ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in $000s, except share and per share data)
Overview
Our net loss for the third quarter includes the effect of a non-cash impairment charge of $14,089 ($8,735 or $0.31 per diluted share, net of tax). Of the total pre-tax charges, $4,818 stems from agroup of 12 stores that we plan to close in the fourth quarter of fiscal 2008. The $8,794 relates to 18 restaurants to be held and used which were impaired because the carrying values of their underlying assets exceeded expected future cash flows. The remaining $477 relates to three stores involved in a sale-leaseback transaction whose net book values exceeded their fair values.
We anticipate recording additional future charges which emanate from leased units. Pursuant to SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” upon closure of such stores, charges may be recorded for the costs of early lease termination costs or for our estimate of costs that will continue to be incurred for the remaining term of the lease agreement without economic benefit to us. While these actions would impact our income statement, they are intended to improve future cash flows.
Our cash flow from operations in the third quarter was $9,684 million. Our capital expenditures were $4,654 million, which included the rollout of the Point of Sale system, recent store openings, and maintenance. In the fourth quarter capital spending will be largely limited to maintenance capital expenditures.
We are presently undergoing a comprehensive examination of the Company and are in the process of implementing a restructuring program. We are intent on maximizing cash flows and are therefore undertaking many initiatives such as the following:
● | Closing underperforming locations |
● | Reducing General and administrative expenses further |
● | Shortening hours of operation in many locations |
● | Tax planning to recover a substantial amount of taxes paid in fiscal 2006 |
● | Limiting capital spending at the store level to maintenance — no new Company store openings |
In addition, we are working with a sense of urgency to revive our operations. We believe the lack of store level execution in recent years has significantly contributed to a decline in our guest counts. During the third fiscal quarter, same store sales decreased 5.8%. Same store sales refers to the sales of only those units open 18 months as of the beginning of the current fiscal quarter and which remained open through the end of the fiscal quarter. In addition to the downturn in sales in the third fiscal quarter, the Company experienced deterioration in operating margins because of aggressive discounting, increases in commodity prices, and minimum wage rates. We will continue to take action to manage our costs while concurrently investing in our future by improving unit economics.
In the third quarter, franchisees opened two new restaurants, bringing the total number of franchised units to 69. The total number of Company-owned restaurants remains 436. We did not open, close, or transfer any Company-owned units during the current quarter.
Critical Accounting Policies
Management’s discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, expenses and related disclosure of contingent assets and liabilities. Critical accounting policies are those we believe are most important to portraying our financial condition and results of operations and also require the most subjective or complex judgments by management. Judgments and uncertainties regarding the application of these policies may result in materially different amounts being reported under various conditions or using different assumptions. On an ongoing basis, we evaluate our estimates and assumptions based on historical experience and other factors that are believed to be relevant under the circumstances. Except for income taxes, there have been no material changes to the critical accounting policies previously disclosed in our Annual Report on Form 10-K for the fiscal year ended September 26, 2007. The methodology applied to management’s estimate for income taxes has changed due to the implementation of a new accounting pronouncement as described below.
In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109” (“FIN 48”), which became effective for us at the beginning of our current fiscal year, September 27, 2007. FIN 48 addresses the determination of how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, we must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. As a result of the implementation of FIN 48, we recognized an increase of $614 in the liability for unrecognized tax benefits, which was accounted for as a reduction of $312 to retained earnings and $302 to deferred taxes as of the adoption date. Our estimates of the tax benefit from uncertain tax positions may change in the future due to new developments in each matter.
For additional information regarding the adoption of FIN 48, see Note 10 of Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q.
