Why I Could Not Make A Submission to This Book

Chris Cramer

(Note from editor: I am at the printer as I write this. I just received this message from Chris and as I read it, and the accompanying letter to his investors, I knew that I had to find a way to share this with our classmates. As I said to Chris just now, I learned more from reading his letter than from all the media I have consumed in the past three months. I got his permission to reprint the letter here, and I stopped the press in time to add it to the book. I thank Chris for allowing us to share in this.)

Dear Karl Strauss Brewing Company Partners,

I hope this communication finds you and your loved ones safe and healthy. As you likely have heard, with the recent surge of COVID-19 cases in California, Governor Gavin Newsom this past Monday ordered the re-closure of bars, indoor restaurants, movie theaters, and many other recently reopened businesses across the state including gyms, houses of worship, hair and nail salons, offices for noncritical work sectors, shopping malls, and barbershops. This reversal in California’s policy signals a major retreat in the state’s two-month effort to recover from the economic collapse caused by the coronavirus and significantly impacts our Limited Partnership’s business operations both with respect to our ability to fully reopen our brewpubs for on-premise dining, as well as selling our beers to other bars and restaurants for on-premise consumption. Also on Monday, Los Angeles Mayor Eric Garcetti said that the city’s COVID-19 threat meter is “on the border of going to red,” the highest level, which would mean a complete shutdown in L.A. owing to the coronavirus pandemic and as hospitalizations and ICU cases hit a new high. As I learned of these pronouncements by Newsom and Garcetti on Monday and realized the impacts they would have on our Partnership’s business operations, the tagline for the movie Jaws 2 immediately jumped to mind: “Just when you thought it was safe to go back in the water…” In continuance of the bad coronavirus news this week, yesterday San Diego County recorded its highest number of new infections (634) since the pandemic began, with two new outbreaks linked to unnamed area restaurants. With such unprecedented uncertainty in the business environment in which we must operate, I wanted to update you on the current state of our Partnership’s operations and illuminate the philosophy and thought processes which guide our decision-making.

As you know from my previous investor communications, as soon as it became evident in mid-March that due to the pandemic we were headed for a business shutdown and statewide shelter at home order, our Karl Strauss management team moved quickly to use all the tools at our disposal to minimize Partnership costs and overhead including making deep and painful layoffs, employee furloughs, salary reductions, rent deferment/abatement, etc. Some of you may remember that Matt Rattner and I modeled our original 1987 business plan on the book Entrepreneuring: Ten Commandments for Building a Growth Company, by former Stanford University Graduate School of Business Professor Steven C. Brandt. Professor Brandt’s 8th Commandment was “Go With the (Cash) Flow: Project, monitor, and conserve cash and credit capability,” and that is exactly what we have been doing. Our goal in preserving our Partnership’s financial resources is not just to ensure we survive the COVID-19 crisis, but to emerge from this unprecedented period of disruption with sufficient resources to rebound quickly when the pandemic is over and be positioned to grow and thrive in the new market environment.

As you may also remember, Jim Collins, another Stanford University Graduate School of Business Professor who was on the faculty when Matt and I attended, has significantly inspired our management philosophy over the years. In his bestselling book Good to Great, Professor Collins develops the companion concepts of “Confront the Brutal Facts” and “The Stockdale Paradox.” Collins asserts that productive change begins when you confront the brutal facts. Every good-to-great company embraced what he came to call “The Stockdale Paradox”: you must maintain unwavering faith that you can and will prevail in the end, regardless of the difficulties, and at the same time, have the discipline to confront the most brutal facts of your current reality, whatever they might be.

When the COVID-19 pandemic began, Matt and I did what we always do. As lifelong students, we conducted exhaustive research and engaged in numerous consultations with experts. Based on the best medical science available to us (and after having worked our way through the five stages of grief to get to “Acceptance”), Matt and I came to the conclusion it would be a long time (at least 12–24 months or longer) before the U.S. population’s propensity to dine or drink in public in close proximity to strangers in brewpubs, restaurants, and bars would return to anywhere near pre-pandemic levels. The “Brutal Facts” of COVID-19 that we concluded we must confront for our Partnership’s businesses to first survive the current crisis, and then to thrive again are:

