Kelley Restaurants Acquisition
On December 29, 2004, the Company acquired KRI for $16,082. KRI operated 17 Steak n Shake restaurants in Atlanta, Georgia and Charlotte, North Carolina. The President of KRI is a member of the Company's board of directors.
The transaction was accounted for using the purchase method of accounting as required by SFAS 141, "Business Combinations." The purchase price has been allocated to tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values at the date of the acquisition. The excess of the purchase price over the fair value of net assets acquired was recorded as goodwill. The allocation of the purchase price to specific assets and liabilities was based, in part, upon internal estimates of assets and liabilities. The Company has received independent appraisals for certain assets. Based on the final purchase price allocation, the following table summarizes the fair value of the assets acquired and liabilities assumed at the acquisition date.
| | | | |
| Current assets | | $ | 617 | |
| Property and equipment | | | 21,660 | |
| Goodwill | | | 7,803 | |
| Intangible assets | | | 1,051 | |
| Other assets | | | 46 | |
| | | | | |
| Total assets acquired | | | 31,177 | |
| | | | | |
| Current liabilities | | | 3,723 | |
| Deferred income taxes | | | 925 | |
| Obligations under lease | | | 6,486 | |
| Long-term debt | | | 3,961 | |
| | | | | |
| Total liabilities assumed | | | 15,095 | |
| | | | | |
| Net assets acquired | | $ | 16,082 | |
| | | | | |
Provision for Restaurant Closings
During the fourth quarter of fiscal year 2005, the Company identified two under-performing restaurants for disposal. In connection with the decision to dispose of these restaurants, the Company recorded a charge of $1,400 primarily for property and equipment write-downs. Similarly in 2003, the Company identified nine underperforming restaurants and recorded charges of $5,200. Of these nine restaurants, five were sold in 2004. The Company is currently seeking buyers for the remaining four properties, in addition to the two closed in fiscal 2005, all of which are classified as held for sale. The Company is currently marketing the properties, and intends to sell the properties within the next twelve months.
Activity related to the provision for restaurant closings is as follows:
(amounts in $000’s) | | | Balance at September 28, 2005 | | | Amounts Charged during 2006 | | | Amounts Utilized (cash)during 2006 | | | Amounts Utilized (non-cash) during 2006 | | | Other Adjustments during 2006 | | | Balance at December 21, 2005 | |
Asset write-downs(1) | | $ | 4,413 | | $ | - | | $ | - | | $ | (17 | ) | $ | - | | $ | 4,396 | |
| Closing costs | | | 53 | | | - | | | - | | | - | | | | | | 53 | |
| Total | | $ | 4,466 | | $ | - | | $ | - | | $ | (17 | ) | $ | - | | $ | 4,449 | |
(amounts in $000’s) | | | Balance at September 29, 2004 | | | Amounts Charged during 2005 | | | Amounts Utilized (cash) during 2005 | | | Amounts Utilized (non-cash) during 2005 | | | Other Adjustments during 2005 | | | Balance at December 22, 2004 | |
Asset write-downs(1) | | $ | 3,058 | | $ | (5 | ) | $ | - | | $ | - | | $ | - | | $ | 3.053 | |
| Closing costs | | | 24 | | | | | | (11 | ) | | - | | | - | | | 13 | |
| Total | | $ | 3,082 | | $ | (5 | ) | $ | (11 | ) | $ | - | | $ | - | | $ | 3,066 | |
(1) Amounts represent adjustments to cost basis of the assets.
Related Party Transactions
On December 15, 2005, Steak n Shake Operations, Inc. entered into an agreement to sell its Greenville, South Carolina store to Kelley Operations, Inc. Wayne Kelley is both President of Kelley Operations, Inc. and a member of the Board of Directors of the Company. The sale of this location for $1,350 includes both real estate and personal property. The closing of the transaction is scheduled to occur in March 2006.
Supplemental Cash Flow Information
During the twelve week period ended December 21, 2005, the Company issued 20,000 shares of restricted stock under its Capital Appreciation Plan with a market value of $363. During the twelve week period ended December 22, 2004, the Company issued 125,500 shares of restricted stock under its Capital Appreciation Plan with a market value of $2,205.
