SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
(Amendment No. 1)
(Mark One)
(X) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the quarterly period ended August 1, 2004
OR
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the transition period from ______________ to ____________________
Commission file number 0-23420
QUALITY DINING, INC.
(Exact name of registrant as specified in its charter)
Indiana 35-1804902
----------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4220 Edison Lakes Parkway, Mishawaka, Indiana 46545
---------------------------------------------------
(Address of principal executive offices and zip code)
(574) 271-4600
--------------
(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 ( )
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes ( ) No (X)
The number of shares of the registrant's common stock outstanding as of
September 10, 2004 was 11,596,781.
Page 1
Explanatory Note
This Quarterly Report on Form 10-Q/A is being filed to revise the financial
statements for the twelve and forty weeks ended August 1, 2004 and August 3,
2003 contained in Part I, Item 1 hereof to correct an error in the allocation of
tax expense (benefit) between continuing operations and discontinued operations.
This change did not affect the Company's reported financial position or net
income but did affect the Company's income tax provision, net income (loss) from
continuing operations and net income (loss) from discontinued operations for the
twelve and forty weeks ended August 1, 2004 and August 3, 2003. The change also
affected the allocation of basic and diluted net income per share between
continuing operations and discontinued operations for the twelve and forty weeks
ended August 1, 2004 and August 3, 2003.
Accordingly, the Company has revised its financial statements for the twelve and
forty weeks ended August 1, 2004 and August 3, 2003 and is filing this Amendment
No. 1 to Form 10-Q to reflect the proper income tax provision, income (loss)
from continuing operations, income (loss) from discontinued operations, basic
and diluted net income per share from continuing operations and basic and
diluted net income per share from discontinued operations. This Quarterly Report
on Form 10-Q/A amends and restates Item 1 of Part I, Item 2 of Part I and Item 4
of Part I of the original Quarterly Report on Form 10-Q. All other Items in Part
I and Part II are included in their entirety. Other than the changes to reflect
the adjustments, the Company has not updated the information contained herein to
reflect events and transactions occurring subsequent to the date of the Form
10-Q filing on September 15, 2004. All information contained in this amended
report is subject to updating and supplementing as provided in the Company's
reports filed with the Securities and Exchange Commission subsequent to the date
of the original Form 10-Q filing date.
Page 2
QUALITY DINING, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED AUGUST 1, 2004
INDEX
Page
----
PART I - Financial Information
Item 1. Consolidated Financial Statements (Unaudited):
Consolidated Statements of Operations 4
Consolidated Balance Sheets 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 21
Item 3. Quantitative and Qualitative Disclosures About Market
Risk 33
Item 4. Controls and Procedures 33
Part II - Other Information
Item 1. Legal Proceedings 34
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds 34
Item 3. Defaults upon Senior Securities 34
Item 4. Submission of Matters to a Vote of Security Holders 34
Item 5. Other Information 34
Item 6. Exhibits 34
Signatures 35
Page 3
PART I. FINANCIAL INFORMATION
ITEM 1. - CONSOLIDATED FINANCIAL STATEMENTS
QUALITY DINING, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Twelve Weeks Ended Forty Weeks Ended
August 1, August 3, August 1, August 3,
2004 2003 2004 2003
----------- ----------- ----------- ------------
As Restated As Restated As Restated As Restated
(See Note 1A) (See Note 1A)
Revenues:
Burger King $ 31,561 $ 27,851 $ 90,446 $ 87,244
Chili's Grill & Bar 20,634 19,028 65,787 61,160
Italian Dining Division 3,581 3,864 12,473 13,671
Grady's American Grill 1,163 1,288 4,523 4,789
--------- --------- --------- ---------
Total revenues 56,939 52,031 173,229 166,864
--------- --------- --------- ---------
Operating expenses:
Restaurant operating expenses:
Food and beverage 16,011 13,893 47,867 44,742
Payroll and benefits 16,237 15,138 50,132 48,768
Depreciation and amortization 2,153 2,260 7,119 7,620
Other operating expenses 14,560 13,651 44,977 43,729
--------- --------- --------- ---------
Total restaurant operating expenses 48,961 44,942 150,095 144,859
--------- --------- --------- ---------
Income from restaurant operations 7,978 7,089 23,134 22,005
General and administrative 3,675 3,861 12,354 12,841
Amortization of intangibles 25 100 144 302
--------- --------- --------- ---------
Operating income 4,278 3,128 10,636 8,862
--------- --------- --------- ---------
Other income (expense):
Recovery of note receivable -- -- -- 3,459
Interest expense (1,462) (1,561) (4,985) (5,554)
Loss on sale of property
and equipment (26) (24) (101) (32)
Minority interest in earnings (618) (604) (1,672) (1,974)
Stock purchase expense -- (1,294) -- (1,294)
Other income, net 15 125 165 872
--------- --------- --------- ---------
Total other income (expense), net (2,091) (3,358) (6,593) (4,523)
--------- --------- --------- ---------
Income (loss) from continuing
operations before income taxes 2,187 (230) 4,043 4,339
Income tax provision 795 489 1,654 2,282
--------- --------- --------- ---------
Income (loss) from continuing
operations 1,392 (719) 2,389 2,057
Income (loss) from discontinued
operations, net of taxes (156) 586 (620) (2,290)
--------- --------- --------- ---------
Net income (loss) $ 1,236 $ (133) $ 1,769 $ (233)
========= ========= ========= =========
Basic net income (loss) per share:
Continuing operations 0.14 (0.07) 0.23 0.18
Discontinued operations (0.02) 0.06 (0.06) (0.20)
--------- --------- --------- ---------
Basic net income (loss) per share $ 0.12 $ (0.01) $ 0.17 $ (0.02)
========= ========= ========= =========
Diluted net income (loss) per share:
Continuing operations 0.14 (0.07) 0.23 0.18
Discontinued operations (0.02) 0.06 (0.06) (0.20)
--------- --------- --------- ---------
Diluted net income (loss) per share $ 0.12 $ (0.01) $ 0.17 $ (0.02)
========= ========= ========= =========
Weighted average shares outstanding:
Basic 10,163 10,805 10,163 11,142
========= ========= ========= =========
Diluted 10,212 10,805 10,212 11,156
========= ========= ========= =========
See Notes to Consolidated Financial Statements.
