,795

 

54,018,124

 

Intangible assets and other

 

795,555

 

760,420

 

Total assets

 

$

69,896,048

 

$

63,858,510

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY:

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

4,761,472

 

$

2,289,433

 

Accrued expenses

 

4,313,924

 

5,104,730

 

Deferred rent, current portion

 

184,982

 

143,928

 

Long-term debt, current portion

 

277,692

 

259,940

 

Capital lease obligations, current portion

 

976,287

 

1,885,388

 

Total current liabilities

 

10,514,357

 

9,683,419

 

 

 

 

 

 

 

Deferred rent, net of current portion

 

2,095,772

 

1,603,557

 

Long-term debt, net of current portion

 

1,805,197

 

2,004,986

 

Capital lease obligations, net of current portion

 

33,935,620

 

37,501,605

 

Total liabilities

 

48,350,946

 

50,793,567

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $0.01 par value, 90,000,000 shares authorized; 16,059,165 and 13,370,331 shares issued and outstanding at September 25, 2007 and December 26, 2006, respectively

 

160,592

 

133,703

 

Additional paid-in capital

 

42,678,377

 

29,122,306

 

 

 

 

 

 

 

Accumulated deficit

 

(21,293,867

)

(16,191,066

)

Total shareholders’ equity

 

21,545,102

 

13,064,943

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

69,896,048

 

$

63,858,510

 

 

See notes to condensed consolidated financial statements.

 

1



 

GRANITE CITY FOOD & BREWERY LTD.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

 

 

September 25,
2007

 

September 26,
2006

 

September 25,
2007

 

September 26,
2006

 

 

 

 

 

 

 

 

 

 

 

Restaurant revenues

 

$

19,584,040

 

$

15,028,065

 

$

56,220,186

 

$

41,337,502

 

 

 

 

 

 

 

 

 

 

 

Cost of sales:

 

 

 

 

 

 

 

 

 

Food, beverage and retail

 

5,969,977

 

4,522,565

 

16,889,600

 

12,295,648

 

Labor

 

7,046,219

 

5,404,636

 

20,197,394

 

14,662,268

 

Direct restaurant operating

 

2,845,705

 

1,856,222

 

7,779,859

 

5,103,711

 

Occupancy

 

1,210,115

 

850,788

 

3,485,007

 

2,328,316

 

Total cost of sales

 

17,072,016

 

12,634,211

 

48,351,860

 

34,389,943

 

 

 

 

 

 

 

 

 

 

 

Pre-opening

 

732,679

 

866,193

 

1,244,861

 

1,940,567

 

General and administrative

 

2,050,251

 

1,640,752

 

5,689,249

 

4,711,686

 

Depreciation and amortization

 

1,159,885

 

877,988

 

3,402,613

 

2,444,933

 

 

 

 

 

 

 

 

 

 

 

Operating loss

 

(1,430,791

)

(991,079

)

(2,468,397

)

(2,149,627

)

 

 

 

 

 

 

 

 

 

 

Interest:

 

 

 

 

 

 

 

 

 

Income

 

87,131

 

16,803

 

189,616

 

72,967

 

Expense

 

(910,637

)

(607,890

)

(2,813,915

)

(1,669,567

)

Net interest expense

 

(823,506

)

(591,087

)

(2,624,299

)

(1,596,600

)

 

 

 

 

 

 

 

 

 

 

Loss before income tax

 

(2,254,297

)

(1,582,166

)

(5,092,696

)

(3,746,227

)

Income tax provision

 

(5,157

)

(10,110

)

(10,105

)

(10,610

)

Net loss

 

$

(2,259,454

)

$

(1,592,276

)

$

(5,102,801

)

$

(3,756,837

)

 

 

 

 

 

 

 

 

 

 

Loss per common share, basic and diluted

 

$

(0.14

)

$

(0.12

)

$

(0.33

)

$

(0.28

)

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding, basic and diluted

 

16,038,302

 

13,242,173

 

15,329,517

 

13,231,742

 

 

See notes to condensed consolidated financial statements.

 

2



 

GRANITE CITY FOOD & BREWERY LTD.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Thirty-nine Weeks Ended

 

 

 

September 25,
2007

 

September 26,
2006

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(5,102,801

)

$

(3,756,837

)

Adjustments to reconcile net loss to net cash  used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

3,402,613

 

2,444,933

 

Stock option compensation expense

 

786,994

 

550,848

 

Loss on disposal of asset

 

89,525

 

2,746

 

Deferred rent

 

514,380

 

356,168

 

Changes in operating assets and liabilities:

 

 

 

 

 

Inventory

 

(25,992

)

(133,826

)

Prepaids and other

 

(75,502

)

(937,712

)

Accounts payable

 

(162,028

)

900,277

 

Accrued expenses

 

(790,806

)

132,740

 

Net cash used in operating activities

 

(1,363,617

)

(440,663

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of:

 

 

 

 

 

Property and equipment

 

(5,634,505

)

(5,673,006

)

Intangible assets and other

 

(16,395

)

(131,419

)

Net cash used in investing activities

 

(5,650,900

)

(5,804,425

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Payments on capital lease obligations

 

(6,787,174

)

(642,087

)

Payments on long term-debt

 

(182,037

)

(177,907

)

Proceeds (cost incurred) from issuance of stock

 

12,795,966

 

(9,443

)

Net cash provided by (used in) financing activities

 

5,826,755

 

(829,437

)

 

 

 

 

 

 

Net decrease in cash

 

(1,187,762

)

(7,074,525

)

Cash and cash equivalents, beginning

 

7,671,750

 

9,836,231

 

Cash and cash equivalents, ending

 

$

6,483,988

 

$

2,761,706

 

 

 

 

 

 

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

Land, buildings and equipment acquired under capital lease agreements

 

$

2,312,088

 

$

8,053,638

 

Property and equipment, intangibles and stock issuance costs included in accounts payable

 

$

2,634,067

 

$

1,602,251

 

Income taxes paid

 

$

10,105

 

$

10,610

 

 

See notes to condensed consolidated financial statements.

 

3



 

GRANITE CITY FOOD & BREWERY LTD.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Thirteen and Thirty-nine weeks ended September 25, 2007 and September 26, 2006

 

1.     Summary of significant accounting policies

 

Background

Granite City Food & Brewery Ltd. (the “Company”) develops and operates Modern American casual dining restaurants known as Granite City Food & Brewery®.   The restaurant theme is upscale casual dining with a wide variety of menu items that are prepared fresh daily, combined with freshly brewed hand-crafted beers finished on-site.  The first Granite City restaurant opened in St. Cloud, Minnesota in July 1999 and the Company subsequently expanded to other Midwest markets, opening its 21st restaurant on October 30, 2007.  The Company also operates a beer production facility which is used to provide raw material support to its restaurants to create consistent quality and operational efficiencies in the production of its proprietary beer.  In 2007, the Company was granted a patent by the United States Patent Office for its brewing process.

 

The Company’s expansion strategy focuses on development of restaurants in markets where management believes the Company’s concept will have broad appeal and attractive restaurant-level economics.

 

Principles of consolidation and presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and regulations of the Securities and Exchange Commission.  Accordingly, they do not include all the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  These statements include the accounts and operations of the Company and its subsidiary corporations under which its Kansas locations are operated.  Fifty-one percent of the stock of each of the subsidiary corporations is owned by a resident of Kansas and the Company owns the remainder of the stock of each corporation.  Each resident-owner of the stock of these entities has entered into a buy-sell agreement with each corporation providing, among other things, that transfer of the shares is restricted and that the shareholder must sell his shares to the corporation upon certain events, including termination of employment (if employed by the Company) or any event which disqualifies the resident-owner from owning the shares under applicable laws and regulations of the state.  The Company has entered into a master agreement with each separate corporation that permits the operation of the restaurants and leases to each corporation the Company’s property and facilities.  Each corporation pays all of its operating expenses and obligations, and the Company retains, as consideration for the operating arrangements and the lease of property and facilities, the net profit from its operations.  The Company has determined that the foregoing ownership structure will cause these separate corporations to be treated as variable interest entities in which the Company has a controlling financial interest for the purpose of FASB Interpretation 46 (R), Consolidation of Variable Interest Entities.  As such, the corporations are consolidated with the Company’s financial statements and the Company’s financial statements do not reflect a minority ownership in those separate corporations.  All references to the Company in these financial statements relate to the consolidated entity.

 

In the opinion of management, all adjustments, consisting of normal recurring adjustments, which are necessary for a fair statement of its financial position as of September 25, 2007 and the results of operations for the interim periods ended September 25, 2007 and September 26, 2006 have been included.

 

The balance sheet at December 26, 2006, has been derived from the audited financial statements at that date, but does not include all of the information and notes required by generally accepted accounting principles for complete financial statements.  Certain information and note disclosures normally included in the Company’s annual financial statements have been condensed or omitted.  These condensed financial statements should be

 

4



 

read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 26, 2006, filed with the Securities and Exchange Commission on February 21, 2007.

