UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K Mark One X Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended January 2, 2000 Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File Number 0-20716 TACO CABANA, INC. (Exact name of registrant as specified in its charter) Delaware 74-2201241 (State or other jurisdiction (IRS employer identification no.) of incorporation or organization) 8918 Tesoro Drive, Suite 200, San Antonio, Texas 78217 (Address of principal executive offices, including ZIP Code) (210) 804-0990 (Registrant's telephone number, including area code) Securities Registered Pursuant to Section 12(b) of the Act: Title of Each Class Name of Exchange on Which Registered None None Securities Registered Pursuant to Section 12(g) of the Act: Title of Each Class Common Stock, $0.01 par value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X As of February 28, 2000, the aggregate market value of the voting stock held by non-affiliates of the Registrant, based on the last sale price of the Common Stock of the Registrant as quoted on the NASDAQ National Market was $63,170,586 (for purposes of calculating this amount, only directors, officers, and beneficial owners of 5% or more of the capital stock of the Registrant have been deemed affiliates). The number of shares of the Common Stock of the Registrant outstanding as of February 28, 2000 was 11,586,375. DOCUMENTS INCORPORATED BY REFERENCE Part III of this report incorporates by reference certain portions of the definitive proxy statement which the Registrant will file with the Securities and Exchange Commission in connection with the Company's annual meeting of stockholders following the fiscal year ended January 2, 2000. FORM 10-K INDEX PART I ITEM 1. BUSINESS............................................ 3 ITEM 2. PROPERTIES.......................................... 10 ITEM 3. LEGAL PROCEEDINGS................................... 10 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. 10 EXECUTIVE OFFICERS OF THE COMPANY................... 11 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS................................. 12 ITEM 6. SELECTED FINANCIAL DATA............................. 13 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................. 15 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......................................... 24 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......... 24 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE................. 24 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.. 25 ITEM 11. EXECUTIVE COMPENSATION.............................. 25 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.......................................... 25 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...... 25 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K......................................... 26 PART I ITEM 1. BUSINESS General Taco Cabana, Inc., a Delaware corporation (the "Company" ), pioneered the Mexican patio cafe concept with its first restaurant in 1978 and, as of January 2, 2000, operates and franchises a total of 119 such restaurants system-wide. Of these, the Company owns and operates 109 Taco Cabana restaurants and franchisees of the Company own and operate the remaining 10 Taco Cabana restaurants. The Company's restaurants (including franchises) are located primarily in Texas, and are also located in Georgia, Indiana, New Mexico, and Oklahoma. Taco Cabana restaurants feature generous portions of fresh, premium quality Tex-Mex and traditional Mexican style food at an exceptional value. The restaurants provide interior, semi-enclosed and patio dining areas with a festive Mexican theme. Menu items include flame-grilled beef and chicken fajitas served on sizzling iron skillets, " Chicken Flameante" TM (a marinated rotisserie chicken), quesadillas, traditional Mexican and American breakfasts, other Tex-Mex dishes and fresh, hot flour tortillas. Unlike many of its competitors, the Company makes most menu items fresh daily in each of its restaurants. Taco Cabana Food and Pricing Philosophy The Company is committed to selling premium food which it believes to be among the highest quality of any chain in the restaurant industry. This process begins with the selection of the freshest available ingredients. The Company's menu items are prepared strictly in accordance with authentic and well-tested recipes. Taco Cabana restaurants also offer a variety of beverage choices, including margaritas and beer. Alcoholic beverages currently account for less than 4% of gross sales. The Ingredients. The Company has implemented a purchasing program structured to ensure that all of the ingredients used in the preparation of the Taco Cabana menu items are of the highest quality. The Company regularly inspects its vendors to ensure both that the products purchased by the Company conform to its standards, and that the prices offered are competitive. The meat used in making fajitas as well as most other principal ingredients are purchased through supply contracts to ensure availability and minimize the risks of price fluctuation. The Preparation. The menu items offered at any Taco Cabana restaurant are prepared at that restaurant from fresh meat and produce ingredients delivered by suppliers to most restaurants three times each week. The Company is committed to differentiating itself from other quick service competitors by utilizing fresh, high quality ingredients as well as the preparation of most items "from scratch". In order to simplify operations and provide a more consistent product, the Company has recently implemented the usage of a number of pre- prepared items. Pricing Philosophy. The Company offers value by pricing its menu items below the price of comparable menu items in sit-down Mexican restaurants. Although Taco Cabana's food costs (as a percentage of sales) are generally higher than quick service chains as a result of the premium quality of ingredients used, the Company believes that this point of differentiation contributes to the achievement of average unit volumes in excess of most quick service restaurants. Taco Cabana Restaurants Restaurant Layout. Taco Cabana restaurants average approximately 3,200 square feet (exclusive of the exterior dining area) and provide seating for approximately 80 customers, with additional patio seating for approximately 50 customers. Taco Cabana restaurants are typically distinctive in appearance, conveying a Mexican theme and permitting easy identification by passing motorists. Inside, exposed elements of the kitchen display the freshness of Taco Cabana's food and the authenticity of its preparation. Taco Cabana's restaurant design enables customers to observe fresh fajitas cooking on a charcoal grill, a machine making fresh, hot flour tortillas, Chicken FlameanteTM rotating on spits and the preparation of other food items. Upon entry, the customer places an order selected from an overhead menu board, proceeds down a service line to where the order is picked up, and then passes a Salsa Bar en route to the dining area. The distinctive Salsa Bar offers Taco Cabana customers freshly prepared, authentic Tex-Mex ingredients such as Salsa de Fuego (made with charred peppers and tomatoes), pico de gallo and salsa (all "made from scratch" throughout the day at each restaurant), cilantro, pickled jalapeno slices, crisp chopped onions, and fresh sliced limes. According to the season, time of day and personal preference, the customer may choose to dine either in the restaurant's brightly colored and festive interior dining area or the semi-enclosed or outdoor patio areas. The addition of traditional and contemporary Latin music, tropical landscaping, and authentic decorative artifacts create an overall dining environment which the Company believes is both attractive and festive. Most Taco Cabana restaurants also offer drive-thru service. The Company began constructing its new prototype restaurant in 1996 with further improvements made to the design in 1998 and 1999. The prototypes incorporate several new and different features that set them apart from Taco Cabana restaurants previously constructed. The prototypes feature rounded fronts, as well as Southwest accents such as a clay tile roof, heavy wood beams and a trellis that shades the patio area, and add the use of bright colors outside and inside, including colored tiles, doors, windows, and awnings. Corrugated metal wall panels, aged wood finishes, and distressed stainless steel counter tops are featured inside, all of which are intended to replicate an old Mexican cafe. Backlit signage on the exterior of the building broadcasts the unique menu items served at Taco Cabana. Favorite features retained from the original Taco Cabana restaurants include display cooking where the guest can see the food being prepared, liberal use of the Taco Cabana's signature pink color, and the self-serve fresh Salsa Bar. The prototypes were designed to reduce overall construction costs, improve functional efficiency, allow for better guest service, and enhance Taco Cabana's unique patio cafe image. Since November 1996, the Company has opened 25 restaurants under this new design. During 1997, the Company initiated a re-image program for existing restaurants which incorporates many of the features of the new prototype design. As of January 2, 2000, 69 restaurants were re-imaged or converted to the new prototype design, bringing a system-wide total of 94 restaurants with the new design. The Company expects to re-image the remaining restaurants during 2000. Restaurant Locations. The following table sets forth the number of restaurants as of January 2, 2000 by area of dominant influence ( "ADI") for television and radio advertising: ADI* Company-Owned Franchised(1) Total San Antonio 33 0 33 Houston 31(2) 0 31 Austin 15 0 15 Dallas/Fort Worth 20 0 20 El Paso 6 0 6 Oklahoma City, Oklahoma 3 0 3 Bryan/College Station 0 2 2 Albuquerque, New Mexico 0 2 2 Amarillo 0 2 2 Atlanta, Georgia 0 1 1 Tulsa, Oklahoma 1 0 1 Waco 0 1 1 Corpus Christi 0 1 1 Ft. Wayne, Indiana 0 1 1 --- -- --- Total 109 10 119 === == === ___________________________________________________________________ * All of the ADIs are located in Texas except as otherwise indicated. (1) Represents franchised Taco Cabana restaurants. (2) Includes three mall-unit Taco Cabana restaurants. Customer Convenience The Company operates its restaurants to enable customers to dine-in or take-out, as they choose. In most cases, the restaurants also provide the convenience of drive-thru windows which, in the aggregate, account for approximately 40% of the Company's sales. A majority of the restaurants are open 24 hours a day. This strategy is continually evaluated for economic viability on a restaurant by restaurant basis. Customer Service The Company is committed to consistently providing personal, attentive and efficient service in order to attract repeat customers. Restaurant and shift managers are encouraged to follow a " front of the house" style of management, which requires that the managers spend most of their time attending to customers at the register, drive-thru windows or in the dining areas. Marketing The Company utilizes an integrated, multi-level marketing approach which includes periodic company-wide promotions, direct mail, in-store promotions, local store marketing, and other strategies, including the use of radio advertising in its major markets. The Company expects to execute this plan utilizing a marketing budget of approximately 3.65% of sales. Expansion The Company's near-term strategy is to achieve a dominant or leading position among quick service Mexican food restaurants in each of its targeted principal markets in order to obtain marketing and operating efficiencies. The Company seeks to implement this strategy by selectively adding restaurants in existing and new markets. The Company's 2000 objective is to continue expanding into new markets. The Company plans to open fifteen freestanding restaurants in 2000, approximately twelve of which will be outside the State of Texas. The Company will continue its development of the Oklahoma City and Tulsa markets and will begin development of the Phoenix market. In conjunction with the opening of the Company's new restaurants in the Tulsa market, an existing unit will be closed. The Company believes the site selection process is very important in determining the potential success of a particular restaurant and senior management devotes substantial time and resources to analyzing each prospective site. The Company focuses on selecting locations which clear stringent hurdles with regards to the projected return on initial investment. A variety of factors are considered in the site selection process, including local market demographics, site visibility and accessibility (including drive-by traffic and ease of drive-thru accessibility), proximity to competitive operations, and proximity to generators of potential customers, such as major retailers, retail centers, medical or hospital facilities, office complexes, hotel concentrations, and stadiums, arenas, theaters or other entertainment centers. Restaurant Operations and Management The Company seeks to maintain quality and consistency in its restaurant operations by carefully training and supervising personnel and establishing exacting standards relating to food quality, friendliness of service and cleanliness of the restaurant facility. A Mystery Shop program requires random visits with the purpose of scoring each restaurant on its