SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended June 30, 1996
Commission File Number 0-27182
THE ITALIAN OVEN, Inc.
(Exact name of registrant as specified in its charter)
Pennsylvania 25-1624305
------------------------------ ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Eleven Lloyd Avenue, Latrobe, PA 15650
------------------------------------------
(Address of principal executive offices, including zip code)
(412) 537-5380
--------------
(Registrant's telephone number, including area code)
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
------ ------
Number of shares of Common Stock, $.01 par value per share outstanding at
August 15, 1996: 4,363,991
THE ITALIAN OVEN, Inc.
Index
Page
Part I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
June 30, 1996 and December 31, 1995
Consolidated Statements of Operations
Quarter and Six Months Ended June 30, 1996 and 1995
Consolidated Statements of Cash Flows
Six Months Ended June 30, 1996 and 1995
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition
Part II OTHER INFORMATION
The Company's fiscal year is comprised of 52 or 53 weeks, divided into four
periods of 13 or 14 weeks, which ends on the last Sunday in December. For
convenience, the Company has indicated throughout this Report, including in the
financial statements, that the fiscal year end is December 31, and each of the
four periods are referred to as three-month or quarterly periods which end on
March 31, June 30, September 30 and December 31. References in this Report to
the "Company" or "The Italian Oven" mean the Company, its predecessors, and its
and their subsidiaries, unless the context otherwise requires.
THE ITALIAN OVEN, Inc.
Consolidated Balance Sheets
June 30, December 31,
1996 1995
---------- ----------
ASSETS (Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 143,828 $11,425,916
Receivables, net of allowance of
$95,000 and $85,000 respectively 465,253 844,163
Notes receivable from related parties,
net of allowance of $732,450 in 1996 -0- 442,249
Inventories 311,033 286,427
Prepaid expenses and other current assets 117,225 51,479
---------- ----------
Total current assets 1,037,339 13,050,234
PROPERTY AND EQUIPMENT:
Restaurant equipment 3,955,163 2,010,179
Building and leasehold improvements 5,591,018 2,457,274
Office furniture and equipment 1,004,140 492,896
Construction-in-progress 3,605,811 1,238,814
---------- ----------
14,156,132 6,199,163
Less-accumulated depreciation 2,673,291 1,723,444
---------- ----------
Property and equipment, net 11,482,841 4,475,719
---------- ----------
INTANGIBLE ASSETS:
Preopening costs, net 962,793 179,415
Equity in and advances to joint venture 202,707 172,597
Liquor licenses, net 157,762 53,460
Other long-term assets 80,407 25,302
Goodwill, net 1,718,294 197,731
---------- ----------
3,121,963 628,505
---------- ----------
TOTAL ASSETS $15,642,143 $18,154,458
========== ==========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
THE ITALIAN OVEN, Inc.
Consolidated Balance Sheets
June 30, December 31,
1996 1995
---------- ----------
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 57,555 $ 176,962
Notes payable -0- 423,032
Accounts payable 3,470,603 1,586,940
Deferred franchise and development revenue 1,012,577 1,264,577
Reserve for store closing 444,057 464,143
Accrued payroll and other employee benefits 778,336 360,223
Accrual for gift certificates outstanding 250,105 559,002
Other accrued expenses 634,337 450,741
---------- ----------
Total current liabilities 6,647,570 5,285,620
LONG-TERM LIABILITIES:
Deferred franchise and development revenue 1,427,000 1,715,125
Long-term debt 147,553 180,437
Other long-term liabilities 421,841 342,273
---------- ----------
Total long-term liabilities 1,996,394 2,237,835
SHAREHOLDERS' EQUITY:
Common stock, par value $.01 per share-
Authorized, 20,000,000 shares
Issued, 4,386,912 shares 43,869 43,509
Additional paid-in-capital 22,186,204 22,006,566
Warrants outstanding 1,975,000 1,975,000
Accumulated deficit (16,975,526) (13,162,704)
---------- ----------
7,229,547 10,862,371
Less-cost of common stock in treasury-
22,921 shares (231,368) (231,368)
---------- ----------
Total shareholders' equity 6,998,179 10,631,003
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $15,642,143 $18,154,458
========== ==========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
THE ITALIAN OVEN, Inc.