Commitments and Contingencies
The Company is engaged in various legal proceedings and has certain unresolved claims pending. The ultimate liability, in any, for the aggregate amounts claimed cannot be determined at this time. However, management of the Company, believes, based on examination of these matters and experiences to date, that the ultimate liability, if any, in excess of amounts already provided in the Company's consolidated financial statements is not likely to have a material effect on its results of operations, financial position or cash flows.
Reclassifications
Certain amounts in the fiscal 2006 financial statements have been reclassified to conform to the fiscal 2005 presentation.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in $000's, except share and per share data)
Overview
In the following discussion, the term "same store sales" refers to the sales of only those units open eighteen months as of the beginning of the current fiscal period and which remained open through the end of the fiscal period.
Quarter Highlights:
- Total revenues increased 9.7% to $138,741
- Net Earnings were $4,659
- Diluted earnings per share were $.17 (includes $.01 impact of adopting SFAS 123(R))
- Same Store Sales decreased by 1.1%
In the current quarter, the Company opened six Company owned restaurants. In addition, two franchise units opened during the first quarter. As previously represented, the Company is continuing to prepare for accelerated expansion as it executes is five year strategic plan. The Company continues to execute the Key Results Areas ("KRA's") of the strategic plan and has made significant strides in the current quarter. The KRA's are same store sales, expansion, leaders and associates, margins, and an improved operating model.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to use its judgment to make estimates and assumptions that can have a material impact on the results of operations and reported amounts of assets and liabilities. The Company evaluates its assumptions and estimates on an ongoing basis based on historical experience and various other factors that are believed to be relevant under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
The Company believes that, of its significant accounting policies, the following policies involve a higher degree of risk, judgement and/or complexity.
Impairment of Long-lived Assets
The Company reviews its restaurants for impairment on a restaurant-by-restaurant basis when events or circumstances indicate a possible impairment. The Company tests for impairment by comparing the carrying value of the asset to the undiscounted future cash flows expected to be generated by the asset. If the total estimated future cash flows are less than the carrying amount of the asset, the carrying amount is written down to the estimated fair value, and a loss is recognized in earnings. Because depreciation and amortization expense is based upon useful lives of assets and the net salvage value at the end of their lives, significant judgment is required in estimating this expense. Additionally, the future cash flows expected to be generated by an asset requires significant judgment regarding future performance of the asset, fair market value if the asset were to be sold, and other financial and economic assumptions. Accordingly, management believes that accounting estimates related to long-lived assets are critical.
Insurance Reserves
The Company self-insures a significant portion of expected losses under its workers' compensation, general liability, and auto liability insurance programs. The Company purchases reinsurance for individual and aggregate claims that exceed predetermined limits. The Company records a liability for all unresolved claims and its estimate of incurred but not reported ("IBNR") claims at the anticipated cost to the Company. The liability estimate is based on information received from insurance companies, combined with management's judgments regarding frequency and severity of claims, claims development history, and settlement practices. Significant judgment is required to estimate IBNR claims as parties have yet to assert a claim and therefore the degree to which injuries have been incurred, and the related costs, have not yet been determined. Additionally, estimates about future costs involve significant judgment regarding legislation, case jurisdictions and other matters. Accordingly, management believes that estimates related to self-insurance reserves are critical.
Beginning January 1, 2006, the Company self-insures its group health insurance risk. Similar to the reserves for worker's compensation, general liability and auto liability insurance, the Company will determine the amount of a liability based on information received including claims incurred but not reported and known claims that are scheduled to be paid. The Company will continue to work with a third party processor to handle the specific payment of individual claims.
Income Taxes
The Company records deferred tax assets or liabilities based on differences between financial reporting and tax basis of assets and liabilities using currently enacted rates and laws that will be in effect when the differences are expected to reverse. Management records deferred tax assets to the extent it believes there will be sufficient future taxable income to utilize those assets prior to their expiration. To the extent deferred tax assets would be unable to be utilized, management would record a valuation allowance against the unrealizable amount, and record that amount as a charge against earnings. Due to changing tax laws and state income tax rates, significant judgment is required to estimate the effective tax rate expected to apply to tax differences that are expected to reverse in the future. Management must also make estimates about the sufficiency of taxable income in future periods to offset any deductions related to deferred tax assets currently recorded. Accordingly, management believes estimates related to income taxes are critical.
