MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations Net Revenues: Net revenues for fiscal 2013 increased $3,186,000 (+16.2%) to $22,892,000 from $19,706,000 for fiscal 2012. Same store restaurant sales increased $2,271,000 (+11.9%) during fiscal 2013. Restaurants are included in same store sales after they have been open a full fifteen months. Restaurant sales increased $1,738,000 due to three restaurants purchased from franchisees in fiscal 2012 and 2013. Restaurant sales decreased $59,000 due to two company-owned restaurants not included in same store sales, one non-traditional location and one severely affected by road construction. Restaurant sales decreased $701,000 due to two company-owned restaurants sold in fiscal 2012. Net revenues decreased $63,000 in fiscal 2013 due to a decrease in franchise royalties and fees. The positive same store sales results for fiscal 2013 reflect the continuation of the positive momentum we experienced in fiscal 2011 and 2012 when same store sales increased 6.2% and 3.1%, respectively. In addition we introduced a limited breakfast menu in November 2012 and total net revenues for breakfast were approximately $1,700,000 for fiscal 2013. Our outlook for fiscal 2014 is cautiously optimistic based on the last three years of positive sales trends; however our sales trends are influenced by many factors and the macroeconomic environment remains challenging for smaller restaurant chains. Our average transaction decreased slightly in fiscal 2013 compared to fiscal 2012 with the addition of breakfast, while our total customer traffic increased in excess of 12%. We are continuing to manage our marketing communications to balance growth in customer traffic and the average customer expenditure. Average restaurant sales for company-owned and co-developed restaurants (including double drive thru restaurants and restaurants with dining rooms but excluding dual brand restaurants and out of market restaurants) for fiscal 2012 and 2013 were as follows: Fiscal 2013 Fiscal 2012 Company-operated $903,000 $807,000 Company operated restaurants' sales range from a low of $613,000 to a high of $1,734,000 . For factors which may affect future results of operations, please refer to a discussion of planned product and system changes discussed in the section entitled "Business Strategy" in Item 1 on pages 5 - 6 of this report. Restaurant Operating Costs: Drive Thru restaurant operating costs as a percent of restaurant sales were 91.1% for fiscal 2013 compared to 93.5% in fiscal 2012. The changes in restaurant-level costs are explained as follows: Drive Thru Restaurant -level costs for the period ended 93.5% September 30, 2012 Decrease in food and packaging costs (.2%) Payroll and other employee benefit costs (.1%) Decrease in occupancy and other operating costs (1.2%) Decrease in depreciation and amortization costs (.9%) Drive Thru Restaurant -level costs for the period ended 91.1% September 30, 2013 New store preopening costs of $99,000 , included in total restaurant operating costs, were related to the first Bad Daddy's restaurant that is expected to open in January 2014 . Food and Packaging Costs: Food and packaging costs for fiscal 2013 increased $1,063,000 from $6,592,000 (34.2% of restaurant sales) in fiscal 2012 to $7,655,000 (34% of restaurant sales). In fiscal 2013 our weighted food and packaging costs increased approximately 1.3% compared to fiscal 2012. The total menu price increases taken during fiscal 2013 were 2.2%. We anticipate cost pressure on several core commodities, including beef, bacon and dairy for fiscal 2014. However, we anticipate our food and packaging costs as a percentage of sales will decrease slightly in fiscal 2014 from a combination of price increases, product sales mix changes and recipe modifications. Payroll and Other Employee Benefit Costs: For fiscal 2013, payroll and other employee benefit costs increased $1,118,000 from $6,691,000 (34.7% of restaurant sales) in fiscal 2012 to $7,809,000 (34.7% of restaurant sales). The increase in payroll and other employee benefit expenses is primarily due to the increase in restaurant sales. Additionally with the implementation of breakfast in November 2012 our payroll and employee benefit costs were abnormally high during the first six months of fiscal 2013 due to training and over staffing to handle the additional sales. Because payroll costs are semi-variable in nature they normally decrease as a percentage of restaurant sales when there is an increase in restaurant 23 sales, however the lower average customer expenditure at breakfast somewhat mitigates this decrease. Payroll and other employee benefits increased approximately $603,000 in fiscal 2013 due to three restaurants purchased from franchisees in fiscal 2012 and 2013 and decreased approximately $293,000 in fiscal 2013 due to two company-owned restaurants sold in 2012. We anticipate payroll and other employee benefit costs will decrease as a percentage of sales in fiscal 2014 