Consolidated Statements of Operations
(Unaudited)
Quarter Ended June 30, Six Months Ended June 30,
---------------------- -------------------------
1996 1995 1996 1995
--------- --------- --------- ---------
REVENUE:
Restaurant sales $ 4,752,965 $ 2,430,101 $ 7,848,484 $ 4,869,309
Franchise and development fees 237,000 232,832 756,125 883,832
Royalty fees 684,339 693,742 1,388,309 1,321,988
--------- --------- --------- ---------
Total revenue 5,674,304 3,356,675 9,992,918 7,075,129
COSTS AND EXPENSES
Costs of restaurant sales 1,315,957 644,767 2,132,132 1,309,897
Other restaurant expenses:
Restaurant labor expenses 1,986,545 858,023 3,321,045 1,764,159
Occupancy and other costs 1,362,289 598,241 2,135,638 1,236,646
General and administrative 2,881,737 1,486,387 4,349,618 2,996,953
Provision for employment agreements 445,000 -0- 445,000 -0-
Provision for losses on advances and loans
to related parties 732,450 -0- 732,450 -0-
Depreciation and amortization 494,242 157,005 760,945 318,998
--------- --------- --------- ---------
Total costs and expenses 9,218,220 3,744,423 13,876,828 7,626,653
--------- --------- ---------- ---------
Loss from operations (3,543,916) (387,748) (3,883,910) (551,524)
OTHER INCOME (EXPENSE):
Equity in loss of joint venture (8,525) (34,054) (28,933) (65,541)
Interest income 34,512 -0- 173,984 2,637
Interest expense (54,913) (34,840) (75,587) (66,299)
Other income (expense), net (3,478) 14,043 ( 2,885) 25,855
--------- --------- --------- ---------
Total other income (expense) (32,404) (54,851) 66,579 (103,348)
--------- --------- --------- ---------
Loss before taxes (3,567,320) (442,599) (3,817,331) (654,872)
PROVISION FOR INCOME TAXES (107,811) -0- (5,493) (375)
--------- --------- --------- ---------
Net loss (3,684,131) (442,599) (3,822,824) (655,247)
UNDECLARED DIVIDENDS ON
PREFERRED STOCK -0- (53,221) -0- (107,503)
ACCRETION OF DISCOUNT ON
PREFERRED STOCK -0- (1,139) -0- (2,279)
--------- --------- --------- ---------
NET LOSS APPLICABLE TO COMMON STOCK (3,684,131) $(496,959) $(3,822,824) $(765,029)
========= ========= ========= =========
NET LOSS PER COMMON SHARE $ (0.85) $ (0.21)* $ (0.88) $ (0.32)*
========= ========= ========= =========
SHARES USED IN COMPUTING PER SHARE
AMOUNTS 4,351,991 2,067,168* 4,339,991 2,067,166*
========= ========= ========= =========
<FN>
* 1995 per share and share amounts are computed on a pro forma basis
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
THE ITALIAN OVEN, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended June 30,
---------------------------
1996 1995
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (3,822,824) $ (655,247)
Adjustments required to reconcile net loss to
net cash used for operating activities-
Depreciation and amortization 760,945 318,998
Bad debt expense and provision for losses 742,450 -0-
Equity in loss of joint venture 28,933 65,541
----------- -----------
1,532,328 384,539
Cash provided by (used for) working capital items-
Receivables 368,910 93,843
Inventories (24,606) 46,445
Prepaid expenses and other current assets (65,746) (124,690)
Accounts payable 1,883,663 347,314
Deferred franchise and development fees (540,125) (390,832)
Accrued payroll and other employee benefits 418,113 (88,803)
Change in gift certificates outstanding (308,897) (236,180)
Other accrued expenses 183,596 115,888
Other long-term liabilities and other (83,979) 84,876
----------- -----------
Cash provided by (used for) working
capital items 1,830.929 (152,139)
----------- -----------
Net cash used for operating activities (459,567) (422,847)
CASH FLOWS FROM INVESTING ACTIVITIES:
Net acquisitions of property, equipment
and liquor licenses (6,355,159) (650,166)
Acquisition of franchise restaurants (2,534,500) -0-
Preopening costs (1,008,295) (63,427)
Advances to joint venture (59,043) (34,995)
Net increase in notes receivable from related parties (290,201) -0-
----------- -----------
Net cash used for investing activities (10,247,198) (748,588)
CASH FLOWS FROM FINANCING ACTIVITIES:
Notes payable borrowings -0- 1,721,975
Notes payable payments (423,032) (636,530)
Long-term debt payments (152,291) (147,220)
----------- -----------
Net cash (used for) provided by
financing activities (575,323) 938,225
----------- -----------
Net decrease in cash and cash equivalents (11,282,088) (233,210)
Cash and cash equivalents, beginning of period 11,425,916 349,711
----------- -----------
Cash and cash equivalents, end of period $ 143,828 $ 116,501
=========== ===========
Supplemental disclosure of cash flow information:
Interest paid $ 50,587 $ 33,408
=========== ===========
Income taxes paid $ 5,493 $ 375
=========== ===========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</FN>
THE ITALIAN OVEN, Inc.
Notes to Consolidated Financial Statements
August 19, 1996
1. Basis of Presentation
In the opinion of management, the accompanying consolidated financial
statements contain all normal recurring adjustments necessary for a
fair presentation. The results of operations for the quarter and six
months ended June 30, 1996 are not necessarily indicative of the
results to be expected for the full year.
The interim consolidated financial statements have been prepared
without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain financial information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. These
consolidated financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto for the
year ended December 31, 1995 included on Form 10-K.
2. Legal Proceedings
In July and August 1996, the Company and certain of its current and
former officers and directors and the managing underwriters for the
Company's November 1995 initial public offering of common stock were
named as defendants in three complaints (the "Class Action Suits@)
filed in the United States District Court for the Western District of
Pennsylvania by stockholders who purport to represent a class of
stockholders who purchased shares of the Company's common stock during
the Company's initial public offering or thereafter on the secondary
market, all during the period from November 21, 1995 to June 24, 1996.
