| GRILL CONCEPTS INC ITEM 1A RISK FACTORS 15 ITEM 1A RISK FACTORS The following are certain risk factors that could affect our business, financial results and results of operations |
| These risk factors should be considered in connection with evaluating the forward-looking statements contained in this Annual Report on Form 10-K because these factors could cause the actual results and conditions to differ materially from those projected in forward-looking statements |
| Before you buy our common stock, you should know that making such an investment involves some risks, including the risks described below |
| The risks that we have highlighted here are not the only ones that we face |
| If any of the risks actually occur, our business, financial condition or results of operations could be negatively affected |
| In that case, the trading price of our stock could decline, and you may lose all or part of your investment |
| OUR FUTURE GROWTH AND EXPANSION ARE DEPENDENT UPON OUR ABILITY TO OPEN ADDITIONAL RESTAURANTS AND OPERATE NEW RESTAURANTS PROFITABLY Future growth in sales and profits will depend to a substantial extent on our ability to increase the number of restaurants we operate, license or manage |
| Our ability to open additional restaurants will depend upon a number of factors, including the availability of suitable locations, our ability to negotiate leases on acceptable terms, the securing of required governmental permits and approvals, the hiring and training of skilled restaurant management and hourly employees, the availability of financing on acceptable terms (if at all), general economic conditions and other factors, many of which are beyond our control |
| Due to the highly customized nature of our restaurant concept and the complex design, construction, and pre-opening processes for each new location, the lease negotiation and restaurant development timeframes vary from location to location and can be subject to unforeseen delays |
| There can be no assurance that we will be able to open new restaurants or that, if opened, those restaurants will be operated profitably |
| 15 OUR RELATIVE SMALL SIZE MAKES US VULNERABLE TO RISKS ASSOCIATED WITH LACK OF DIVERSIFICATION AND RISKS ASSOCIATED WITH MANAGING AND SUPPORTING GROWING OPERATIONS We operated 22 restaurants at December 31, 2005 |
| Due to this relatively small number of restaurants, poor operations at any one restaurant could materially affect our overall profitability |
| Even though our revenues have grown over the last decade, our current restaurant field supervision and corporate support infrastructures remain relatively small |
| Accordingly, we remain vulnerable to a variety of business risks generally associated with smaller, growing companies |
| Any failure to continue to upgrade operating, financial, and restaurant support systems or unexpected difficulties encountered during expansion could adversely affect our business, financial condition, and results of operations |
| Although we believe that our systems and controls are adequate to address our current needs and we are in the process of upgrading certain of our operating and financial systems and processes, there can be no assurance that such upgraded systems and processes will be adequate to sustain future growth, and that further upgrades will not be necessary |
| OUR PROFITABILITY IS SUBJECT TO RISKS ASSOCIATED WITH FLUCTUATIONS IN COSTS OF KEY INGREDIENTS, LABOR AND UTILITIES Our profitability is dependent upon our ability to anticipate and react to changes in the costs of key operating resources, including food and other raw materials, labor, utilities and other supplies and services |
| Various factors beyond our control, including adverse weather and general marketplace conditions, may affect the availability and cost of food and other raw materials |
| Recent increases in energy costs may have a material adverse impact on our restaurant profitability if those costs continue at current, or higher, levels |
| The impact of inflation on food, labor and occupancy costs can significantly affect our operations |
| While management has been able to react to inflation and other changes in the costs of key operating resources by increasing prices for menu items, there can be no assurance that we will be able to continue to do so in the future |
| There can also be no assurance that we will continue to generate increases in comparable restaurant sales in amounts sufficient to offset inflationary or other cost pressures |
| OUR SUCCESS IS DEPENDENT UPON OUR ABILITY TO RETAIN THE SERVICES OF KEY SENIOR MANAGEMENT PERSONNEL AND ATTRACT AND RETAIN ADDITIONAL KEY PERSONNEL The success of our business is highly dependent upon the services of our senior executive team |
| Robert Spivak, our co-founder and President and Chief Executive Officer has announced his pending retirement |
| In conjunction with Mr |
| Spivakapstas pending retirement, Philip Gay, our current Executive Vice President and Chief Financial Officer is to be promoted to the position of President and Chief Executive Officer and a new Chief Financial Officer is to be named |
| Spivak has agreed to continue providing services as a part time consultant following his retirement |
| Our success will be dependent, during the period immediately following Mr |
| Spivakapstas retirement, upon our ability to successfully transition our senior management team under the leadership of Mr |