due to the operating leverage on increasing sales. Occupancy and Other Operating Costs: For fiscal 2013, occupancy and other operating costs increased $406,000 from $3,939,000 (20.4% of restaurant sales) in fiscal 2012 to $4,345,000 (19.3% of restaurant sales). The $406,000 increase in occupancy and other costs is primarily attributable to: A decrease of $214,000 in occupancy and other restaurant operating costs due to the two restaurants sold in fiscal 2012. The decrease above was offset by the following increases: · Increase of $310,000 in occupancy and other restaurant operating costs due to the three restaurants purchased from franchisees in fiscal 2012 and 2013. · Increases in various other restaurant operating costs of $125,000 at existing restaurants comprised primarily of repairs and maintenance, property taxes, utility costs and bank fees. · Increase in rent expense of $107,000 due to two sale leaseback transactions completed in fiscal 2013. · An increase of $78,000 to our liability for the accretion of deferred rent in fiscal 2013. Occupancy costs may increase as a percent of sales as new company-owned restaurants are developed due to higher rent associated with sale-leaseback operating leases, as well as increased property taxes on those locations. New Store Preopening Costs: In fiscal 2013 we incurred $99,000 of preopening costs related to the first new Bad Daddy's restaurant which is expected to open in January 2014 . Costs for this initial store opening will be higher than normal due to payroll, travel and lodging costs incurred to train the management team in North Carolina at an existing Bad Daddy's franchisee. Depreciation and Amortization Costs: For fiscal 2013, depreciation and amortization costs decreased $76,000 from $795,000 in fiscal 2012 to $719,000 . Depreciation costs primarily decreased due to the two restaurants sold in fiscal 2012 as well as due to declining depreciation expense in our aging company-owned and joint-venture restaurants. General and Administrative Costs: For fiscal 2013, general and administrative costs increased $345,000 from $1,358,000 (6.9% of total revenues) in fiscal 2012 to $1,703,000 (7.4% of total revenues). The $345,000 increase in general and administrative expenses in fiscal 2013 is primarily attributable to: · Increase in payroll and employee benefit costs of $132,000 due to the reinstatement of certain management level salaries that were reduced in fiscal 2009 and 2010, as well as an increase in health insurance costs. · Increase in professional services and financial relations costs of $50,000 . · Increase in incentive stock option compensation expense of $101,000 . · Net increases in various other expenses of $62,000 . Advertising Costs: For fiscal 2013, advertising costs increased $109,000 from $796,000 (4.1% of restaurant sales) in fiscal 2012 to $905,000 (4% of restaurant sales). Contributions are made to the advertising materials fund and regional advertising cooperative based on a percentage of sales. The contribution remained the same for fiscal 2013 compared to fiscal 2012. We anticipate that fiscal 2014 advertising expense will remain consistent with fiscal 2013 and will consist primarily of cable television advertising, social media and on-site and point-of-purchase merchandising totaling approximately 4% of restaurant sales. Franchise Costs: For fiscal 2013 franchise costs increased $7,000 from $60,000 (.3% of total revenues) in fiscal 2012 to $67,000 (.3% of total revenues). Gain on Restaurant Asset Sales: For fiscal 2013 the gain on restaurant asset sales decreased to $18,000 compared to $51,000 in fiscal 2012. The gain on restaurant assets sales in fiscal 2013 is comprised of a $25,000 deferred gain on a previous sale lease-back transaction, a $67,000 gain on a current sale lease-back transaction for one company-owned restaurant, offset by a $74,000 loss to write off the assets of an under-performing restaurant that was closed in September 2013 . Loss from Operations: The loss from operations was $392,000 in fiscal 2013 compared to a loss from operations of $474,000 in fiscal 2012. The decrease in loss from operations for the fiscal year is due primarily to matters discussed in the "Restaurant 24 Operating Costs", "General and Administrative Costs", "Franchise Costs" and "Gain on Restaurant Asset Sales" sections above. Net Loss: The net loss was $544,000 for fiscal 2013 compared to $668,000 in fiscal 2012. The change from fiscal 2012 to fiscal 2013 was primarily attributable to the matters discussed in the "Net Revenues", "Restaurant Operating Costs", "Selling, General and Administrative Costs" and "Franchise Costs" sections of Item 6, as well as 1) a decrease in net interest expense of $155,000 compared to the same prior year period; and 2) an affiliate investment loss of $102,000 in fiscal 2013. Net interest expense decreased in fiscal 2013 compared to the same prior year period due to the payoff of the notes payable to Wells Fargo Bank and PFGI II. The