The complaints allege, among other things, that the defendants caused,
or controlled persons who caused, misrepresentations concerning the
Company's business and affairs to be made in, or materially adverse
information concerning the same to be omitted from, the Company's
registration statement and prospectus in violation of the anti-fraud
provisions of the Securities Act of 1933 and the Pennsylvania
Securities Act. The plaintiffs are demanding unspecified damages plus
interest, costs and attorney's fees. The Company believes that the
allegations in the Class Action Suits are without merit and intends to
vigorously defend the action.
In April 1996, the Company, James A. Frye, a Director and formerly the
Chairman and Chief Executive Officer of the Company, and his wife,
Janice M. Frye, formerly the Vice President of Design of the Company,
were named as defendants in a complaint filed in the United States
District Court for the Western District of Pennsylvania (under the
caption Bahl v. Frye) by four shareholders of the Company, Asish Bahl,
Yashmeen Vij Bahl, Mohinder Bahl and Jerome Scherer. These shareholders
allegedly purchased 17,000 shares of the Company's common stock at $10
per share and 11,000 shares of the Company's common stock at $20 per
share from Mr. and Mrs. Frye prior to the Company's November 1995
initial public offering of Common Stock. The complaint alleges, among
other things, that the defendants violated the anti-fraud provisions of
the Securities Act of 1933, the Securities Exchange Act of 1934 and the
Pennsylvania Securities Act and made common law fraudulent
misrepresentations, all in connection with the sale to the plaintiffs
of the Company's Common Stock. The plaintiffs are demanding damages in
excess of $390,000, plus interest, costs and attorney's fees. The
Company believes that the allegations in the complaint are without
merit and intends to vigorously defend the action.
In June 1996, the Company and James A. Frye, a Director and formerly
the Chairman and Chief Executive Officer of the Company, were named as
defendants in a complaint filed in the United States District Court for
the Western District of Pennsylvania (under the caption Stein v. The
Italian Oven, Inc.) by Steven Stein and Neal Holmes. These shareholders
allegedly purchased 5,000 shares of the Company Common Stock from
unspecified shareholders at $20 per share prior to the Company's
November 1995 initial public offering of Common Stock. The complaint
alleges, among other things, that the defendants made false statements
and misrepresentations regarding the Company in violation of the
anti-fraud provisions of the Securities Exchange Act of 1934. The
plaintiffs are demanding unspecified damages plus interest, costs and
attorney's fees. The Company believes that the allegations in the
complaint are without merit and intends to vigorously defend the
action. The Company has filed a motion to dismiss the case which is
presently pending before the court.
The Company and Mr. Frye are parties to an indemnification agreement
under which Mr. Frye has agreed to indemnify the Company for claims
arising from his sale of shares of the Company's Common Stock owned by
him.
The Company maintains Directors, Officers and Corporate Liability
insurance coverage in the amount of $5 million with a deductible of
$100,000. The policy provides coverage for securities claims, including
defense costs, in excess of the deductible.
3. Acquisition
Effective April 29, 1996, the Company acquired the operating assets of
four franchised restaurants in the western Pennsylvania market. The
acquisition price was $2,534,500 in cash and 36,000 shares of the
Company's Common Stock. The acquisition was accounted for as a purchase
with the excess of the purchase price over fair market value of assets
acquired being amortized on a straight-line basis over five years. The
Company's consolidated results of operations include the operations of
the four restaurants since the acquisition date.
The following unaudited pro forma consolidated results of operations
give effect to the above acquisition as though it had occurred on
January 1, 1995.
Six Months Ended June 30,
-------------------------
1995 1996
---- ----
Total Revenue $9,320,781 $11,282,513
Net Loss (648,364) (4,021,044)
Net Loss per common share $ (0.31) $ (0.93)
The unaudited pro forma information is not necessarily indicative
either of results of operations that would have occurred had the
purchase been made on January 1, 1995, or future results of operations
of the combined companies.
Effective as of July 29, 1996, the operating assets of two of these
restaurants were sold by the Company. (See Note 5).
4. Going Concern
During the first six months of 1996, the Company has suffered losses
from operations of $3,823,000. The Company has also utilized all of the
cash proceeds from the initial public offering in November, 1995
("IPO"), and has not been able to obtain alternate sources of financing
to cover immediate and future cash needs for general operating
purposes. At June 30, 1996, the current liabilities of the Company
exceeded the current assets by $5,610,231. Also, at June 30, 1996, the
Company had $3,606,000 in construction in progress for new restaurant
sites, one of which was subsequently opened in July, 1996. No assurance
can be given that the Company will obtain sufficient capital to
complete the construction of these restaurants. The first six months of
1996 has shown a decrease in cash and cash equivalents of $11,282,000.
These factors, among others, create a substantial doubt about the
Company's ability to continue as a going concern.
Management is attempting to resolve the current shortage of operation
capital by selling certain assets, seeking alternate sources of
financing and by restructuring the corporate functions in an effort to
reduce general and administrative costs. There can be no assurance that
the Company's efforts will be sufficient to enable the Company to
continue as a going concern.