| Gay and a new Chief Financial Officer |
| Further, our success will be dependent upon the continued services of our senior management team and our ability to attract and retain skilled management employees at all levels of operations |
| Poor execution in our transition of senior management personnel or the loss of services of key personnel could have a material adverse effect upon our business |
| OUR OPERATIONS ARE SUBJECT TO INTENSE COMPETITION AND CHANGES IN CONSUMER PREFERENCES The restaurant industry is highly competitive |
| There are a substantial number of restaurant operations that compete directly and indirectly with us, some of which may have significantly greater financial resources, higher revenues, and greater economies of scale than we enjoy |
| The restaurant business is often affected by changes in consumer tastes and discretionary spending patterns, national and regional economic conditions, demographic trends, consumer confidence in the economy, traffic patterns, the cost and availability of raw materials and labor, purchasing power, governmental regulations and local competitive factors |
| Any change in these factors could adversely affect our restaurant operations |
| Multi-unit foodservice operations such as ours can also be substantially affected by adverse publicity resulting from food quality, illness, injury, health concerns, or operating issues stemming from a single restaurant |
| We attempt to manage these factors, but the occurrence of any one of these factors could cause our business to be adversely affected |
| We believe that our restaurants compete favorably in the consumer marketplace with respect to the attributes of quality, variety, taste, service, consistency, and overall value |
| OUR BUSINESS IS SUBJECT TO SEASONAL FLUCTUATIONS THAT MAY ADVERSELY AFFECT OUR QUARTERLY OPERATING RESULTS IN SELECT PERIODS Our business is subject to seasonal fluctuations |
| Historically, our highest earnings have occurred in the first and fourth quarters of the fiscal year, as our sales in most of our restaurants have typically been higher during the first 16 and fourth quarters of the fiscal year |
| As a result of these factors, results of operations for any single quarter are not necessarily indicative of the results that may be achieved for a full fiscal year |
| Quarterly results have been, and in the future will continue to be, significantly impacted by the timing of new restaurant openings and their respective pre-opening costs |
| OUR CALIFORNIA BASED RESTAURANTS HAVE IN THE PAST BEEN, AND MAY IN THE FUTURE BE, SUBJECT TO TEMPORARY CLOSURE DUE TO ENERGY SHORTAGES High energy costs and consumption and constrained energy supplies have periodically resulted in rolling blackouts in California, particularly during summer months |
| We have experienced periodic temporary restaurant closures in the past as a result of such rolling blackouts and may experience similar closures in the future |
| Any such closures will result in loss of revenues from the effected restaurants and potentially higher occupancy and operating costs |
| OUR BUSINESS IS SUBJECT TO EXTENSIVE GOVERNMENT REGULATIONS THAT MAY ADVERSELY AFFECT OUR EXISTING OR PLANNED OPERATIONS OR RESULT IN ADDITIONAL COSTS OR POTENTIAL LIABILITIES Our business is subject to extensive state and local government regulation in the various jurisdictions in which our restaurants are located, including regulations relating to alcoholic beverage control, public health and safety and fire codes |
| The failure to obtain or retain food and liquor licenses could adversely affect the operation of our restaurants |
| Any difficulties, delays or failures in obtaining and/or retaining licenses, permits or other regulatory approvals could delay or prevent the opening and/or continued operation of a restaurant in a particular area |
| We may also be subject to "e dram shop "e statutes in certain states which generally provide a person injured by an intoxicated person the right to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person |
| We are subject to the Fair Labor Standards Act, which governs such matters as minimum wages, overtime and other working conditions, along with the Americans With Disabilities Act, various family leave mandates and a variety of other laws enacted, or rules and regulations promulgated, by federal, state and local governmental authorities that govern these and other employment matters |
| We expect increases in payroll expenses as a result of federal, state and local mandated increases in the minimum wage, and although such increases are not expected to be material, we cannot assure that there will not be material increases in the future |
| In addition, our vendors may be affected by higher minimum wage standards, which may increase the price of goods and services supplied to us |
| WE ARE SUBJECT TO PENDING LITIGATION, AND POTENTIAL LIABILITY, REGARDING APPLICATION OF EMPLOYMENT REGULATIONS Complex issues relating to the interpretation and application of various labor regulations may result in our incurring unforeseen costs and/or liabilities relating to compliance with such regulations |
| Many restaurant operators in California have been subject to litigation over the last year relating to non-compliance with California labor provisions mandating that employees be provided meal and break periods |