Page 4
QUALITY DINING, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
August 1, October 26,
2004 2003
--------- ----------
ASSETS
Current assets:
Cash and cash equivalents $ 1,692 $ 1,724
Accounts receivable 1,816 1,723
Inventories 1,838 1,670
Deferred income taxes 2,706 2,251
Assets held for sale 9 10,737
Other current assets 1,553 2,192
--------- ---------
Total current assets 9,614 20,297
--------- ---------
Property and equipment, net 110,997 107,910
--------- ---------
Other assets:
Deferred income taxes 5,631 6,749
Trademarks, net 470 1,285
Franchise fees and development fees, net 8,429 8,801
Goodwill 7,960 7,960
Liquor licenses, net 2,839 2,820
Other 3,551 3,454
--------- ---------
Total other assets 28,880 31,069
--------- ---------
Total assets $ 149,491 $ 159,276
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 9,181 $ 10,055
Accounts payable 4,756 6,182
Accrued liabilities 22,623 19,520
--------- ---------
Total current liabilities 36,560 35,757
Long-term debt 73,512 85,335
--------- ---------
Total liabilities 110,072 121,092
--------- ---------
Minority interest 13,656 14,272
Stockholders' equity:
Preferred stock, without par value:
5,000,000 shares authorized; none issued - -
Common stock, without par value: 50,000,000
shares authorized; 12,955,781 shares issued 28 28
Additional paid-in capital 237,402 237,402
Accumulated deficit (204,745) (206,514)
Unearned compensation (493) (575)
--------- ---------
32,192 30,341
Treasury stock, at cost, 2,508,587 shares (6,429) (6,429)
--------- ---------
Total stockholders' equity 25,763 23,912
--------- ---------
Total liabilities and stockholders' equity $ 149,491 $ 159,276
========= =========
See Notes to Consolidated Financial Statements.
Page 5
QUALITY DINING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
Forty Weeks Ended
August 1, August 3,
2004 2003
As Restated As Restated
----------- -----------
Cash flows from operating activities:
Net income (loss) $ 1,769 $ (233)
Loss from discontinued operations 620 2,290
Minority interest in earnings 1,672 1,974
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization of
property and equipment 6,752 7,370
Amortization of other assets 1,092 1,219
Loss on sale of property and equipment 101 32
Deferred income taxes 663 -
Amortization of unearned compensation 82 71
Changes in current assets and current liabilities:
Net decrease (increase) in current assets 378 356
Net increase (decrease) in current liabilities 903 (3,398)
-------- --------
Net cash provided by operating activities 14,032 9,681
-------- --------
Cash flows from investing activities:
Purchase of property and equipment (7,359) (7,841)
Proceeds from the sales of property and equipment 8,637 3,665
Purchase of other assets (727) (501)
Other 35 265
-------- --------
Net cash provided by (used) for investing activities 586 (4,412)
-------- --------
Cash flows from financing activities:
Purchase of treasury stock - (2,806)
Borrowings of long-term debt 41,555 42,435
Repayment of long-term debt (54,252) (43,567)
Cash distributions to minority interest
in consolidated partnerships (2,288) (3,719)
-------- --------
Net cash used by financing activities (14,985) (7,657)
-------- --------
Cash provided by discontinued operations 335 2,302
-------- --------
Net decrease in cash and cash equivalents (32) (86)
Cash and cash equivalents, beginning of period 1,724 1,174
-------- --------
Cash and cash equivalents, end of period $ 1,692 $ 1,088
======== ========
See Notes to Consolidated Financial Statements.
Page 6
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
Note 1: Description of Business.
Quality Dining, Inc. (the "Company") operates four distinct restaurant concepts.
It owns the Grady's American Grill(R) and two Italian Dining concepts and
operates Burger King(R) restaurants and Chili's Grill & Bar(R) ("Chili's") as a
franchisee of Burger King Corporation and Brinker International, Inc.
("Brinker"), respectively. The Company operates its Italian Dining restaurants
under the tradenames of Spageddies Italian Kitchen(R) ("Spageddies"(R)) and Papa
Vino's(TM) Italian Kitchen ("Papa Vino's"). The Company operates one of its
Grady's American Grill(R) restaurants under the tradename Porterhouse Steaks and
Seafood(TM) and one under the tradename Regas Grill(R). As of August 1, 2004,
the Company operated 179 restaurants, including 123 Burger Kings, 39 Chili's
Grill & Bar restaurants, six Grady's American Grill restaurants, six Papa
Vino's, three Spageddies, one Regas Grill(R) and one Porterhouse Steaks and
Seafood(TM) restaurant.
Note 1A: Restatement of Tax Expense (Benefit)
This Quarterly Report on Form 10-Q/A is being filed to revise the financial
statements for the twelve and forty weeks ended August 1, 2004 and August 3,
2003 contained in Part I, Item 1 hereof to correct an error in the allocation of
tax expense (benefit) between continuing operations and discontinued operations
related to the closure or sale of certain Grady's American Grill restaurants in
fiscal 2004 as discussed in Note 3. This change did not affect the Company's
reported financial position or net income but did affect the Company's income
tax provision, net income (loss) from continuing operations and net income
(loss) from discontinued operations for the twelve and forty weeks ended August
1, 2004 and August 3, 2003. The change also affected the allocation of basic and
diluted net income per share between continuing operations and discontinued
operations for the twelve and forty weeks ended August 1, 2004 and August 3,
2003.
Accordingly, the Company has revised its financial statements for the twelve and
forty weeks ended August 1, 2004 and August 3, 2003 and is filing this Amendment
No. 1 to Form 10-Q to reflect the proper income tax provision, income (loss)
from continuing operations, income (loss) from discontinued operations, basic
and diluted net income per share from continuing operations and basic and
diluted net income per share from discontinued operations. This Quarterly Report
on Form 10-Q/A amends and restates Item 1 of Part I, Item 2 of Part I and Item 4
of Part I of the original Quarterly Report on Form 10-Q. All other Items in Part
I and Part II are included in their entirety. Other than the changes to reflect
the adjustments the Company has not updated the information contained herein to
reflect events and transactions occurring subsequent to the date of the Form
10-Q filing on September 15, 2004. All information contained in this amended
report is subject to updating and supplementing as provided in the Company's
reports filed with the Securities and Exchange Commission subsequent to the date
of the original Form 10-Q filing date.