Results of Operations
The following table sets forth the percentage relationship to total revenues, unless otherwise indicated, of items included in our condensed consolidated Statements of Operations for the periods indicated:
| | | Twelve Weeks Ended | | | Forty Weeks Ended | |
| | | July 2, | | | July 4, | | | July 2, | | | July 4, | |
| | | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| Revenues: | | | | | | | | | | | | |
| Net sales | | | 99.3 | % | | | 99.4 | % | | | 99.3 | % | | | 99.4 | % |
| Franchise fees | | | 0.7 | % | | | 0.6 | % | | | 0.7 | % | | | 0.6 | % |
| Total revenues | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % |
| | | | | | | | | | | | | | | | | |
| Costs and Expenses: | | | | | | | | | | | | | | | | |
| Cost of sales (1) | | | 24.8 | % | | | 23.1 | % | | | 24.7 | % | | | 22.9 | % |
| Restaurant operating costs (1) | | | 55.3 | % | | | 52.3 | % | | | 55.4 | % | | | 51.4 | % |
| General and administrative | | | 7.4 | % | | | 8.3 | % | | | 7.5 | % | | | 8.7 | % |
| Depreciation and amortization | | | 5.4 | % | | | 4.9 | % | | | 5.5 | % | | | 4.9 | % |
| Marketing | | | 4.6 | % | | | 4.6 | % | | | 4.9 | % | | | 4.5 | % |
| Interest | | | 2.3 | % | | | 2.2 | % | | | 2.3 | % | | | 2.1 | % |
| Rent | | | 2.3 | % | | | 2.2 | % | | | 2.4 | % | | | 2.1 | % |
| Pre-opening costs | | | 0.1 | % | | | 0.4 | % | | | 0.3 | % | | | 0.5 | % |
Asset impairments and provision for restaurant closings | | | 9.8 | % | | | 3.5 | % | | | 3.0 | % | | | 1.0 | % |
| Other income, net | | | (0.2 | ) % | | | (0.4 | ) % | | | (0.3 | ) % | | | (0.3 | ) % |
| | | | | | | | | | | | | | | | | |
| (Loss) Earnings Before Income Taxes | | | (11.2 | ) % | | | (0.6 | ) % | | | (5.0 | ) % | | | 2.6 | % |
| | | | | | | | | | | | | | | | | |
| Income Taxes | | | (4.4 | ) % | | | (0.6 | ) % | | | (2.1 | ) % | | | 0.5 | % |
| | | | | | | | | | | | | | | | | |
| Net (Loss) Earnings | | | (6.8 | ) % | | | 0.1 | % | | | (2.9 | ) % | | | 2.0 | % |
| | | | | | | | | | | | | | | | | |
| (1) Cost of sales and restaurant operating costs are expressed as a percentage of net sales. | | | | | | | | | |
Comparison of Twelve Weeks Ended July 2, 2008 to Twelve Weeks Ended July 4, 2007
Net (Loss) Earnings
We recorded a net loss of ($9,797), or ($0.35) per diluted share, as compared with net earnings of $124 or $0.00 per diluted share for the third quarter of fiscal 2007. The decrease was primarily driven by the decline in same store sales and the impairment charges noted below.
Revenues
Net sales decreased 6.2% from $152,700 to $143,303 in the current quarter primarily due to the decline in same store sales. Same store sales decreased 5.8% due to a decline in guest traffic of 8.5%, which was partially offset by a 2.7% increase in average guest expenditure. Guest traffic was negatively impacted by a continued lack of focus on core products and operations. The increase in average guest expenditure results primarily from menu price increases of approximately 3.3%, which are made up of the annualization of fiscal 2007 price increases in addition to a 2.1% increase in the first quarter of fiscal 2008.
Franchise fees increased $104 (11.7%) to $990 in the current fiscal quarter. The increase is primarily the result of growth in the number of franchised units from 54 at the end of the third quarter of fiscal 2007 to 69 at the end of the current quarter. The increase in franchise fees was offset by a decrease in franchisee same store sales of 4.7%, which resulted in lower royalty fees accrued.
Costs and Expenses
Cost of sales was $35,527 or 24.8% of net sales, compared with $35,318 or 23.1% of net sales in the third quarter of fiscal 2007. The increase as a percentage of net sales included a 1.1% increase related to higher commodity costs, particularly for dairy, beef and fried products, as well as increased distribution expenses related to higher fuel costs. New menu items with higher percentage food cost (including new entrée salads, chicken sandwiches and Fruit n Frozen yogurt shakes) and operational inefficiencies from implementing the new product mix also contributed to the increase.