| A former employee has filed a class action lawsuit against us asserting violation of the applicable California regulations regarding meal and break periods |
| While we believe that all of our employees were provided with the opportunity to take all required meal and rest breaks, many restaurant operators in California have incurred substantial expenses in settling similar claims and we may incur substantial expenses in connection with defending or settling the pending litigation |
| A Class Action complaint was filed in the Superior Court of the State of California for the County of Los Angeles on March 15, 2006 |
| The plaintiff and those similarly situated (Servers) complain that the company has violated the labor code by having Servers "e Tip Out "e Bartenders and Expeditors a percentage of their tips to these employees who provide no direct table service |
| The company has not yet been served with this complaint |
| WE MAY BE SUBJECT TO INCREASED LIABILITY RESULTING FROM OUR PARTIAL SELF-INSURANCE OF WORKERS COMPENSATION CLAIMS In order to better manage the cost of our workers compensation expense, commencing in 2004, we altered our workers compensation coverage to substantially increase our per event and aggregate deductibles |
| As a result, we expect to reduce our recurring cost of workers compensation insurance but are 17 exposed to substantially higher potential losses that could result from claims under that policy should those claims exceed our prior deductible levels |
| WE MAY EXPERIENCE INCREASED COSTS, WORKER RELATED IMPEDIMENTS AND OTHER LOSSES AT OUR CHICAGO RESTAURANT AS A RESULT OF OUR USE OF UNION WORKERS The employees of our Chicago restaurant are members of the Hotel Employees and Restaurant Employees Union, Local 1, AFL-CIO As a result of our Chicago workforce being unionized, we experience higher labor costs in our Chicago operations, have less managerial control over our workforce and are subject to certain impediments, delays, costs and other potential risks not faced at our other restaurants |
| Accordingly, we may experience unexpected losses or costs in our Chicago operations |
| PROVISIONS IN OUR CHARTER AND IN DELAWARE LAW MAY IMPEDE, DELAY OR PREVENT POTENTIAL TAKEOVERS THAT MIGHT OTHERWISE BE BENEFICIAL TO OUR STOCKHOLDERS Our Certificate of Incorporation and By-Laws contain various provisions and Delaware law contains certain provisions that could make more difficult a merger, tender offer or proxy contest involving the Company, even if such events would be beneficial to the interests of our stockholders |
| Such provisions could limit the price that certain investors might be willing to pay in the future for shares of our Common Stock |
| In addition, we may issue shares of preferred stock without stockholder approval on such terms as the Board of Directors may determine |
| The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future |
| Moreover, although the ability to issue preferred stock may provide flexibility in connection with possible acquisitions and other corporate purposes, such issuance may make it more difficult for a third party to acquire, or may discourage a third party from acquiring, a majority of our voting stock |
| We have no current plans to issue any shares of preferred stock |
| We may in the future adopt other measures that may have the effect of delaying, deferring or preventing a change in control |
| Certain of such measures may be adopted without any further vote or action by the stockholders, although we have no present plans to adopt any such measures |
| IDENTIFICATION OF MATERIAL WEAKNESS IN INTERNAL CONTROL MAY ADVERSELY AFFECT OUR FINANCIAL RESULTS We are subject to the ongoing internal control provisions of Section 404 of the Sarbanes-Oxley Act of 2002 |
| Those provisions provide for, among other things, the identification of material weaknesses in internal control that could indicate a lack of adequate controls to generate accurate financial statements |
| Though we routinely assess our internal controls, there can be no assurance that we will be able to timely remediate material weaknesses, if any, that may be identified in future periods, or maintain all of the controls necessary for continued compliance |
| There likewise can be no assurance that we will be able to retain sufficient skilled finance and accounting personnel, especially in light of the increased demand for such personnel among publicly traded companies |
| Because we are not an "e accelerated filer "e , as defined in the Securities Exchange Act of 1934, certain provisions of Section 404 relating to the provision of a report of management and accompanying auditorapstas report on a companyapstas internal controls over financial reporting will not be applicable until our first fiscal year ending on or after July 15, 2007 |
| Based on the experiences of other issuers currently subject to the full requirements of Section 404, we expect that we will incur substantial additional costs in order to prepare for our first required report under Section 404 and increased recurring costs thereafter |
| OUR STOCK PRICE IS SUBJECT TO VOLATILITY ASSOCIATED WITH MARKET FLUCTUATIONS AS WELL AS OUR OPERATING PERFORMANCE AND LIMITED TRADING VOLUME IN OUR STOCK The price at which the our common stock trades is determined in the marketplace and may be influenced by many factors, including our performance, investor expectations, the trading volume in our common stock, general economic and market conditions and competition |