Goodwill and Other Intangible Assets
The Company evaluates goodwill and other indefinite life intangible assets annually, or more frequently if indicators of impairment are present. If the determined fair values of these assets are less than the related carrying amounts an impairment loss is recognized. The methods used to estimate fair value include future cash flow assumptions, which may differ from actual cash flows due to, among other things, economic conditions or changes in operating performance. The future cash flows expected to be generated by an asset requires significant judgment regarding future performance of the asset, and other financial and economic assumptions. Accordingly, management believes that accounting estimates related to goodwill and other intangible assets are critical.
Leases
The Company leases certain properties under operating leases. Many lease agreements contain rent holidays, rent escalation clauses and/or contingent rent provisions. The Company recognizes rent expense on a straight-line basis over the expected lease term, including cancelable option periods where failure to exercise such options would result in an economic penalty. The Company uses a time period for its straight-line rent expense calculation that equals or exceeds the time period used for depreciation. In addition, the rent commencement date of the lease term is the earlier of the date when the Company becomes legally obligated for the rent payments or the date when the Company takes access to the property. As the assumptions inherent in determining lease commencement and lease expiration dates and other related complexities of accounting for leases involve significant judgement, management has determined lease accounting is critical.
Results of Operations
The following table sets forth the percentage relationship to total revenues, unless otherwise indicated, of items included in the Company's consolidated statements of earnings for the periods indicated:
| | | Twelve Weeks Ended | |
| | | December 21, | | December 22, | |
| | | 2005 | | 2004 | |
Revenues | | | | | |
| Net sales | | | 99.4 | % | | 99.2 | % |
| Franchise fees | | | .6 | | | .8 | |
| | | | 100.0 | | | 100.0 | |
Costs and Expenses | | | | | | | |
Cost of sales(1) | | | 22.9 | | | 23.6 | |
Restaurant operating costs(1) | | | 50.6 | | | 49.8 | |
| General and administrative | | | 9.0 | | | 8.6 | |
| Depreciation and amortization | | | 4.6 | | | 4.5 | |
| Marketing | | | 4.2 | | | 4.0 | |
| Interest | | | 2.0 | | | 2.2 | |
| Rent | | | 1.8 | | | 1.6 | |
| Pre-opening costs | | | .8 | | | .4 | |
| Other income, net | | | (.5 | ) | | (.4 | ) |
| Total costs and expenses | | | 95.1 | | | 93.9 | |
| | | | | | | | |
Earnings Before Income Taxes | | | 4.9 | | | 6.1 | |
| | | | | | | | |
Income Taxes | | | 1.6 | | | 2.1 | |
| | | | | | | | |
Net Earnings | | | 3.4 | % | | 4.0 | % |
| | | | | | | | |
| (1) Cost of sales and restaurant operating costs are expressed as a percentage of net sales. |
Comparison of Twelve Weeks Ended December 21, 2005 to Twelve Weeks Ended December 22, 2004
(Amounts in $000's)
Revenues
Net sales increased $12,348 (9.8%) to $137,852 primarily due to the increase in Company-owned restaurants slightly offset by a decrease in same store sales. At the end of the quarter, the Company operated 403 Company-owned restaurants compared to 368 at the end of the quarter in the previous year. The same store sales decrease consists of a 4.0% increase in check average offset by a decrease in guest traffic of 5.1%. The increase in check average results primarily from a 2.9% weighted average menu price increase compared to the same period in the prior year.
Costs and Expenses
Cost of sales increased $1,894 (6.4%) to $31,520 primarily due to increased net sales. Cost of sales as a percentage of net sales decreased to 22.9% from 23.6%, primarily as a result of lower commodity costs including chicken, bacon, dairy and tomatoes and the positive impact of the menu price increase.
Restaurant operating costs increased $7,269 (11.6%) to $69,791 due to increased net sales and higher costs in operating components. Restaurant operating costs as a percentage of net sales increased from 49.8% to 50.6%, primarily due to substanially higher energy costs, petroleum based supplies, and the timing of repairs. Restaurant labor costs as a percentage of sales remained fairly consistent with the prior year as a percentage of sales.