Page 7
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
The changes are as follows:
The twelve and forty weeks August 1, 2004
Twelve Weeks Ended Forty Weeks Ended
As restated As Previously As restated As Previously
Reported Reported
----------- ------------- ----------- -------------
Income from continuing operations
before income taxes 2,187 2,187 4,043 4,043
Income tax provision 795 784 1,654 1,343
--------- --------- --------- ---------
Income from continuing operations 1,392 1,403 2,389 2,700
Loss from discontinued operations (156) (167) (620) (931)
--------- --------- --------- ---------
Net income (loss) $ 1,236 $ 1,236 $ 1,769 $ 1,769
========= ========= ========= =========
Basic net income (loss) per share:
Continuing operations 0.14 0.14 0.23 0.26
Discontinued operations (0.02) (0.02) (.06) (0.09)
--------- --------- --------- ---------
Basic net income (loss) per share $ 0.12 $ 0.12 $ 0.17 $ 0.17
========= ========= ========= =========
Diluted net income (loss) per share:
Continuing operations 0.14 0.14 0.23 0.26
Discontinued operations (0.02) (0.02) (0.06) (0.09)
--------- --------- --------- ---------
Diluted net income (loss) per share $ 0.12 $ 0.12 $ 0.17 $ 0.17
========= ========= ========= =========
The twelve and forty weeks ended August 3, 2003
Twelve Weeks Ended Forty Weeks Ended
As restated As Previously As restated As Previously
Reported Reported
----------- ------------- ----------- -------------
Income (loss)from continuing
Operations before income taxes (230) (230) 4,339 4,339
Income tax provision 489 181 2,282 777
------- ------- -------- --------
Income (loss) from continuing
operations (719) (411) 2,057 3,562
Income (loss) from discontinued
operations 586 278 (2,290) (3,795)
------- ------- -------- --------
Net income (loss) $ (133) $ (133) $ (233) $ (233)
======= ======= ======== ========
Basic net income (loss) per share:
Continuing operations (0.07) (0.04) 0.18 0.32
Discontinued operations 0.06 0.03 (.20) (0.34)
------- ------- -------- --------
Basic net income (loss) per share $ (0.01) $ (0.01) $ (0.02) $ (0.02)
======= ======= ======== ========
Diluted net income (loss) per share:
Continuing operations (0.07) (0.04) 0.18 0.32
Discontinued operations 0.06 0.03 (0.20) (0.34)
------- ------- -------- --------
Diluted net income (loss) per share $ (0.01) $ (0.01) $ (0.02) $ (0.02)
======= ======= ======== ========
Page 8
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
Note 2: Summary of Significant Accounting Policies.
Basis of Presentation
During the first quarter of 2004, the Company adopted FASB Interpretation No.
46, "Consolidation of Variable Interest Entities", as revised by the FASB in
December 2003 (FIN 46R). As a result of the adoption of this Interpretation, the
Company changed its consolidation policy whereby the accompanying consolidated
financial statements now include the accounts of Quality Dining, Inc., its
wholly owned subsidiaries, and certain related party affiliates that are
variable interest entities. Previously, the consolidated financial statements
included only the accounts of Quality Dining, Inc. and its wholly owned
subsidiaries. Prior periods have been restated to reflect this change.
The Company determined that certain affiliated real estate partnerships from
which the Company leases 42 of its Burger King restaurants and that are
substantially owned by certain directors, officers, and stockholders of the
Company meet the definition of variable interest entities as defined in FIN 46R
("VIE's"). Furthermore, the Company has determined that it is the primary
beneficiary of these VIE's, based on the criteria in FIN 46R. The Company holds
no direct ownership or voting interest in the VIE's. Additionally, the creditors
and beneficial interest holders of the VIE's have no recourse to the general
credit of the Company.
The assets of the VIE's, which consist primarily of property and equipment,
totaled $17,919,000 and $18,599,000 at August 1, 2004 and October 26, 2003,
respectively. The liabilities of the VIE's, which consist primarily of bank
debt, totaled $7,268,000 and $7,493,000 at August 1, 2004 and October 26, 2003,
respectively. Certain of the assets of the VIE's serve as collateral for the
debt obligations. Because certain of these assets were previously recorded as
capital leases by the Company, with a resulting lease obligation, the
consolidation of the VIE's served to increase total assets as reported by the
Company by $13,477,000 and $13,869,000 and total liabilities by $3,921,000 and
$3,697,000 at August 1, 2004 and October 26, 2003, respectively. Additionally,
the consolidation of the VIE's increased treasury stock by $2,806,000 at August
1, 2004 and October 26, 2003, as one of the VIE's owns common stock of the
Company. The change had no impact on reported net income for the forty weeks
ended August 1, 2004 and August 3, 2003. However, the change did decrease
weighted average shares outstanding, basic and diluted, for the twelve and forty
weeks ending August 1, 2004 and August 3, 2003, because one of the VIE's
purchased 1,148,014 shares of the Company's common stock on June 27, 2003.
Page 9
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
The following table presents the effect of the consolidation of the VIE's on
depreciation and amortization expense, other operating expenses, general and
administrative expense, interest expense, other income (expense) and weighted
average shares for the twelve weeks and forty weeks ended August 1, 2004 and
August 3, 2003:
(In thousands) 12-Weeks Ended 40-Weeks Ended
---------------------- ----------------------
August 1, August 3, August 1, August 3,
2004 2003 2004 2003
-------- -------- -------- --------
Depreciation and amortization expense $ 2,124 $ 2,229 $ 7,027 $ 7,513
Change in consolidation policy 29 31 92 107
-------- -------- -------- --------
Consolidated depreciation and
amortization $ 2,153 $ 2,260 $ 7,119 $ 7,620
======== ======== ======== ========
Other operating expenses $ 15,174 $ 14,230 $ 46,879 $ 45,544
Change in consolidation policy (614) (579) (1,902) (1,815)
-------- -------- -------- --------
Consolidated other operating expenses $ 14,560 $ 13,651 $ 44,977 $ 43,729
======== ======== ======== ========
General and administrative expenses $ 3,656 $ 3,837 $ 12,316 $ 12,774
Change in consolidation policy 19 24 38 67
-------- -------- -------- --------
Consolidated general and administrative
expenses $ 3,675 $ 3,861 $ 12,354 $ 12,841
======== ======== ======== ========
Interest expense $ 1,514 $ 1,641 $ 5,160 $ 5,847
Change in consolidation policy (52) (80) (175) (293)
-------- -------- -------- --------
Consolidated interest expense $ 1,462 $ 1,561 $ 4,985 $ 5,554
======== ======== ======== ========
Other income, net $ 15 $ 125 $ 440 $ 832
Change in consolidation policy - - (275) 40
-------- -------- -------- --------
Consolidated other income, net $ 15 $ 125 $ 165 $ 872
======== ======== ======== ========
Basic net income (loss) per share $ 0.11 $ (0.01) $ 0.16 $ (0.02)
Change in consolidation policy .01 - 0.01 -
-------- -------- -------- --------
Consolidated basic net income (loss)
per share $ 0.12 $ (0.01) $ 0.17 $ (0.02)
======== ======== ======== ========
Diluted net income (loss) per share $ 0.11 $ (0.01) $ 0.16 $ (0.02)
Change in consolidation policy 0.01 - 0.01 -
-------- -------- -------- --------
Consolidated diluted net income (loss)
per share $ 0.12 $ (0.01) $ 0.17 $ (0.02)
======== ======== ======== ========
Page 10
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
(In thousands) 12-Weeks Ended 40-Weeks Ended
----------------- -----------------
Weighted average shares outstanding:
Basic 11,311 11,311 11,311 11,311
Change in consolidation policy (1,148) (506) (1,148) (169)
------ ------ ------ ------
Consolidated basic 10,163 10,805 10,163 11,142
====== ====== ====== ======
Diluted 11,360 11,311 11,360 11,325
Change in consolidation policy (1,148) (506) (1,148) (169)
------ ------ ------ ------
Consolidated diluted 10,212 10,805 10,212 11,156
====== ====== ====== ======
All significant intercompany balances and transactions have been eliminated.