food quality, friendly service and cleanliness. The Company has also established an 800 hotline for customer comments. It is the Company's policy to ensure that customers are served quickly and that customers receive orders correctly filled and delivered in a courteous manner. The Company maintains financial and accounting controls for each of its restaurants through use of centralized accounting and management information systems. The Company has installed throughout all of its company-owned restaurants an in-store computer-based management support system that allows for daily polling of sales and labor information. Additionally, a separate management information system has been developed and implemented in all company-owned restaurants which provides for daily polling of food costs. This system records the receipt of inventory through the scanning of bar-codes and integrates with the point of sale system thus providing immediate cost of sales data and inventory records. The system is designed to improve food cost management, provide corporate management quicker access to financial data and reduce the time devoted by its restaurant managers to administrative responsibilities. Operations are managed by restaurant general managers who complete an intensive training program during which they are instructed in all areas of Taco Cabana's restaurant operations. Such areas of training include food preparation, customer service, cost controls, facility maintenance, communications skills and employee relations. Restaurant general managers are overseen by division leaders (individuals with responsibility for the operation of multiple restaurants within a market) and by regional Vice Presidents of Operations. An incentive plan has been established in which all restaurant and division leaders participate. Awards under the incentive plan are tied to the achievement of specified sales, profitability and qualitative performance goals. In addition to the incentive plan, general managers and corporate staff are periodically granted stock options which vest over five years. Franchising Program At January 2, 2000, the Company had five franchisees operating a total of 10 Taco Cabana restaurants. The Company did not enter into any new franchise agreements during 1999 and does not currently anticipate new franchisee signings during 2000. Competition Taco Cabana's restaurants compete both with fast food operations and with traditional sit-down Mexican restaurants. Management believes that the Company's combination of freshly prepared food, distinctive ambiance, and superior service help to distinguish Taco Cabana restaurants from fast food operations, while Taco Cabana's price-value relationship differentiates its restaurants from more expensive sit-down or casual dining restaurants. The food service industry is intensely competitive with respect to price, service, location and food quality, and there are many well-established national, regional and locally-owned competitors in the Company's market areas, some of which have greater financial and other resources than the Company. Some of such competitors have also been in existence longer than the Company and are better established in areas where Taco Cabana's restaurants are or will be located. The restaurant business is often affected by changes in consumer tastes, economic conditions, population, traffic patterns, availability of employees and cost increases. Employees At January 2, 2000, the Company employed approximately 3,500 persons, of whom approximately 3,400 were operations employees and the remainder were corporate personnel. Most employees, other than restaurant management and corporate personnel, are paid on an hourly basis. The Company believes that it provides working conditions and wages that are comparable with those of other companies in the restaurant industry operating in its market area. The Company's employees are not covered by a collective bargaining agreement. The Company does not subscribe to any workers' compensation insurance program in the State of Texas, where the great majority of its company-owned restaurants are currently located. As such, it is subject to negligence actions by its employees and is not able to assert contributory negligence and certain other defenses. In addition, employees might be able to recover certain types of damages that would not be available to them if the Company subscribed to a workers' compensation insurance program. The Company self-insures a portion of such risk, and carries excess liability coverage that it believes is adequate. This practice has not had any material adverse effect upon the Company's operations or financial position since it was adopted in 1988. Trademarks, Service Marks and Trade Dress The Company regards its trademarks, service marks and trade dress as having significant value and as being important to its marketing efforts. The Company has registered its principal Taco Cabana logo and design with the United States Patent and Trademark Office on the Principal Register as a service mark for its restaurant services, has secured or has applied for state and federal registrations of several other advertising or promotional marks, including variations of its principal mark, and has applied for registrations in foreign countries of its principal mark and several other marks. The Company's policy is to pursue registration of its principal marks and to oppose strenuously any infringement of its marks or trade dress. Government Regulation Each company-owned and franchised restaurant is subject to regulation by federal agencies and to licensing and regulation by state and local health, sanitation, safety, fire and other departments relating to the development and operation of restaurants, including regulations relating to alcoholic beverage sales, environmental, building and zoning requirements, preparation and sale of food, and laws governing the Company's relationship with its employees, including minimum wage requirements, overtime, working conditions and citizenship requirements. Difficulties or failures in obtaining the required licenses or approvals could delay or prevent the opening of new restaurants or the continued operation of existing restaurants. The Company is subject to Federal Trade Commission ( "FTC") regulation and state laws which regulate the offer and sales of franchises. The Company may also become subject to state laws which regulate substantive aspects of the franchisor-franchisee relationship. The FTC requires the Company to furnish to prospective franchisees a franchise offering circular containing prescribed information. A number of states in which the Company might consider franchising also regulate the offer and sale of franchises and require registration of the franchise offering with state authorities. State laws that regulate the franchisor-franchisee relationship presently exist in a substantial number of states and bills have been introduced in Congress and other states from time to time which would provide for regulation of the franchisor-franchisee relationship in certain respects. Certain of such laws may restrict a franchisor in the termination of a franchise agreement, although these provisions have not had a significant effect on the Company's operations. The Company is subject to the Fair Labor Standards Act and various state laws governing such matters as minimum wage requirements, overtime and other working conditions and citizenship requirements. A significant number of the Company's food service personnel are paid at rates related to the federal minimum wage and increases in the minimum wage will increase the Company's labor costs. The Company is subject to the Texas "dram-shop" laws and may be subject to the " dram-shop" laws of certain other states. Dram-shop laws provide a person injured by an intoxicated person the right to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person. The Company is also subject to the Americans with Disabilities Act of 1990, which, among other things, may require certain minor further renovations to existing restaurants to meet federally mandated access and use requirements. The cost of these renovations is not expected to be material to the Company. The Company must also comply with the Family Medical Leave Act (the "Family Leave Act"), which covers employers of 50 or more persons at locations within any 75-mile radius. The Family Leave Act requires covered employers to grant eligible employees up to 12 weeks of unpaid leave for family and medical reasons and to reinstate the employee to the same or an equivalent position at the end of the leave. An employee may take leave for the birth, adoption, or foster care of a child; for any serious health condition of a spouse, sibling, child or parent; or for an employee's own serious health condition. The Company believes that it is operating in substantial compliance with applicable laws and regulations governing its operations. Geographic Concentration During fiscal 1999, approximately 98% of the Company's net sales were derived from restaurants located in the State of Texas. As a result, the Company's results of operations may be materially affected by weather, economic or business conditions within these markets. Also, given the Company's present geographic concentration, adverse publicity relating to Taco Cabana restaurants could have a more pronounced adverse effect on the Company's overall sales than might be the case if the Company's restaurants were more broadly dispersed. ITEM 2. PROPERTIES The Company currently owns 37 of its restaurant sites and owns an additional thirteen buildings on properties with ground leases. The Company leases its remaining restaurant locations. The Company may purchase a number of its current and future restaurant locations where it is cost effective to do so. Substantially all of Taco Cabana's restaurants are free-standing buildings. The Company has typically needed 120 days after the signing of a lease and obtaining required permits to complete construction and open a new restaurant. Additional time is sometimes needed to obtain certain government approvals and licenses, such as liquor licenses. Properties leased by the Company are typically leased under "triple net" leases that require the Company to pay real estate taxes and utilities and maintain insurance with respect to the premises and, in many cases, to pay contingent rentals based on sales in excess of specified amounts. The leases have initial terms of 10 to 20 years with options to renew for additional periods which range from 5 to 15 years. Approximately 90% of the Company's current leases have remaining terms or renewal options extending more than five years from January 2, 2000. ITEM 3. LEGAL PROCEEDINGS The Company is a party to routine negligence or employment-related litigation in the ordinary course of its business. No such pending matters, individually or in the aggregate, are deemed to be material to the results of operations or financial condition of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company did not submit any matter during the fourth quarter of the Company's fiscal year ended January 2, 2000 to a vote of the Company's stockholders, through the solicitation of proxies or otherwise. EXECUTIVE OFFICERS OF THE COMPANY The executive officers of the Company and their respective ages are as follows: Name Age Position Stephen V. Clark 46 Chief Executive Officer, President and Director Douglas Gammon 53 Senior Vice President - Human Resources and People Development Dennis Greenia 50 Senior Vice President Marketing David G. Lloyd 36 Senior Vice President - Finance, Chief Financial Officer, Secretary and Treasurer Mr. Clark has served as the Company's Chief Executive Officer since November 1996, and as the President, Chief Operating Officer, and as a Director since April 1995. Prior to that, Mr. Clark was with Church's Chicken, a division of America's Favorite Chicken, for seventeen years with his final title having been Senior Vice President and Concept General Manager. He also served on the executive committee of America's Favorite Chicken and was on the Board of Directors of Church's Operators Purchasing Association. In his final position with America's Favorite Chicken, Mr. Clark was primarily responsible for the day-to-day operations of over 1,100 company-owned and franchised units with aggregate sales volume in excess of $600 million. Mr. Gammon joined the Company in March 1997 as Senior Vice President, Human Resources and People Development. From December 1989 to March 1997, Mr. Gammon served as Vice President of Human Resources at Marriott International which has over 15,000 employees in 50 states. Mr. Gammon has over 18 years of experience in the human resources field as well as over six years experience in restaurant operations. He was the past President for the Council of Hotel and Restaurant Trainers. Mr. Greenia joined the Company in July 1998 as Senior Vice President - Marketing. From January 1989 to July 1998, Mr. Greenia served as President of the Merrill Group, a marketing consulting firm in Atlanta, GA., whose clients included the Coca-Cola Company, Dominos Pizza, Bally's Total Fitness and Hardee's Foods. Mr. Greenia has over 19 years experience both nationally and internationally in the food service industry, holding positions with Burger King Corporation, J. Walter Thompson Advertising and Coca Cola USA. Mr. Greenia is also a majority partner in Mobile Media Network of Atlanta, Inc. Mr. Lloyd joined the Company in October 1994 as Vice President - Finance, Chief Financial Officer, Secretary and Treasurer and was promoted to Senior Vice President in May 1996. From August 1985 to October 1994, Mr. Lloyd served in various capacities with Deloitte & Touche (the Company's independent auditors), with his last position being Senior Audit Manager. Mr. Lloyd is a certified public accountant. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Common Stock, $.01 par value, of the Company ("Common Stock") began trading on the NASDAQ National Market on October 16, 1992, the effective date of the Company's initial public offering. Prior to October 16, 1992, there was no public market for the Common Stock. The table below sets forth, for the periods indicated, the reported high and low last sale prices of the Company's Common Stock, as reported on the NASDAQ National Market: High Low Fiscal Year Ended January 2, 2000 Quarter Ended January 2, 2000 $ 9 9/16 $ 7 7/16 Quarter Ended October 3, 1999 10 3/4 7 7/8 Quarter Ended July 4, 1999 10 3/4 8 5/16 Quarter Ended April 4, 1999 9 7/16 8 Fiscal Year Ended January 3, 1999 Quarter Ended January 3, 1999 $ 7 3/4 $ 4 7/8 Quarter Ended September 27, 1998 6 5/8 4 7/8 Quarter Ended June 28, 1998 7 1/8 5 3/4 Quarter Ended March 29, 1998 7 1/16 4 7/16 As of February 28, 2000, the last reported sale price of the Common Stock on the NASDAQ National Market System was $6 per share. As of February 28, 2000, there were approximately 900 record holders of Common Stock. The Company has never declared or paid cash dividends on the Common Stock or any of its other securities. The Company presently intends to retain all earnings for the operation and development of its business and does not anticipate paying any cash dividends on the Common Stock in the foreseeable future. Any future determination as to the payment of cash dividends will depend on a number of factors, including future earnings, capital requirements, the financial condition and prospects of the Company and present restrictions under credit facilities, as well as such other factors as the Board of Directors may deem relevant. There can be no assurance that the Company will pay any dividends in the future. ITEM 6. SELECTED FINANCIAL DATA The following selected financial data, which set forth certain financial information with respect to the Company, have been derived from the financial statements of the Company. The financial statements of the Company for each of the fiscal years in the five-year period ended January 2, 2000 have been audited by Deloitte & Touche LLP, independent certified public accountants. The following selected financial data should be read in conjunction with the Consolidated Financial Statements and the notes thereto included elsewhere in this report. December 31,December 29,December 28,January 3,January 2, 1995 1996 1997 1999 2000 52 Weeks 52 Weeks 52 Weeks 53 Weeks 52 Weeks ----------- ----------- ----------- ---------- --------- (in thousands, except per share data) Income Statement Data: REVENUES: Restaurant sales $ 137,191 $ 131,680 $131,857 $142,592 $ 159,241 Franchise fees and royalty income 1,342 516 346 358 359 --------- --------- -------- -------- --------- Total revenues 138,533 132,196 132,203 142,950 159,600 COSTS AND EXPENSES: Restaurant cost of sales and operating costs 115,195 107,703 110,440 114,111 126,571 General and administrative 6,068 6,445 6,964 7,829 7,907 Depreciation, amortization and restaurant opening costs 10,301 9,245 9,659 7,990 9,581 Special charges (reversal) (1) 8,100 2,497 78,738 (2,665) - Litigation settlement (2) - 3,400 - - - Reserve for notes and other receivables (3) 3,500 - - - - --------- --------- --------- --------- --------- Total costs and expenses 143,164 129,290 205,801 127,265 144,059 --------- --------- --------- --------- --------- INCOME (LOSS) FROM OPERATIONS (4,631) 2,906 (73,598) 15,685 15,541 NON-OPERATING INCOME (EXPENSE) (1,397) (1,348) (1,137) (1,951) (2,424) --------- --------- --------- --------- --------- INCOME (LOSS) BEFORE INCOME TAXES (6,028) 1,558 (74,735) 13,734 13,117 (PROVISION) BENEFIT FOR INCOME TAXES 2,230 (854) 1,537 - - --------- --------- --------- --------- --------- NET INCOME (LOSS) $ (3,798) $ 704 $ (73,198) $ 13,734 $ 13,117 ========= ========= ========= ========= ========= BASIC EARNINGS (LOSS) PER SHARE (4) $ (0.24) $ 0.04 $ (4.78) $ 0.96 $ 0.99 ========= ========= ========= ========= ========= DILUTED EARNINGS (LOSS) PER SHARE (4) $ (0.24) $ 0.04 $ (4.78) $ 0.95 $ 0.97 ========= ========= ========= ========= ========= Balance Sheet Data: TOTAL ASSETS $148,578 $142,706 $ 76,260 $ 90,202 $101,005 LINE OF CREDIT,LONG-TERM DEBT AND CAPITAL LEASES, INCLUDING CURRENT MATURITIES 19,290 13,668 19,323 30,324 39,908 STOCKHOLDERS' EQUITY 112,327 113,172 36,413 40,777 42,998 DIVIDENDS PER COMMON SHARE - - - - - (1) Includes the charge related to the 1995 operations review of $8.1 million, the 1996 write-down of the Company's investment in a joint venture and the accrual of related exit costs of $2.5 million, the 1997 charge for the write-down of impaired assets and the closure of seventeen restaurants and the reversal of special charges in 1998 as described in Note 2 to the Consolidated Financial Statements. (2) Includes the 1996 litigation settlement for $3.4 million pre-tax. (3) Reserve resulted from the 1995 operations review. (4) The earnings per share amounts prior to 1997 have been restated as required to comply with Statement of Financial Standards No. 128, Earnings Per Share. For further discussion of earnings per share and the impact of Statement No. 128, see Notes 1 and 11 to the Consolidated Financial Statements. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction The Company commenced operations in 1978 with the opening of its first Taco Cabana restaurant in San Antonio. As of January 2, 2000, the Company had 109 company-owned restaurants, and 10 franchised restaurants. The Company's revenues are derived primarily from sales by company-owned restaurants, with franchise fees and royalty income contributing less than 1% of total revenues for the 1999 fiscal year. During the fiscal year ended January 2, 2000, the Company opened ten restaurants and closed three restaurants. Results of Operations The following table sets forth the percentage relationship to total revenues, unless otherwise indicated, of certain income statement data. The table also sets forth certain restaurant data for the periods indicated. Fiscal Year Ended ---------------------------------- December 28, January 3, January 2, 1997 1999 2000 Income Statement Data: REVENUES: Restaurant sales 99.7% 99.7% 99.8% Franchise fees and royalty income 0.3 0.3 0.2 ----- ----- ----- Total revenues 100.0 100.0 100.0 ===== ===== ===== COSTS AND EXPENSES: Restaurant cost of sales (1) 30.8 30.4 30.0 Labor (1) 27.4 26.8 27.5 Occupancy (1) 6.2 5.5 5.2 Other restaurant operating costs (1) 19.3 17.3 16.8 General and administrative costs 5.3 5.5 5.0 Depreciation, amortization and restaurant opening costs 7.3 5.6 6.0 Special charge (reversal) 59.6 (1.9) - ----- ----- ----- INCOME (LOSS) FROM OPERATIONS (55.7) 11.0 9.7 INTEREST EXPENSE, NET (0.9) (1.4) (1.5) ----- ----- ----- INCOME (LOSS) BEFORE INCOME TAXES (56.5) 9.6 8.2 INCOME TAXES 1.2 - - ----- ----- ----- NET INCOME (LOSS) (55.4)% 9.6% 8.2% ===== ===== ===== Restaurant Data: COMPANY-OWNED RESTAURANTS: Beginning of period 104 98 102 Opened 7 9 10 Acquired 1 - - Closed (14) (5) (3) ---- ---- ---- End of period 98 102 109 FRANCHISED RESTAURANTS: 11 10 10 ---- ---- ---- TOTAL RESTAURANTS: 109 112 119 ==== ==== ==== ______________ (1) As a percentage of restaurant sales. Fiscal 1999 Compared to Fiscal 1998 Restaurant Sales. Restaurant sales increased $16.6 million, or 11.7%, to $159.2 million for fiscal 1999 from $142.6 million for fiscal 1998. The increase in sales is due to an increase in sales at existing restaurants and the opening of new restaurants during 1999, offset by a decrease in sales from restaurant closures. Comparable store sales, defined as Taco Cabana restaurants that have been open 18 months or more at the beginning of each quarter, increased 5.5% during 1999. Management attributes the increase in comparable store sales to several factors including a more consistent marketing program, a commitment to increased staffing levels at existing restaurants, a price increase in the last quarter of 1998 and early 1999, and the ongoing reimage program. Sales from restaurants opened after January 3, 1999 accounted for an increase of $9.3 million. This increase was offset by restaurants closed during 1998 which accounted for sales of $1.3 million during 1998. Due to the fact that the Company's fiscal year is a 52 - 53 week year ending on the closest Sunday to December 31, fiscal year 1999 contained 52 weeks and fiscal year 1998 contained 53 weeks. The additional week in 1998 accounted for approximately $2.6 million in sales. Franchise Fees and Royalty Income. Franchise and royalty fees remained relatively constant for fiscal 1999 compared to fiscal 1998. There were no new franchisee openings or closures during 1999. Restaurant Cost of Sales. Restaurant cost of sales, calculated as a percentage of restaurant sales, decreased to 30.0% in 1999 from 30.4% in 1998. The decrease was primarily due to menu price increases of 2.6% implemented in the last quarter of 1998 and early 1999, continued improvements in the management of food costs through utilizing increased controls and improved purchasing programs, including the continued negotiation of favorable commodity pricing. Management expects this amount, as a percentage of sales, to be slightly lower or remain constant in 2000. Labor. Labor costs, calculated as a percentage of restaurant sales, increased to 27.5% for the year ended January 2, 2000 compared to 26.8% in 1998. The increase in labor costs is due to management's continued commitment to increased staffing levels at the restaurants in order to provide a consistent guest experience as well as higher than normal labor costs at newer restaurants. New restaurants generally have higher than normal costs for the first four to six months of operations. Management expects labor costs as a percentage of sales to be slightly higher in 2000 as the Company moves into new markets and continues to invest in the guest experience. Occupancy. Occupancy costs increased by $462,000 during 1999 compared to 1998. As a percentage of restaurant sales, occupancy costs decreased to 5.2% in the year ended January 2, 2000 compared to 5.5% in 1998. The decrease is due to an increase in average unit sales volumes during 1999, which was in turn attributable to the opening of new restaurants with higher volumes and increased sales at existing restaurants. Management expects the dollar amount to increase due to new restaurant openings but continue to decrease as a percentage of sales in 2000. Other Restaurant Operating Costs. Other restaurant operating costs increased by $2.1 million to $26.8 million for the year ended January 2, 2000 compared to $24.7 million in the same period of 1998. As a percentage of restaurant sales, other restaurant operating costs decreased to 16.8% for the year ended January 2, 2000 compared to 17.3% in the same period of 1998. The decrease as a percentage of sales is primarily due to leverage from higher than average sales along with a relatively flat dollar amount per store open. Management expects this amount, as a percentage of sales, to be flat or slightly lower in 2000. General and Administrative. General and administrative expenses decreased as a percentage of total revenues to 5.0% for the year ended January 2, 2000 from 5.5% for the comparable period in 1998. This decrease was primarily attributable to an increase in sales at existing restaurants and the opening of new restaurants. Management expects this amount to remain constant, as a percentage of sales, in 2000. Depreciation, Amortization and Restaurant Opening Costs. Depreciation, amortization and restaurant opening expenses consisted of the following: Year Ended ------------------------ January 3, January 2, 1999 2000 Depreciation of property and equipment ......................... $ 6,816,000 $ 8,175,000 Amortization of intangible assets ............................ 569,000 586,000 Restaurant opening costs .......... 