| The market price of our common stock could fluctuate substantially due to a variety of factors, including our quarterly operating results and those of other restaurant companies, changes in general conditions in the economy, the financial markets or the restaurant industry, natural disasters or other developments affecting our business or our competitors |
| In addition, in recent years the stock market has experienced extreme price and volume fluctuations |
| This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to the operating performance of these companies |
| 18 OUR DIRECTORS, EXECUTIVE OFFICERS AND SIGNIFICANT SHAREHOLDERS HOLD A SUBSTANTIAL PORTION OF OUR STOCK THAT MAY LEAD TO CONFLICTS WITH OTHER SHAREHOLDERS OVER CORPORATE GOVERNANCE Our directors, executive officers and current holders of 5prca or more of our outstanding common stock hold a substantial portion of our stock |
| At March 10, 2006, Starwood Hotels and Resorts held 666cmam667 shares of our common stock and warrants entitling Starwood to purchase an additional 666cmam667 shares of our common stock at dlra2dtta00 per share |
| At March 10, 2006, Lewis Wolff, a director, and his family members and entities controlled by Mr |
| Wolff and his family members, held 501cmam781shares of our common stock, warrants and options to purchase an additional 246cmam250 shares of our common stock at prices ranging from dlra1dtta65 to dlra4dtta527 per share and 500 shares of Series II Convertible Preferred Stock that may be converted into 125cmam000 shares of our common stock, in addition to options held by Mr |
| Wolff received in his capacity as a director |
| Other members of senior management held in excess of 946cmam400 shares of our common stock, as well as options to purchase 217cmam983 shares of our common stock, at March 10, 2006 |
| Such persons, acting together, and each acting alone, will be able to significantly influence all matters requiring shareholder approval, including the election of directors and significant corporate transactions, such as mergers or other business combinations |
| CONVERSION OF OUR OUTSTANDING CONVERTIBLE SECURITIES COULD SUBSTANTIALLY DILUTE COMMON STOCK PRICES BECAUSE THE CONVERSION PRICES OF THOSE SECURITIES ARE BELOW OUR CURRENT MARKET PRICE We have issued, and may issue in the future, various securities that are convertible or exercisable at prices that are lower than the current market price of our common stock or are subject to adjustment due to a variety of factors, including fluctuations in the market price of our common stock and the issuance of securities at an exercise or conversion price less than the then-current exercise or conversion price of those securities |
| For example, at March 10, 2006, we had issued and outstanding 1cmam309cmam896 warrants to purchase shares our common stock at prices ranging from dlra2dtta00 to dlra7dtta00 per share |
| On March 10, 2006, the closing price of our common stock on the Nasdaq SmallCap Market was dlra3dtta35 |
| The value of our common stock could, therefore, experience substantial dilution as a result of the conversion or exercise of our outstanding derivative securities or as a result of any issuance of additional securities at prices lower than the conversion prices of such securities |
| Also, as a result of conversions of our Series II Convertible Preferred Stock and any related sales of our common stock by the holders, the market price of our common stock could be depressed |
| OUR BUSINESS MAY BE ADVERSELY AFFECTED BY CONFLICTS OF INTEREST ASSOCIATED WITH DOING BUSINESS WITH AFFILIATES OF CERTAIN DIRECTORS AND PRINCIPAL SHAREHOLDERS We are presently party to business arrangements with affiliates of two directors and principal shareholders |
| We are party to agreements with two entities affiliated with Lewis Wolff, a director and principal shareholder |
| We lease the site of the San Jose Grill restaurant from an entity in which Mr |
| Similarly, we are party to an agreement with Hotel Restaurant Properties, Inc, an entity controlled by a member of Mr |
| Wolffapstas family, pursuant to which HRP assists in locating hotel locations for restaurants and pursuant to which HRP is entitled to a portion of the fees or profits from those restaurants |
| During 2005, we paid rents of dlra257cmam000 with respect to the San Jose Grill and paid, or accrued, management fees of dlra423cmam000 to HRP We are also party to various agreements with Starwood Hotels and Resorts, the employer of one of our directors, Richard Dantas, and one of our principal shareholders |
| Under a Development Agreement, we agreed to work with Starwood to identify potential restaurant locations in Starwood properties and, subject to negotiating acceptable terms, develop and operate restaurants in Starwood properties under management or license arrangements |
| Pursuant to the Development Agreement, we granted certain exclusivity rights to Starwood and agreed to grant certain warrants to Starwood based on restaurant openings |
| As of December 31, 2005, we operated two restaurants pursuant to management agreements with Starwood |
| Our business dealings with Starwood and affiliates of Mr |
| Wolff create potential conflicts of interest that could result in our securing terms that are less favorable than might otherwise be available in the absence of such conflicts |