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X promulgated by the
Securities and Exchange Commission. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for annual financial statement reporting purposes. In the opinion of management,
all adjustments, consisting only of normal recurring accruals, considered
necessary for a fair presentation have been included. Operating results for the
40-week period ended August 1, 2004 are not necessarily indicative of the
results that may be expected for the 53-week year ending October 31, 2004.
These financial statements should be read in conjunction with the Company's
audited financial statements for the fiscal year ended October 26, 2003 included
in the Company's Annual Report on Form 10-K filed with the Securities and
Exchange Commission.
As a result of the adoption of Statement of Financial Accounting Standard
("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", the Company has classified the revenues, expenses and related assets
and liabilities of four Grady's American Grill restaurants that were sold in
fiscal 2003, one Grady's American Grill restaurant that was sold and one that
was closed in fiscal 2004, six Grady's American Grill restaurants that the
Company sold and leased back in fiscal 2004 and one Grady's American Grill
restaurant that was held for sale at the end of the third quarter of fiscal
2004, as discontinued operations in the accompanying consolidated financial
statements.
Intangible Assets
Franchise Fees and Development Fees - The Company's Burger King and Chili's
franchise agreements require the payment of a franchise fee for each restaurant
opened. Franchise fees are deferred and amortized on the straight-line method
over the lives of the respective franchise agreements. Development fees paid to
Brinker were deferred and expensed in the period the related restaurants were
opened. Franchise fees are being amortized on a straight-line basis, generally
over 20 years.
Page 11
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
Trademarks - The Company owns the trademarks for its Grady's American Grill,
Spageddies Italian Kitchen, Papa Vino's Italian Kitchen, Regas Grill and
Porterhouse Steaks and Seafood. During the second quarter of fiscal 2003 the
Company recorded an impairment charge of $4,411,000, consisting of a reduction
in the net book value of the Grady's American Grill trademark of $2,882,000 and
in the net book value of certain fixed assets of $1,529,000. The net book value
of the Grady's American Grill trademark was $392,000 as of August 1, 2004.
During the second quarter of fiscal 2003 the Company reviewed the useful life of
the Grady's American Grill trademark and determined that the remaining useful
life should be reduced from 15 years to five years. In determining the fair
value of the impaired assets, the Company relied primarily on the discounted
cash flow analyses that incorporated an investment horizon of five years and
utilized a risk adjusted discount factor.
Below are the gross carrying amount and accumulated amortization of the
trademarks, franchise fees and development fees as of August 1, 2004 and October
26, 2003.
Amortized Intangible Assets
(Dollars in thousands) As of August 1, 2004
--------------------------------------
Gross Carrying Accumulated Net
Amount Amortization Book
Value
-------------- ------------ --------
Amortized intangible assets:
Trademarks $ 2,050 $(1,580) $ 470
Franchise fees and development fees 14,988 (6,559) 8,429
------- ------- -------
Total $17,038 $(8,139) $ 8,899
======= ======= =======
As of October 26, 2003
--------------------------------------
Gross Carrying Accumulated Net
Amount Amortization Book
Value
-------------- ------------ -------
Amortized intangible assets:
Trademarks $ 2,961 $(1,676) $ 1,285
Franchise fees and development fees 14,782 (5,981) 8,801
------- ------- -------
Total $17,743 $(7,657) $10,086
======= ======= =======
The Company's intangible asset amortization expense for the forty-week period
ended August 1, 2004 was $721,000 compared to $841,000 for the comparable period
in fiscal 2003. The estimated annual intangible amortization expense for each of
the next five years is as follows:
Year one $ 872,000
Year two $ 872,000
Year three $ 872,000
Year four $ 848,000
Year five $ 768,000
Page 12
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
Goodwill - The Company operates four distinct restaurant concepts in the
food-service industry. It owns the Grady's American Grill and two Italian Dining
concepts and operates Burger King restaurants and Chili's Grill & Bar
restaurants as a franchisee of Burger King Corporation and Brinker
International, Inc., respectively. The Company has identified each restaurant
concept as an operating segment based on management structure and internal
reporting. The Company has two operating segments with goodwill - Chili's Grill
& Bar and Burger King. The Company had a total of $7,960,000 in goodwill as of
August 1, 2004 and October 26, 2003. The Chili's Grill and Bar operating segment
had $6,902,000 of goodwill and the Burger King operating segment had $1,058,000
of goodwill.
Stock Options
The Company accounts for all of its stock-based compensation awards in
accordance with APB Opinion No. 25 which requires compensation cost to be
recognized based on the excess, if any, between the quoted market price of the
stock at the date of grant and the amount an employee must pay to acquire the
stock. Under this method, no compensation cost has been recognized for stock
option awards.
Had compensation cost for the Company's stock-based compensation plans been
determined based on the fair value method as prescribed by SFAS 123, the
Company's net earnings (loss) and net earnings (loss) per share would have been
the pro forma amounts indicated below:
Twelve Forty
Weeks Ended Weeks Ended
August 1, August 3, August 1, August 3,
2004 2003 2004 2003
------- ------- ------- -------
(In thousands, except per share amounts)
Net income (loss), as reported $ 1,236 $ (133) $ 1,769 $ (233)
Deduct: Total stock option based employee
compensation expense determined by using
the Black-Scholes option pricing model,
net of related tax effects (7) (8) (23) (28)
------- ------- ------- -------
Net income (loss), pro forma $ 1,229 $ (141) $ 1,746 $ (261)
======= ======= ======= =======
Basic and diluted net income (loss)
per common share, as reported $ 0.12 $ (0.01) $ 0.17 $ (0.02)
======= ======= ======= =======
Basic and diluted net income (loss)
per common share, pro forma $ 0.12 $ (0.01) $ 0.17 $ (0.02)
======= ======= ======= =======
Page 13
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
Note 3: Acquisitions and Dispositions.
During the first forty weeks of fiscal 2004, the Company received net proceeds
of $8,628,000 from the sale of seven Grady's American Grill restaurants. The
Company recorded a loss in discontinued operations of $981,000 related to the
closure and disposal of Grady's restaurants during the first forty weeks of
fiscal 2004. Six of the restaurants sold were sale-leaseback transactions. In
each of the six sale-leaseback transactions, the Company's lease obligations
extend for less than one year.
The Company purchased the operating assets and franchise rights of five existing
Burger King restaurants from a Burger King franchisee in the third quarter of
fiscal 2004 for $1,150,000. The results of operations for these Burger King
restaurants have been included in the consolidated financial statements since
June 16, 2004.
During the first forty weeks of fiscal 2003, the Company sold three Grady's
American Grill restaurants for net proceeds of $3,041,000. The Company recorded
a $4,354,000 loss in discontinued operations related to these sales and
impairments in the first forty weeks of fiscal 2003.