605,000 820,000 Depreciation expense increased by approximately $1.4 million for fiscal 1999 compared to fiscal 1998. The increase was due primarily to the addition of new restaurants as well as continued capital improvements to existing restaurants. Restaurants opened after January 1, 1998 accounted for $1.1 million of the increase. Restaurant opening costs increased by approximately $215,000 during fiscal 1999 compared to fiscal 1998, due primarily to the opening of three restaurants outside of existing markets. Management expects these amounts to increase during 2000 due to the opening of new restaurants, the opening of restaurants in new markets and the ongoing reimage program. Interest Expense, net. Interest expense, net of interest income and interest capitalized on construction costs, increased to $2.4 million in fiscal 1999 from $2.0 million in fiscal 1998, primarily as a result of additional borrowings under the Company's debt facilities. In addition, the Company capitalized $151,000 of interest during 1999 compared to $117,000 during 1998. Income Taxes. Income tax expense was zero for 1998 and 1999 due to the utilization of net operating loss carryforwards relating to the special charge of 1997. Management anticipates paying alternative minimum taxes in 2000 at a rate of approximately 20%. Net Income and Net Income Per Share. The Company recorded net income of $13.1 million for 1999 compared to $13.7 million for 1998. Diluted earnings per share was $0.97 for 1999 compared to $0.95 in 1998. The decrease in net income is primarily due to fiscal year 1999 containing 52 weeks compared to 53 weeks in fiscal year 1998 and net income recorded in 1998 included a $2.7 million reversal of a portion of the special charges recorded during 1996 and 1997. Net income recorded in 1999 and 1998 does not include any income tax expense due to the utilization of previously unrecognized net operating loss carryforwards relating to the special charge recorded in 1997. Including a pro-forma income tax expense utilizing the same rate as the prior year, excluding the special charge reversal in 1998 and excluding the estimated impact of the additional week in 1998, the Company would have reported net income of approximately $8.3 million, or $0.61 per share (diluted) in 1999 compared to net income of approximately $6.6 million, or $0.45 per share (diluted) in 1998. Management attributes the increase in net income and diluted earnings per share to higher average weekly sales at existing restaurants, continued strong cost controls at the restaurant level and fewer shares outstanding. Fiscal 1998 Compared to Fiscal 1997 Restaurant Sales. Restaurant sales increased $10.7 million, or 8.1%, to $142.6 million for fiscal 1998 from $131.9 million for fiscal 1997. The increase in sales was due to an increase in sales at existing restaurants, an additional week of sales in 1998 compared to 1997 and the opening of new restaurants during 1998, offset by a decrease in sales from restaurant closures. Comparable store sales, defined as Taco Cabana restaurants that have been open 18 months or more at the beginning of each quarter, increased 4.7% during 1998. Management attributes the increase in comparable store sales to several factors including a more consistent marketing program featuring a value meal message, a commitment to increased staffing levels at existing restaurants and the ongoing reimage program. The additional week of sales in 1998 was due to the fact the Company's fiscal year is a 52 - 53 week year ending on the closest Sunday to December 31. Fiscal year 1998 contained 53 weeks and fiscal year 1997 contained 52 weeks. The additional week accounted for approximately $2.6 million in additional sales for 1998 compared to 1997. Sales from restaurants opened after December 29, 1997 accounted for an increase of $8.3 million. This increase was offset by restaurants closed during 1997 which accounted for sales of $7.1 million during 1997. Franchise Fees and Royalty Income. Franchise and royalty fees remained relatively constant for fiscal 1998 compared to fiscal 1997. There were no new franchisee openings and one franchisee closing during 1998. Restaurant Cost of Sales. Restaurant cost of sales, calculated as a percentage of restaurant sales, decreased to 30.4% in 1998 from 30.8% in 1997. The decrease was due primarily to a price increase taken in the first quarter of 1998 and continued improvements in the management of food costs through utilizing increased controls and improved purchasing programs, including the continued negotiation of favorable commodity pricing. Labor. Labor costs, calculated as a percentage of sales, decreased to 26.8% for the year ended January 3, 1999 compared to 27.4% in 1997. Adjusting for restaurants closed during 1997, comparable labor as a percentage of restaurant sales during 1997 was 26.5%. The increase in comparable labor costs is due to an increase in the minimum wage in September 1997 and management's commitment to increased staffing levels at the restaurant in order to provide a consistent guest experience as well as higher than normal labor costs at newer restaurants. New restaurants generally have higher than normal costs for the first four to six months of operations. Occupancy. Occupancy costs decreased by $345,000 during 1998 compared to 1997. The decrease was primarily due to the closure of underperforming restaurants during 1997. As a percentage of restaurant sales, occupancy costs decreased to 5.5% in the year ended January 3, 1999 compared to 6.2% in 1997. The decrease was due to an increase in average unit sales volumes during 1998, which was in turn attributable to the closure of underperforming restaurants, the opening of new restaurants with higher volumes and increased sales at existing restaurants. Other Restaurant Operating Costs. Other restaurant operating costs decreased by $679,000 to $24.7 million for the year ended January 3, 1999 compared to $25.4 million in the same period of 1997. As a percentage of restaurant sales, other restaurant operating costs decreased to 17.3% for the year ended January 3, 1999 compared to 19.3% in the same period of 1997. The decrease was due to decreased marketing and promotional activities and an increase in average unit sales volumes. The decrease in marketing and promotional costs is attributed to management's decision to exit the underperforming Colorado market in December 1997, as well as the decision to move to a radio only media strategy in 1998. General and Administrative. General and administrative expenses increased to $7.8 million from $7.0 million, and increased as a percentage of total revenues to 5.5% for the year ended January 3, 1999 from 5.3% for the comparable period in 1997. This increase was primarily attributable to an increased level of expenditures to support the Company's operations, and an increase in the bonus accrual during 1998. Depreciation, Amortization and Restaurant Opening Costs. Depreciation, amortization and restaurant opening expenses consisted of the following: Year Ended -------------------------- December 28, January 3, 1997 1999 Depreciation of property and equipment ......................... $ 7,942,000 $ 6,816,000 Amortization of intangible assets 1,313,000 569,000 Restaurant opening costs .......... 404,000 605,000 Depreciation expense decreased by approximately $1.1 million for fiscal 1998 compared to fiscal 1997. The decrease was due primarily to the closure of restaurants and write-down of assets in conjunction with the special charge recorded in the fourth quarter of 1997, offset by new restaurants opened after December 28, 1997, as well as continued capital improvements to existing restaurants. Amortization of intangible assets decreased by approximately $744,000 primarily due to the write-down of goodwill and other intangible assets during the fourth quarter of 1997. Restaurant opening costs increased by approximately $201,000 during fiscal 1998 compared to fiscal 1997, due to the increase in the number of restaurants opened during 1998 compared to 1997. Special Charge Reversal. As part of the special charges recorded in the fourth quarter of 1996 and 1997, the Company reduced the carrying value of assets and established reserves for the estimated lease liabilities associated with restaurants that were closed. During 1998, the Company successfully completed sales of several of these properties to third parties or negotiated favorable lease terminations. The amount of the proceeds in excess of the carrying value of the assets and the remaining lease liabilities was approximately $2.7 million. This amount was recorded as a special charge reversal during the fourth quarter of 1998. Interest Expense, net. Interest expense, net of interest income and interest capitalized on construction costs, increased to $2.0 million in fiscal 1998 from $1.1 million in fiscal 1997, primarily as a result of additional borrowings under the Company's debt facilities. In addition, the Company capitalized $117,000 of interest during 1998 compared to $147,000 during 1997. Net Income (Loss) and Net Income (Loss) Per Share. The Company recorded net income of $13.7 million for 1998 compared to a net loss of $73.2 million for 1997. Diluted earnings per share was $0.95 for 1998 compared to a loss per share of $4.78 in 1997. The net income recorded in 1998 includes the reversal of a portion of the special charges recorded during 1996 and 1997 totaling $2.7 million. Also, net income recorded in 1998 does not include any income tax expense due to the utilization of previously unrecognized net operating loss carryforwards relating to the special charge recorded in 1997. Including a pro- forma income tax expense utilizing the same rate as the prior year, and excluding the special charge reversal in 1998, the Company would have reported net income of approximately $7.0 million, or $0.48 per share (diluted). The loss recorded in 1997 includes special charges totaling $78.7 million pretax ($75.7 million after-tax, or $4.94 per share). Excluding these charges, the Company would have reported net income of $2.5 million equal to $0.16 per share in fiscal 1997. In summary, the increase in net income and diluted earnings per share in 1998 is attributable to several factors including an increase in sales at existing restaurants, continued strong cost controls, the closing of underperforming restaurants and an extra week of operations in 1998 compared to 1997. Year 2000 The Year 2000 ( "Y2K" ) issue is the result of computer programs written using two digits (rather than four) to define the applicable year. Without corrective actions, programs with date-sensitive logic may recognize "00" as 1900 rather than 2000. This problem could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions or engage in similar normal business activities. The Company relies to a large extent on computer technology to carry out its day-to-day operations. For this reason, the Company implemented a Year 2000 project so that the Company's computer systems would function properly in the year 2000 and thereafter. The Company's Year 2000 project involved the review of a number of internal and third party systems. The Company completed its system review and made certain modifications to its existing software and systems and/or conversions to new software. The Company assessed the Year 2000 readiness of its third party business partners and developed contingency plans for those that appeared to have substantial Year 2000 operational risks. There were no major internal or third party systems issues reported over the year 2000 transition. The total cost of the Year 2000 project was approximately $600,000 and was funded through operating cash flows and borrowings from the Company's available credit facilities. Liquidity and Capital Resources Historically, the Company has financed business and expansion activities by using funds generated from operating activities, build-to-suit leases, equity financing, short and long-term debt and capital leases. The Company currently maintains credit facilities totaling $50 million, including a $5 million unsecured revolving line of credit. As of February 28, 2000, the aggregate outstanding balance under these commitments was $41.8 million. Net cash provided by operating activities was $20.3 million for 1999, compared to $15.7 million for 1998. Net cash used in investing activities was $18.4 million for 1999, representing the construction of ten Company owned restaurants, the reimaging of twenty-nine restaurants and capital expenditures for improvements to existing restaurants, offset by the sale of assets generating $1.3 million in proceeds. This compared to $16.9 million of net cash used in investing activities for 1998, representing primarily the construction of nine Company owned restaurants and the reimaging of twenty-seven restaurants, offset by the sale of assets generating $4.3 million in proceeds. Net cash used by financing activities was $1.3 million for 1999 representing the purchase of $11.4 million of the Company's stock, which is held as treasury stock, offset in part by $9.8 million in net borrowings under the Company's credit facilities. This compared to net cash provided by financing activities of $1.6 million in 1998, representing primarily net borrowings under the Company's credit facilities, offset in part by the purchase of $10.3 million in treasury stock. The Company's Board of Directors previously approved plans to repurchase up to a total of 4,500,000 shares of the Company's Common Stock. As of February 28, 2000, the Company had repurchased 4,450,000 shares at an average cost of $6.50 per share. The Company has funded the repurchases primarily through available bank credit facilities. The timing, price, quantity and manner of future purchases will be made at the discretion of management and will depend upon market conditions. The Company intends to fund additional share repurchases, if any, through available credit under its bank credit facilities and current cash flows from operations. The special charges recorded in 1997 and 1995 included accruals totaling approximately $10.2 million to record the estimated monthly lease payments, net of expected sublease receipts, associated with certain restaurants which have been closed. Cash requirements for this accrual were approximately $754,000 during year ended January 2, 2000. During the year ended January 2, 2000, the Company sold properties relating to the special charges which resulted in proceeds of $1.3 million, which approximated the carrying value of the assets sold. The Company currently has two closed restaurant properties for sale which were covered by the special charges. Although there can be no assurance of the particular price at which such properties will be sold, the Company expects to receive funds equal to or