net loss from affiliate investment activities consists of the Company's share of net earnings or loss of its affiliates as they occur. The loss from investment activities is related to our 48% ownership in BDFD which is a result of initial costs of developing the Bad Daddy's franchise program. Income Attributable to Non-controlling Interests: For fiscal 2013 the income attributable to non-controlling interests was $143,000 compared to $109,000 in fiscal 2012. The loss from non-controlling interest represents the limited partner's share of income in the co-developed restaurants. Net Loss Attributable to Common Shareholders: For fiscal 2013 the net loss attributable to common shareholders includes dividends of $120,000 related to the Series C Convertible Preferred Stock transaction completed with SII on September 28, 2012 . Liquidity and Capital Resources Cash and Working Capital : As of September 30, 2013 , we had a working capital excess of $4,836,000 . Because restaurant sales are collected in cash and accounts payable for food and paper products are paid two to four weeks later, restaurant companies often operate with working capital deficits. We anticipate that working capital deficits may be incurred in the future and possibly increase if and when new Good Times restaurants are opened. We believe that we will have sufficient capital to meet our working capital, long term debt obligations and recurring capital expenditure needs in fiscal 2014 and beyond. Financing: Public Offering: On August 21, 2013 we completed a public offering of 2,200,000 shares of common stock, together with warrants to purchase 2,200,000 shares of our common stock ("A Warrants") and additional warrants to purchase 1,100,000 shares of our common stock ("B Warrants") with a per unit purchase price of $2.50 . One share of common stock was sold together with one A Warrant, with each A Warrant being exercisable on or before August 16, 2018 for one share of common stock at an exercise price of $2.75 per share, and together with one B Warrant, with two B Warrants being exercisable on or before May 16, 2014 for one share of common stock at an exercise price of $2.50 per share. We intend to use the $4,659,000 net proceeds from this offering for our remaining required equity contribution to BDFD; for the remodeling and reimaging of existing Good Times Burgers & Frozen Custard restaurants; for the development of new Bad Daddy's Burger Bar restaurants through BD of Colo; and as working capital reserves and future investment at the discretion of our Board of Directors. Wells Fargo Note Payable: The balance of our loan from Wells Fargo Bank, N.A. ("Wells Fargo") at September 30, 2012 was $232,000 . We used a portion of the proceeds received by the Company from the sale of Series C Convertible Preferred Stock to SII to pay in full the outstanding balance, along with the associated interest rate swap with Wells Fargo in October, 2012. PFGI II LLC Promissory Note: The balance of our loan from PFGI II LLC at September 30, 2012 was $1,318,000 . On November 30, 2012 we entered into a sale lease-back transaction on the Firestone property with net proceeds of $1,377,000 and we used $765,000 to pay down the PFGI II Note. The remaining balance of $541,000 was paid on January 25, 2013 from the proceeds of another sale leaseback transaction. SII Investment Transaction: On September 28, 2012 , we closed on an investment transaction with SII, in which the Company sold and issued to SII 355,451 shares of Series C Convertible Preferred Stock for an aggregate purchase price of $1,500,000 (or $4.22 per share) pursuant to the Purchase Agreement, with each share of Series C Convertible Preferred Stock convertible at the option of the holder into two shares of our Common Stock, subject to certain anti-dilution adjustments. The proceeds from this transaction were used to pay approximately $40,000 of expenses related to the transaction and to repay $232,000 to Wells Fargo, with the balance of the proceeds going to increase the Company's working capital. 25 Cash Flows: Net cash provided by operating activities was $703,000 for fiscal 2013 compared to net cash used in operating activities of $22,000 in fiscal 2012. The increase in net cash provided by operating activities for fiscal 2013 was the result of a net loss of $544,000 and non-cash reconciling items totaling $1,247,000 (comprised principally of 1) depreciation and amortization of $719,000 ; 2) $171,000 of stock option compensation expense; 3) an $18,000 gain on asset sales; 4) an affiliate investment loss of $102,000 ; 5) a $352,000 increase in other accounts payable and other accrued liabilities; and 6) net increases in operating assets and liabilities totaling $79,000 ). Net cash provided by investing activities in fiscal 2013 was $453,000 compared to $594,000 in fiscal 2012. The fiscal 2013 activity reflects payments for the purchase of property and equipment of $2,506,000 , proceeds from sale lease-back transactions of $3,329,000 , a $375,000 investment in the BDFD affiliate and $5,000 of payments received on loans to franchisees. Net cash provided by financing activities in fiscal 2013 was $4,371,000 compared to net cash used in financing activities of $803,000 in fiscal 2012. The fiscal 2013 activity includes principal payments on notes payable and long term debt of $1,593,000 , proceeds from the public offering of $6,158,000 , $90,000 in dividends paid on the preferred stock and distributions to non-controlling interests in partnerships of $104,000 . Contingencies and Off-Balance Sheet Arrangements: We remain contingently liable on various land leases underlying restaurants that were previously sold to franchisees. We have never experienced any losses related to these contingent lease liabilities; however, if a franchisee defaults on the payments under the leases, we would be liable for the lease payments as the assignor or sub-lessor of the lease. Currently we have not been notified nor are we aware of any leases in default under which we are contingently liable. However there can be no assurance that there will not be in the future, which could have a material adverse effect on our future operating results. Critical Accounting Policies and Estimates: We follow accounting standards set by the Financial Accounting Standards Board , commonly referred to as the "FASB." The FASB sets generally accepted accounting principles (GAAP) that we follow to ensure we consistently report our financial condition, results of operations, and cash flows. Over the years, the FASB and other designated GAAP-setting bodies, have issued standards in the form of FASB Statements, Interpretations, FASB Staff Positions, EITF consensuses, AICPA Statements of Position, etc. The FASB recognized the complexity of its standard-setting process and embarked on a revised process in 2004 that culminated in the release on July 1, 2009 , of the FASB Accounting Standards Codification,™ sometimes referred to as the Codification or ASC. To the Company, this means instead of following the Statements, Interpretations, Staff Positions, etc., we will follow the guidance in Topics as defined in the ASC. The Codification does not change how the Company accounts for its transactions or the nature of related disclosures made. However, when referring to guidance issued by the FASB, the Company refers to topics in the ASC rather than Statements, etc. The above change was made effective by the FASB for periods ending on or after September 15, 2009 . We have updated references to GAAP in this Annual Report on Form 10-K to reflect the guidance in the Codification. Notes Receivable: We evaluate the collectability of our note receivables from franchisees annually. The aggregate notes receivable on the consolidated balance sheet at September 30, 2013 were $15,000 . Discontinued Operations: The Company analyzes its operations on a regional basis, when evaluating closed restaurant operations for consideration as to the classification between continuing operations and discontinued operations. Prior to 2010 the Company evaluated operations at the restaurant level. In its reevaluation the Company determined that as most of the Company's restaurants are within the Denver metropolitan region and share common advertising, distribution, supervision, and to a certain extent even customers, the Company believes it appropriate to perform its analysis on a regional basis. During fiscal 2011 the Company closed two restaurants, and in fiscal 2012, the Company closed an additional two restaurants. The operations related to these restaurants are reflected as part of continuing operations as they were within one continuing operating region. Non-controlling Interests: Non-controlling interests, previously called minority interests, are presented as a separate item in the equity section of the consolidated balance sheet. Consolidated net income or loss attributable to non-controlling interests are presented on the face of the consolidated statement of operations. Additionally, changes in a parent's ownership interest in a subsidiary that do not result in deconsolidation are equity transactions, and that deconsolidation of a subsidiary is recorded as a gain or loss based on the fair value on the deconsolidation date. Impairment of Long-Lived Assets: We review our long-lived assets for impairment, including land, property and equipment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the capitalized costs of the assets to the future 26 undiscounted net cash flows expected to be generated by the assets and the expected cash flows are based on recent historical cash flows at the restaurant level (the lowest level that cash flows can be determined). An analysis was performed on a restaurant by restaurant basis at September 30, 2013 . Assumptions used in preparing expected cash flows were as follows: · Sales projections are as follows: Fiscal 2014 sales are projected to increase 6% with respect to fiscal 2013 and for