5. Subsequent Event
Effective July 29, 1996, in order to obtain cash for immediate
operating needs, the Company sold the operating assets of the Company's
Erie and Cranberry, Pennsylvania restaurants. These restaurants had
been acquired by the Company in April 1996. The assets were sold
pursuant to an Asset Purchase Agreement dated as of August 1, 1996 (the
AAsset Purchase Agreement@) to Armstrong Restaurants, L.P.
(AArmstrong@), a limited partnership affiliated with (i) a current
franchisee of the Company, The Armstrong Group of Companies, (ii) a
stockholder of the Company, Armstrong Holdings, Inc., and (iii) two of
the Company's directors, Kirby Campbell and Dru Sedwick. As a result of
the sale, the Company will record a loss from the transaction of
approximately $554,000 in the third quarter of 1996.
Under he terms of the Asset Purchase Agreement, Armstrong purchased
these restaurant assets for aggregate consideration of $970,000,
consisting of $800,000 in cash and the relinquishment of $170,000 in
prepaid franchise fees under Armstrong's northeastern Ohio franchise
development agreement. The selling price was determined on the basis of
arm's length negotiations between the parties. To assist the Company in
improving its cash position, the Asset Purchase Agreement required
Armstrong to prepay at closing $300,000 in franchise royalties for
these restaurants. The transaction was approved by the Board of
Directors at a special meeting at which Mr. Sedwick was not present and
Mr. Campbell abstained from voting due to his interest in the
transaction.
Under the terms of the Asset Purchase Agreement, Armstrong also agreed
to waive its development rights to northeastern Ohio, preserving only a
five year right of first refusal to match the terms of any development
proposed by any other persons in that territory and certain other areas
in Western Pennsylvania. Should Armstrong elect to develop a restaurant
in any of the locations included in the right of first refusal, the
Company must grant a credit or reduction of $10,000 toward the
franchise fees payable as to each restaurant which Armstrong agrees to
develop, such credit or reduction not to exceed $40,000 in the
aggregate.
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition.
Recent Developments.
The Company began to experience liquidity problems in the second quarter of
1996, following the use of all of the proceeds of the Company's initial public
offering in November, 1995 (the "IPO") principally to acquire new restaurants
and for working capital purposes. The Company was negatively impacted by weaker
than projected sales in the first six months of 1996 due, in part, to adverse
weather conditions in the first quarter.
The Company's cash position was further impacted by net amounts advanced to
James A. Frye, a Director of the Company and formerly its Chairman and Chief
Executive Officer, of $435,000 at June 24, 1996. The Board has made demand of
Mr. Frye to repay all outstanding amounts. Since that date, Mr. Frye has repaid
$103,000 but has failed to repay the balance (as of August 19, 1996) of $332,000
despite the Company's demand for repayment in full. The Company has fully
reserved for this outstanding balance.
In addition, PNC Bank, National Association terminated its credit agreement (the
"Credit Agreement") with the Company in June 1996. The Credit Agreement had
provided for a line of credit to the Company up to $2,500,000. However, the
Company had never satisfied the requirements necessary to draw funds under the
Credit Agreement, and, consequently, no funds were outstanding under the Credit
Agreement when it was terminated.
On June 24, 1996, the Board engaged Cornerstone Capital Advisors, Ltd.
("Cornerstone") as the Company's interim manager to seek to improve the
Company's liquidity. Mr. Frye relinquished the day-to-day responsibilities of
his office to Cornerstone on that date. In addition, the Company promoted
Michael Understein, formerly the Company's Senior Vice President of Operations,
to Chief Operating Officer. Subsequently, on July 10, 1996, Mr. Frye was
terminated by the Board as the Company's Chairman and Chief Executive Officer.
Thereafter, J. Garvin Warden, a principal of Cornerstone, was appointed as the
Company's Interim Chief Executive Officer.
In an effort to reduce overhead costs, in July 1996, the Company terminated (or
suspended without pay) 10 employees at its Latrobe, Pennsylvania headquarters,
representing approximately 25% of the corporate staff of the Company immediately
prior to the reductions. In addition, the Company is seeking to improve its cash
position through the development and implementation of cost reduction plans. The
Company has also entered into agreements with various landlords to defer lease
rentals until September 1996, has obtained the assurances of certain contractors
to forbear in seeking to collect amounts due for the construction of restaurant
improvements and has entered into an agreement with its principal restaurant
supplier, as described below.
On July 30, 1996, the Company reached agreement with Mid-Central Sysco Food
Services, Inc. and Deaktor/Sysco Food Services Company (collectively, "Sysco")
to continue supplying food and restaurant supplies to the Company's restaurants,
to document the terms of repayment of existing and future payables and to
collateralize these obligations. In this connection, the Company delivered its
demand promissory note to Sysco in the original principal amount of $1,088,000
(the "Sysco Note"). The Sysco Note, which bears interest at the per annum rate
of 6% (subject to an 18% default rate), provides for five daily installment
payments per week of $30,000 through December 30, 1996, with all outstanding
indebtedness due and payable on December 31, 1996. The Sysco Note evidences
existing payables and will evidence future purchases by the Company from Sysco.
The Sysco Note is collateralized by a Security Agreement dated July 30, 1996
under which the Company granted to Sysco a security interest in substantially
all of the Company's assets. The Sysco Note is further collateralized by the
Collateral Assignment of Trademarks, Copyrights and Licenses dated July 30, 1996
under which the Company collaterally assigned to Sysco substantially all of its
intellectual property, including rights to the name "The Italian Oven."