 

The results of operations for the thirty-nine weeks ended September 25, 2007 are not necessarily indicative of the results to be expected for the entire year.

 

Reclassification

Certain reclassifications have been made to the financial statements for the third quarter and first three quarters of 2006 in order for them to conform to the presentation of the financial statements for the third quarter and first three quarters of 2007.  These reclassifications have no effect on the accumulated deficit or net loss previously reported.

 

Revenue recognition

Revenue is derived from the sale of prepared food and beverage and select retail items.  Revenue is recognized at the time of sale and is reported on the Company’s statement of operations net of sales taxes collected.  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 the accompanying consolidated balance sheets.  The Company recognizes gift card breakage amounts based upon historical redemption patterns, which represent the balance of gift cards for which the Company believes the likelihood of redemption by the customer is remote.

Cash and cash equivalents

The Company maintains its cash at financial institutions in Minnesota, South Dakota, Kansas and Ohio.  At times the bank balances exceed the limits insured by federal agencies.  The Company considers all highly liquid instruments with maturities of three months or less at the time of issuance to be cash equivalents.

 

Stock-based compensation

The Company records stock-based compensation in accordance with the provisions of Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard (“SFAS”) No. 123 (revised 2004) (“SFAS 123(R)”), Share-Based Payment, and SEC Staff Accounting Bulletin No. 107 (“SAB 107”), Share-Based Payment, requiring the measurement and recognition of all share-based compensation under the fair value method.  The Company implemented SFAS 123(R) using the modified prospective method, effective December 28, 2005, the first day of its 2006 fiscal year.

 

Accounting for leases

The Company leases most of its restaurant properties.  Leases are accounted for under the provisions of SFAS No. 13 and SFAS No. 98, Accounting for Leases, as well as other subsequent amendments and authoritative literature including FASB Staff Position No. FAS 13-1, Accounting for Rental Costs Incurred During a Construction Period.  For leases that contain rent escalations, the Company records the total rent payable during the lease term on a straight-line basis over the initial lease term, including the “build-out” or “rent-holiday” period where no rent payments are typically due under the terms of the lease.  Any difference between minimum rent and straight-line rent is recorded as deferred rent.  Contingent rent expense, which is based on a percentage of revenue, is also recorded to the extent it exceeds minimum base rent per the lease agreement.  Deferred rent also includes a tenant improvement allowance the Company received which is being amortized as a reduction of rent expense on a straight-line basis over the initial term of the lease.

Earnings (loss) per share

Basic loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding in each respective fiscal period.

 

5



 

Recent accounting pronouncements

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48,”) which clarifies the accounting and disclosures for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.”  FIN 48 also provides guidance on the de-recognition of uncertain tax positions, financial statement classification, accounting for interest and penalties, accounting for interim periods and adds new disclosure requirements.  The adoption of FIN 48 did not have a material impact on the Company’s financial statements or disclosures.  As of December 26, 2006 and September 25, 2007 the Company did not recognize any assets or liabilities for unrecognized tax benefits relative to uncertain tax positions.  Upon review of the Company’s net operating loss carryforwards, management believes it is more likely than not that the Company’s tax positions taken will be sustained.  Any interest or penalties resulting from examinations will be recognized as a component of the income tax provision.  However, since there are no unrecognized tax benefits as a result of tax positions taken, there are no accrued interest and penalties.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”).  SFAS 157 provides guidance for using fair value to measure assets and liabilities.  The standard expands required disclosures about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 is effective for fiscal years beginning after November 15, 2007.  The Company is currently evaluating the impact of adopting SFAS 157 on its consolidated financial statements.

In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities (as amended (“SFAS 159”), which permits entities to choose to measure many financial instruments and certain other items at fair value.  The standard provides companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.  The provisions of SFAS 159 are effective for fiscal years beginning after November 15, 2007.  The Company is currently evaluating the impact of adopting SFAS 159 on its financial statements.

In May 2007, the FASB issued FASB Staff Position No. FIN 48-1, Definition of Settlement in FASB Interpretation No. 48 (the “FSP”).  The FSP provides guidance about how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits.  Under the FSP, a tax position could be effectively settled on completion of examination by a taxing authority if the entity does not intend to appeal or litigate the result and it is remote that the taxing authority would examine or re-examine the tax position.  Application of the FSP was upon the initial adoption date of FIN 48.  The FSP did not have a material impact on the Company’s consolidated financial statements.

2.              Non-current assets

 

Property and equipment

Property and equipment are recorded at cost and depreciated over the estimated useful lives of the related assets.  The cost of leasehold improvements is depreciated over the initial term of the related lease.  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.  The following is a summary of the Company’s property and equipment at September 25, 2007 and December 26, 2006:

 

6



 

 

 

September 25, 2007

 

December 26, 2006

 

 

 

 

 

 

 

 

 

$

18,000

 

$

18,000

 

Buildings

 

36,111,702

 

33,851,945

 

Leasehold improvements

 

8,325,161

 

8,220,963

 

Equipment and furniture

 

22,565,116

 

20,728,013

 

Construction in progress*

 

6,843,947

 

624,422

 

 

 

73,863,926

 

63,443,343

 

Less accumulated depreciation

 

12,757,131

 

9,425,219

 

 

 

$

61,106,795

 

$

54,018,124

 


*Construction in progress includes the following approximate amounts for items yet to be placed in service:

 

 

 

September 25, 2007

 

December 26, 2006

 

Architecture fees for future locations

 

$

410,000

 

$

100,000

 

Equipment at future locations

 

6,340,000

 

400,000

 

Equipment at the beer production facility

 

 

125,000

 

Cost to secure property leases at future locations

 

95,000

 

 

 

Included in property and equipment are the following assets held under capital leases:

 

 

 

September 25, 2007

 

December 26, 2006

 

Land

 

$

18,000

 

$

18,000

 

Building

 

36,123,702

 

33,851,945

 

Equipment and leasehold improvements

 

1,654,864

 

7,807,724

 

 

 

37,796,566

 

41,677,669

 

Less accumulated depreciation

 

4,836,946

 

3,718,654

 

 

 

$

32,959,620

 

$

37,959,015

 

 

Intangible assets and other

            Intangible assets and other assets consisted of the following:

 

 

 

September 25, 2007

 

December 26, 2006

 

Intangible assets:

 

 

 

 

 

Liquor licenses

 

$

264,415

 

$

264,415

 

Trademarks

 

132,671

 

109,741

 

Other:

 

 

 

 

 

Capitalized loan costs

 

250,379

 

205,054

 

Security deposits

 

271,017

 

279,427

 

 

 

918,482

 

858,637

 

Less accumulated amortization

 

122,927

 

98,217

 

 

 

$

795,555

 

$

760,420

 

 

7



 

 

3.        Accrued expenses

 

Accrued expenses consisted of the following:

 

 

 

September 25, 2007

 

December 26, 2006

 

Payroll related

 

$

1,639,746

 

$

2,205,712

 

Deferred revenue from gift cards

 

928,634

 

1,355,773

 

Sales taxes

 

568,043

 

493,772

 

Interest

 

297,732

 

278,131

 

Real estate taxes

 

376,159

 

245,299

 

Insurance

 

 

89,646

 

Other

 

503,610

 

436,397

 

 

 

$

4,313,924

 

$

5,104,730

 

 

4.        Long-term debt

 

As of the end of the third quarter of fiscal year 2007, the Company had two outstanding long-term loans with an independent financial institution for the purchase of equipment for its restaurants located in Des Moines and Davenport.  These loans are secured only by the personal property and fixture property at the respective locations.  In addition to these two loan agreements, the Company has a long-term loan outstanding with the same independent financial institution secured by the tangible personal property and fixtures at the Fargo restaurant.  Such loan is guaranteed by Steven J. Wagenheim, the Company’s president, chief executive officer and one of its directors.  As of September 25, 2007, the balances, interest rates and maturity dates of these loans were:

 

 

 

Des Moines

 

Davenport

 

Fargo

 

Loan balance

 

$373,172

 

$409,520

 

$1,300,197

 

Annual interest rate

 

10.25%

 

10.25%

 

8.75%

 

Maturity date

 

August 27, 2010

 

January 6, 2011

 

August 15, 2011

 

 

5.        Capital leases

 

In March 2007, the Company completed a private placement of common stock to accredited investors described in Note 7 below.  Utilizing approximately $6.0 million of these proceeds, the Company retired the entire balance of capital lease debt due DHW Leasing, L.L.C. (“DHW”) pursuant to the master lease agreement entered into in September 2006.

 

Minimum future lease payments under all capital leases as of September 25, 2007 are:

 

 

 

Capital

 

Year ended:

 

Leases

 

2007

 

$

1,110,333

 

2008

 

4,366,113

 

2009

 

4,313,324

 

2010

 

4,137,121

 

2011

 

4,027,598

 

Thereafter

 

57,927,763

 

Total minimum lease payments

 

75,882,252

 

 

 

 

 

Less amount representing interest

 

40,970,345

 

Present value of net minimum lease payments

 

34,911,907

 

Less current portion

 

976,287

 

Long-term portion of obligations

 

$

33,935,620

 

 

8



 

Amortization expense related to the assets held under capital leases is included with depreciation expense on the Company’s statements of operations.