Restaurant operating costs decreased $641 (0.8%) to $79,241 but increased as a percentage of net sales from 52.3% to 55.3% in the current quarter. Labor costs declined by $1,410, which was partially offset by an $810 increase in utility costs and property taxes. The increase as a percentage of net sales was due to higher minimum wage rates and the impact of negative same store sales on fixed costs.
General and administrative expenses decreased $2,026 (16.0%) to $10,671 and decreased as a percentage of total revenues from 8.3% to 7.4%. Approximately $840 of the decrease resulted from lower wages, payroll taxes and related benefits due to reductions in staffing that occurred during the fourth quarter of fiscal 2007 and during the current quarter. Planned cutbacks in outside consulting services, bonuses and stock compensation contributed an additional $880 of cost savings. A $550 increase in the gain on sale of assets also contributed to lower General and administrative expenses. These reductions were partially offset by a $400 increase in severance charges related to the departure of certain executives and the headcount reductions in the current quarter.
Depreciation and amortization expense was $7,812 or 5.4% of total revenues, versus $7,577 or 4.9% of total revenues in the third quarter of fiscal 2007. The increase as a percentage of total revenues was due to the impact of negative same store sales on fixed costs.
Marketing expense decreased $388 (5.5%) to $6,666 and remained constant as a percentage of total revenues at 4.6%. The decrease in the current quarter was a result of variances in the timing of television and coupon advertising.
Pre-opening costs for the current quarter decreased $469 (80.7%) to $112, due primarily to the fact that we did not open any new units in the current quarter, compared to four during the third quarter of fiscal 2007. All planned Company-owned restaurant openings for fiscal 2008 were completed in the first and second quarters.
Asset impairments and provision for restaurant closings for the current quarter was $14,089, or 9.8% of total revenues, versus $5,369, or 3.5% of total revenues in the third quarter of fiscal 2007. The impairment charge in the current quarter included $8,794 related to 18 restaurants for which current operating performance is significantly below our expectations and the carrying values of these properties exceed the expected future cash flows to be generated by the underlying assets, $4,818 related to a group of 12 stores that we plan to close in the fourth quarter of fiscal 2008, and $477 related to three stores involved a sale-leaseback transaction whose net book values exceeded their fair values. The 2007 impairment charge related to the planned closure or sale of 14 restaurant properties and certain undeveloped parcels of land.
Income Taxes
Our effective income tax rate was 39.4% for the third quarter of fiscal 2008. Income taxes for the quarter reflect the impact of the decrease in pre-tax (loss) earnings and the related proportionate increase of federal income tax credits when compared to total pre-tax (loss) earnings. The income tax credit for the third quarter of fiscal 2007 resulted from adjusting year-to-date estimated income tax expense due to the proportionate increase of federal income tax credits when compared to total estimated annual pre-tax earnings.
Comparison of Forty Weeks Ended July 2, 2008 to Forty Weeks Ended July 4, 2007
Net (Loss) Earnings
We recorded a net loss of ($13,794), or ($0.49) per diluted share for the current year-to-date period, as compared with net earnings of $10,281 or $0.36 per diluted share, for the same period of fiscal 2007. The decrease was primarily driven by the decline in same store sales, the impairment charge, and increases in cost of sales and restaurant operating costs noted below. Net (loss) for the year-to-date period also includes the impact of $1,000 ($6200, net of tax) of incremental non-operating charges in the second fiscal quarter, which had an impact of $0.02 per diluted share. These charges related to the strategic alternative process we concluded in the second quarter of 2008, the proxy contest related to our 2008 annual meeting and severance charges related to management changes.