As discussed in Note 2, discontinued operations includes the revenues and
expenses of the four Grady's American Grill restaurants that were sold in fiscal
2003, the seven restaurants sold and one restaurant closed in the first forty
weeks of fiscal 2004 and the one restaurant that was being held for sale as of
August 1, 2004. The decision to dispose of the locations reflects the Company's
ongoing process of evaluating the performance of the Grady's American Grill
restaurants and using the proceeds from dispositions to reduce debt. Assets held
for sale includes restaurant equipment totaling $9,000 as of August 1, 2004.
Page 14
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
Net income (loss) from discontinued operations for the periods ended August 1,
2004, and August 3, 2003 were made up of the following components:
Twelve Forty
Weeks Ended Weeks Ended
August 1, August 3, August 1, August 3,
2004 2003 2004 2003
----------- ----------- ----------- -----------
As Restated As Restated As Restated As Restated
(See Note 1A) (See Note 1A)
(In thousands, except per share amounts)
Revenue discontinued operations $ 1,460 $ 3,084 $ 7,239 $ 13,570
Income (loss) discontinued restaurant
operations (63) 62 77 591
Asset impairment and facility closing
expense (94) (50) (1,555) (4,575)
Gain on sale of property and
equipment 2 275 574 221
-------- -------- -------- --------
Loss before taxes (155) 287 (904) (3,763)
Income tax provision (1) 299 284 1,473
-------- -------- -------- --------
Income (loss) from discontinued operations $ (156) $ 586 $ (620) $ (2,290)
======== ======== ======== ========
Basic and diluted income (loss) per share
from discontinued operations $ (0.02) $ 0.06 $ (0.06) $ (0.20)
======== ======== ======== ========
Note 4: Commitments.
The Company is self-insured for a portion of its employee health care costs. The
Company is liable for medical claims up to $125,000 per eligible employee
annually, and aggregate annual claims up to approximately $3,160,000. The
aggregate annual deductible is determined by the number of eligible covered
employees during the year and the coverage they elect.
The Company is self-insured with respect to any worker's compensation claims not
covered by insurance. The Company maintains a $250,000 per occurrence deductible
and is liable for aggregate claims up to $2,400,000 for the twelve-month period
beginning September 1, 2003 and ending August 31, 2004.
The Company is self-insured with respect to any general liability claims below
the Company's self-insured retention of $150,000 per occurrence for the
twelve-month period beginning September 1, 2003 and ending August 31, 2004.
As of August 1, 2004, the Company had accrued $4,311,000 for the estimated
expense for its self-insured insurance plans. These accruals require management
to make significant estimates and assumptions. Actual results could differ from
management's estimates.
At August 1, 2004, the Company had commitments aggregating $108,000 for the
construction of restaurants.
The Company is involved in various legal proceedings incidental to the conduct
of its business, including employment discrimination claims. Based upon
currently available information, the Company does not expect that any such
proceedings will have a material adverse effect on the Company's financial
position or results of operations but there can be no assurance thereof.
Page 15
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
Note 5: Debt Instruments.
As of August 1, 2004, the Company had a financing package totaling $89,066,000,
consisting of a $40,000,000 revolving credit agreement (the "Bank Facility") and
a $49,066,000 mortgage facility (the "Mortgage Facility"), as described below.
The Mortgage Facility currently includes 34 separate mortgage notes, with
initial terms of either 15 or 20 years. The notes have fixed rates of interest
of either 9.79% or 9.94%. The notes require equal monthly interest and principal
payments. The mortgage notes are collateralized by a first mortgage/deed of
trust and security agreement on the real estate, improvements and equipment on
19 of the Company's Chili's restaurants (nine of which the Company mortgaged its
leasehold interest) and 15 of the Company's Burger King restaurants (three of
which the Company mortgaged its leasehold interest). The mortgage notes contain,
among other provisions, financial covenants that require the Company to maintain
a consolidated fixed charge coverage ratio of at least 1.30 for each of six
subsets of the financed properties.
The Company was not in compliance with the required consolidated fixed charge
coverage ratio for two of the subsets of the financed properties as of October
26, 2003. Both of these subsets were comprised solely of Burger King restaurants
and had fixed charge coverage ratios of 1.11 and 1.26 as of October 26, 2003.
The Company sought and obtained waivers of these covenant defaults from the
mortgage lenders through November 28, 2004. The Company does not expect to be in
compliance with these covenants by November 28, 2004. If the Company is not in
compliance with these covenants as of November 28, 2004, the Company will most
likely seek additional waivers. The Company believes it would be able to obtain
such waivers but there can be no assurance thereof. If the Company is unable to
obtain such waivers it is contractually entitled to pre-pay the outstanding
balances under one or more of the separate mortgage notes such that the
remaining properties in the subsets would meet the required ratio. However, any
such prepayments would be subject to prepayment premiums and to the Company's
ability to maintain its compliance with the financial covenants in its Bank
Facility. Alternatively, the Company is contractually entitled to substitute one
or more better performing restaurants for under-performing restaurants such that
the reconstituted subsets of properties would meet the required ratio. However,
any such substitutions would require the consent of the lenders in the Bank
Facility. For these reasons, the Company believes that its rights to prepay
mortgage notes or substitute properties may be impractical depending on the
circumstances existing at the time.
On June 10, 2002, the Company refinanced its Bank Facility with a $60,000,000
revolving credit agreement with JP Morgan Chase Bank, as agent, and four other
banks. During the third quarter of fiscal 2004 the Company voluntarily reduced
the capacity under the revolving credit agreement to $40,000,000. The Bank
Facility is collateralized by the stock of certain subsidiaries of the Company,
certain interests in the Company's franchise agreements with Brinker and Burger
King Corporation and substantially all of the Company's personal property not
pledged in the Mortgage Facility.
The Bank Facility contains restrictive covenants including maintenance of
certain prescribed debt and fixed charge coverage ratios, limitations on the
incurrence of additional indebtedness, limitations on consolidated capital
expenditures, cross-default provisions with other material agreements,
restrictions on the payment of dividends (other than stock dividends) and
limitations on the purchase or redemption of shares of the Company's capital
stock.
Page 16
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
The Bank Facility provides for borrowings at the adjusted LIBOR rate plus a
contractual spread which is as follows:
RATIO OF FUNDED DEBT
TO CASH FLOW LIBOR MARGIN
- ------------------------------------------------ ------------
Greater than or equal to 3.50 3.00%
Less than 3.5x but greater than or equal to 3.00 2.75%
Less than 3.0x but greater than or equal to 2.5x 2.25%
Less than 2.5x 1.75%
The Bank Facility also contains covenants requiring maintenance of funded debt
to cash flow and fixed charge coverage ratios as follows:
MAXIMUM FUNDED DEBT
TO CASH FLOW RATIO COVENANT
- --------------------------- --------
Fiscal 2003
Q1 through Q3 4.00
Q4 3.75
Fiscal 2004
Q1 through Q3 3.75
Q4 3.50
Fiscal 2005
Q1 through Q2 3.50
Thereafter 3.00
FIXED CHARGE COVERAGE RATIO 1.50
The Company's funded debt to consolidated cash flow ratio may not exceed 3.75
through the third quarter of fiscal 2004 and 3.50 by the end of fiscal 2004. The
Company's funded debt to consolidated cash flow ratio on August 1, 2004 was
3.16.