 

6.        Commitments and contingencies

 

Litigation

            From time to time, lawsuits are threatened or filed against the Company in the ordinary course of business.  Such lawsuits typically involve claims from customers, former or current employees, and others related to issues common to the restaurant industry.  A number of such claims may exist at any given time.  Although there can be no assurance as to the ultimate disposition of these matters, it is management’s opinion, based upon the information available at this time, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the results of operation, liquidity or financial condition of the Company.

 

Rogers, Arkansas and East Peoria, Illinois

In October 2007, the Company commenced 20-year net lease agreements relating to restaurants it opened in Rogers, Arkansas and East Peoria, Illinois under the terms specified in the development agreement with Dunham Capital Management L.L.C. (“Dunham”) for the development of restaurants.  Each restaurant was constructed for the Company on a build-to-suit basis.  The annual rent of each is equal to 10.5% of the construction cost including land cost and escalates 10% at the end of each five-year period.  The Company is responsible for any real-estate taxes and all operating costs.  The term of each lease commenced when operations began and may be extended at the Company’s option for up to five additional five-year periods on the same terms and conditions.  The portion of the rent related to the land of each lease will be classified as an operating lease while the building portion of each will be classified as a capital lease.  Rental costs associated with these operating leases incurred during the construction period were recognized as pre-opening costs and escalating rent will be recognized as expense on a straight-line basis over the terms of the leases.

 

Orland Park, Illinois and Creve Coeur, Missouri

In February and June 2007, the Company entered into 20-year net lease agreements relating to restaurants it anticipates opening during the fourth quarter of 2007 in Orland Park, Illinois and Creve Coeur, Missouri, respectively, under the terms specified in the development agreement with Dunham.  Each restaurant will be constructed for the Company on a build-to-suit basis.  The annual rent of each will be equal to 10.5% of the construction cost including land cost and will escalate 10% at the end of each five-year period.  The Company will be responsible for any real-estate taxes and all operating costs.  The term of each lease will commence when operations begin and may be extended at the Company’s option for up to five additional five-year periods on the same terms and conditions.  Rental costs associated with the operating leases incurred during the construction period are recognized as pre-opening costs and escalated rent will be recognized as expense on a straight-line basis over the term of the leases.

 

Woodbury, Minnesota

In April 2007, the Company entered into a development agreement and a 20-year net lease with an independent third party relating to the restaurant it plans to open in Woodbury, Minnesota.  The restaurant will be constructed on a build-to-suit basis and the annual rent will be equal to 10.5% of the total construction cost.  The Company will be responsible for any real-estate taxes and all operating costs.  The lease may be extended at the Company’s option for up to four additional five-year periods on the same terms and conditions, except the rent may increase based on a formula using the Consumer Price Index during any such extension.  Rental costs associated with the operating lease incurred during the construction period are recognized as pre-opening costs and escalated rent will be recognized as expense on a straight-line basis over the term of the lease.

 

Toledo, Ohio and Ft. Wayne, Indiana

In August 2007, the Company entered into 20-year net lease agreements relating to restaurants it anticipates opening in Ft. Wayne, Indiana in the fourth quarter of 2007 and in Toledo, Ohio in the first quarter of 2008

 

9



 

under the terms specified in the development agreement with Dunham.  The restaurants will be constructed for the Company on a build-to-suit basis.  Basic terms of the leases include annual rent equal to 10.5% of the construction cost plus the land lease and percentage rent.  The base rent will escalate 10% at the end of each five-year period.  The term of each lease will commence when operations begin and the Company will be responsible for any real-estate taxes and all operating costs.  Rental costs associated with the operating lease incurred during the construction period are recognized as pre-opening costs and escalated rent will be recognized as expense on a straight-line basis over the term of the lease.

 

7.              Common stock

 

Sale of stock

On March 8, 2007, the Company entered into a stock purchase agreement with accredited investors under which it sold 2,617,334 shares of common stock at a price of $5.35 per share.  The Company obtained gross proceeds of $14,002,737, paid its placement agents cash commissions aggregating $1,050,205 and paid expenses aggregating $181,675.  Pursuant to the conditions of the stock purchase agreement, the Company used approximately $6.0 million of the $12,770,857 net proceeds to retire the entire balance of equipment lease debt obtained from DHW pursuant to the master lease agreement entered into in September 2006.  The members of DHW are Donald A. Dunham, Charles J. Hey and Steven J. Wagenheim.  Mr. Wagenheim is the Company’s president, chief executive officer and one of its directors.  Mr. Wagenheim owns a 20% membership interest in DHW and personally guaranteed 20% of DHW’s indebtedness to its lenders. The remaining net proceeds from this placement are being used to fund expansion of the Company’s restaurant operations.

 

Exercise of warrants and options

On April 3, 2007, the Company issued 4,102 shares of common stock upon the cashless exercise of a warrant for the purchase of 5,538 shares of common stock originally issued November 27, 2002 to one of the agents for the Company’s private placement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise price of $1.58 per share and an expiration date of November 27, 2007.

 

On May 2, 2007, the Company issued 19,353 shares of common stock upon the cashless exercise of a warrant for the purchase of 25,842 shares of common stock originally issued December 20, 2002 to one of the agents for the Company’s private placement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise price of $1.58 per share and an expiration date of December 20, 2007.

 

On May 21, 2007, an employee of the Company exercised a stock option for the purchase of 700 shares of common stock at an exercise price of $4.31 per share.  The foregoing option was issued pursuant to the Company’s 2002 Equity Incentive Plan and had an expiration date of March 15, 2015.

 

On May 22, 2007, an employee of the Company exercised a stock option for the purchase of 2,500 shares of common stock at an exercise price of $1.65 per share.  The foregoing option was issued outside the Company’s plans and had an expiration date of December 26, 2011.

 

On August 8, 2007, the Company issued 26,302 shares of common stock upon the cashless exercise of a warrant for the purchase of 38,170 shares of common stock originally issued October 1, 2002 to one of the agents for its private placement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise price of $1.58 per share and an expiration date of October 1, 2007.

 

On August 8, 2007, the Company issued 3,543 shares of common stock upon the cashless exercise of a warrant for the purchase of 5,142 shares of common stock originally issued November 27, 2002 to one of the agents for its private placement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise price of $1.58 per share and an expiration date of November 27, 2007.

 

10



 

On August 9, 2007, a director of the Company exercised a stock option for the purchase of 15,000 shares of common stock at an exercise price of $1.26 per share.  These options were issued pursuant to the 1997 Director Stock Option Plan and had an expiration date of August 18, 2007.

 

8.              Stock plans

 

In July 1997, the Company adopted the 1997 Stock Option Plan for employees and non-employees, including consultants to the Company, to purchase the Company’s common stock at an exercise price that equals or exceeds the fair market value on the date of grant.   As of September 25, 2007, options to purchase 316,500 shares of common stock were outstanding under the plan.  No additional options will be issued pursuant to the terms of this plan which expired July 28, 2007.  All options outstanding under this plan are fully vested and are exercisable for ten years from the date of grant.

 

As of September 25, 2007, options to purchase 330,000 shares of common stock were outstanding under the 1997 Director Stock Option Plan (“DSOP”).  No additional options will be issued pursuant to the terms of this plan which expired July 29, 2007.  Under this plan, the Company automatically granted an option to each outside director on the date such person became a director for the purchase of 15,000 shares of common stock and thereafter on each successive anniversary of the grant of the first option for the purchase of 15,000 shares.  Each option vests one year after the option was granted and is exercisable for five years from the date of grant. Options were granted at fair market value.  On May 2, 2007, the Company’s board of directors agreed that until the adoption of any future equity plan for non-employee directors, award of stock options for the purchase of 15,000 shares of common stock per year should continue to be made to each non-employee director on the anniversary of his election to the Board under the 2002 Equity Incentive Plan.  The board further resolved that such awards are to have the same terms and conditions as those made under the DSOP; provided, however, that they are to be exercisable for a period of ten years rather than five years.

 

In August 2002, the Company adopted the 2002 Equity Incentive Plan for employees, prospective employees, officers and members of the Company’s board of directors, as well as consultants and advisors to the Company, to purchase shares of the Company’s common stock at an exercise price that equals or exceeds the fair market value on the date of grant.  The number of shares authorized for issuance as of September 25, 2007 was 1,826,264, of which 286,264 shares remained available for future issuance and 1,464,300 were outstanding.  Although vesting schedules may vary, option grants under this plan generally vest evenly over a three or four-year period and options are exercisable for no more than ten years from the date of grant.  On October 30, 2007, our shareholders approved an amendment to this plan that increased the total number of shares for which awards may be granted by 500,000.