Revenues
Net sales decreased 6.4% from $500,213 to $468,071 in the current year-to-date period primarily due to the decline in same store sales. Same store sales decreased 7.7% due to a decline in guest traffic of 10.8%, which was partially offset by a 3.1% increase in average guest expenditure. Year-to-date same store sales were negatively affected by a continued lack of focus on core products and operations. The increase in average guest expenditure results primarily from menu price increases of 3.7%, which are made up of the annualization of fiscal 2007 price increases in addition to a 2.1% increase in the first quarter of fiscal 2008. These price increases were implemented to offset minimum wage and commodity cost pressures.
Franchise fees increased $315 (11.3%) to $3,105 in the current year-to-date period. The increase is primarily the result of growth in the number of franchised units from 54 at the end of the third quarter of fiscal 2007 to 69 at the end of the current quarter. The increase in franchise fees was offset by a decrease in franchisee same store sales of 6.8%, which resulted in lower royalty fees accrued.
Costs and Expenses
Cost of sales was $115,658 or 24.7% of net sales, compared with $114,576 or 22.9% of net sales in the prior year-to-date period. The increase as a percentage of net sales reflected higher commodity costs(primarily for dairy, beef and fried products), new menu items with higher percentage food cost (including new entrée salads, chicken sandwiches and Fruit n Frozen yogurt shakes), and operational inefficiencies from implementing the new product mix.
Restaurant operating costs were $259,090 or 55.4% of net sales compared to $257,133 or 51.4% of net sales in the prior year-to-date period. Higher utility costs, repairs and maintenance and property taxes caused $2,990 of the increase. Outside services increased $870 in the current year-to-date period due to the addition of a new contractor and more frequent snow removal services attributable to unfavorable weather conditions during the second fiscal quarter. These increases were offset by a decline in labor costs of $1,620 for the current year-to-date period.
General and administrative expenses for the current year-to-date period decreased $8,629 (19.7%) to $35,174 and decreased as a percentage of total revenues from 8.7% to 7.5%. Specifically, $3,130 of the decrease resulted from lower wages, payroll taxes and related benefits due to reductions in staffing that occurred during the fourth quarter of fiscal 2007 and during the current quarter. Planned cutbacks in outside consulting services, bonuses and stock compensation contributed an additional $3,550 of cost savings, and travel and relocation expenses declined $780. An $870 increase in the gain on sale of assets also contributed to lower General and administrative expenses. These reductions were partially offset by the impact of $1,400 ($870, net of tax) of incremental non-operating charges related to the strategic alternative process, the proxy contest and severance charges. We have exceeded our previous goal of reducing general and administrative spending by a net $8,100 over the course of fiscal 2008 and will continue to evaluate opportunities for further cost savings.
Depreciation and amortization expense was $25,925 or 5.5% of total revenues, versus $24,628 or 4.9% of total revenues in the prior year-to-date period. The increase as a percentage of total revenues was primarily due to the impact of negative same store sales on fixed costs.
Marketing expense for the current year-to-date period was $23,043 or 4.9% of total revenues, versus $22,628 or 4.5% of total revenues in the same period of fiscal 2007. The increase is primarily a result of higher menu printing and distribution costs, as well as a shift in the timing of television advertising, which was reallocated to the second quarter to support a limited-time promotion. The increases in menu and television production expenses were offset by a 4.5% net decrease in coupon printing and distribution costs compared to the prior year-to-date period, which related to an incremental coupon from first quarter 2007 that was not repeated in the current year.
Rent expense increased slightly as a percentage of total revenues over the prior year-to-date period primarily due to the decline in same store sales, as well as increases in rental rates for new unit leases.
Pre-opening costs for the current year-to-date period decreased $1,084 (46.6%) to $1,243, due primarily to opening fewer new restaurants in the current year-to-date period compared to the same period in fiscal 2007. We opened nine restaurants during the current year-to-date period compared to 15 during the same period of the prior year. The decrease is also due to variances in the timing of when pre-opening costs are incurred in relation to when the stores are opened. All planned Company-owned restaurant openings for fiscal 2008 were completed in the first and second quarters.