1. The virus is not “going away”. We are still in the first wave of the contagion with the country having reached a new peak of more than 71,000 new coronavirus cases in the last 24 hours. More than 4.4 million people in the U.S. have tested positive for the coronavirus, and more than 152,000 have died from it since February. With new cases rising in more than 40 states, widespread returns to lockdowns and sheltering at home orders are potentially looming. We believe this first wave of the pandemic is going to get worse before it gets better, and that the only way for our society to return to normal is to do what other countries across the globe have done to achieve a better result. Specifically, containing COVID-19 will require the nearly universal embracing of mask wearing, social distancing, sanitation, regular handwashing, refraining from touching one’s hands and face, and potentially reinstating sheltering in place orders to bring the number of infected persons down to an extremely low level – much lower than they were in April and May when states began opening up again. Then, before slowly re-opening businesses, we must have in place:

1. effective pandemic abatement actions applied consistently across broad geographic areas;
2. widespread COVID-19 testing with test results quickly available;
3. robust contact tracing systems; and
4. the ability and political will to quickly identify and contain (including mandating new shutdowns) any new flare-ups of the virus as it reappears.

Back on April 18th, New York Times science reporter Donald McNeil published an in-depth look at the path ahead entitled “The Coronavirus in America: The Year Ahead,” which Matt and I embraced as being the single viewpoint which was most closely aligned with our vision of how the pandemic would play out. I encourage you to read it, along with transcripts of the interviews McNeil did with Rachel Maddow of MSNBC and Michael Barbaro of The Daily on April 20th so you can see just how scarily prescient and on-the-money his predictions were. As Governor Newsom said during his Monday news conference in Sacramento announcing the new ban on indoor dining, “This virus is not going away any time soon…It’s incumbent upon all of us to recognize soberly that COVID-19 is not going away…until there is a vaccine and/or an effective therapy.”

2. There will be a second wave of the pandemic, likely to be worse than the first, that will come in the fall and winter in conjunction with the regular flu season. History reminds us that after the first wave of the “Spanish” flu hit the U.S. in the spring of 1918, the virus mutated over the summer into a more virulent strain which then took the lives of 195,000 Americans in the single month of October 1918 at a time when the U.S. population was only 103 million (vs. 331 million today). Ultimately, approximately 0.5 percent of the U.S. population died as a result of that epidemic.

3. Any potential COVID-19 vaccine (if one is ever developed) is not likely to be widely available and distributed in the quantities needed to achieve herd immunity until the first half of 2021 at the earliest, and the efficacy of any first vaccine(s) is unlikely to be sufficient to provide the most at-risk segments of the population (e.g., persons 65 years or older, those who have co-morbidities such as diabetes, etc.) enough assurance of protection to induce them to resume socializing with other humans in the manner they did before the pandemic began.

4. Therapeutic treatments for COVID-19 will continue to improve and ultimately may provide the best hope for moving past this pandemic – much as has been the case with HIV/AIDS for which, nearly 40 years after the first cases were reported in 1981, an effective vaccine still has never been developed.

5. Even as the pandemic is contained by potential vaccines providing herd immunity or by new therapies, there will likely be a continuing drag on consumer demand for on-premise dining based on an anticipated prolonged deep economic recession or depression. U.S. employment is unlikely to return to pre-pandemic levels for potentially years which will be a limiting factor on discretionary income and the number of people who will be able to afford to go out to brewpubs, breweries, bars, restaurants, etc. In addition, consumers who are in higher health risk groups for COVID-19 are likely to continue their physical distancing from strangers for an extended period of time which will also suppress the overall demand for on-premise drinking and dining.

In the context of these Brutal Facts as we see them, we believe it is likely that 30–40% or more of the restaurants and breweries in California will fail in the next 12–24 months. Depending on the stimulus package the Federal Government passes in the coming weeks and on the actions of our state and local officials, we anticipate a large wave of business failures may start this October when the first round of PPP funds which have been propping up so many small businesses run out, and these businesses are left with no financial reserves with which to continue their fight to survive. That is why since March Matt and I have so purposefully focused on adhering to Professor Brandt’s 8th Commandment: conserving cash and credit capability, protecting our Partnership’s significant real estate and other assets, and have only used funds from the federal Paycheck Protection Program (“PPP”) loan which AML received for paychecks to our team members – the intended purpose of the program. Having access to cash and credit capability will be of paramount importance in the days and months to come. Those businesses which have preserved their capital resources and survive the “thinning of the herds” which we believe is coming in our industries will be in a strong position to reap significant financial rewards as the pandemic ultimately passes.