in excess of the carrying value upon the actual disposition of these properties. In addition, certain acquisition and accrued liabilities related to a prior acquisition were reduced by payments of approximately $236,000 during the year ended January 2, 2000. The Company believes that existing cash balances, funds generated from operations, its ability to borrow, and the possible use of lease financing will be sufficient to meet the Company's capital requirements through 2000, including the planned opening of fifteen restaurants and the reimaging of fourteen restaurants. Total capital expenditures related to new restaurants are estimated to be $19.0 to $22.0 million. The total for other capital expenditures, including the cost of the reimagings, is estimated to be $4.0 to $6.0 million. Total capital expenditures for 2000 are expected to approximate $23.0 to $28.0 million. Impact of Inflation Although increases in labor, food or other operating costs could adversely affect the Company's operations, management does not believe that inflation has had a material adverse effect on the Company's operations to date. Seasonality and Quarterly Results The Company's sales fluctuate seasonally. Historically, the Company's highest sales and earnings occur in the second and third quarters. In addition, quarterly results are affected by the timing of the opening of new stores, and the Company's growth may offset the impact of seasonal influences. Therefore, quarterly results are not indicative of results for the entire year. Forward-Looking Statements Statements in this annual report concerning Taco Cabana which are (a) projections of revenues, costs, including trends in cost of sales, operating costs, labor and general and administrative costs or other financial items, (b) statements of plans and objectives for future operations, specifically statements regarding planned restaurant openings, closings and reimages as well as property sales, share repurchases and cash flows, (c) statements of future economic performance, (d) statements of projected tax rates or the utilization of net operating loss tax carryforwards, or (e) statements of assumptions or estimates underlying or supporting the foregoing are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The ultimate accuracy of forward - -looking statements is subject to a wide range of risks, uncertainties and other factors which may cause actual results and outcomes to differ, often materially, from expectations. Any number of important factors could cause actual results to differ materially from those in the forward-looking statements herein, including the following: the timing and extent of changes in prices of commodities and supplies that the Company utilizes; cost and availability of labor; actions of our customers and competitors; changes in state and federal environmental, economic, safety and other policies and regulations and any legal or regulatory delays or other factors beyond the Company's control; execution of planned capital projects; weather conditions affecting the Company's operations; natural disasters affecting operations; and adverse rulings, judgments, or settlements in litigation or other legal matters. The Company disclaims any intention or obligation to update or revise any such forward- looking statements, whether as a result of new information, future events or otherwise. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to market risk from changes in interest rates on debt and changes in commodity prices. The Company's exposure to interest rate risk currently consists of its notes payable and outstanding line of credit. The Company has notes payable and a line of credit which bear interest at the lesser of the London Interbank Offer Rate plus 2.25% or the prime rate, adjusted quarterly. The aggregate balance outstanding of these notes and the line of credit as of February 28, 2000 was $41.8 million. The Company also has a note payable which bears interest at the prime rate. The outstanding balance of this note as of February 28, 2000 was $886,000. The impact on the Company's results of operations of a one-point interest rate change on the outstanding balances under the notes payable and line of credit as of February 28, 2000 would be approximately $430,000. The Company purchases certain commodities such as beef, chicken, flour, produce and dairy products. These commodities are generally purchased based upon market prices established with vendors. These purchase arrangements may contain contractual features that limit the price paid by establishing price floors or caps. The Company does not use financial instruments to hedge commodity prices because these purchase arrangements help control the ultimate cost and any commodity price aberrations are generally short term in nature. This market risk discussion contains forward-looking statements. Actual results may differ materially from this discussion based upon general market conditions and changes in financial markets. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data are set forth in this annual report on Form 10-K commencing on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The response to this Item required by Item 401 of Regulation S-K, with respect to directors, is incorporated by reference to the information under the caption "Directors and Executive Officers" in Taco Cabana's Proxy Statement for the 2000 annual meeting of stockholders to be filed with the Securities and Exchange Commission on or before May 1, 2000 and with respect to executive officers, is contained in Part I, hereof under the caption "Executive Officers of the Company". The response to this Item required by Item 405 of Regulation S-K is incorporated by reference to the information under the caption "Compliance with Section 16(a) of the Securities Exchange Act of 1934" of Taco Cabana's Proxy Statement for the 2000 annual meeting of stockholders to be filed with the Securities and Exchange Commission on or before May 1, 2000. ITEM 11. EXECUTIVE COMPENSATION The response to this Item is incorporated by reference to the information under the captions "Executive Compensation" , "Summary Compensation Table" , "Stock Option Plans and Director's Options" , "Option Grants in Last Fiscal Year", and "Aggregated Option Exercises in Last Fiscal Year and Fiscal Year- End Option Values" of Taco Cabana's Proxy Statement for the 2000 annual meeting of stockholders to be filed with the Securities and Exchange Commission on or before May 1, 2000. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The response to this Item is incorporated by reference to the information under the caption "Principal Stockholders" of Taco Cabana's Proxy Statement for the 2000 annual meeting of stockholders to be filed with the Securities and Exchange Commission on or before May 1, 2000. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: Financial Statements Independent Auditors' Report Consolidated Balance Sheets at January 3, 1999 and January 2, 2000 Consolidated Statements of Operations for the years ended December 28, 1997, January 3, 1999 and January 2, 2000 Consolidated Statements of Stockholders' Equity for the years ended December 28, 1997, January 3, 1999 and January 2, 2000 Consolidated Statements of Cash Flows for the years ended December 28, 1997, January 3, 1999 and January 2, 2000 Notes to Consolidated Financial Statements Financial Statement Schedules No financial statement schedules are submitted because of the absence of the conditions under which they are required or because the required information is included in the Consolidated Financial Statements or notes thereto. Exhibits 3.1 Restated Certificate of Incorporation, filed on December 29, 1993. (b) 3.2 Bylaws of Registrant. (a) 4.1 Form of Common Stock Certificate. (a) 4.2 Rights Agreement dated as of June 9, 1995, between Taco Cabana, Inc. and Society National Bank, as Rights Agent. (c) 10.5 Sample Franchise Agreement. (a) 10.6 Sample Franchise Development Agreement. (a) 10.7 Sample Beverage Sublease Agreement. (a) 10.8 Sample Concessionaire Management Agreement. (a) 10.9* Amended and Restated Stock Option Plan. (a) 10.14* 1994 Stock Option Plan. (b) 10.20 Fifth Amended Loan Agreement with International Bank of Commerce (d) 21. Subsidiaries of the Registrant. (d) 23. Consent of Deloitte & Touche LLP. (d) 24. Powers of attorney to sign amendments to this report. Reference is made to the signature page of this report. 27. Financial Data Schedule. (d) ________________________ * Executive compensation plan or arrangement. (a) Filed as an exhibit to Form S-1 Registration Statement No. 33-51430, effective October 16, 1992. (b) Filed as an exhibit to Form 10-K for the fiscal year ended January 1, 1995. (c) Filed as an exhibit to Form 8-A Registration Statement No. 0-20716, effective June 9,1995. (d) Filed herewith. (b) Reports on Form 8-K None. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TACO CABANA, INC. By: STEPHEN V. CLARK Stephen V. Clark Chief Executive Officer and President Date: March 29, 2000 Each person whose signature appears below authorizes Stephen V. Clark and David G. Lloyd or either of them, each of whom may act without joinder of the other, to execute in the name of each such person who is then an officer or director of the Registrant and to file any amendments to this annual report on Form 10-K necessary or advisable to enable the Registrant to comply with the Securities Exchange Act of 1934, as amended, and any rules, regulations and requirements of the Securities and Exchange Commission in respect thereof, which amendments may make such changes in such report as such attorney-in-fact may deem appropriate. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons in the capacities and on the dates indicated. Signature Title Date STEPHEN V. CLARK Chief Executive Officer, March 29, 2000 Stephen V. Clark President and Director (Principal Executive Officer) DAVID G. LLOYD Senior Vice President - Finance, March 29, 2000 David G. Lloyd Chief Financial Officer, Secretary and Treasurer (Principal Financial and Accounting Officer) WILLIAM J. NIMMO Director March 29, 2000 William J. Nimmo ROD SANDS Director March 29, 2000 Rod Sands CECIL SCHENKER Director March 29, 2000 Cecil Schenker RICHARD SHERMAN Director March 29, 2000 Richard Sherman LIONEL SOSA Director March 29, 2000 Lionel Sosa EXHIBIT INDEX Exhibit No. 10.20 Fifth Amended Loan Agreement with International Bank of Commerce. 21. Subsidiaries of the Registrant 23. Consent of Deloitte & Touche LLP 27. Financial Data Schedule EXHIBIT 21 Subsidiaries of Registrant TP Acquisition Corp., a Texas corporation Get Real, Inc., a Delaware corporation Texas Taco Cabana, L.P., a Texas limited partnership T. C. Management Inc., a Delaware corporation T.C Lease Holdings III, V and VI, Inc., a Texas corporation Taco Cabana Multistate, Inc., a Delaware corporation Colorado Cabana, Inc., a Colorado corporation Taco Cabana Atlanta, Inc., a Delaware corporation Taco Cabana Investments, Inc., a Delaware corporation Taco Cabana Management, Inc., a Texas corporation EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statements No. 33- 56438 and No. 33-98124 of Taco Cabana, Inc. on Form S-8 of our report dated February 1, 2000 appearing in this Annual Report on Form 10-K of Taco Cabana, Inc. for the year ended January 2, 2000. DELOITTE & TOUCHE LLP San Antonio, Texas March 29, 2000 This page intentionally left blank. TACO CABANA, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Consolidated Financial Statements: Independent Auditors' Report F-2 Consolidated Balance Sheets at January 3, 1999 and January 2, 2000 F-3 Consolidated Statements of Operations for the Years Ended December 28, 1997, January 3, 1999, and January 2, 2000 F-4 Consolidated Statements of Stockholders' Equity for the Years Ended December 28, 1997, January 3, 1999 and January 2, 2000 F-5 Consolidated Statements of Cash Flows for the Years Ended December 28, 1997, January 3, 1999 and January 2, 2000 F-6 Notes to Consolidated Financial Statements F-8 INDEPENDENT AUDITORS' REPORT To the Board of Directors Taco Cabana, Inc. We have audited the accompanying consolidated balance sheets of Taco Cabana, Inc. and subsidiaries ("the Company" ) as of January 2, 2000 and January 3, 1999, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended January 2, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Taco Cabana, Inc. and subsidiaries at January 2, 2000 and January 3, 1999, and the results of their operations and their cash flows for each of the three years in the period ended January 2, 2000 in conformity with accounting principles generally accepted in the United States of America. DELOITTE & TOUCHE LLP San Antonio, Texas February 1, 2000 TACO CABANA, INC. CONSOLIDATED BALANCE SHEETS January 3, January 2, ASSETS 1999 2000 CURRENT ASSETS: Cash and cash equivalents $ 719,000 $ 1,303,000 Receivables, net 438,000 507,000 Inventory 2,273,000 2,413,000 Prepaid expenses 3,128,000 3,237,000 Federal income taxes receivable 200,000 200,000 ----------- ------------ Total current assets 6,758,000 7,660,000 PROPERTY AND EQUIPMENT, net 72,250,000 82,616,000 NOTES RECEIVABLE 258,000 278,000 INTANGIBLE ASSETS, net 10,724,000 10,139,000 OTHER ASSETS 212,000 312,000 ----------- ------------ TOTAL ASSETS $90,202,000 $101,005,000 =========== ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 5,362,000 $ 4,962,000 Accrued liabilities 5,265,000 6,063,000 Current maturities of long-term debt and capital leases 5,704,000 5,251,000 Line of credit 3,550,000 1,000,000 ----------- ------------ Total current liabilities 19,881,000 17,276,000 LONG-TERM OBLIGATIONS, net of current maturities: Capital leases 2,140,000 1,901,000 Long-term debt 18,930,000 31,756,000 ----------- ------------ Total long-term obligations 21,070,000 33,657,000 ACQUISITION AND CLOSED RESTAURANT LIABILITIES 7,713,000 6,330,000 DEFERRED LEASE PAYMENTS 761,000 744,000 STOCKHOLDERS' EQUITY: Preferred stock, series A; $.01 par value, 100,000 shares authorized - - Common stock; $.01 par value, 30,000,000 shares authorized - 15,907,937 and 13,435,575 shares issued at January 3, 1999 and January 2, 2000, respectively 159,000 134,000 Additional paid-in capital 98,056,000 84,731,000 Retained deficit (43,544,000) (30,427,000) Treasury stock, at cost - 2,576,937 shares at January 3, 1999 and 1,354,600 shares at January 2, 2000 (13,894,000) (11,440,000) ----------- ------------ Total stockholders' equity 40,777,000 42,998,000 ----------- ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $90,202,000 $101,005,000 =========== ============ See notes to consolidated financial statements. TACO CABANA, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended -------------------------------------- December 28, January 3, January 2, 1997 1999 2000 (52 Weeks) (53 Weeks) (52 Weeks) REVENUES: Restaurant sales $ 131,857,000 $ 142,592,000 $ 159,241,000 Franchise fees and royalty income 346,000 358,000 359,000 -------------- ------------- ------------- Total revenues 132,203,000 142,950,000 159,600,000 -------------- ------------- ------------- COSTS AND EXPENSES: Restaurant cost of sales 40,668,000 43,347,000 47,764,000 Labor 36,169,000 38,185,000 43,715,000 Occupancy 8,185,000 7,840,000 8,302,000 Other restaurant operating costs 25,418,000 24,739,000 26,790,000 General and administrative 6,964,000 7,829,000 7,907,000 Depreciation, amortization and restaurant opening costs 9,659,000 7,990,000 9,581,000 Special charge (reversal) 78,738,000 (2,665,000) - -------------- ------------- ------------- Total costs and expenses 205,801,000 127,265,000 144,059,000 -------------- ------------- ------------- INCOME (LOSS) FROM OPERATIONS (73,598,000) 15,685,000 15,541,000 INTEREST EXPENSE, NET (1,137,000) (1,951,000) (2,424,000) -------------- ------------- ------------- INCOME (LOSS) BEFORE INCOME TAXES (74,735,000) 13,734,000 13,117,000 BENEFIT FOR INCOME TAXES 1,537,000 - - -------------- ------------- ------------- NET INCOME (LOSS) $ (73,198,000) $ 13,734,000 $ 13,117,000 ============== ============= ============= BASIC EARNINGS (LOSS) PER SHARE $ (4.78) $ 0.96 $ 0.99 ============== ============= ============= DILUTED EARNINGS (LOSS) PER SHARE $ (4.78) $ 0.95 $ 0.97 ============== ============= ============= See notes to consolidated financial statements. TACO CABANA, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Preferred Stock Common Stock Additional Retained Treasury Stock ------------ --------------------- Paid-in Eanings ---------------------------- Amount Shares Amount Capital (Deficit) Shares Amount BALANCE, December 30, 1996 $ - 15,706,537 $157,000 $97,095,000 $15,920,000 - $ - Purchase of stock - - - - - 871,937 (3,561,000) Net loss - - - - (73,198,000) - - ----- ---------- -------- ----------- ----------- ---------- ------------- BALANCE, December 28, 1997 - 15,706,537 157,000 97,095,000 (57,278,000) 871,937 (3,561,000) Options exercised - 201,400 2,000 961,000 - - - Purchase of stock - - - - - 1,705,000 (10,333,000) Net income - - - - 13,734,000 - - ----- ---------- -------- ----------- ----------- ----------- ------------- BALANCE, January 3, 1999 - 15,907,937 159,000 98,056,000 (43,544,000) 2,576,937 (13,894,000) Options exercised - 104,575 1,000 543,000 - - - Purchase of stock - - - - - 1,354,600 (11,440,000) Retirement of treasury stock - (2,576,937) (26,000) (13,868,000) - (2,576,937) 13,894,000 Net income - - - - 13,117,000 - - ----- ---------- ------- ----------- ----------- ---------- ------------- BALANCE, January 2, 2000 $ - 13,435,575 $134,000 $84,731,000 $(30,427,000) 1,354,600 $ (11,440,000) ===== ========== ======= =========== =========== ========== ============= See notes to consolidated financial statements. TACO CABANA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended -------------------------------------- December 28, January 3, January 2, 1997 1999 2000 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $(73,198,000) $13,734,000 $13,117,000 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 9,659,000 7,385,000 8,761,000 Deferred income taxes (1,818,000) - - Special charge (reversal) 78,738,000 (2,665,000) - Capitalized interest (147,000) (117,000) (151,000) Deferred income and lease payments (157,000) 59,000 (17,000) Decrease (increase) in assets: Receivables 634,000 150,000 (89,000) Inventory (656,000) (168,000) (140,000) Prepaid expenses (1,018,000) (1,424,000) (109,000) Federal income taxes receivable 163,000 - - Other assets 58,000 21,000 (100,000) (Decrease) increase in liabilities: Accounts payable and accrued liabilities 2,328,000 (103,000) 398,000 Acquisition and closed restaurant liabilities (1,656,000) (1,194,000) (1,348,000) ----------- ----------- ----------- Net cash provided by operating activities 12,930,000 15,678,000 20,322,000 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (16,812,000) (21,259,000) (19,763,000) Proceeds from sales of property and equipment 1,379,000 4,330,000 1,337,000 ----------- ----------- ----------- Net cash used by investing activities (15,433,000) (16,929,000) (18,426,000) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of long-term debt and draws on line of credit 18,423,000 14,469,000 20,045,000 Principal payments under long- term debt and line of credit (11,074,000) (3,276,000) (10,246,000) Principal payments under capital leases (1,694,000) (192,000) (215,000) Purchase of treasury stock (3,561,000) (10,333,000) (11,440,000) Exercise of stock options - 963,000 544,000 ----------- ----------- ----------- Net cash (used) provided by financing activities 2,094,000 1,631,000 (1,312,000) ----------- ----------- ----------- NET (DECREASE) INCREASE IN CASH (409,000) 380,000 584,000 CASH AND CASH EQUIVALENTS, beginning of period 748,000 339,000 719,000 ----------- ----------- ----------- CASH AND CASH EQUIVALENTS, end of period $339,000 $719,000 $1,303,000 =========== =========== =========== (Continued) TACO CABANA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS SUMMARY OF NON-CASH TRANSACTIONS: During 1999, assets having a net book value of $439,000 were disposed of and charged to acquisition and closed restaurant liabilities. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Year Ended --------------------------------------- December 28, January 3, January 2, 1997 1999 2000 Cash paid for interest, net of interest capitalized $1,171,000 $1,848,000 $2,092,000 Cash received for income taxes 4,000 9,000 - Cash paid for income taxes 74,000 - 2,000 (Concluded) See notes to consolidated financial statements. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS Nature of Operations - Taco Cabana, Inc. (the " Company" ) operates a chain of Tex-Mex patio style quick service restaurants located primarily in the Southwestern United States. At January 2, 2000, the Company owned and operated a total of 109 units. There were also 10 Taco Cabana franchised units. Principles of Consolidation - The consolidated financial statements include all accounts of the Company and its wholly-owned subsidiaries. All significant inter-company balances and transactions have been eliminated. Fiscal Year - The Company's accounting period is based upon a 52 or 53 week fiscal year ending on the Sunday closest to December 31. The fiscal years 1997, 1998 and 1999 were comprised of the 52 weeks ended December 28, 1997, the 53 weeks ended January 3, 1999 and the 52 weeks ended January 2, 2000. Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Liquor Sales - To conform to state liquor laws, liquor licenses are maintained and liquor sales are accounted for by a separate liquor corporation. The liquor corporation pays the Company a management fee based on liquor sales, reimburses the Company for its share of operating costs, and pays base and additional rent based on liquor sales. In order to more accurately reflect restaurant operations, all revenues and expenses relating to liquor sales have been included in the consolidated financial statements of the Company. Inventory - Inventory is stated at the lower of cost using the first-in, first-out method or market, and consists primarily of food products, beverages and paper supplies. Property and Equipment - Property and equipment is stated at cost. Equipment and buildings under capital leases are stated at the lower of the present value of minimum lease payments or fair market value of the asset at the inception of the lease. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets or the applicable lease term, if less. The estimated useful lives used in computing depreciation and amortization are as follows: Furniture, fixtures and equipment 2-10 years Buildings 20-30 years Leasehold improvements 5-30 years Maintenance and repairs are charged to expense as incurred; improvements which increase the value of the property and extend the useful life are capitalized. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (Continued) Intangible Assets - Goodwill, or the excess of acquisition costs over the fair market value of the assets acquired and liabilities assumed, is amortized using the straight-line method over 10 to 40 years. The trade name and the rights to the Taco Cabana name are amortized using the straight-line method over 40 years. Franchise Income - The Company has sold franchises that give the franchisees the right to operate Taco Cabana restaurants in specified areas. Generally, each franchisee acquires the right to open three or more restaurants. A development fee is recognized as income when the agreement is signed, while the franchise fee on each restaurant is deferred until the opening of the franchised restaurant. In addition, the franchise agreement requires a franchise royalty fee and an advertising fee on gross sales; such fees are recorded as income when earned. The Company has not recognized any franchise fees in the fiscal years 1997, 1998 or 1999. Concentrations of Credit Risk - Financial instruments that potentially subject the Company to concentrations of credit risk consisted principally of amounts due from franchisees and receivables from credit card sales. These risks are limited due to their geographic dispersion. The Company has no significant concentrations of credit risk. Income Taxes - Deferred income taxes are recognized by applying statutory tax rates in effect at the balance sheet date to differences between the financial statement basis and the tax basis of assets and liabilities. The resulting deferred tax assets and liabilities are adjusted to reflect changes in tax laws or rates at the time such changes occur. Deferred tax assets are reported net of an allowance that management believes reduces net deferred tax assets to the amount that is more likely than not realizable. Earnings (Loss) Per Share - Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the reporting period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Outstanding stock options issued by the Company represent the only dilutive effect reflected in diluted weighted average shares. Statements of Cash Flows - For purposes of reporting cash flows, the Company considers all highly liquid debt instruments with a remaining maturity at the date of purchase of three months or less to be cash equivalents. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NATURE OF OPERATIONS (Continued) Commitments and Contingencies - The Company does not subscribe to worker's compensation insurance in its Texas market. The Company accrues for claims based on historical actual payments made for such claims and expenses, as well as an evaluation of current and anticipated claims and expenses. The Company does maintain an excess liability coverage which management believes is adequate to cover any substantial claims. Stock-Based Compensation - The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board ( "APB") No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's common stock at the date of grant over the amount an employee must pay to acquire the stock. The Company has adopted the disclosure requirements of Statement of Financial Accounting Standards ( "SFAS" ) No. 123, Accounting for Stock-Based Compensation, as included in Note 12. Reclassifications - Certain reclassifications have been made to the 1997 and 1998 consolidated financial statements to conform to the presentation and classification used in fiscal 1998 and 1999. 2. SPECIAL CHARGE (REVERSAL) During fiscal 1997 and 1998, the following special charge and reversal are included in the Company's consolidated financial statements: December 28, January 3, 1997 1999 Special charge (reversal) $78,738,000 $(2,665,000) Pro forma income tax (benefit) provision (3,018,000) 986,000 Decrease (increase) on net income 75,720,000 (1,679,000) Decrease (increase) per share $ 4.94 $ (0.12) Fiscal 1998 - As part of the special charges recorded in the fourth quarter of 1996 and 1997, the Company reduced the carrying value of assets and established reserves for the estimated lease liabilities associated with restaurants that were closed. During 1998, the company successfully completed sales of several of these properties to third parties or negotiated favorable lease terminations. The amount of the proceeds in excess of the carrying value of the assets and the remaining lease liabilities was approximately $2.7 million. This amount was recorded as a special charge reversal during the fourth quarter of 1998. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SPECIAL CHARGE (REVERSAL) (Continued) Fiscal 1997 - During the fourth quarter of fiscal 1997, management made the decision to close the seven restaurants in its Colorado market. The Company committed substantial resources to this market during 1997 in an attempt to reverse trends of poor sales and losses. The desired results from the implementation of the plan were not achieved and the decision to close the market was made. These seven restaurants had total sales of approximately $3.0 million and operating losses of $2.1 million during the approximately eleven months of 1997 that they were in operation. Additionally, the Company continued to experience unfavorable sales trends during 1997, concluding the year with comparable restaurant sales declining 2.9%. However, during the first six months of 1997, comparable restaurant sales declined 4.8%. This trend compelled management to continue its evaluation of the operating model of the Company. During this evaluation, management concluded that certain volumes must be achieved in order to operate individual restaurants in accordance with Company standards. These standards include food quality, cleanliness, speed of service, and profitability. Management reviewed all existing restaurants to determine which restaurants could not reasonably be expected to achieve these volume levels, generally annual revenues of at least $1 million. This led to the decision to close an additional ten restaurants. Due to the significance of the closures described above, management performed an evaluation of the recoverability of all remaining assets as described in Statement of Financial Accounting Standards No. 121 ( "SFAS 121" ), Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. Management concluded from the results of this evaluation that a significant impairment of intangible as well as long-lived assets was required to be recognized. The impairment was reflective of a market value determined to be less than the carrying value of approximately 40 restaurants, 31 of which were acquired. The assets were tested for impairment by projecting cash flows for individual restaurants based on recent results and trends specific to that restaurant. The undiscounted projected cash flows for each restaurant were compared to the carrying value for that restaurant, including allocated goodwill, where applicable. If the undiscounted cash flows were less than the carrying value, an impairment was deemed to have occurred. The amount of the impairment was determined by calculating the difference between the present value of the projected cash flows and the carrying value attributable to the specific restaurant. The cash flows were discounted using the rate of return the Company utilizes for approving new restaurant construction. Such discounted cash flows are, in management's opinion, the best estimate of the assets current value. Considerable management judgment is necessary to estimate future discounted cash flows. Accordingly, actual results could vary significantly from management's estimates. The process described above resulted in the Company's recording a special charge during the fourth quarter of 1997 of $78.7 million pre-tax, $75.7 million after- tax, or $4.94 per share. This amount had the following components: . Impairment of intangible assets of $33.1 million and impairment of long- lived assets of $22.1 million for restaurants that will continue in operation, based on the SFAS 121 analysis described above; TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. SPECIAL CHARGE (REVERSAL) (Continued) . A provision of $23.3 million for the closure of seventeen restaurants, including all of the restaurants in the Colorado market. The amount was determined in accordance with FAS 121 and was comprised of: . $13.3 million for the carrying value of the assets, net of estimated proceeds of $1.5 million for the sale of restaurant properties; . $9.0 million to record the estimated lease related obligations for closed restaurants. This amount was determined as the lesser of the present value of the monthly lease commitments, net of expected sublease receipts, or lease termination provisions; . $500,000 for severance and relocation benefits paid to employees displaced by the restaurant closures; . $500,000 for the probable settlement of a franchisee lawsuit related to the Colorado market. . The write-off of other assets totaling $200,000. During 1997, the seventeen restaurants contributed a total of $9.6 million in sales, and had operating losses totaling $2.5 million. In addition, the total amount of depreciation recorded during 1997 relating to assets which were impaired was approximately $2.5 million. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. ACCOUNTS AND NOTES RECEIVABLE Accounts and notes receivable consisted of the following: January 3, January 2, 1999 2000 Trade receivables: Royalties $ 97,000 $ 75,000 Other 365,000 505,000 Notes receivable - current portion 78,000 26,000 -------- -------- Total 540,000 606,000 Less allowance for doubtful accounts (102,000) (99,000) -------- -------- Receivables, net $438,000 $507,000 ======== ======== Notes receivable - noncurrent: Franchisees $258,000 $278,000 ======== ======== Notes receivable from franchisees approximate fair value because the underlying instruments have an interest rate that approximates current market rates. The Company's allowance for doubtful accounts is reflected as a reduction of receivables in the consolidated balance sheets. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4. PROPERTY AND EQUIPMENT, NET Property and equipment, net, consisted of the following: January 3, January 2, 1999 2000 Property and equipment: Land $20,384,000 $21,635,000 Furniture, fixtures and equipment 48,245,000 56,416,000 Leasehold improvements 13,820,000 18,272,000 Buildings 17,322,000 21,355,000 Construction in progress 920,000 616,000 ----------- ----------- 100,691,000 118,294,000 Less accumulated depreciation and amortization (31,424,000) (39,007,000) ----------- ----------- Total 69,267,000 79,287,000 ----------- ----------- Property and equipment held under capital leases: Buildings 4,401,000 4,915,000 Less accumulated amortization (1,418,000) (1,586,000) ----------- ----------- Total 2,983,000 3,329,000 ----------- ----------- Property and equipment, net $72,250,000 $82,616,000 =========== =========== At January 2, 2000, the Company had two properties held for sale. The total carrying amount of these assets is $600,000, which management estimates to be the net proceeds from the disposition of these assets. See Note 2. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. INTANGIBLE AND OTHER ASSETS Intangible and other assets consisted of the following: January 3, January 2, 1999 2000 Intangible assets: Goodwill $16,154,000 $16,154,000 Trade name 1,576,000 1,576,000 ----------- ----------- 17,730,000 17,730,000 Less accumulated amortization (7,006,000) (7,591,000) ----------- ----------- Intangible assets, net $10,724,000 $10,139,000 =========== =========== Other assets: Deposits $ 177,000 $ 184,000 Other 35,000 128,000 ----------- ----------- Other assets $ 212,000 $ 312,000 =========== =========== 6. ACCRUED LIABILITIES Accrued liabilities consisted of the following: January 3, January 2, 1999 2000 Payroll related $2,380,000 $2,807,000 Closed restaurant obligations 740,000 798,000 Property taxes 557,000 583,000 Restaurant expenses 433,000 472,000 Interest 36,000 306,000 Employee injury 271,000 297,000 Legal 168,000 157,000 Other 680,000 643,000 ---------- ---------- Total $5,265,000 $6,063,000 ========== ========== TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. LEASES Operating Leases - The Company leases restaurant facilities under non- cancelable operating leases with initial terms ranging from ten to twenty years with options to renew. The future minimum lease commitments under all non-cancelable operating lease obligations as of January 2, 2000 were as follows: Years ending: 2000 $ 7,710,000 2001 7,879,000 2002 7,671,000 2003 7,587,000 2004 7,459,000 Thereafter 34,889,000 ----------- Total $73,195,000 =========== The total rental expense for operating leases was approximately $6.6 million for 1997, $6.2 million for 1998 and $6.7 million for 1999, including additional rents of approximately $291,000, $185,000 and $215,000 for 1997, 1998 and 1999, respectively. The Company remains contingently liable on eight operating leases which were assigned to the purchasers of units previously sold or closed. Future minimum lease commitments under these contingent obligations approximate $669,000 in 2000, and a total of $2.4 million in 2001 through 2004. Thereafter, the total minimum lease payments are approximately $ 2.0 million. The Company assesses the probability of its having to assume primary liability under these assignments on an annual basis. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. LEASES (Continued) Capital Leases - The Company leases certain buildings under capital lease agreements with third parties. The leases have fifteen and twenty year terms. Future minimum lease payments under the capital leases and the net present value of the minimum lease payments at January 2, 2000 were: Years ending: 2000 $ 445,000 2001 446,000 2002 446,000 2003 439,000 2004 368,000 Thereafter 846,000 ----------- Total minimum lease payments 2,990,000 Less amount representing interest at 9% to 13% 851,000 ----------- Net present value of minimum lease payments 2,139,000 Less current portion 238,000 ----------- Long-term portion of capital leases $ 1,901,000 =========== In addition to the minimum lease payments, several of the leases have a contingent rental based on 5% to 6% of gross sales, if such amounts exceed minimum rent. No payments have been made under these agreements. Furthermore, certain leases have been guaranteed by a former employee of the Company. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. LONG-TERM DEBT Long-term debt consisted of the following notes payable: January 3, January 2, 1999 2000 Notes payable to a bank, bearing interest at the lessor of prime or LIBOR plus 2.25% (8.25% at January 2, 2000), collateralized by certain restaurant assets, due in installments of principal and interest through December 2006 $23,054,000 $35,815,000 Note payable to a bank, bearing interest at prime (8.50% at January 2, 2000), unsecured, due in monthly installments of principal and interest through April 2000 1,365,000 954,000 ----------- ----------- Total 24,419,000 36,769,000 Less current maturities 5,489,000 5,013,000 ----------- ----------- Long-term debt, net $18,930,000 $31,756,000 =========== =========== The future minimum payments of long-term debt outstanding at January 2, 2000 were as follows: Years ending: 2000 $ 5,013,000 2001 4,157,000 2002 4,519,000 2003 4,515,000 2004 11,000,000 Thereafter 7,565,000 --------------- Total $ 36,769,000 =============== The amounts stated in the Company's consolidated balance sheets for long-term debt approximate fair value because the underlying note payable balance fluctuates frequently or it is at a rate approximating current market rates. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. LINE OF CREDIT During 1999 the Company had in place two secured credit facilities totaling $40 million, including a $5 million revolving line of credit. On December 20, 1999 the credit facilities were amended and increased to a total of $50 million. As part of the amendment, the commitments were extended to December 31, 2001. Interest on funds borrowed under the facilities are charged at the prime rate or, at the Company's choice, 2.25% over the London Interbank Offered Rate (LIBOR), adjusted quarterly. The credit facilities are secured by property and equipment. The facilities contain certain covenants, including cash flow to fixed charges ratio, minimum net worth, debt to tangible net worth ratio, and intangible assets to net worth ratio requirements. During the year ended January 2, 2000, the Company was in compliance with all such covenants. At January 2, 2000, the Company had approximately $9.0 million available for cash borrowings under these credit facilities. 10.ACQUISITION AND CLOSED RESTAURANT LIABILITIES The Company establishes acquisition liabilities, as necessary, in connection with the purchase method of accounting for restaurants and other assets it acquires. Such liabilities are primarily related to leases that were at terms less favorable than market rates prevailing at the acquisition date and anticipated restaurant closure costs, if any. The liability established for leases in excess of the prevailing market were based on current market rental rates at the date of acquisition as compared to the terms of the leases acquired. This liability is being amortized as a reduction of occupancy expense over the remaining term of the applicable leases. The total amount of this reserve was $1.2 million and $1.0 million, at January 3, 1999 and January 2, 2000, respectively. During 1998 and 1999, approximately $181,000 and $170,000, respectively, of the balance was amortized in this manner. Acquisition liabilities include reserves established for the closure of certain acquired restaurants. These restaurants were anticipated to be closed at the time of acquisition. The amounts reserved were equal to the value assigned to the building and equipment acquired, less any anticipated salvage value, plus an amount estimated to terminate the lease prior to its expiration date. The total amount of this reserve was $261,000 and $175,000 at January 3, 1999 and January 2, 2000, respectively. During 1998 and 1999, approximately $1.0 million and $86,000, respectively, of this reserve was utilized in the closure of restaurants. As part of the special charge reversal recorded in 1998, the Company reversed $200,000 of this reserve. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10.ACQUISITION AND CLOSED RESTAURANT LIABILITIES (continued) In 1997, as part of the special charge, the Company reserved amounts for closed restaurant liabilities. The amounts reserved were equal to the lesser of the present value of the monthly lease commitments, net of expected sublease receipts, or lease termination provisions. These reserves were approximately $6.2 million and $5.5 million at January 3, 1999 and January 2, 2000, respectively. It is currently anticipated that payments of approximately $800,000 will be made under lease and other obligations during 2000. During 1998 and 1999, approximately $2.7 million and $754,000, respectively, of this reserve was utilized in the closure of restaurants. During 1998 and 1999, the Company received proceeds of approximately $4.3 million and $1.3 million, respectively, from the sales of closed restaurant properties. As part of the special charge reversal recorded in 1998, the Company re-evaluated lease obligations for closed restaurants and reversed approximately $2.5 million of the lease liability reserves for such restaurants. 11.EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share: Year Ended ----------------------------------------- December 28, January 3, January 2, 1997 1999 2000 Numerator for basic and diluted earnings per share - net income (loss) $(73,198,000) $13,734,000 $ 13,117,000 Denominator: Denominator for basic earnings per share - weighted-average shares 15,314,665 14,336,526 13,199,044 Effect of dilutive securities - Employee stock options - 140,067 366,806 ------------ ----------- ------------- Denominator for diluted earnings per share - adjusted weighted-average and assumed conversions 15,314,665 14,476,593 13,565,850 ============ =========== ============= Basic earnings (loss) per share $ (4.78) $ 0.96 $ 0.99 ============ =========== ============= Diluted earnings (loss) per share $ (4.78) $ 0.95 $ 0.97 ============ =========== ============= For additional disclosures regarding outstanding employee stock options, see Note 12. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12.STOCKHOLDERS' EQUITY AND STOCK OPTIONS Stock Options - The Company has stock option plans (the " Plans" ) for employees, outside directors, and advisors of the Company covering 2,750,000 shares of the Company's common stock. Options under such plans generally become exercisable ratably over a two to five year period. All options expire at the earlier of termination of employment or ten years after the date of grant. The Plans terminate in 2000 and in 2004. The Plans are administered by a committee of outside members of the Board of Directors. In addition, certain directors were awarded non-qualified stock options pursuant to the terms of separate compensation agreements. At January 2, 2000, there were no shares available for issuance. Options outstanding are as follows: Weighted Average Total Options Exercise Outstanding Price Options outstanding, December 29, 1996 1,111,500 $ 6.18 Granted 379,750 4.63 Exercised - - Expired or canceled (140,375) 8.57 --------- Options outstanding, December 28, 1997 1,350,875 $ 5.64 Granted 480,050 6.17 Exercised (201,400) 4.78 Expired or canceled (125,000) 5.24 --------- Options outstanding, January 3, 1999 1,504,525 $ 5.76 Granted 218,908 8.75 Exercised (104,575) 5.20 Expired or canceled (39,675) 7.05 --------- Options outstanding, January 2, 2000 1,579,183 $ 6.17 ========= Options exercisable, January 2, 2000 838,304 $ 5.82 ========= TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12.STOCKHOLDERS' EQUITY AND STOCK OPTIONS (Continued) For the options outstanding at January 2, 2000, the weighted average remaining life and exercise price of these outstanding options were 42 months and $6.12, respectively. In addition, the weighted average exercise price of options granted during 1999 was $8.75. SFAS No. 123, Accounting for Stock-Based Compensation, allows entities to continue to use Accounting Principles Board (" APB") Opinion No. 25, Accounting for Stock Issued to Employees. The Company has evaluated SFAS No. 123 and intends to continue following APB Opinion No. 25. The pro-forma compensation expense, net income (loss) and earnings (loss) per share which were calculated as if SFAS No. 123 had been applied are as follows: Year Ended ----------------------------------------- December 28, January 3, January 2, Pro Forma 1997 1999 2000 Compensation expense $ 555,000 $ 329,000 $ 380,000 Net income (loss) (73,548,000) 13,405,000 12,737,000 Basic earnings (loss) per share $ (4.80) $ 0.94 $ 0.96 Diluted earnings (loss) per share $ (4.80) $ 0.93 $ 0.94 The Black-Scholes option pricing model was used to determine the above pro- forma information. The calculations relied upon estimates of the volatility of the Company's stock and expected dividends, as well as determinations of a risk-free interest rate and expected life of the options. A volatility rate of 49.0% was used for options granted prior to 1994, 37.5% was used for options granted during 1994, 36.0% was used for options granted during 1995 through 1996, 34.0% was used for options granted during 1997, 33.0% was used for options granted during 1998, and 26% was used for options granted during 1999. Dividends were estimated at zero. The discount rate charged on loans to depository institutions by the Federal Reserve Bank was used as the risk- free interest rate. The discount rate was approximately 5.0% for all of 1999. The Company's options have a ten year life and vesting periods ranging from two to five years. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12.STOCKHOLDERS' EQUITY AND STOCK OPTIONS (Continued) Preferred Stock Purchase Rights - In June 1995, the Company's Board of Directors declared a distribution of one preferred stock purchase right for each share of the Company's common stock. The rights were distributed on June 20, 1995 to stockholders of record as of the close of business on that day. Each right will entitle the holder to buy 1/1000 of a share of a newly authorized Series A preferred stock at an exercise price of $37.50 per right. The rights become exercisable on the tenth day after public announcement that a person or group has acquired 15% or more of the Company's common stock. The rights may be redeemed by the Company prior to becoming exercisable by action of the Board of Directors at a redemption price of $0.01 per right. If the Company is acquired in a merger or other business combination transaction in which it is not the surviving corporation, each right will entitle its holder to purchase stock of the acquiring company having a market value of twice the exercise price. In the event that the Company is the surviving corporation, each right will entitle its holder to purchase the Company's common stock having a market value of twice the exercise price of each right. At January 2, 2000, there were 12,080,975 rights outstanding. Preferred Stock - In June 1995, in connection with its implementation of the stockholders' rights plan discussed above, the Company authorized 100,000 shares of Series A, preferred stock with a par value of $0.01 per share, which would become issuable only at such time, if ever, as the rights become exercisable. As of January 2, 2000 there were no shares outstanding. Treasury Stock - The Company's Board of Directors previously authorized the purchase in the open market of up to 4,500,000 shares of the Company's outstanding common stock. Through the first quarter of 1999, the Company had repurchased 2,585,000 shares with an aggregate cost of $13.9 million. During the first quarter, the Company retired all shares held as treasury shares. The cost of retired shares in excess of par value has been charged to additional paid in capital. Subsequent to the first quarter, the Company repurchased an additional 1,354,600 shares at an aggregate cost of $11.4 million, which as of January 2, 2000 were held as treasury stock. Subsequent to January 2, 2000, the Company purchased an additional 510,400 shares of the Company's common stock at an average price of $6.93. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13.INCOME TAXES The provision (benefit) for income taxes differs from the amount computed using statutory rates as shown below: Year Ended ------------------------------------------- December 28, January 3, January 2, 1997 1999 2000 Federal income tax at starting date $(25,410,000) $4,670,000 $ 4,460,000 State income taxes 48,000 - - Goodwill and other 4,819,000 (15,000) (339,000) Change in valuation allowance 19,006,000 (4,655,000) (4,121,000) ------------ ---------- ----------- Total $ (1,537,000) $ - $ - ============ ========== =========== The provision (benefit) for income taxes is comprised of the following: Year Ended ------------------------------------------ December 28, January 3, January 2, 1997 1999 2000 Current $ 281,000 $ - $ - Deferred (1,818,000) - - ------------ ---------- ---------- Total $ (1,537,000) $ - $ - ============ ========== ========== TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. INCOME TAXES (Continued) Deferred income taxes and benefits are provided for differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Significant deferred tax assets and liabilities are as follows: January 3, January 2, 1999 2000 Current: Deferred Federal Tax Assets: Workmen's compensation claims $ 337,000 $ 101,000 Accounts receivable 35,000 34,000 Accrued vacation 21,000 30,000 ----------- ----------- Net Current Deferred Tax Asset $ 393,000 $ 165,000 =========== =========== Noncurrent: Deferred Federal Tax Assets: Net operating loss carryforward $ 6,955,000 $ 4,672,000 General business tax credit carryforward 590,000 655,000 Closed stores and lease liabilities 1,400,000 2,435,000 Alternative minimum tax credit carryforward 1,277,000 997,000 Deferred rent 2,416,000 766,000 Other - Special charge 378,000 266,000 Charitable Contributions 51,000 149,000 Intangible Assets 1,857,000 1,591,000 Other - 159,000 ----------- ----------- Total 14,924,000 11,690,000 ----------- ----------- Deferred Federal Tax Liabilities: Fixed assets (966,000) (1,625,000) ----------- ----------- Total (966,000) (1,625,000) ----------- ----------- Net Noncurrent Deferred Tax Asset 13,958,000 10,065,000 ----------- ----------- Net Deferred Tax Asset before valuation allowance 14,351,000 10,230,000 Valuation Allowance (14,351,000) (10,230,000) ----------- ----------- Net Deferred Tax Asset $ - $ - =========== =========== TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13.INCOME TAXES (Continued) At January 2, 2000, the Company had net operating loss, alternative minimum tax and general business tax credit carry-overs of approximately $13.7 million, $997,000 and $655,000, respectively. A portion of the above carry- overs resulted from a prior acquisition; the Company was allowed to utilize the net operating loss of $5.4 million and tax credit carry-overs of $178,000 that existed at the date of acquisition. However, because of the change in ownership, the net operating loss carry-over utilization is further limited to approximately $953,000 per year, and the tax credit carry-over acquired from a prior acquisition is limited each year to the tax equivalent of any remaining portion of the net operating loss limitation. The net operating loss and tax credit carry-overs begin to expire in 2003 and 2000, respectively. The alternative minimum tax credit carry-over and the remaining general business credit carry-overs are available to offset future regular tax liabilities. The general business credit begins to expire in 2007. The alternative minimum tax credit has no expiration date. 14.LITIGATION SETTLEMENT AND LEGAL PROCEEDINGS The Company is a party to routine negligence or employment-related litigation in the ordinary course of its business. No such pending matters, individually or in the aggregate, are deemed to be material to the results of operations or financial condition of the Company. TACO CABANA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15.QUARTERLY FINANCIAL DATA (Unaudited) Quarter Ended ---------------------------------------------------- March 29, June 28, September 27, January 3, 1998 1998 1998 1999 (1) Total revenues $ 32,407,000 $36,292,000 $36,270,000 $37,981,000 Gross profit 22,615,000 25,463,000 25,168,000 26,357,000 Net income applicable to common stock 1,857,000 3,297,000 2,895,000 5,686,000 Basic earnings per share $ 0.13 $ 0.22 $ 0.20 $ 0.42 Diluted earnings per share $ 0.12 $ 0.22 $ 0.20 $ 0.41 Quarter Ended ----------------------------------------------------- April 4, July 4, October 3, January 2, 1999 1999 1999 2000 Total revenues $ 36,910,000 $41,417,000 $41,449,000 $39,824,000 Gross profit 25,983,000 28,908,000 28,910,000 28,035,000 Net income applicable to common stock 2,764,000 3,857,000 3,655,000 2,840,000 Basic earnings per share $ 0.21 $ 0.29 $ 0.27 $ 0.22 Diluted earnings per share $ 0.20 $ 0.28 $ 0.27 $ 0.22 (1) See Note 2 for discussion of the special charge reversal recorded in this quarter.