In addition, effective July 29, 1996, in order to obtain cash for immediate
operating needs, the Company sold the operating assets of the Company's Erie and
Cranberry, Pennsylvania restaurants. These restaurants had been acquired by the
Company in April 1996. The assets were sold pursuant to an Asset Purchase
Agreement dated as of August 1, 1996 (the "Asset Purchase Agreement") to
Armstrong Restaurants, L.P. ("Armstrong"), a limited partnership affiliated with
(i) a current franchisee of the Company, The Armstrong Group of Companies, (ii)
a stockholder of the Company, Armstrong Holdings, Inc., and (iii) two of the
Company's directors, Kirby Campbell and Dru Sedwick. As a result of the sale,
the Company will record a loss from the transaction of approximately $554,000 in
the third quarter of 1996.
Under the terms of the Asset Purchase Agreement, Armstrong purchased these
restaurant assets for aggregate consideration of $970,000, consisting of
$800,000 in cash and the relinquishment of $170,000 in prepaid franchise fees
under Armstrong's northeastern Ohio franchise development agreement. The selling
price was determined on the basis of arm's length negotiations between the
parties. The transaction was approved by the Board of Directors at a special
meeting at which Mr. Sedwick was not present and at which Mr. Campbell abstained
from voting due to his interest in the transaction.
The Erie and Cranberry, Pennsylvania restaurants will be operated by Armstrong
as franchised restaurants. To assist the Company in improving its cash position,
the Asset Purchase Agreement required Armstrong to prepay at closing $300,000 in
franchise royalties for these restaurants.
Under the terms of the Asset Purchase Agreement, Armstrong also agreed to waive
its development rights to northeastern Ohio, preserving only a five year right
of first refusal to match the terms of any development proposed by any other
persons in that territory and certain other areas in Western Pennsylvania.
Should Armstrong elect to develop a restaurant in any of the locations included
in the right of first refusal, the Company must grant a credit or reduction of
$10,000 toward the franchise fees payable as to each restaurant which Armstrong
agrees to develop, such credit or reduction not to exceed $40,000 in the
aggregate.
Management believes that the funds made available through the sale of these
restaurant assets to Armstrong, together with revenues from operations, will
enable the Company to meet its cash requirements through the end of 1996 so long
as (i) trade and construction creditors continue to agree to the deferral of
certain trade and construction debt (currently aggregating approximately $1
million), or (ii) the Company is successful in obtaining alternate sources of
financing. The Company has engaged Wheat, First Securities, Inc. to assist and
advise the Company in seeking to obtain suitable financing of up to $4 million
and to explore potential strategic partnerships.
No assurance can be given that the Company's creditors will continue to forbear
in demanding payment or that Wheat, First Securities, Inc. will be successful in
obtaining suitable financing or partnership opportunities. Furthermore, the
statement that the Company expects to have sufficient funds to continue in
operation through the balance of 1996 (pending the satisfaction of either of the
stated conditions) is a forward looking statement. As described in Note 4 to the
consolidated financial statements, a substantial doubt exists as to the
Company's ability to continue as a going concern. Other factors which could
prevent the Company from being able to satisfy its cash requirements for the
balance of 1996 include (but are not limited to) the following:
(i) Restaurant revenues and/or profits being lower than projected
by management for the balance of 1996 as a result of changes
in consumer tastes, adverse weather conditions (as has been
the case during the first quarter of 1996), increased
competition in the casual dining sector, adverse publicity
concerning the Company's operations (which management
believes may have had an impact on sales in the Pittsburgh
metropolitan area market), or higher restaurant operating
costs due to factors such as labor shortages or increases in
food or supply costs;
(ii) There being fewer franchised store openings than projected by
management due to the inability of developers to obtain
needed financing, or due to the decisions of developers to
delay or terminate plans to open new restaurants as a result
of their incurring losses from existing franchised
restaurants (as has been the case with certain developers
during the first six months of 1996), with the attendant loss
to the Company of royalties from franchised restaurant sales
and of the ability to recognize income from franchise fees;
or
(iii) The Company being unable to sell the number of new franchises
projected by management, with the attendant loss to the
Company of cash flow from franchise and development fees
payable prior to the opening of new restaurants.
As reported in the Company's Annual Report on Form 10-K for the year ended
December 31, 1995, the Company anticipated that it would open or acquire 20-28
restaurants with the net proceeds of the IPO and revenues from operations. The
Company will be opening or acquiring fewer restaurants than had been targeted.
During the first six months of 1996, the Company opened nine new Company-owned
restaurants, acquired the leasehold interests and operating assets of six
restaurants (three of which have been converted into The Italian Oven
restaurants, two of which are expected to be so converted subject to receipt of
necessary financing of approximately $650,000 and one of which is being held for
sale) and acquired the operating assets of four franchised restaurants currently
in operation (two of which were subsequently sold to meet the Company's
immediate cash needs (see Note 5 to the notes to the consolidated financial
statements)). One additional new Company-owned restaurant was opened in July
1996, and the Company expects to open another Company-owned restaurant in the
fourth quarter of 1996.