 

A summary of the status of the Company’s stock options as of September 25, 2007 is presented below:

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

Weighted

 

Average

 

Aggregate

 

 

 

 

 

Average

 

Remaining

 

Intrinsic

 

Fixed Options

 

Shares

 

Exercise Price

 

Contractual Life

 

Value

 

Outstanding at December 26, 2006

 

1,595,000

 

$

3.70

 

6.1 years

 

 

 

Granted

 

613,000

 

5.28

 

6.8 years

 

 

 

Exercised

 

(18,200

)

1.43

 

 

 

 

Forfeited

 

(30,000

)

5.17

 

 

 

 

Outstanding at September 25, 2007

 

2,159,800

 

$

4.15

 

5.8 years

 

$

933,002

 

 

 

 

 

 

 

 

 

 

 

Options exercisable at December 26, 2006

 

1,076,502

 

$

3.46

 

5.6 years

 

 

 

Options exercisable at September 25, 2007

 

1,467,804

 

$

3.69

 

5.5 years

 

$

890,552

 

 

 

 

 

 

 

 

 

 

 

Weighted-average fair value of options granted during 2007

 

$

3.43

 

 

 

 

 

 

 

 

11



 

The fair value of options at date of grant was estimated using the Black-Scholes option pricing model with the following assumptions:  (a) no dividend yield, (b) 58.13% to 66.86% expected volatility, (c) expected life of options of five to ten years and (d) a risk-free interest rate of 4.46% to 4.80%.

 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the closing price of the Company’s stock on September 25, 2007 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 25, 2007.  As of September 25, 2007, there was approximately $1,590,431 of total unrecognized compensation cost related to unvested share-based compensation arrangements, of which $320,535 is expected to be recognized during the remainder of fiscal year 2007, $761,572 in fiscal year 2008, $419,293 in fiscal year 2009, $75,825 in fiscal year 2010 and $13,206 in fiscal year 2011.

 

If all options outstanding at September 25, 2007 were exercised for cash, proceeds to the Company would be approximately $9.0 million.

 

The following table summarizes information about stock options outstanding at September 25, 2007:

 

 

 

Options Outstanding

 

Options Exercisable

 

 

 

Number of

 

Weighted

 

 

 

Number of

 

 

 

 

 

Options

 

Average

 

Weighted

 

Options

 

Weighted

 

Range of

 

Outstanding

 

Remaining

 

Average

 

Exercisable

 

Average

 

Exercise Prices

 

9/25/2007

 

Contractual Life

 

Exercise Price

 

9/25/2007

 

Exercise Price

 

 

 

 

 

 

 

 

 

 

 

 

 

$ 1.00 - $2.00

 

140,500

 

3.8 years

 

$

1.64

 

140,500

 

$

1.64

 

$ 2.01 - $3.00

 

180,000

 

4.6 years

 

$

2.41

 

180,000

 

$

2.41

 

$ 3.01 - $4.00

 

698,000

 

5.2 years

 

$

3.89

 

591,002

 

$

3.90

 

$ 4.01 - $5.00

 

607,300

 

7.2 years

 

$

4.37

 

526,302

 

$

4.38

 

$ 5.01 - $6.00

 

384,000

 

4.4 years

 

$

5.20

 

30,000

 

$

5.02

 

$ 6.01 - $7.00

 

150,000

 

9.6 years

 

$

6.20

 

 

$

 

Total

 

2,159,800

 

5.8 years

 

$

4.15

 

1,467,804

 

$

3.69

 

 

In November 2002, the Company completed a private placement of Series A Convertible Preferred Stock and warrants to purchase common stock.  As part of the agreement between the Company and its private placement agents, the agents received five-year warrants to purchase an aggregate of 288,604 shares of common stock at an exercise price of $1.58 per share. During the second and third quarters of fiscal year 2007, the Company issued an aggregate of 53,300 shares of common stock upon the cashless exercise of such warrants for the purchase of an aggregate of 74,692 shares of common stock.  As of September 25, 2007, 166,910 of the agent warrants remained exercisable.

 

In May 2003, the Company entered into a two-year financial advisory services agreement. As part of the agreement between the Company and the financial consultant, the consultant received five-year warrants to purchase an aggregate of 35,000 shares of common stock at exercise prices ranging from $2.85 to $5.40 per share.  As of September 25, 2007, none of such warrants had been exercised.

 

12



 

In September 2004, the Company entered into a securities purchase agreement with certain accredited investors for the sale of approximately $8.5 million of common stock and warrants.  Under this agreement, the Company issued five-year warrants for the purchase of 1,045,844 shares of common stock at an exercise price of $5.00 per share.  The Company may call for the mandatory exercise of such warrants if certain conditions are met.  As part of this private placement, the Company sold to its placement agents, for $100, five-year warrants to purchase an aggregate of 130,730 shares of common stock at an exercise price of $5.00 per share.  As of September 25, 2007, none of such warrants had been exercised.

 

In October 2005, the Company entered into a securities purchase agreement with certain accredited investors for the sale of approximately $5.34 million of common stock and warrants.  Under this agreement, the Company issued five-year warrants for the purchase of 221,762 shares of common stock at an exercise price of $6.50 per share to such investors and five-year warrants for the purchase of 55,436 shares of common stock at an exercise price of $6.50 to the Company’s placement agent. As of September 25, 2007, none of such warrants had been exercised.

 

During the first three quarters of fiscal year 2007, no warrants were issued and no warrants expired.  As of September 25, 2007, 1,655,682 were outstanding and exercisable.  The weighted average exercise price of such warrants was $4.88 per share.

 

If all warrants outstanding at September 25, 2007 were exercised for cash, proceeds to the Company would be approximately $8.1 million.

 

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

 

This discussion and analysis contains various non-historical forward-looking statements within the meaning of Section 21E of the Exchange Act.  Although we believe that, in making any such statement, our expectations are based on reasonable assumptions, any such statement may be influenced by factors that could cause actual outcomes and results to be materially different from those projected.  When used in the following discussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,” “estimates” and similar expressions, as they relate to us or our management, are intended to identify such forward-looking statements.  You are cautioned not to attribute undue certainty to such forward-looking statements, which are qualified in their entirety by the cautions and risks described herein.  Please refer to the “Cautionary Statement” section of our Current Report on Form 8-K, filed with the Securities and Exchange Commission on May 4, 2007, for additional factors known to us that may cause actual results to vary.

 

Overview

 

                We are a Modern American upscale casual restaurant chain.  As of November 1, 2007, we operated 21 restaurants in ten Midwestern states featuring on-premises breweries under the name of Granite City Food & Brewery®.  We believe our menu features high quality yet affordable family favorite menu items prepared from made-from-scratch recipes and served in generous portions. We believe that the sophisticated yet unpretentious restaurants, proprietary food and beverage products, attractive price points and high service standards combine for a great dining experience.  The location of each restaurant and the month and year of its opening appear in the following chart:

13



 

Unit

 

Location

 

Opened

 

1

 

St. Cloud, Minnesota

 

Jun-99

 

2

 

Sioux Falls, South Dakota

 

Dec-00

 

3

 

Fargo, North Dakota

 

Nov-01

 

4

 

Des Moines, Iowa

 

Sep-03

 

5

 

Cedar Rapids, Iowa

 

Nov-03

 

6

 

Davenport, Iowa

 

Jan-04

 

7

 

Lincoln, Nebraska

 

May-04

 

8

 

Maple Grove, Minnesota

 

Jun-04

 

9

 

East Wichita, Kansas

 

Jul-05

 

10

 

Eagan, Minnesota

 

Sep-05

 

11

 

Kansas City, Missouri

 

Nov-05

 

12

 

Kansas City, Kansas

 

Jan-06

 

13

 

Olathe, Kansas

 

Mar-06

 

14

 

West Wichita, Kansas

 

Jul-06

 

15

 

St. Louis Park, Minnesota

 

Sep-06

 

16

 

Omaha, Nebraska

 

Oct-06

 

17

 

Roseville, Minnesota

 

Nov-06

 

18

 

Madison, Wisconsin

 

Dec-06

 

19

 

Rockford, Illinois

 

Jul-07

 

20

 

Rogers, Arkansas

 

Oct-07

 

21

 

East Peoria, Illinois

 

Oct-07

 

 

We developed the foregoing restaurants using proceeds from the sale of our securities, building and equipment financing and cash flow from operations.  We built units 4-9, 11-14 and 16-21 based upon the prototype we developed in early 2003.  In 2004 and 2005, we retrofitted units 1-3 to conform to this prototype model.  In 2005 and 2006, we developed units 10 and 15, respectively, which were conversions of existing restaurants.  With the exception of units 1-3 and 15, we developed all of our units under our multi-site development agreement with a commercial developer that provides us with assistance in site selection, construction management and financing for new restaurants.  Under this agreement, we lease the land and building of each new restaurant from our developer.