General and administrative expenses increased $1,641 (15.2%) to $12,472, and increased to 9.0% as a percentage of revenue, compared to 8.6% in the same period in the prior year. The higher spending as a percent of revenues versus prior year was driven by the acquisition of Kelley Restaurants, Inc. ("KRI"), $392 of stock compensation expense related to the adoption of SFAS 123(R), and investments to support future expansion.
Depreciation and amortization expense increased $662 (11.5%) to $6,397. The increase is attributable to additional restaurants, including the 17 restaurants that were acquired from Kelley Restaurants, Inc in the second quarter of the prior fiscal year. As a percentage of total revenues, depreciation and amortization expense increased slightly to 4.6% from 4.5% in the prior year.
Marketing expense increased $762 (15.0%) to $5,852, and as a percentage of revenue increased to 4.2% from 4.0% in the same period in the prior year. The increase in marketing expense was primarily due to increased television advertising in support of the Halloween milk shake launch.
Interest expense decreased $58 (2.0%) to $2,787. The slight decrease is a result of decreased net borrowings under the Company’s Senior Note Agreement.
Rent expense increased $477 (23.2%) to $2,534 as a result of an increased number of restaurants, primarily due to the 17 restaurants acquired from KRI. As a percentage of revenue, rent expense increased from 1.6% to 1.8% largely due to the increased number of rented units and the decline in same store sales.
Pre-opening costs increased $620 (110.9%) to $1,179 as the Company was in the process of opening more restaurants in the current year versus the prior year. During the quarter, the Company opened six new restaurants compared to three in the same period in the prior year.
Other income remained fairly consistent at $656 in the current year versus $482 in the prior year.
Income Taxes
The Company's effective income tax rate decreased to 32.1% from 34.0% in the same period in the prior year primarily due to increased FICA tax credits and Work Opportunity Tax Credits and favorable resolution of income tax contingencies.
Liquidity and Capital Resources
During the twelve week period ended December 21, 2005, the Company opened six Company-owned Steak n Shake restaurants and two franchised restaurants. In the twelve week period ended December 22, 2004, the Company opened three Company-owned Steak n Shake restaurants and opened one rebuilt location. Twelve new restaurants and two rebuilds were under construction at the end of the current quarter. For the twelve weeks ended December 21, 2005, capital expenditures totaled $16,888 as compared to $12,773 for the same period in the prior year.
The Company anticipates opening at least 20 new Steak n Shake restaurants during the remainder of fiscal year 2006, for a total of at least 26 new Company-owned stores. The average cost of a new Company-operated Steak n Shake restaurant, including land, site improvements, building and equipment is approximately $2,000 - $2,500. Total capital expenditures for fiscal year 2006 are estimated to be $70,000 to $80,000 which includes corporate expenditures and existing location expenditures. The Company intends to fund 2006 capital expenditures, and meet other working capital needs, with existing cash and anticipated cash flows from operations.
During the twelve weeks ended December 21, 2005, cash provided by operations totaled $17,509, compared to $16,664 in the same period in the prior year. This increase in cash provided by operations is attributable primarily to changes in deferred taxes slightly offset by the decrease in net income. Net cash used in financing activities for the twelve weeks ended December 21, 2005, totaled $201 compared to $664 in the comparable prior period. This decline was due to proceeds received from build-to-suit transactions.
As of December 21, 2005, the Company had outstanding borrowings of $9,428 under its Senior Note Agreement and Private Shelf Facility ("Senior Note Agreement") and $75,000 of additional borrowing capacity available. Borrowings under the Senior Note Agreement bear interest at an average fixed rate of 7.6%. In addition, the Company has one mortgage which it assumed in the KRI acquisition. The mortgage bears interest at a fixed rate of 5% and had an outstanding balance of $795 at December 21, 2005.
The Company has a $50,000 Revolving Credit Facility ("the Facility") that bears interest based on LIBOR plus 55 basis points, or the prime rate minus 100 basis points, at the election of the Company, and matures on January 30, 2008. There were no borrowings under the Facility at December 21, 2005.