Matt and I wholeheartedly embrace “The Stockdale Paradox” and maintain an unwavering faith that Karl Strauss Brewing Company will prevail in the end, regardless of the difficulties. Having confronted the Brutal Facts of the COVID-19 pandemic, our Senior Leadership Team has been adapting and pivoting our operations to align them to take advantage of the business opportunities available to us in the current pandemic-impacted environment and to position our company for rapid future growth.

Since my last investor communication our Karl Strauss Brewpubs Operations Team has worked tirelessly to re-invent and re-open our brewpubs for on-premise dining (now limited by Governor Newsom’s recent Executive Order to outdoor dining only on-premise) and today, 8 of our 10 brewpub locations are open for business! Our original Karl Strauss Downtown San Diego Brewpub is open only for takeout and delivery, although on Friday-Sundays a temporary weekend patio will be set up outside on Columbia Street where it will be possible to enjoy the food and beverages purchased for takeout. Karl Strauss Los Angeles and Karl Strauss Universal CitiWalk remain closed at present.

Below, please find Matt Rattner’s communication which was sent earlier this week to all our Karl Strauss Team Members explaining in detail the operational changes that we have been making and the rationales behind them. With respect to our Karl Strauss brewpubs, we realized early on that to continue operating them as full-service dining establishments as we had done before the pandemic, and then add in all the additional costs to protect the health of our team members and guests (including PPE, sanitizing, etc.), was simply not sustainable financially.

Professor Brandt’s 7th Commandment in Entrepreneuring is “Walk Before You Run: Expand methodically from a profitable base toward a balanced business.” To make our brewpub operations achieve a profitable base in light of the Brutal Facts we are confronting, we felt it was imperative we re-invent our guest service model, menu offerings, and overall cost structures so that we could scale our operations and labor requirements quickly and appropriately to meet weakened and potentially inconsistent demand. The goal was to create a new hybrid service model for our brewpub operations that could be sustained on brewpub sales that might only achieve 30–60% of pre-pandemic levels for the next year or two.

Looking back on the past few months it is remarkable just how much our Brewpub Operations team has accomplished in so little time; from developing a new company-wide takeout and delivery program to implementing comprehensive COVID-19 health and safety protocols to creating inviting outdoor dining patios in parking lots – and our new systems will only get better as we continue to hone our operations and make additional improvements over time. We have leveraged the fact that at this point in history with the whole world having been disrupted simultaneously, consumers are more understanding of and receptive to changes in long-established businesses than ever before, and loyal fans of strong brands like Karl Strauss are rooting for us to succeed. We have seized the opportunity created by COVID-19 to embrace lower-touch (and also lower labor cost) consumer interfaces such as providing menus and self-ordering on personal handheld devices as they are consistent with best practices to ensure health and safety and to lower the possibility of disease transmission. At the end of this transformational reinvention process we expect to have positioned Karl Strauss Brewing Company with a new, highly scalable brewpub model which has been comprehensively redesigned to have a lower and more flexible cost structure while still giving guests the traditional warm Karl Strauss hospitality experience, and which is capable of achieving high sales volumes once the COVID-19 pandemic is over. Going forward, our plan is to take the knowledge gained from this exercise in adapting our existing brewpubs to this new model and then apply these learnings to inform the building of a theoretical ideal Karl Strauss brewpub model that can be used as the template for future expansion, giving our Partnership a new growth vehicle specifically designed to take advantage of the extraordinary real estate opportunities we anticipate this pandemic will create.

Proactively addressing and containing indirect overhead costs such as rents has been a critical component in making our new brewpub model’s financial structure adhere to Professor Brandt’s 7th Commandment of first achieving a profitable base, and then expanding methodically toward a balanced business. Consequently, since March we have been fully engaged in lease discussions with our Karl Strauss brewpub landlords asking them, as partners in the success of our business, to participate in making fair and reasonable accommodations to our lease agreements that will help ensure our continued operation throughout the pandemic, as well as the long-term viability of each brewpub location. Working in our favor with respect to this effort is the anticipation there soon may be an historically high vacancy rate in real properties built for on-premise dining if a large number of full-service restaurants fail in a short period of time. Restaurant industry experts with whom we have consulted believe it is unlikely that many new operators will be lining up any time soon to take over vacant full-service restaurant spaces should a current restaurant tenant fail during the pandemic. Savvy landlords understand a) how expensive it can be to re-purpose a restaurant building to another use, b) that there are significant friction costs in any tenant turnover, and c) that having a good, long-term tenant who pays some rent reliably is much better than having no tenant at all. We are hopeful we will be able to successfully reach agreements with our various landlords that benefit our mutual interests.