In March 2007, we entered into a stock purchase agreement with accredited investors under which we sold 2,617,334 shares of common stock at a price of $5.35 per share.  We obtained gross proceeds of $14,002,737, paid our placement agents cash commissions aggregating $1,050,205 and paid expenses aggregating $181,675.  Pursuant to the conditions of the stock purchase agreement, we used approximately $6.0 million of the $12,770,857 net proceeds to retire the entire balance of equipment lease debt we had obtained from DHW pursuant to the master lease agreement we entered into in September 2006.  The members of DHW are Donald A. Dunham, Charles J. Hey and Steven J. Wagenheim.  Mr. Wagenheim is our company’s president, chief executive officer and one of its directors.  Mr. Wagenheim owns a 20% membership interest in DHW and personally guaranteed 20% of DHW’s indebtedness to its lenders.  The remaining net proceeds from this placement are being used to fund the expansion of our restaurant operations.

We operate a beer production facility which facilitates the initial stage of our brewing process using our patented brewing process.  We believe that this brewing process, which we refer to as “Beverage Leverage,” and the use of a centrally located beer production facility improve the economics of microbrewing as they eliminate the initial stages of brewing and storage at multiple locations, thereby reducing equipment and development costs at new restaurant locations.  Additionally, having a common starting point, the beer production creates consistency of taste for our product from unit to unit.  The initial product produced at our beer production facility is transported by truck to the fermentation vessels at each of our restaurants where the brewing process is

 

14



 

completed. In 2007, we were granted a patent by the United States Patent Office for this brewing process. We believe that our current beer production facility, which opened in June 2005, has the capacity to service up to 35 restaurant locations.

 

We operate Granite City University, where the training of each of our managers takes place under the instruction of full-time, dedicated trainers.  Our eight-week training program consists of both “hands on” as well as classroom training for all aspects of management.  All salaries of our managers in training and our trainers as well as all related costs incurred at Granite City University are recorded as a component of corporate general and administrative costs.

We utilize a new store opening team which consists of experienced restaurant managers who are dedicated to the opening of our new restaurants.  Generally, this team arrives at a new restaurant site two to three months in advance of the restaurant opening date and coordinates all staffing and training matters for that new restaurant.  We believe that a dedicated team delivers a more disciplined opening process and ensures adherence to our company’s exacting standards and culture.

We believe that our operating results will fluctuate significantly because of several factors, including the timing of new restaurant openings and related expenses, profitability of new 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, competitive factors, the skill and experience of our restaurant-level management teams and weather conditions.

We expect the timing of new restaurant openings to have a significant impact on restaurant revenues and costs.  We believe we will incur the most significant portion of pre-opening costs associated with a new restaurant within the two months immediately preceding, and the month of, the opening of such restaurant.

The thirteen and thirty-nine weeks ended September 25, 2007 included 246 and 714 restaurant weeks, respectively, which is the sum of the actual number of weeks each restaurant operated. The thirteen and thirty-nine weeks ended September 25, 2006 included ­­­180 and 500 restaurant weeks, respectively.  The source of the additional restaurant weeks in fiscal year 2007 is shown in the following chart:

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

Location

 

September 25, 2007

 

September 25,2007

Kansas City, Kansas

 

0

 

5

Olathe, Kansas

 

0

 

13

West Wichita

 

3

 

29

St. Louis Park, Minnesota

 

12

 

38

Omaha, Nebraska

 

13

 

39

Roseville, Minnesota

 

13

 

39

Madison, Wisconsin

 

13

 

39

Rockford, Illinois

 

12

 

12

Total Additional Restaurant Weeks

 

66

 

214

 

Because we continue to expand our operations and open new restaurants at various times throughout the year, we provide this statistical measure to enhance the comparison of revenues from period to period as changes occur in the number of units we are operating.

Our restaurant revenues are comprised almost entirely of the sales of food and beverages.  The sale of retail items, such as cigarettes and promotional items, typically represents less than 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. 

 

15



 

Pre-opening costs consist of direct costs related to hiring and training the initial restaurant workforce, the salaries and related costs of our dedicated new store opening team, rent expense incurred during the construction period and 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. 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 net of interest income on invested assets.

 

Results of operations as a percentage of sales

The following table compares operating results expressed as a percentage of total revenue for the thirteen and thirty-nine weeks ended September 25, 2007 and September 26, 2006.

 

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

 

 

September 25,

 

September 26

 

September 25,

 

September 26

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Restaurant revenues

 

100.0

%

100.0

%

100.0

%

100.0

%

 

 

 

 

 

 

 

 

 

 

Cost of sales:

 

 

 

 

 

 

 

 

 

Food, beverage and retail

 

30.5

 

30.1

 

30.0

 

29.7

 

Labor

 

36.0

 

36.0

 

35.9

 

35.5

 

Direct restaurant operating

 

14.5

 

12.4

 

13.8

 

12.3

 

Occupancy

 

6.2

 

5.7

 

6.2

 

5.6

 

Total cost of sales

 

87.2

 

84.1

 

86.0

 

83.2

 

 

 

 

 

 

 

 

 

 

 

Pre-opening

 

3.7

 

5.8

 

2.2

 

4.7

 

General and administrative

 

10.5

 

10.9

 

10.1

 

11.4

 

Depreciation and amortization

 

5.9

 

5.8

 

6.1

 

5.9

 

 

 

 

 

 

 

 

 

 

 

Operating loss

 

(7.3

)

(6.6

)

(4.4

)

(5.2

)

 

 

 

 

 

 

 

 

 

 

Interest:

 

 

 

 

 

 

 

 

 

Income

 

0.4

 

0.1

 

0.3

 

0.2

 

Expense

 

(4.6

)

(4.0

)

(5.0

)

(4.0

)

Net interest expense

 

(4.2

)

(3.9

)

(4.7

)

(3.9

)

 

 

 

 

 

 

 

 

 

 

Net loss

 

(11.5

)%

(10.5

)%

(9.1

)%

(9.1

)%

 

Certain percentage amounts do not sum due to rounding.

 

Results of operations for the thirteen and thirty-nine weeks ended September 25, 2007 and September 26, 2006

 

Revenue

 

We generated $19,584,040 and $15,028,065 of revenues during the third quarter of 2007 and 2006, respectively. This 30.3% increase was primarily the result of 66 additional operating weeks, which is the sum of the actual number of weeks each restaurant operated, due to the five restaurants we opened during the third and

 

16



 

fourth quarters of 2006 and the restaurant we opened in Rockford in the third quarter of 2007. Comparable restaurant revenues, which include restaurants in operation over 18 months, increased 2.7% from the third quarter of 2006 to the third quarter of 2007 primarily due to a 2.1% price increase that took effect in late November 2006. Average weekly revenue per comparable restaurant increased $2,168 from $81,542 in the third quarter of 2006 to $83,710 in the third quarter of 2007.

 

During the first three quarters of 2007 and 2006, we generated revenues of $56,220,186 and $41,337,502, respectively.  The increase in first three quarters revenues of 36.0% was primarily the result of the additional restaurant operating weeks related to the five restaurants that opened during the third and fourth quarters of 2006.  The first three quarters of 2007 included 714 restaurant operating weeks, while the first three quarters of 2006 included 500 operating weeks.  Comparable restaurant revenues increased 2.5% in the first three quarters of 2007 over the first three quarters of 2006.  The increase in comparable restaurant revenues was due primarily to a 2.1% price increase that took effect in late November 2006.  Average weekly revenue per comparable restaurant increased $1,725 from $80,755 in the first three quarters of 2006 to $82,480 in the first three quarters of 2007.

We anticipate that restaurant revenues will vary from quarter to quarter.  We anticipate seasonal fluctuations in restaurant revenues due in part to increased outdoor seating and generally favorable weather conditions at many of our locations during the summer months.   Due to the honeymoon effect that periodically occurs with the opening of a restaurant, we expect the timing of new restaurant openings to cause fluctuations in restaurant revenues.  Additionally, consumer confidence in the economy and changes in consumer preferences may affect our future revenues.

Restaurant costs

Food and beverage

Our food and beverage costs increased 0.4% as a percentage of revenue from 30.1% in the third quarter of 2006 to 30.5% in the third quarter of 2007.  These costs increased 0.3% as a percentage of revenue from 29.7% in the first three quarters of 2006 to 30.0% in the first three quarters of 2007.  Food and beverage costs increased as a percentage of revenues largely due to the increase in the cost of meat and dairy.

We expect that our food and beverage costs will vary going forward due to numerous variables, including seasonal changes in food and beverage costs, and guest preferences.  We periodically create new menu offerings and introduce new craft brewed beers based upon guest preferences.  Although such menu modifications may temporarily result in increased food and beverage cost, we believe we are able to offset such increases with our weekly specials which provide variety and value to our guests.  Our varieties of craft brewed beer, which we believe we can produce at 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.  We expect food and beverage costs at our newer restaurants to be higher initially due to inefficiencies that are part of the start-up process of a new restaurant.  However, as we open additional restaurants, we believe we will experience increased purchasing power company-wide, partially offsetting food and beverage cost increases, thereby enabling us to maintain or reduce our food and beverage costs as a percentage of revenue.  Additionally, as we add new restaurants, we believe our Beverage Leverage brewing process will allow us to keep our high quality beer products intact while leveraging our fixed production costs, thereby enhancing overall profitability.