If the Company does not maintain the required funded debt to consolidated cash
flow ratio, that would constitute an event of default under the Bank Facility.
The Company would then need to seek waivers from its lenders or amendments to
the covenants. If the Company was unable to obtain waivers from its lenders or
amendments to the covenants the Company would be in default under the Bank
Facility. During continuance of an event of default, the Company would be
subject to a post-default interest rate under the Bank Facility that increases
the otherwise effective interest rate by 1.50%. In addition to the right to
declare all obligations immediately due and payable, the Bank Facility also has
additional rights including, among other things, the right to sell any of the
collateral securing the Company's obligations under the Bank Facility. In the
event the Company's obligations under the Bank Facility become immediately due
and payable the Company does not have sufficient liquidity to satisfy these
obligations and it is likely that the Company would be forced to seek protection
from its creditors. Such events would also constitute a default under the
Company's franchise agreements with Brinker and Burger King Corporation.
Page 17
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
Note 6: Net Income Per Share
Basic net income (loss) per share is computed by dividing net income (loss) by
the weighted average number of common shares outstanding. Diluted earnings per
share is based on the weighted average number of common shares outstanding plus
all potential dilutive common shares outstanding. For all years presented, the
difference between basic and diluted shares represents options on common stock.
For the twelve and forty week periods ended August 1, 2004, 528,843 options were
excluded from the diluted earnings per share calculations because to include
them would have been anti-dilutive. For the twelve and forty week periods ended
August 1, 2003, 575,053 and 581,053 options respectively were excluded from the
diluted earnings per share calculations because to include them would have been
anti-dilutive.
Note 7: Other Information
On June 15, 2004 a group of five shareholders led by Company CEO Daniel B.
Fitzpatrick ("Fitzpatrick Group") presented the Board with a proposal to
purchase all outstanding shares of common stock owned by the public
shareholders. Under the terms of the proposed transaction, the public holders of
the outstanding shares of the Company would each receive $2.75 in cash in
exchange for each of their shares. The purchase would take the form of a merger
in which the Company would survive as a privately held corporation. The
Fitzpatrick Group advised the Board that it was not interested in selling its
shares to a third party, whether in connection with a sale of the company or
otherwise.
On October 13, 2004, the special committee of independent directors
established by the Company's Board approved in principle, by a vote of three to
one, a transaction by which the Fitzpatrick Group would purchase all outstanding
shares of common stock owned by the public shareholders. Under the terms of the
proposed transaction, the public holders of the outstanding shares of Quality
Dining would receive $3.20 in cash in exchange for each of their shares.
On November 9, 2004, the Company entered into a definitive merger
agreement with a newly-formed entity owned by the Fitzpatrick Group. Under the
terms of the agreement, the public shareholders will receive $3.20 in cash in
exchange for each of their shares. Following the merger, the Company's common
stock will no longer be traded on NASDAQ or registered with the Securities and
Exchange Commission. The Fitzpatrick Group has agreed to vote their shares for
and against approval of the transaction in the same proportion as the votes cast
by all other shareholders voting at the special meeting to be held to vote on
the transaction. The agreement provides that if the shareholders do not approve
the transaction, the Company will reimburse the Fitzpatrick Group for its
reasonable out-of-pocket expenses not to exceed $750,000. The agreement is
subject to customary conditions, including, financing and the approval of the
Company's shareholders and Franchisors.
Page 18
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
Note 8: Segment Reporting
The Company operates four distinct restaurant concepts in the food-service
industry. It owns the Grady's American Grill and two Italian Dining concepts and
operates Burger King restaurants and Chili's Grill & Bar as a franchisee of
Burger King Corporation and Brinker International, Inc., respectively. The
Company has identified each restaurant concept as an operating segment based on
management structure and internal reporting. For purposes of applying SFAS 131,
the Company considers the Grady's American Grill, the two Italian concepts and
Chili's Grill & Bar to be similar and has aggregated them into a single
reportable operating segment (Full Service). The Company considers the Burger
King restaurants as a separate reportable segment (Quick Service). Summarized
financial information concerning the Company's reportable segments is shown in
the following table. The "all other" column is the VIE activity, see Note 2. The
"other reconciling items" column includes corporate related items, intercompany
eliminations and income and expense not allocated to reportable segments.
Other
Full Quick All Reconciling
(Dollars in thousands) Service Service Other Items Total
- -------------------------- -------- -------- -------- ----------- --------
Third quarter fiscal 2004
Revenues $ 25,378 $ 31,561 $ 892 $ (892) $ 56,939
Income from restaurant
operations 3,325 4,042 737 (126) 7,978
Operating income (loss) 1,977 1,768 718 (185) 4,278
Interest expense (1,462)
Other expense (629)
--------
Income from continuing
operations before income
taxes $ 2,187
========
Total Assets 72,613 48,214 17,919 10,745 $149,491
Depreciation and
amortization 1,047 1,030 113 140 $ 2,330
Third quarter fiscal 2003
Revenues $ 24,180 $ 27,851 $ 843 $ (843) $ 52,031
Income from restaurant
operations 2,906 3,616 700 (133) 7,089
Operating income (loss) 1,562 1,317 676 (427) 3,128
Interest expense (1,561)
Other income (1,797)
Loss from continuing
operations before income --------
taxes $ (230)
========
Total Assets 76,511 49,246 18,855 16,818 $161,430
Depreciation and
amortization 1,122 1,135 118 238 $ 2,613
Page 19
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AUGUST 1, 2004
(UNAUDITED)
Other
Full Quick All Reconciling
(Dollars in thousands) Service Service Other Items Total
- -------------------------------- -------- -------- -------- ------------ ---------
First forty weeks of fiscal 2004
Revenues $ 82,783 $ 90,446 $ 2,831 $ (2,831) $173,229
Income from restaurant
operations 10,890 10,351 2,318 (425) 23,134
Operating income (loss) 6,482 2,796 2,280 (922) 10,636
Interest expense (4,985)
Other income (1,608)
Income from continuing
operations before income --------
taxes $ 4,043
========
Total Assets 72,613 48,214 17,919 10,745 $149,491
Depreciation and
amortization 3,560 3,373 373 538 $ 7,844
First forty weeks of fiscal 2003
Revenues $ 79,620 $ 87,244 $ 2,697 (2,697) $166,864
Income from restaurant
operations 10,757 9,472 2,216 (440) 22,005
Operating income (loss) 6,205 1,853 2,149 (1,345) 8,862
Interest expense (5,554)
Other income 1,031
Income from continuing --------
operations before income
taxes $ 4,339
========
Total Assets 76,511 49,246 18,855 16,818 $161,430
Depreciation and
amortization 3,728 3,847 391 623 $ 8,589
Page 20
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company has a 52/53-week fiscal year ending on the last Sunday in October of
each year. The current fiscal year consists of 53 weeks and ends October 31,
2004. The first quarter of the Company's fiscal year consists of 16 weeks. The
second and third quarter of fiscal 2004 each consist of 12 weeks. The fiscal
2004 fourth quarter consists of 13 weeks.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentages which
certain items of revenue and expense bear to total revenues.