Asset impairments and provision for restaurant closings for the current year-to-date period was $14,089, or 3.0% of total revenues, versus $5,176, or 1.0% of total revenues in the same period of fiscal 2007. The impairment charge in the current year included $8,794 related to 18 restaurants for which current operating performance is significantly below our expectations and the carrying values of these properties exceed the expected future cash flows to be generated by the underlying assets, $4,818 related to a group of 12 stores that we plan to close in the fourth quarter of fiscal 2008, and $477 related to three stores involved a sale-leaseback transaction whose net book values exceeded their fair values. The 2007 impairment charge related to the planned closure or sale of 14 restaurant properties and certain undeveloped parcels of land and was offset by the impact of net gains on properties sold in excess of previously recorded impairments.
Income Taxes
Our effective income tax rate increased to 41.8% from 21.2% in the same year-to-date period of fiscal 2007. Current year-to-date income taxes reflect the impact of the decrease in pre-tax (loss) earnings and the related proportionate increase of federal income tax credits when compared to total pre-tax (loss) earnings. In addition, the year-to-date period for the prior year included the impact of the extension of the Work Opportunity and Welfare to Work Tax Credits retroactive to January 1, 2006. The adjustment related to the aforementioned tax credit extension totaled approximately $650.
Liquidity and Capital Resources
During the forty weeks ended July 2, 2008, we opened a total of nine Company-owned restaurants and sold a total of eight stores to franchisees. In addition, franchisees opened four new restaurants during the current year-to-date period. In the forty week period ended July 4, 2007, we opened 15 Company-owned restaurants and sold one store to a franchisee; franchisees opened five new restaurants. For the forty weeks ended July 2, 2008, capital expenditures totaled $28,512 as compared to $56,193 for the same period in the prior year. In addition, during the forty weeks ended July 2, 2008, we received proceeds of $11,531 from the sale of eight parcels of land classified as held for sale, and from the transfer of three Company-owned buildings and various equipment to franchisees. Comparatively, proceeds of $5,956 from the sale of five properties were received during the same year-to-date period of fiscal 2007.
We completed the opening of all nine planned new Company-owned restaurants during the first and second fiscal quarters of 2008 and do not anticipate opening any additional Company-owned units during the remainder of fiscal year 2008. The average cost of each of the nine new Company-owned restaurants, including land, site improvements, building, equipment and pre-opening costs is approximately $2,000 to $2,500. We intend to fund future capital expenditures and meet our working capital needs by using anticipated cash flows from operations, sale-leaseback transactions and our existing credit facilities.
During the forty weeks ended July 2, 2008, cash provided by operations totaled $23,571, compared to $36,463 in the same period in the prior year. This decrease in cash provided by operations is attributable primarily to a decline in net earnings excluding the impact of the non-cash impairment charges. Net cash used in financing activities for the forty weeks ended July 2, 2008 totaled ($6,466) compared to net cash provided of $12,828 in the comparable prior year period. This decrease is primarily due to borrowings under the Senior Note Agreement and Private Shelf Facility (“Senior Note Agreement”) in the prior year.
As of July 2, 2008, we had outstanding borrowings of $17,143under our amended and restated Senior Note Agreement. Principal payments due under the Senior Note Agreement over the next year total $714 and the remaining principal payments of $16,429 aredue beyond one year. Current borrowings bear interest at a weighted average fixed rate of 8.49%. Our total borrowing capacity under the Senior Note Agreement at July 2, 2008 was $75,000 and our ability to borrow additional funds expires September 29, 2008. We are currently evaluating other financing alternatives.
The Senior Note Agreement contains restrictions and covenants customary for credit agreements of these types which, among other things, require us to maintain certain financial ratios. On August 11, 2008, we were granted a current quarter waiver of certain financial covenants. We also amended the Senior Note Agreement prospectively to revise certain financial covenants. The amendment excludes from the calculations of the covenants under the Senior Note Agreement the non-cash impairment charges incurred in the current quarter. The amendment also requires pro rata prepayments on the Senior Notes and the Revolving Credit Facility (“Facility”) once the balance of our Facility reaches a specific threshold amount. Giving effect to the most recent amendment, we are in compliance with all covenants as of July 2, 2008.