Labor

Labor expenses consist of restaurant management salaries, hourly staff payroll costs, other payroll-related items including partner and 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 revenues.

 

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Our labor costs, as a percentage of revenues, remained steady at 36.0% in the third quarter of 2007 and 2006.  These costs increased 0.4% as a percentage of revenues from 35.5% in the first three quarters of 2006 to 35.9% in the first three quarters of 2007 due in part to minimum wage increases which took effect at some of our markets in the second quarter 2007 and non-cash stock-based compensation of $34,190 and $116,258 in the third quarter and first three quarters of 2007, respectively, resulting from stock options issued in the first three quarters of 2007.

We expect that labor costs will vary as we add new restaurants.  Minimum wage laws, local labor laws and practices, as well as unemployment rates vary from state to state and will affect our labor costs, as will hiring and training expenses at our new units.  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 expenses, a substantial portion of which is fixed or indirectly variable.  Our direct restaurant operating expenses as a percentage of revenue increased 2.1% from 12.4% in the third quarter of 2006 to 14.5% in the third quarter of 2007.  These expenses increased 1.5% as a percentage of revenues from 12.3% in the first three quarters of 2006 to 13.8% in the first three quarters of 2007.  We experienced an increase in expenses related to hiring and training, janitorial and guest supplies, advertising and promotions and loss on disposal of assets attributable to certain upgrades primarily at our mature properties.

Occupancy

Our occupancy costs, which include both fixed and variable portions of rent, common area maintenance charges, property insurance and property taxes, increased 0.5% as a percentage of revenues from 5.7% in the third quarter of 2006 to 6.2% in the third quarter of 2007.  These costs increased 0.6% as a percentage of revenues from 5.6% in the first three quarters of 2006 to 6.2% in the first three quarters of 2007.  These increases were due to higher rent expense and property tax, offset in part by a decrease in property and casualty insurance.

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 our dedicated new store opening teams, rental costs incurred during the construction period and certain other direct costs associated with opening new restaurants.  Pre-opening costs, excluding construction-period rent, are primarily incurred in the month of, and two months prior to, the restaurant opening.

Pre-opening costs decreased $133,514 from $866,193 in the third quarter of 2006 to $732,679 in the third quarter of 2007.  Included in such expense was $236,456 and $197,931 of non-cash rental costs incurred during construction periods in the third quarters of 2007 and 2006, respectively.  Pre-opening costs in the third quarter of 2007 were made up primarily of costs incurred during construction periods of the restaurants we opened in Rockford in July 2007 and Rogers and East Peoria in October 2007 as well as the restaurants we plan to open later this year in Orland Park and Creve Coeur.  Pre-opening costs in the third quarter of 2006 related primarily to the two restaurant we opened in the third quarter and three opened in the fourth quarters of that year.  Pre-opening costs decreased $695,706 from $1,940,567 in the first three quarters of 2006 to $1,244,861 in the first three quarters of 2007.  Included in such expense was $505,149 and $420,086 of non-cash rental costs incurred during construction periods in the first three quarters of 2007 and 2006, respectively.

General and administrative

General and administrative expenses include all salaries and benefits, including non-cash stock-based compensation, associated with our corporate staff that is responsible for overall restaurant quality, future expansion into new locations, financial controls and reporting, restaurant management recruiting, training at

 

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Granite City University, excess capacity costs related to our beer production facility, and salaries and expenses of our new store opening team when it is not dedicated to a particular restaurant opening. Other general and administrative expenses also include advertising, professional fees, investor relations, office administration, centralized accounting system costs, and travel by our corporate management.

 

General and administrative expenses increased $409,499 from $1,640,752 in the third quarter of 2006 to $2,050,251 in the third quarter of 2007.  These expenses increased $977,563 from $4,711,686 in the first three quarters of 2006 to $5,689,249 in the first three quarters of 2007.  The primary sources of such increase were expenses related to stock-based compensation, legal, investor relations, consulting related to compliance with the Sarbanes-Oxley Act, recruiting, insurance and payroll.  These increases were partially offset by decreases in accounting fees, marketing costs and travel expense.  Non-cash stock-based compensation expense included in general and administrative expense was $320,535 and $143,364 in the third quarter of 2007 and 2006, respectively.  Such non-cash expense was $786,994 in the first three quarters of 2007 compared to $550,848 in the same period in 2006.

Despite the foregoing increases in general and administrative expenses, the increase in restaurant revenues associated with additional locations and the increase in comparable sales caused our general and administrative expenses to decrease 0.4% as a percentage of revenue from 10.9% in the third quarter of 2006 to 10.5% in the third quarter of 2007.  These expenses decreased 1.3% as a percentage of revenue from 11.4% in the first three quarters of 2006 to 10.1% in the first three quarters of 2007.

As we continue to expand our restaurant chain, we expect general and administrative expenses will decrease as a percentage of revenues in the long term due to economies of scale.

Depreciation and amortization

Depreciation and amortization expense increased $281,897 during the third quarter of 2007 compared to the same period in 2006.  These expenses increased $957,680 during the first three quarters of 2007 compared to the first three quarters of 2006, due principally to the additional depreciation related to new restaurants.  As a percentage of revenues, depreciation expense increased as a percentage of revenue by 0.1% and 0.2% for the third quarter and first three quarters of 2007 over the same periods of 2006, respectively.

Interest

Net interest expense consists of interest expense on capital leases and long-term debt, net of interest earned from cash on hand.  Interest expense increased $302,747 from $607,890 in the third quarter of 2006 to $910,637 in the third quarter of 2007, and increased $1,144,348 from $1,669,567 in the first three quarters of 2006 to $2,813,915 in the first three quarters of 2007.  The increases were due to increases in capital leases as a result of additional restaurants.  Interest income increased $70,327 and $116,649 for the third quarter and first three quarters of 2007 over the same periods of 2006, respectively, due to the proceeds from the sale of our common stock in March 2007.

 

Liquidity and capital resources

As of September 25, 2007, we had $6,483,988 of cash and a working capital deficit of $2,980,531 compared to $7,671,750 of cash and a working capital deficit of $1,106,720 at December 26, 2006.

During the thirty-nine weeks ended September 25, 2007, we used $1,363,617 of net cash in operating activities, $5,650,900 of net cash to purchase equipment and other assets primarily related to our new restaurant expansion, and made payments aggregating $6,969,211 on our debt and capital lease obligations.  Of such capital lease payments, approximation $6.0 million represented a one-time payment to retire debt obtained from DHW, as detailed below.  Additionally, we received net cash of $12,795,966 from the issuance of our common stock, of which approximately $25,000 was received from the exercise of options and warrants while the remainder represented the net proceeds from the sale of common stock in March 2007, as detailed below.

 

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During the thirty-nine weeks ended September 26, 2006, we used $440,663 of net cash in operating activities, $5,804,425 in net cash to purchase equipment and other assets primarily for our new restaurants and those restaurants under construction, and made payments aggregating $819,994 on our debt and capital lease obligations.  Additionally, during the first three quarters of 2006, we used $9,443 of cash to pay expenses associated with the issuance of our common stock, net of cash received through the exercise of options.

 

In March 2007, we entered into a stock purchase agreement with accredited investors under which we sold 2,617,334 shares of common stock at a price of $5.35 per share.  We obtained gross proceeds of $14,002,737, paid our placement agents cash commissions aggregating $1,050,205 and paid expenses aggregating $181,675.  Pursuant to the conditions of the stock purchase agreement, we used approximately $6.0 million of the $12,770,857 net proceeds to retire the entire balance of equipment lease debt we had obtained from DHW pursuant to the master lease agreement we entered into in September 2006.  The members of DHW are Donald A. Dunham, Charles J. Hey and Steven J. Wagenheim.  Mr. Wagenheim is our company’s president, chief executive officer and one of its directors.  Mr. Wagenheim owns a 20% membership interest in DHW and personally guaranteed 20% of DHW’s indebtedness to its lenders.  The remaining net proceeds from this placement are being used to fund the expansion of our restaurant operations.

 

We intend to continue expansion in markets where we believe our concept will have broad appeal and attractive restaurant-level economics.  We plan to continue using our model as we open future restaurants; however, where appropriate, we will convert existing restaurants to our Granite City concept.  Additionally, we intend to explore alternative restaurant designs to reduce the cost of our initial capital investment and we may alter our model to meet various state and local regulatory requirements, including, but not limited to, pollution control requirements, liquor license ordinances and smoking regulations.  We opened a restaurant in Rockford, Illinois in July 2007 and one each in Rogers, Arkansas and East Peoria, Illinois in October 2007.  Because it is often difficult to recruit staff during the holiday season, we intend to open two additional restaurants during the fourth quarter of 2007 along with two additional restaurants in the first quarter of 2008.  Additionally, we have entered into agreements or are in negotiation for locations in Illinois, Missouri, Ohio, Indiana and Minnesota.