Twelve Weeks Ended Forty Weeks Ended
August 1, August 3, August 1, August 3,
2004 2003 2004 2003
--------- --------- --------- ---------
As Restated As Restated
(See Note 1A to the unaudited financial statements)
Total revenues 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Restaurant operating expenses
Food and beverage 28.1 26.7 27.6 26.8
Payroll and benefits 28.5 29.1 28.9 29.2
Depreciation and amortization 3.8 4.3 4.1 4.6
Other operating expenses 25.6 26.3 26.0 26.2
----- ----- ----- -----
Total restaurant operating expenses 86.0 86.4 86.6 86.8
----- ----- ----- -----
Income from operations 14.0 13.6 13.4 13.2
----- ----- ----- -----
General and administrative 6.5 7.4 7.1 7.7
Amortization of intangibles - 0.2 0.1 0.2
----- ----- ----- -----
Operating income 7.5 6.0 6.2 5.3
----- ----- ----- -----
Other income (expense):
Recovery of note receivable - - - 2.1
Interest expense (2.6) (3.0) (2.9) (3.3)
Minority interest in earnings (1.1) (1.2) (1.0) (1.2)
Stock purchase expense - (2.5) - (0.8)
Other income, net - 0.2 0.1 0.5
----- ----- ----- -----
Total other income (expense), net (3.7) (6.5) (3.8) (2.7)
----- ----- ----- -----
Income (loss) from continuing operations before
income taxes 3.8 (0.5) 2.4 2. 6
Income tax provision 1.4 0.9 1.0 1. 4
----- ----- ----- -----
Income (loss) from continuing operations 2.4 (1.4) 1.4 1.2
Income (loss) from discontinued operations,
net of tax 0.3 1.1 (0.4) (1.3)
----- ----- ----- -----
Net Income (loss) 2.1% (0.3)% 1.0% (0.1)%
===== ===== ===== =====
Page 21
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Restaurant sales for the Company were $56,939,000 for the third quarter of
fiscal 2004 versus $52,031,000 for the comparable period in fiscal 2003, an
increase of $4,908,000. Restaurant sales for the first forty weeks of fiscal
2004 were $173,229,000 versus $166,864,000 for the comparable period in fiscal
2003, an increase of $6,365,000.
The Company's Burger King restaurant sales were $31,561,000 in the third quarter
of fiscal 2004 compared to sales of $27,851,000 in the same period of fiscal
2003, an increase of $3,710,000. The Company had increased revenue of $994,000
from the three new restaurants opened in fiscal 2003 and the five restaurants
purchased from a third party in the third quarter of fiscal 2004. The Company's
Burger King restaurants had average weekly sales of $21,773 in the third quarter
of fiscal 2004 versus $19,825 in the same period in fiscal 2003. Sales at
restaurants open for more than one year increased 8.8% in the third quarter of
fiscal 2004 when compared to the same period in fiscal 2003. Sales increased
$3,202,000 to $90,446,000 for the first forty weeks of fiscal 2004 compared to
$87,244,000 for the comparable period in fiscal 2003. The Company had increased
revenue of $2,204,000 from the three new restaurants opened in fiscal 2003 and
the five restaurants purchased in fiscal 2004. Average weekly sales were $19,027
in the first forty weeks of fiscal 2004 versus $18,802 in the same period in
fiscal 2003. Sales at restaurants open for more than one year increased 0.7% in
the first forty weeks of fiscal 2004 when compared to the same period in fiscal
2003. During the third quarter of fiscal 2004 Burger King introduced some
appealing new products and had improved promotional campaigns. The Company
believes these actions were responsible for the positive same store sales
results.
The Company's Chili's Grill & Bar restaurant sales increased $1,606,000 to
$20,634,000 in the third quarter of fiscal 2004 compared to $19,028,000 in the
same period in fiscal 2003. The Company had increased revenue of $1,986,000 from
three restaurants opened during fiscal 2003 and two restaurants opened in fiscal
2004. Average weekly sales decreased to $44,760 in the third quarter of fiscal
2004 versus $45,630 in the same period of fiscal 2003. Sales at restaurants open
for more than one year decreased 2.0% in the third quarter of fiscal 2004 when
compared to the same period in fiscal 2003. Sales for the first forty weeks of
fiscal 2004 increased $4,627,000 to $65,787,000 compared to $61,160,000 for the
same period in fiscal 2003. The Company had increased revenue of $5,669,000 from
three restaurants opened during fiscal 2004 and two restaurants opened in fiscal
2003. The average weekly sales were $43,799 in the first forty weeks of fiscal
2004 versus $44,675 in the same period in fiscal 2003. Sales at restaurants open
for more than one year decreased 1.9% in the first forty weeks of fiscal 2004
when compared to the same period in fiscal 2003.
The Company's Italian Dining Division restaurant sales decreased $283,000 to
$3,581,000 in the third quarter of fiscal 2004 compared to $3,864,000 in the
same period in fiscal 2003. The average weekly sales were $33,154 in the third
quarter of fiscal 2004 versus $35,776 in the same period of fiscal 2003. Sales
at restaurants open for more than one year decreased 7.3% in the third quarter
of fiscal 2004 when compared to the same period in fiscal 2003. Sales for the
first forty weeks of fiscal 2004 decreased $1,198,000 to $12,473,000 compared to
$13,671,000 for the same period in fiscal 2003. The average weekly sales were
$34,647 in the first forty weeks of fiscal 2004 versus $37,976 in the same
period in fiscal 2003. Sales at restaurants open for more than one year
decreased 9.1% in the first forty weeks of fiscal 2004 when compared to the same
period in fiscal 2003. The Company has experienced significant competitive
intrusion in the markets where it has Italian Dining restaurants.
Sales in the Company's Grady's American Grill restaurant division were
$1,163,000 in the third quarter of fiscal 2004 compared to sales of $1,288,000
in the same period in fiscal 2003, a decrease of $125,000. The Company sold four
units in fiscal 2003, closed one unit in fiscal 2004, sold and leased back six
restaurants in fiscal 2004 and had one restaurant classified as held for sale as
of August 1, 2004. As required by SFAS 144, the results of operations for these
restaurants have been classified as discontinued operations for all periods
reported. The remaining three Grady's American Grill restaurants had average
weekly sales of $32,306 in the third quarter of fiscal 2004 versus $35,778 in
the third quarter of fiscal 2003, a decrease of 9.7%.