fiscal years 2015 to 2028 we have used annual increases of 2% to 3%. The 6% increase in fiscal 2014 is due to current trends. We believe the 2% to 3% increase in the fiscal years beyond 2014 is a reasonable expectation of growth and that it would be unreasonable to expect no growth in our sales. These increases include menu price increases in addition to any real growth. Historically our weighted menu prices have increased 1.5% to 6%. · Our variable and semi-variable restaurant operating costs are projected to increase proportionately with the sales increases as well as increasing an additional 1.5% per year consistent with inflation. · Our other fixed restaurant operating costs are projected to increase 1.5% to 2% per year. · Food and packaging costs are projected to decrease approximately .5% as a percentage of sales in relation to our fiscal 2013 food and packaging costs as a result of menu price increases and other menu initiatives. · Salvage value has been estimated on a restaurant by restaurant basis considering each restaurant's particular equipment package and building size. Given the results of our impairment analysis at September 30, 2013 there are no restaurants which are impaired as their projected undiscounted cash flows show recoverability of their asset values. Our impairment analysis included a sensitivity analysis with regard to the cash flow projections that determine the recoverability of each restaurant's assets. The results indicate that even with a 15% decline in our projected cash flows we would still not have any potential impairment issues. However if we elect to sublease, close or otherwise exit a restaurant location impairment could be required. Each time we conduct an impairment analysis in the future we will compare actual results to our projections and assumptions, and to the extent our actual results do not meet expectations, we will revise our assumptions and this could result in impairment charges being recognized. All of the judgments and assumptions made in preparing the cash flow projections are consistent with our other financial statement calculations and disclosures. The assumptions used in the cash flow projections are consistent with other forward-looking information prepared by the company, such as those used for internal budgets, discussions with third parties, and/or reporting to management or the board of directors. Projecting the cash flows for the impairment analysis involves significant estimates with regard to the performance of each restaurant, and it is reasonably possible that the estimates of cash flows may change in the near term resulting in the need to write down operating assets to fair value. If the assets are determined to be impaired, the amount of impairment recognized is the amount by which the carrying amount of the assets exceeds their fair value. Fair value would be determined using forecasted cash flows discounted using an estimated average cost of capital and the impairment charge would be recognized in income from operations. Income Taxes: We account for income taxes under the liability method whereby deferred tax asset and liability account balances are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company provides a valuation allowance, if necessary, to reduce deferred tax assets to their estimated realizable value. The deferred tax assets are reviewed periodically for recoverability, and valuation allowances are adjusted as necessary. We believe it is more likely than not that the recorded deferred tax assets will be realized. The Company is subject to taxation in various jurisdictions. The Company continues to remain subject to examination by U.S. federal authorities for the years 2010 through 2013. The Company believes that its income tax filing positions and deductions will be sustained on audit and does not anticipate any adjustments that will result in a material adverse effect on the Company's financial condition, results of operations, or cash flows. Therefore, no reserves for uncertain income tax positions have been recorded. The Company's practice is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company has accrued $0 for interest and penalties as of September 30, 2013 . Variable Interest Entities: Once an entity is determined to be a Variable Interest Entity (VIE), the party with the controlling financial interest, the primary beneficiary, is required to consolidate it. We have one franchisee with a note payable to the Company and after analysis we have determined that, while this franchisee is a VIE, we are not the primary beneficiary of the entity, and therefore it is not required to be consolidated. 27 Fair Value of Financial Instruments: Fair value is established under a framework for measuring fair value under GAAP and enhances disclosure about fair value measurements. New Accounting Pronouncements: There are no new accounting pronouncements that affect the Company. ITEM 7A.
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