As of July 2, 2008, we had borrowings under our $45,000 Facility of $9,180 at a current interest rate of 4.94%. The Facility currently bears interest based on LIBOR plus 250 basis points, or the prime rate, at our election, and matures on January 30, 2009. We intend to either renew the Facility or negotiate a new facility prior to its maturity. On August 1, 2008, the borrowing capacity under the Facility was reduced to $40,000. On August 6, 2008, we were granted a current quarter waiver of certain financial covenants. We also amended the Facility prospectively to revise certain financial covenants by excluding from the calculation of the debt ratio under the Facility the non-cash impairment charges incurred in the current quarter and to reduce the borrowing capacity of our Facility to $30,000 through maturity. Giving effect to the most recent amendment, we are in compliance with all covenants as of July 2, 2008.
As a result of the May 2008 amendments, the Senior Note Agreements and the Facility are secured with the deposit accounts, accounts receivable, inventory, equipment, general intangibles, fixtures and all other personal property. With the most recent amendments to the Senior Note Agreement and the Facility, we are prohibited from making cash dividends or repurchasing shares common stock of the Company. Effective November 21, 2008, our amended Senior Note Agreement will require us to secure the borrowings with certain real estate assets.
After giving consideration to the issues noted above and reference to the applicable accounting guidance in EITF No. 86-30, “Classification of Obligations When a Violation is Waived by the Creditor,” and SFAS No. 78, “Classification of Obligations That Are Callable by the Creditor,” management does not believe it is probable that we will not comply with the amended covenants at measurement dates within the next twelve months. Accordingly, we have classified the borrowings under the Senior Note Agreement as noncurrent at July 2, 2008.
In addition, we have one mortgage which was assumed in the acquisition of KRI in fiscal 2005. The mortgage matures in August 2008, bears interest at a fixed rate of 5% and had an outstanding balance of $597 at July 2, 2008. We also have one note in the amount of $92 outstanding as of July 2, 2008 on a property in Jonesboro, Arkansas.
New Accounting Standards
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a formal framework for measuring fair value and expands disclosures about fair value measurements. In February 2008, the FASB issued FSP 157-2, “Effective Date of FASB Statement No. 157,” which permits a one-year deferral for the implementation of SFAS 157 with regard to non-financial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Thus, SFAS 157 as it relates to financial assets and liabilities is effective beginning in our fiscal 2009 in accordance with the original Statement, while SFAS 157’s applicability to non-financial assets and liabilities will be deferred until our fiscal 2010. We are in the process of determining the effect, if any, that the adoption of SFAS 157 will have on our financial statements.
In February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 provides companies with an option to report selected financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date. SFAS 159 is effective for fiscal years beginning after November 15, 2007, our fiscal 2009. We are in the process of determining the effect, if any, that the adoption of SFAS 159 will have on our financial statements.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”), which replaces SFAS 141. SFAS 141(R) requires assets and liabilities acquired in a business combination, contingent consideration, and certain acquired contingencies to be measured at their fair values as of the date of acquisition. SFAS 141(R) also requires that acquisition-related costs and restructuring costs be recognized separately from the business combination. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008, our fiscal 2010,and will be effective for business combinations entered into after January 1, 2009. We are in the process of determining the effect, if any, that the adoption of SFAS 141(R) will have on our financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51” (“SFAS 160”). SFAS 160 clarifies the accounting for noncontrolling interests and establishes accounting and reporting standards for the noncontrolling interest in a subsidiary, including classification as a component of equity. SFAS 160 is effective for fiscal years beginning after December 15, 2008, our fiscal 2010. The Company does not currently have any minority interests. We are in the process of determining the effect, if any, that the adoption of SFAS 160 will have on our financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 amends and expands the disclosure requirements in SFAS 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008, the second quarter of our fiscal 2009. We are in the process of determining the effect, if any, that the adoption of SFAS 161 will have on our financial statements.