With respect to our Beer Division operations, the pandemic has forced us to shift our brewery production operations from focusing on producing draft beer in kegs for on-premise consumption in restaurants and bars (a more profitable activity which has been severely and negatively impacted by COVID-19) to producing packaged beer in bottles and cans, which is a less profitable activity. While our packaged beer and Endless Summer Hard Seltzer sales have grown during the pandemic, their growth has been insufficient to overcome the lost profit from our draft beer sales declines caused by the government-imposed mandates restricting or banning on-premise drinking and dining. Looking forward, we see significant opportunities to improve production operational efficiencies and increase the profitability of our packaged products as we continue to grow their sales. For example, we are currently evaluating making an approximately $1.5 million investment in new canning line equipment that would markedly increase the speed (up to four times faster than our current canning line speed) and the quality assurance of our canning line operations, and which would immediately reduce our labor and other canning packaging costs by more than $300,000 each year. As sales of our canned beers and Endless Summer Hard Seltzers grow, the savings realized by making this investment would also grow.

Matt and I believe there are many reasons to be optimistic about our company’s future, starting with our having the best team and investor group in our industry. We took strong and immediate action to preserve company financial resources as soon as the pandemic started, and our realistic (rather than hope-driven) outlook of the likely duration and severity of the pandemic has informed our decision-making throughout. We did not jump to reopen our brewpubs too quickly after the State of California re-allowed on-premise dining. Instead, we took our time to do things right, put strong systems in place, and reinvented our brewpub operations to appropriately meet the current and anticipated future environment. By progressing deliberately and opening just one brewpub at a time we not only were able to apply the lessons learned to each successive re-opening, we also fortuitously avoided over-investing in making modifications to our brewpub interiors which now would be rendered useless by the current statewide ban on indoor dining. Whenever the U.S. finally emerges from this pandemic we expect Karl Strauss Brewing Company will be in an industry leadership position, and the new business environment we envision after the coming wave of restaurant and brewery failures will have many promising aspects that we believe could work in our favor as we accelerate our company’s growth again, including:

1. extraordinary real estate opportunities for fully-fixturized restaurant and brewery properties in favorable locations;
2. reduced industry competition for restaurant and brewery
   guests;
3. a ready supply of affordable, second-hand brewing and restaurant equipment available for those concepts able to
   re-purpose them;
4. a favorable labor environment for employers, and
5. low interest rates for financing growth.

Humans are incredibly social animals. The drive to be in close proximity with others is not erased or diminished by periods of sheltering at home, and in fact, it may be increased. The recent spike in COVID-19 cases has clearly been exacerbated by the intense desire of people to socialize with others after enduring a period of self-isolation, even when many people knew they might be putting themselves at risk of infection by doing so. We remain confident that once this pandemic is in the past, people will still want to get together with others to socialize over great beers and delicious food. And Karl Strauss Brewing Company plans to be there to accommodate and promote that desire.

In Conclusion

Thank you all for your support and encouragement during this extraordinarily
challenging and uncertain time – it means the world to Matt and me and our Senior Leadership Team to know you have our backs as we fight the good fight. If you are near a Karl Strauss brewpub, please go in and experience our new on-premise dining model and give us your honest feedback by email as we want to hear it. To receive your Karl Strauss Partner Dining Discount you will need to go to the counter to place your order and show your Partner Card as our current legacy Aloha Point of Sale (“POS”) system has significant limitations and does not allow for you to receive this discount when you order from your handheld device. FYI – one of the many technology accelerators we are considering to further enhance the guest experience in our new brewpub hybrid service model is replacing our current Aloha POS system with a new-age, cloud-based POS system which would also have significantly greater capabilities with respect to management tools, marketing applications, integration with online ordering for take-out and delivery, etc.

Stay safe, be well, and we look forward to hearing from you and seeing you soon. Onward and UPWARD!