 

Based upon our existing prototype, we anticipate that pre-opening costs and the initial purchase of furniture, fixtures and equipment will require an investment by us of approximately $1.0 million to $1.3 million for each new restaurant.  We anticipate that our new restaurants will require an investment by our developer of approximately $1.8 million to $2.3 million for the building and approximately $1.2 million to $1.5 million for the purchase of the land.  We expect these costs will vary from one market to another based on real estate values, zoning regulations, labor markets and other variables.  Pursuant to the terms of some of our agreements, our developer receives construction allowances from the landlord which, in turn, are passed on to us as reductions in construction costs of our new restaurants.  Landlord contributions received related to restaurants developed in 2007 ranged from $1.0 million to $1.5 million per location.  As a result, the net capital investment is lower for restaurants that receive a landlord contribution.  In some instances we may elect to use our own cash for a portion of the building costs resulting in lower minimum lease payments.

 

We will need to expend significant capital in connection with our expansion plans. With our existing capital resources, cash generated from operations, and the proceeds received from our sale of common stock, we believe that we will have sufficient funds to complete our planned restaurant openings in the fourth quarter of 2007 and the first quarter of 2008 and maintain sufficient working capital for our operations. We will require further funding to open additional restaurants beyond the first quarter of 2008. If our available sources of liquidity are insufficient to fund our expected capital needs, or our needs are greater than anticipated, we will be required to raise additional funds through the incurrence of indebtedness or public or private sales of equity securities. At this time, we are actively pursuing debt financing in order to solidify our 2008 expansion plans. If we do not generate sufficient cash flow from current operations or if financing is not available to us, we will have to curtail projected growth, which could materially adversely affect our business, financial condition, operating results and cash flows.

 

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Commitments and contingent liabilities

 

Capital Leases:

As of September 25, 2007, we had 17 capital lease agreements related to our restaurants.  Of these leases, one expires in 2020, one in 2022, two in 2023, four in 2024, three in 2025, four in 2026 and the remaining two in 2027, all with renewable options for additional periods. Fifteen of these lease agreements are with our developer. Under seven of the leases, we are required to pay additional percentage rent based upon restaurant sales. The land portion of these leases is classified as an operating lease while the building portion of these leases is classified as capital lease because either its present value was greater than 90% of the estimated fair value at the beginning of the lease or the lease term is 75% or more of the estimated life of the property.

In December 2004, we entered into a land and building lease agreement for our beer production facility.  This ten-year lease commenced February 1, 2005, and contains a bargain purchase option.

We entered into a sale-leaseback agreement for the equipment and leasehold improvements at St. Cloud and Sioux Falls in June 2001 and a lease for equipment under agreements expiring in 2008.  A director and former director of our company have personally guaranteed these leases.

In August 2006, we entered into a master lease agreement with Carlton Financial Corporation (“Carlton”) pursuant to which we may “finance lease” up to $3,000,000 of equipment purchases for three future restaurant locations. On September 28, 2006, we entered into a lease schedule and amendment to this master lease, pursuant to which we are leasing equipment for our restaurant in St. Louis Park for an initial lease term of 39 months. Our president and chief executive officer was required to personally guarantee payments to be made to Carlton under the lease financing and our board of directors agreed to pay him for such guarantee.  Details regarding such guarantee fees appear below under the caption “Personal Guaranties.”

In June 2007, we entered into a lease for an energy optimization system at our Maple Grove restaurant for approximately $30,000.  This five-year lease commenced June 28, 2007 and contains a bargain purchase option.

Operating Leases:

The land portions of the 17 property leases referenced above, 15 of which are lease agreements with our developer, are classified as operating leases because the fair value of the land was 25% or more of the leased property at the inception of each lease. All scheduled rent increases for the land during the initial term of each lease are recognized on a straight-line basis. In addition to such property leases, we have obligations under the following operating leases:

In January 2001, we entered into a 20-year operating lease for the land upon which we built our Fargo restaurant.  Under these terms, we are obligated to pay annual rent of $72,000 plus percentage rent based upon restaurant sales.

In August 2005, we entered into a 38-month lease agreement for the office space for our corporate offices.  The lease commenced October 1, 2005.  Annual rent is $41,520 with scheduled annual increases throughout the term of the lease.  Such scheduled rent increases are recognized on a straight-line basis over the term of the lease.

In November 2005, we entered into an agreement for a facility in Minneapolis, Minnesota which we use as a test kitchen.  Obligations under this three-year lease agreement began November 1, 2005.  The agreement calls for annual rent of $42,000 and has an option for a three-year renewal.

In March 2006, we entered into a lease agreement for the land and the building for our St. Louis Park restaurant.  This operating lease expires in 2016 with renewal options for additional periods.

 

21



 

We have also entered into lease agreements relating to restaurants in East Peoria and Orland Park, Illinois, Rogers, Arkansas, Creve Coeur, Missouri, Ft. Wayne, Indiana and Toledo, Ohio under the terms specified in the development agreement with Dunham.  Additionally, we entered into a lease agreement with an independent third party for a restaurant in Woodbury, Minnesota.  Each restaurant will be constructed for us on a build-to-suit basis.  The annual rent of each will be equal to 10.5% of the construction costs paid by the developer including land cost and will escalate 10% at the end of each five-year period.  The term of each lease will commence when operations begin and may be extended at our option for additional five-year periods on the same terms and conditions, except the rent for our Woodbury location may increase based on a formula using the Consumer Price Index during any such extension.  Rental costs associated with the operating leases that are incurred during the construction period are recognized as pre-opening costs, and escalated rent will be recognized as expense on a straight-line basis over the term of the leases.

Personal Guaranties:

Two of our directors and one former director have personally guaranteed certain of our leases and loan agreements.  At a meeting held in March 2004, our board of directors agreed to pay our president and chief executive officer for his personal guaranties of equipment loans entered into in August 2003 and January 2004.  The amount of the annual guarantee fee is 3% of the balance of such loans.  This amount is calculated and accrued based on the weighted average daily balances of such loans at the end of each monthly accounting period.  During the first three quarters of 2007 and 2006, we accrued $18,953 and $23,601 of such fees, respectively, and paid $50,000 and $15,000 of such fees, respectively.

In August 2006, we entered into a lease agreement with Carlton pursuant to which we may finance lease up to $3.0 million of equipment.  Mr. Wagenheim was required to personally guarantee payment to be made to Carlton under this lease financing agreement and our board of directors agreed to pay him for such guarantee.  The amount of the annual guarantee fee is 3% of the balance of such lease and is calculated and accrued based on the weighted average daily balance of the lease at the end of each monthly accounting period.  Although we did not pay any of such fees during the first three quarters of 2007, $15,408 of such expense was recorded in general and administrative expense.

Employment Agreements:

                In June 2005, we entered into a three-year employment agreement with Steven J. Wagenheim, our president and chief executive officer, who is also a director of our company.  The agreement provided for a minimum base salary of $225,000, commencing January 1, 2005, cash incentive compensation ranging from $0 to $125,550 based on performance, and a stock option for the purchase of 150,000 shares of common stock.  In February 2006, we amended the compensatory arrangements under the agreement to provide for an annual base salary of $275,000, commencing January 1, 2006, cash incentive compensation ranging from $0 to $167,400 based on performance, and a stock option for the purchase of 100,000 shares of common stock.  In April 2007, we amended the compensatory arrangements under the agreement to provide for an annual base salary of $300,000, commencing April 1, 2007, cash incentive compensation for 2007 ranging from $0 to $197,400 based on performance, and a stock option for the purchase of 100,000 shares of common stock.  In addition to annual compensation terms and other provisions, the agreement includes change in control provisions that would entitle him to receive severance pay equal to 18 months of salary if there is a change in control of our company and his employment terminates.

In August 2006, we entered into an at-will employment agreement with Peter P. Hausback that provides for Mr. Hausback to serve as our chief financial officer and principal accounting officer. The agreement provides for a minimum annual base salary of $215,000 and the eligibility to participate in any performance-based cash bonus or equity award plans for senior executives based upon goals established by the board or compensation committee. Mr. Hausback’s possible cash incentive compensation for fiscal years 2006 and 2007 is up to $75,000 based upon performance. The employment agreement provides that a severance payment equal to 12 months of base salary will be made if Mr. Hausback’s employment is terminated in connection with a change of control, by our company without cause, or by the officer for good reason.

 

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Development Agreement:

We have entered into a development agreement with Dunham Capital Management L.L.C. (“Dunham”) for the development of our restaurants.  Dunham is controlled by Donald A. Dunham, Jr., who is a member of DHW Leasing, L.L.C. and an affiliate of Granite Partners LLC, a beneficial owner of approximately 1.1% of our securities.  The agreement gives Dunham the right to develop, construct and lease up to 22 restaurants for us prior to December 31, 2012.  We are not bound to authorize the construction of restaurants during the term of the development agreement, but generally cannot use another developer to develop or own a restaurant as long as the development agreement is in effect.  We can use another developer if Dunham declines to build a particular restaurant, if the agreement is terminated because of a default by Dunham, or if our company is sold or merged into another company.  In the case of a merger or sale of our company, the development agreement may be terminated.  As of November 1, 2007, 17 restaurants had been constructed for us under this development agreement.