In April 2008, the FASB issued FASB Staff Position No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”). FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions that are used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets,” and requires enhanced related disclosures. FSP 142-3 must be applied prospectively to all intangible assets acquired as of and subsequent to fiscal years beginning after December 15, 2008, our fiscal 2010. We are in the process of determining the effect, if any, that the adoption of FSP 142-3 will have on our financial statements.
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States of America. SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AICPA Codification of Auditing Standards, AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” We do not anticipate that the adoption of SFAS 162 will materially impact our financial statements.
Effects of Governmental Regulations and Inflation
Most of our employees are paid hourly rates related to federal and state minimum wage laws. Any increase in minimum wage levels directly increases our operating costs. We are 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 operating costs. Inflation in food, labor, fringe benefits, energy costs, transportation costs and other operating costs directly affects our operations. In addition, we are subject to franchise registration requirements and certain related federal and state laws regarding franchise operations. Any changes in these laws could affect our ability to attract and retain franchisees. During fiscal 2007, a number of states passed increases in minimum wages. We took active measures to maintain our profitmargins through increases in menu prices.
Risks Associated with Forward-Looking Statements
Certain statements contained in this report represent forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In general, forward-looking statements include estimates of future revenues, cash flows, capital expenditures or other financial items, as well as 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” and other similar terminology. A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur. Investors should not place undue reliance on the forward-looking statements, which speak only as of the date of this report. These forward-looking statements are based on currently available operating, financial and competitive information and are subject to various risks and uncertainties. Our actual future results and trends may differ materially depending on a variety of factors, many beyond our control, including, but not limited to:
| · | the poor performance or closing of even a small number of restaurants; |
| · | our ability to attract and retain guests; |
| · | the ability of our franchisees to operate profitable restaurants; |
| · | changes in guest preferences, tastes and dietary habits; |
| · | changes in minimum wage rates; |
| · | the availability and cost of qualified personnel; |
| · | fluctuations in food commodity prices and the availability of food commodities; |
| · | harsh weather conditions; |
| · | unfavorable publicity relating to food safety or food borne illness; |
| · | our ability to comply with the restrictions and covenants to our debt agreements; |
| · | our ability to renegotiate our debt agreements and refinance our current debt at similar rates; |
| · | our ability to effectively negotiate sale-leaseback transactions; |
| · | our ability to comply with existing and future governmental regulations; |
| · | our ability to adequately protect our trademarks, service marks and other components of our brand; and |
| · | other risks identified in the periodic reports we file with the Securities and Exchange Commission. |
Accordingly, such forward-looking statements do not purport to be predictions of future events or circumstances and may not be realized. Additional risks and uncertainties not currently known to us or that are currently deemed immaterial may also become important factors that may harm our business, financial condition, results of operations or cash flows. We assume no obligation to update forward-looking statements except as required in our periodic reports.
Our primary market risk exposure with regard to financial instruments is to changes in interest rates. We invest excess cash primarily in cash equivalents due to their relatively low credit risk. Interest rates on these securities are based upon market rates at the time of purchase and remain fixed until maturity.
Pursuant to the terms of our Senior Note Agreement, we may from time to time borrow in increments of at least $5,000. 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. Borrowings under the Revolving Credit Facility bear interest at a rate based on LIBOR plus 250 basis points, or the prime rate, at our election.Historically, we have not used derivative financial instruments to manage exposure to interest rate changes. At July 2, 2008 a hypothetical 100 basis point increase in short-term interest rates would have an impact of approximately $15 and $60 on our quarterly and year-to-date net loss, respectively.
We purchase certain food products which may be affected by volatility in commodity prices due to weather conditions, supply levels and other market conditions. We utilize various purchasing and contract pricing techniques to minimize volatility but do not enter into financial derivative contracts.
ITEM 4. CONTROLS AND PROCEDURES
There have been no changes in our internal control over financial reporting that occurred during the current quarter ended July 2, 2008 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.