Results of Operations
The following table sets forth the percentage relationship of certain income
statement data to total revenues, except as otherwise indicated:
Quarter ended Six Months ended
June 30, June 30,
---------------- ----------------
1996 1995 1996 1995
----- ----- ----- -----
CONSOLIDATED STATEMENTS
OF OPERATIONS DATA:
Revenue:
Restaurant sales 83.8% 72.4% 78.5% 68.8%
Franchise and development fees 4.2% 6.9% 7.6% 12.5%
Royalty fees 12.0% 20.7% 13.9% 18.7%
----- ----- ----- -----
100.0% 100.0% 100.0% 100.0%
Costs and Expenses
Cost of restaurant sales (1) 27.7% 26.5% 27.2% 26.9%
Other restaurant expenses:
Restaurant labor expenses(1) 41.8% 35.3% 42.3% 36.2%
Occupancy and other costs(1) 28.7% 24.6% 27.2% 25.4%
General and administrative 50.8% 44.3% 43.5% 42.4%
Reserves 20.9% 0.0% 11.8% 0.0%
Depreciation and amortization 8.7% 4.7% 7.6% 4.5%
Total operating expenses 162.5% 111.6% 138.9% 107.8%
Loss from operations (62.5)% (11.5)% (38.9)% (7.8)%
Net interest income (expense) (.4)% (1.0)% 1.0% (1.0)%
Provision for income taxes (1.9)% 0.0% (.1)% 0.0%
Net loss (64.9)% (13.2)% (38.3)% (9.3)%
(1) As a percentage of restaurant sales.
Quarter Ended June 30, 1996 Compared to the Quarter Ended June 30, 1995.
Revenues. Total revenue increased by $2,318,000 to $5,674,000 or 69.0% for the
quarter ended June 30, 1996, compared to the quarter ended June 30, 1995.
Restaurant sales at Company-owned restaurants increased $2,323,000 to $4,753,000
or 95.6% for the quarter ended June 30, 1996, compared to the same period in
1995. These increases were largely the result of the addition of 14
Company-owned restaurants during 1996. Restaurant sales for same Company-owned
restaurants declined by 6.6% during the second quarter in 1996 compared to the
same quarter in 1995. Management believes that this decline is due to a number
of factors, including industry-wide declines in restaurant sales and price
increases implemented by the Company early in the second quarter of 1996.
Franchise and development fees increased by $4,000 or 1.8% for the quarter ended
June 30, 1996, compared to the quarter ended June 30, 1995. This increase was
primarily due to the opening of six franchised restaurants during the second
quarter of 1996 compared to three in the second quarter of 1995 and $65,000 in
revenues related to the termination of development agreements in 1995.
Royalties decreased by $9,000 to $684,000 or 1.4% for the quarter ended June 30,
1996, compared to the quarter ended June 30, 1995. This decrease was principally
due to same restaurant sales being down 5.9% for franchised restaurants of the
quarter ended June 30, 1996, compared to the second quarter of 1995.
Costs and expenses. Cost of restaurant sales at Company-owned restaurants
increased by $671,000 to $1,316,000 or 104.1% for the quarter ended June 30,
1996, compared to the quarter ended June 30, 1995, principally due to the
addition of fourteen Company-owned restaurants during 1996. Cost of restaurant
sales increased as a percentage of restaurant sales by 0.9% to 27.3% for the
same restaurants open during both periods due to a decrease in sales.
Labor expenses at Company-owned restaurants increased from 35.3% to 41.8% as a
percentage of restaurant sales for the quarter ended June 30, 1996, compared to
the quarter ended June 30, 1995, for the same restaurants open during both
periods. The percentage increase in labor costs is principally attributable to
lower restaurant sales for the quarter ended June 30, 1996, compared to the same
period in 1995, resulting in increased management labor costs as a percent of
restaurant sales. Occupancy and other costs at Company-owned restaurants
increased as a percentage of restaurant sales from 24.6% to 28.7% for the
quarter ended June 30, 1996, compared to the same period in 1995, principally
due to the start-up costs associated with the addition of 14 restaurants.
General and administrative. General and administrative expenses increased by
$1,395,000 to $2,882,000 or 93.9% for the quarter ended June 30, 1996, compared
to the quarter ended June 30, 1995. These increases were due primarily to the
opening of four Company-owned restaurants, the acquisition of four franchised
restaurants and the opening of six franchised restaurants during the second
quarter of 1996. During the second quarter, the Company also recorded
non-recurring charges of $100,000 related to the Class Action Suits (See Note 2
to the consolidated financial statements), non-recurring charges of $150,000 for
additional Workers Compensation accruals and charges of $483,000 for supplier
contracts the Company does not believe it can fulfill.
Provisions for losses. The Company has recorded non-recurring charges during the
quarter ended June 30, 1996 of $777,000 to reserve for employment agreements
related to three Company officers that were terminated and for advances made to
the Company's former Chairman and Chief Executive Officer.
The Company also reserved $400,000 for a loan previously made to The Italian
Oven National Advertising Fund, Inc.