The Company's debt agreements contain restrictions and covenants customary for credit agreements of these types which, among other things, require the Company to maintain certain financial ratios. The Company was in compliance with all covenants under its borrowing agreements at December 21, 2005.
Effects of Governmental Regulations and Inflation
Most of the Company's employees are paid hourly rates related to federal and state minimum wage laws. Any increase in the legal minimum wage would directly increase the Company's operating costs. The Company is also subject to various federal, state and local laws related to zoning, land use, safety standards, working conditions and accessibility standards. Any changes in these laws that require improvements to our restaurants would increase their operating costs. In addition, the Company is subject to franchise registration requirements and certain related federal and state laws regarding franchise operations. Any changes in these laws could affect the Company’s ability to attract and retain franchisees.
Inflation in food, labor, fringe benefits, and other operating costs directly affects the Company's operations. The Company’s results of operations have not been significantly affected by inflation in the recent past.
Risks Associated with Forward-Looking Statements
Certain statements contained in this report represent forward-looking statements. In general, forward-looking statements include estimates of future revenues, cash flows, capital expenditures, or other financial items, and assumptions underlying any of the foregoing. Forward-looking statements reflect management’s current expectations regarding future events and use words such as "anticipate", "believe", "expect", "may", "will", and other similar terminology. These statements speak only as of the date they were made and involve a number of risks and uncertainties that could cause actual results to differ materially from those expressed in forward-looking statements. Several factors, many beyond our control, could cause actual results to differ significantly from our expectations, such as the following: effectiveness of operating initiatives; changes in economic conditions; effectiveness of advertising and marketing initiatives; harsh weather conditions; availability and cost of qualified restaurant personnel; changes in consumer tastes; changes in consumer behavior based on publicity or concerns relating to food safety or food-borne illnesses; effectiveness of our expansion plans; changes in minimum wage rates; and changes in applicable accounting policies and practices. The foregoing list of important factors is not intended to be all-inclusive as other general market, industry, economic, and political factors may also impact our operations. Readers are cautioned not to place undue reliance on our forward-looking statements, as we assume no obligation to update forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk exposure with regard to financial instruments is to changes in interest rates. Pursuant to the terms of the Senior Note Agreement, the Company may from time to time issue notes in increments of at least $5,000,000. The interest rate on the notes is based upon market rates at the time of the borrowing. Once the interest rate is established at the time of the initial borrowing, the interest rate remains fixed over the term of the underlying note. The Facility bears interest at a rate based upon LIBOR plus 55 basis points or the prime rate minus 100 basis points, at the election of the Company. Historically, the Company has not used derivative financial instruments to manage exposure to interest rate changes. At December 21, 2005, a hypothetical 100 basis point increase in short-term rates would have an immaterial impact on the Company's earnings.
The Company purchases certain food products, which may be affected by volatility in commodity prices due to weather conditions, supply levels, and other market conditions. The Company utilizes various purchasing and contract pricing techniques to minimize volatility, but does not enter into financial derivative contracts.
ITEM 4. CONTROLS AND PROCEDURES
Based on an evaluation of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(c)), the Company's Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures were effective as of December 21, 2005, in timely alerting the Company's management to material information required to be included in this Form 10-Q and other Exchange Act filings. There have been no changes in the Company's internal control over financial reporting during the quarter ended December 21, 2005 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table presents a summary of share repurchases made by the Company:
Period | | Total Number of Shares Purchased | Average Price Paid per Share | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs | |
| | | | | | | | | |
| November 17, 2005 - December 21, 2005 | | -- | -- | | -- | | 3,000,000 | |
The share repurchase program previously authorized by the Board of Directors was announced on November 16, 2005. The program allows for the repurchase of up to three million shares for a period of two years.
Exhibits
31.1 | Rule 13a - 14(a) / 15d - 14(a) Certification of Chief Executive Officer. |
31.2 | Rule 13a - 14(a) / 15d - 14(a) Certification of Chief Financial Officer. |
32 | Section 1350 Certifications. |
SIGNATURE
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, on January 30, 2006.
THE STEAK N SHAKE COMPANY
(Registrant)
By /s/ Jeffrey A. Blade
Jeffrey A. Blade
Senior Vice President
and Chief Financial Officer