The development agreement provides for a cooperative process between Dunham and our company for the selection of restaurant sites and the development of restaurants on those sites, scheduling for the development and construction of each restaurant once a location is approved, and controls on the costs of development and construction using bidding and guaranteed maximum cost concepts.  The development agreement provides that restaurants will be leased to us on the basis of a triple net lease.  The rental rate of each lease will be calculated using a variable formula which is based on approved and specified costs of development and construction and an indexed interest rate.  The term of each lease is generally 20 years with five five-year options to renew.

In September 2006, we entered into an amendment of this development agreement.  Under the terms of the amendment, in lieu of future adjustments to restaurant leases, lease rates will be increased by 10% commencing on the fifth anniversary of each lease and on each five-year anniversary thereafter.  This lease rate increase applies to all leases under the development agreement entered into after March 2006.

 

Dunham also has the right to sell the underlying land and building to third parties or assign our leases. As of November 1, 2007, Dunham had sold three of our restaurants sites to third parties. The assignment or sale of a lease by Dunham has no material impact on our agreement.

Off- balance sheet arrangements:

 

                It is not our business practice to enter into off-balance sheet arrangements.

 

Summary of contractual obligations:

 

The following table summarizes our obligations under contractual agreements as of September 25, 2007 and the time frame within which payments on such obligations are due.  This table does not include amounts related to percentage rent as such future amounts are not determinable.  In addition, whether we would incur any additional expense on our employment agreements depends upon the existence of a change in control of the company.  Therefore, no percentage rent nor severance expense has been included in the following table.

 

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Payments due by period

 

Contractual Obligations

 

Total

 

Fiscal Year 2007

 

Fiscal Years 2008-2009

 

Fiscal Years 2010-2011

 

Fiscal Years Thereafter

 

Long-term debt, principal

 

$

2,082,889

 

$

74,372

 

$

574,272

 

$

1,434,244

 

$

 

Interest on long-term debt

 

548,913

 

47,861

 

319,545

 

181,508

 

 

Capital lease obligations, including interest

 

75,882,252

 

1,110,333

 

8,679,437

 

8,164,719

 

57,927,762

 

Operating lease obligations, including interest

 

41,411,146

 

627,645

 

4,944,765

 

4,913,428

 

30,925,308

 

Loan guarantee

 

94,505

 

42,272

 

48,903

 

3,330

 

 

Total obligations

 

$

120,019,705

 

$

1,902,482

 

$

14,566,923

 

$

14,697,229

 

$

88,853,071

 

 

Certain amounts do not sum due to rounding.

 

Based on our cash position at September 25, 2007, we believe we have sufficient capital to meet our current obligations.

 

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 related lease, which is generally 20 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 to Statement of Financial Accounting Standard (SFAS) No. 144.  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.

 

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Leasing activities

 

We have entered into various leases for our buildings, equipment 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 SFAS No. 13.

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 the lease agreement is signed and ends on the store open date, 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 store 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 account 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 fair value recognition provisions of SFAS No. 123(R).  Under such provisions, 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 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 the accompanying consolidated balance sheets.  We recognize gift card breakage amounts based upon historical redemption patterns, which represent the balance of gift cards for which we believe the likelihood of redemption by the customer is remote.  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.

Seasonality

 

We expect that our sales and earnings will fluctuate based on seasonal patterns.  We anticipate that our highest sales and earnings will occur in the second and third quarters due to the milder climate and availability of outdoor seating during those quarters in our existing and proposed markets.

Inflation

The primary inflationary factors affecting our operations are food, supplies and labor costs. A large number of our restaurant personnel are paid at rates based on the applicable minimum wage, and increases in the minimum wage directly affect our labor costs. In the past, we have been able to minimize the effect of these

 

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increases through menu price increases and other strategies. To date, inflation has not had a material impact on our operating results.

 

ITEM 3   Quantitative and Qualitative Disclosures about Market Risk

 

Our company is exposed to market risk from changes in interest rates on debt and changes in commodity prices.

 

Changes in interest rate:

 

Pursuant to the terms of the loan we entered into in January 2004 for equipment at our Davenport location, the interest rate increased from 6.125% to 10.25% effective January 1, 2007.  As of January 1, 2007, the unpaid balance on this loan was $481,190.  The 412.5 basis point change in this rate, assuming consistent levels of floating rate debt, will have an impact of approximately $16,190 on annual interest expense in fiscal year 2007.

 

Changes in commodity prices:

 

Many of the food products we purchase are affected by commodity pricing and are, therefore, subject to unpredictable price volatility.   These commodities are generally purchased based upon market prices established with vendors.  Extreme fluctuations in commodity prices and/or long-term changes could have an adverse affect on us.  Although SYSCO Corporation is our primary supplier of food, substantially all of the food and supplies we purchase is available from several sources, which helps to control commodity price risks.  Additionally, we have the ability to increase menu prices, or vary the menu items offered, in response to a food product price increase.  If, however, competitive circumstances limit our menu price flexibility, margins could be negatively impacted.

 

Our company does not enter into derivative contracts either to hedge existing risks or for speculative purposes.

 

ITEM 4   Controls and Procedures

Evaluation of disclosure controls and procedures

 

We maintain a system of disclosure controls and procedures that is designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding disclosures.

                Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)).  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 25, 2007, our disclosure controls and procedures were effective.

 

Changes in internal control over financial reporting

 

There were no changes in our internal control over financial reporting that occurred during the quarter ended September 25, 2007, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

26



 

PART II OTHER INFORMATION

ITEM 1   Legal Proceedings

 

Not applicable.

ITEM 1A                Risk Factors

 

On May 4, 2007, we filed with the SEC a Cautionary Statement pursuant to the Private Securities Litigation Reform Act of 1995 for use as a readily available written document to which reference may be made in connection with forward-looking statements, as defined in such act.  Our Cautionary Statement amended and restated the risk factors we previously presented in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 26, 2006.  Our Cautionary Statement, which appears as Exhibit 99 to this report, is incorporated by reference in response to this Item 1A.  There have been no material changes with respect to the risk factors disclosed in such Cautionary Statement.

 

ITEM 2   Unregistered Sales of Equity Securities and Use of Proceeds

 

(a)           On August 8, 2007, we issued 26,302 shares of common stock upon the cashless exercise of a warrant for the purchase of 38,170 shares of common stock originally issued October 1, 2002 to one of the agents for our private placement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise price of $1.58 per share and an expiration date of October 1, 2007.

 

On August 8, 2007, we issued 3,543 shares of common stock upon the cashless exercise of a warrant for the purchase of 5,142 shares of common stock originally issued November 27, 2002 to one of the agents for our private placement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise price of $1.58 per share and an expiration date of November 27, 2007.

 

The foregoing issuances were made in reliance upon the exemption provided in Section 4(2) of the Securities Act.  The certificates representing such securities contain a restrictive legend preventing sale, transfer or other disposition, absent registration or an applicable exemption from registration requirements.  The recipients of such securities received, or had access to, material information concerning our company, including, but not limited to, our reports on Form 10-KSB, Form 10-QSB, and Form 8-K, as filed with the SEC.  No discount or commission was paid in connection with the issuance of common stock upon exercise of such warrants.

 

ITEM 3   Defaults upon Senior Securities

 

Not applicable.

 

ITEM 4   Submission of Matters to a Vote of Security Holders

 

Not applicable.

 

ITEM 5   Other Information

 

Not applicable.

 

ITEM 6   Exhibits

 

See “Index to Exhibits.”

 

27



 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

GRANITE CITY FOOD & BREWERY LTD.

 

 

 

Date:   November 9, 2007

By:

/s/ Peter P. Hausback

 

 

Peter P. Hausback

 

 

Chief Financial Officer

 

28



 

INDEX TO EXHIBITS

 

Exhibit

 

 

Number

 

Description

3.1

 

Articles of Incorporation of the Registrant, as amended (incorporated by reference to our Quarterly Report on Form 10-QSB, filed on November 13, 2002 (File No. 000-29643)).

 

 

 

3.2

 

Amended and Restated Bylaws of the Registrant, dated May 2, 2007 (incorporated by reference to our Current Report on Form 8-K, filed on May 4, 2007 (File No. 000-29643)).

 

 

 

31.1

 

Certification by Steven J. Wagenheim, President and Chief Executive Officer of the Company, pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2

 

Certification by Peter P. Hausback, Chief Financial Officer of the Company, pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1

 

Certification by Steven J. Wagenheim, President and Chief Executive Officer of the Company, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.2

 

Certification by Peter P. Hausback, Chief Financial Officer of the Company, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

99

 

Cautionary Statement (incorporated by reference to our Current Report on Form 8-K, filed on May 4, 2007 (File No. 000-29643)).

 

29


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