Depreciation and amortization. Depreciation and amortization expenses increased
by $337,000 to $494,000 or 214.8% for the quarter ended June 30, 1996, compared
to the quarter ended June 30, 1995. This increase was primarily due to the
addition of fourteen Company-owned restaurants during 1996.
Income Taxes. During the quarter ended March 31, 1996, the Company, under the
provisions of SFAS 109 recorded a tax benefit and related deferred tax asset of
$105,000. This amount was reversed in the quarter ended June 30, 1996, when it
was determined more likely than not that the asset would not be realizable.
Six Months Ended June 30, 1996 Compared to the Six Months Ended June 30, 1995.
Revenues. Total revenue increased by $2,918,000 to $9,993,000 or 41.2% for the
six months ended June 30, 1996, compared to the six months ended June 30, 1995.
Restaurant sales at Company-owned restaurants increased $2,979,000 to $7,848,000
or 61.2% for the six months ended June 30, 1996, compared to the same period in
1995. These increases were largely the result of the addition of fourteen
Company-owned restaurants during 1996. Restaurant sales for same Company-owned
restaurants declined by 7.8% during the period in 1996 compared to the same
period in 1995. Management believes that this decline is due to a number of
factors, including adverse weather conditions in the first quarter of 1996,
industry-wide declines in restaurant sales, and price increases implemented by
the Company early in the second quarter of 1996.
Franchise and development fees decreased by $128,000 or 14.4% for the six months
quarters ended June 30, 1996, compared to the six months ended June 30, 1995.
This decrease was primarily due to the opening of seven franchised restaurant
during 1996 compared to eleven in 1995.
Royalties increased by $66,000 to $1,388,000 or 5.0% for the six months ended
June 30, 1996, compared to the six months ended June 30, 1995. This increase was
principally due to 78 franchised restaurants being in operation at the end of
the second quarter of 1996 compared to 72 franchised restaurants at the end of
the second quarter of 1995.
Costs and expenses. Cost of restaurant sales at Company-owned restaurants
increased by $822,000 to $2,132,000 or 62.8% for the six months ended June 30,
1996, compared to the six months ended June 30, 1995, principally due to the
opening of fourteen additional Company-owned restaurants during 1996, and
increased as a percentage of restaurant sales by only .3% to 27.2% for the same
restaurants open during both periods, principally due to more favorable contract
terms and volume discounts on product purchases.
Labor expenses at Company-owned restaurants increased from 36.4% to 38.8% as a
percentage of restaurant sales for the six months ended June 30, 1996, compared
to the six months ended June 30, 1995, for the same restaurants open during both
periods. Occupancy and other costs at Company-owned restaurants increased as a
percentage of restaurant sales from 25.4% to 27.2% for the six months ended June
30, 1996, compared to the same period in 1995, principally due to the start-up
costs associated with the addition of 14 restaurants.
General and administrative. General and administrative expenses increased by
$1,353,000 to $4,350,000 for the six months ended June 30, 1996, compared to the
same period in 1995. These increases were due primarily to the opening of four
Company-owned restaurants, the acquisition of four franchised restaurants and
the opening of seven franchised restaurants in 1996. The Company, in 1996, also
recorded non-recurring charges of $100,000 related to the Class Action Suits
(See Note 2 to the consolidated financial statements), non-recurring charges of
$150,000 for additional Workers Compensation accruals and charges of $483,000
for supplier contracts the Company does not believe it can fulfill.
Provisions for losses. During the six months ended June 30, 1996, the Company
has recorded non-recurring charges to reserve for employment agreements related
to three Company officers that were terminated and for advances made to the
Company's former Chairman and Chief Executive Officer.
The Company also reserved $400,000 for a loan previously made to The Italian
Oven National Advertising Fund, Inc.
Depreciation and amortization. Depreciation and amortization expenses increased
by $442,000 to $761,000 or 138.5% for the six months ended June 30, 1996,
compared to the six months ended June 30, 1995. This increase was primarily due
to the addition of fourteen Company-owned restaurants during 1996.
Interest income. Interest income increased by $171,000 for the six months ended
June 30, 1996, compared to the six months ended June 30, 1995. This increase was
due to the investment income earned on the net proceeds of the Company's IPO in
November 1995.
Liquidity and Capital Resources
The following table presents a summary of the Company's cash flows for the
periods:
Six Months ended June 30,
----------------------------
1996 1995
---- ----
Net cash used for operating activities $ (459,567) $ (422,847)
Net cash used for investing activities (10,247,198) (748,588)
Net cash (used for) provided by financing
activities (575,323) 938,225
------------ ------------
Net decrease in cash and cash equivalents $(11,282,088) $ (233,210)
============ ============
During the six months ended June 30, 1996, the Company has suffered losses from
operations of $3,823,000. The Company has also utilized all of the cash proceeds
from the IPO, and has not been able to obtain alternate sources of financing to
cover immediate and future cash needs for general operating purposes. The first
six months of 1996 have shown a decrease in cash and equivalents of
approximately $11,282,000. Also unpaid, professional bills total $300,000.
See also "Recent Developments" in this Item 2.
PART II --OTHER INFORMATION
Item 1. Legal Proceedings
In July and August 1996, the Company and certain of its current and former
officers and directors and the managing underwriters for the Company's November
1995 initial public offering of common stock were named as defendants in three
complaints (the "Class Action Suits@) filed in the United States District Court
for the Western District of Pennsylvania by stockholders who purport to
represent a class of stockholders who purchased shares of the Company's common
stock during the Company's initial public offering or thereafter on the
secondary market, all during the period from November 21, 1995 to June 24, 1996.
The complaints allege, among other things, that the defendants caused, or
controlled persons who caused, misrepresentations concerning the Company's
business and affairs to be made in, or materially adverse information concerning
the same to be omitted from, the Company's registration statement and prospectus
in violation of the anti-fraud provisions of the Securities Act of 1933 and the
Pennsylvania Securities Act. The plaintiffs are demanding unspecified damages
plus interest, costs and attorney's fees. The Company believes that the
allegations in the Class Action Suits are without merit and intends to
vigorously defend the action.
In April 1996, the Company, James A. Frye, a Director and formerly the Chairman
and Chief Executive Officer of the Company, and his wife, Janice M. Frye,
formerly the Vice President of Design of the Company, were named as defendants
in a complaint filed in the United States District Court for the Western
District of Pennsylvania (under the caption Bahl v. Frye) by four shareholders
of the Company, Asish Bahl, Yashmeen Vij Bahl, Mohinder Bahl and Jerome Scherer.
These shareholders allegedly purchased 17,000 shares of the Company's common
stock at $10 per share and 11,000 shares of the Company's common stock at $20
per share from Mr. and Mrs. Frye prior to the Company's November 1995 initial
public offering of Common Stock. The complaint alleges, among other things, that
the defendants violated the anti-fraud provisions of the Securities Act of 1933,
the Securities Exchange Act of 1934 and the Pennsylvania Securities Act and made
common law fraudulent misrepresentations, all in connection with the sale to the
plaintiffs of the Company's Common Stock. The plaintiffs are demanding damages
in excess of $390,000, plus interest, costs and attorney's fees. The Company
believes that the allegations in the complaint are without merit and intends to
vigorously defend the action.
In June 1996, the Company and James A. Frye, a Director and formerly the
Chairman and Chief Executive Officer of the Company, were named as defendants in
a complaint filed in the United States District Court for the Western District
of Pennsylvania (under the caption Stein v. The Italian Oven, Inc.) by Steven
Stein and Neal Holmes. These shareholders allegedly purchased 5,000 shares of
the Company Common Stock from an unspecified shareholders at $20 per share prior
to the Company's November 1995 initial public offering of Common Stock. The
complaint alleges, among other things, that the defendants made false statements
and misrepresentations regarding the Company in violation of the anti-fraud
provisions of the Securities Exchange Act of 1934. The plaintiffs are demanding
unspecified damages plus interest, costs and attorney's fees. The Company
believes that the allegations in the complaint are without merit and intends to
vigorously defend the action. The Company has filed a motion to dismiss the case
which is presently pending before the court.
The Company and Mr. Frye are parties to an indemnification agreement under which
Mr. Frye has agreed to indemnify the Company for claims arising from his sale of
shares of the Company's Common Stock owned by him, as is the case in the Bahl
action.
The Company maintains Directors, Officers and Corporate Liability insurance
coverage in the amount of $5 million with a deductible of $100,000. The policy
provides coverage for securities claims, including defense costs, in excess of
the deductible.
The Company is a party to routine contract, negligence and employment-related
litigation matters in the ordinary course of its business. No such pending
matters, individually or in the aggregate, if adversely determined, are believed
by management to be material to the business, results of operations or financial
condition of the Company.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Asset Purchase Agreement dated as of August 1, 1996 by and
between the Company and Armstrong Restaurants, L.P. (included
as an exhibit to the Current Report on Form 8-K of the
Company dated August 16, 1996 and incorporated by reference
herein).
10.2 Demand Note dated July 30, 1996 from the Company to
Deaktor/Sysco Food Services Company and Mid-Central Sysco
Food Services, Inc. (collectively, "Sysco") in the original
principal amount of $1,088,000.
10.3 Security Agreement dated July 30, 1996 from the Company in
favor of Sysco.
10.4 Collateral Assignment of Trademarks, Copyrights and Licenses
dated July 30, 1996 from the Company in favor of Sysco.
10.5 Engagement letter dated June 21, 1996 between the Company and
Cornerstone Capital Advisors, Ltd.
10.6 Employment Agreement dated June 21,1996 between the Company
and Michael Understein.
11.1 Calculation of Net Loss Per Common Share.
99.1 Complaint captioned Smitzer v. The Italian Oven, Inc., et al.
filed July 2, 1996 in the U.S. District Court for the Western
District of Pennsylvania, Civil Action No. 961248.
(b) Reports on Form 8-K
During the quarter ended June 30, 1996, the Company filed a Current Report on
Form 8-K dated May 9, 1996 and Amendment No. 1 to Current Report on Form 8-K/A
dated May 16, 1996, each of which related to the Company's acquisition of the
operating assets of four franchised restaurants in Western Pennsylvania.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THE ITALIAN OVEN, Inc.
By: /s/ Gary L. Steib
____________________________
Dated: August 19, 1996 Gary L. Steib
Vice President of Finance,
Chief Financial Officer
and Treasurer