Page 22
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Sales in the Company's Grady's American Grill restaurant division were
$4,523,000 in the first forty weeks of fiscal 2004 compared to sales of
$4,789,000 in the same period in fiscal 2003, a decrease of $266,000. The
remaining three Grady's American Grill restaurants had average weekly sales of
$37,692 in the first forty weeks of fiscal 2004 versus $39,908 in the same
period of fiscal 2003, a decrease of 5.6%. The Company believes sales declines
in its Grady's American Grill division resulted from competitive intrusion and
the Company's inability to efficiently market this concept.
Total restaurant operating expenses, as a percentage of restaurant sales,
decreased to 86.0% for the third quarter of fiscal 2004 versus 86.4% in the
third quarter of fiscal 2003, and decreased to 86.6% in the first forty weeks of
fiscal 2004 versus 86.8% in the same period of fiscal 2003. The following
factors influenced the operating margins.
Food and beverage costs increased to 28.1% of total revenues in the third
quarter of fiscal 2004 compared to 26.7% of total revenues in the same period in
fiscal 2003, and 27.6% in the first forty weeks of fiscal 2004 compared to 26.8%
in the same period of fiscal 2003. Food and beverage costs have increased in
both the full service and quick service segments. The increases are mainly due
to higher dairy, poultry and beef costs. The Company expects the cost pressures
to persist for the rest of fiscal 2004.
Payroll and benefits were 28.5% of total revenues in the third quarter of fiscal
2004 compared to 29.1% in the same period of fiscal 2003. Payroll and benefits
were 28.9% of total revenues in the first forty weeks of fiscal 2004 compared to
29.2% in the same period of fiscal 2003. The Company had lower payroll and
benefits expense, as a percentage of sales, in the quick service segment for
both the quarter and forty weeks ended August 1, 2004. The improvement was
mainly due to the Company's focus on payroll costs and higher average unit
volumes. The Company had lower payroll and benefits expense, as a percentage of
sales, in the full service segment for both the quarter and forty weeks ended
August 1, 2004. The decrease was mainly due to the reduction in the number of
Grady's restaurants operated by the Company.
Depreciation and amortization, as a percentage of total revenues, decreased to
3.8% for the third quarter of fiscal 2004 compared to 4.3% in the same period in
fiscal 2003. The decrease was mainly due to a $105,000 decrease in depreciation
expense in the quick service segment. The decrease was mainly due to certain
assets becoming fully depreciated. Depreciation and amortization, as a
percentage of total revenues, decreased to 4.1% in the first forty weeks of
fiscal 2004 compared to 4.6% in the same period in fiscal 2003. The decrease was
mainly due to a $474,000 decrease in depreciation expense in the quick service
segment. The decrease was mainly due to certain assets becoming fully
depreciated. As disclosed in note 5 to the 2003 Annual Report on Form 10-K, in
fiscal 2000 the Company executed a "Franchisee Commitment" pursuant to which it
agreed to undertake certain initiatives including capital improvements and other
routine maintenance in all of its Burger King restaurants. The Capital Portion
of the Franchise Commitment($1,966,000) was originally recorded as a reduction
in the cost of the assets acquired. Consequently, the Company has not and will
not incur depreciation expense over the useful life of these assets (which range
between five and ten years).
Other restaurant operating expenses include rent and utilities, royalties,
promotional expense, repairs and maintenance, property taxes and insurance.
Other restaurant operating expenses as a percentage of total revenues decreased
in the third quarter of fiscal 2004 to 25.6% compared to 26.3% in the same
period of fiscal 2003. They decreased to 26.0% in the first forty weeks of
fiscal 2004 compared to 26.2% in the same period of fiscal 2003. The Company's
other operating expenses, as a percentage of sales, decreased in the third
quarter of fiscal 2004, mainly due to the reduction in the number of Grady's
American Grill restaurants. The Company participated in the Burger King 2000 and
2001 Early Renewal programs that included a royalty reduction as an incentive to
franchisees to renew franchise agreements early. The Company included 39
restaurants in the Early Renewal programs. In the first forty weeks of fiscal
2004 and fiscal 2003 the Company's participation in the Early Renewal program
reduced the Company's royalty expense by $305,000 and $218,000, respectively.
Page 23
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Income from restaurant operations increased $889,000 to $7,978,000, or 14.0% of
revenues, in the third quarter of fiscal 2004 compared to $7,089,000, or 13.6%
of revenues, in the comparable period of fiscal 2003. Income from restaurant
operations in the Company's Quick Service segment increased $426,000 while the
Company's Full Service segment increased $419,000 from the prior year. Income
from restaurant operations increased $1,129,000 to $23,134,000, or 13.4% of
revenues, in the first forty weeks of fiscal 2004 compared to $22,005,000, or
13.2% of revenues, in the comparable period of fiscal 2003. Income from
restaurant operations in the Company's Quick Service segment increased $879,000
while the Company's Full Service segment increased $133,000 when compared to the
first forty weeks of the prior year.
General and administrative expenses were $3,675,000 in the third quarter of
fiscal 2004 compared to $3,861,000 in the third quarter of fiscal 2003 and
$12,354,000 in the first forty weeks of fiscal 2004 compared to $12,841,000 in
the same period of fiscal 2003. As a percentage of total restaurant sales,
general and administrative expenses were 6.5% in the third quarter of fiscal
2004 versus 7.4% in the third quarter of fiscal 2003, and 7.1% in the first
forty weeks of fiscal 2004 compared to 7.7% in the same period of fiscal 2003.
The Company has had less legal expenses in fiscal 2004 than in fiscal 2003. In
the third quarter of fiscal 2003 the Company recorded approximately $2,000 in
expenses related to the Company's litigation with BFBC, LTD and in the first
forty weeks of fiscal 2003 the Company recorded approximately $286,000 for the
BFBC, LTD litigation. The Company did not have similar expense in fiscal 2004.
Also, the Company has significantly reduced the number of Grady's restaurants it
owns which has enabled the Company to reduce the costs associated with
supervising the Grady's concept. The Company had reduced supervisory costs of
$51,000 in the third quarter and $126,000 in the first forty weeks of fiscal
2004 compared to the same periods in fiscal 2003.
Total interest expense for the third quarter of fiscal 2004 was $1,462,000
compared to $1,561,000 during the same period in fiscal 2003. Total interest
expense was $4,985,000 in the first forty weeks of fiscal 2004 compared to
interest expense of $5,554,000 in the same period of fiscal 2003. The decreases
were mainly due to lower debt levels.
During the third quarter of fiscal 2003 the Company recorded a $3,459,000 gain
on the collection of a note receivable that had previously been written off. The
Company did not have any similar activity in fiscal 2004.
Minority interest in earnings pertains to certain related party affiliates that
are variable interest entities. The Company holds no direct ownership or voting
interest in the VIE's. Minority interest in earnings was $618,000 for the third
quarter of fiscal 2004 versus $604,000 in the comparable period in fiscal 2003.
Minority interest in earnings was $1,672,000 for the first forty weeks of fiscal
2004 versus $1,974,000 in the comparable period in fiscal 2003. See Note 2 in
the Company's consolidated financial statements for the impact of the variable
interest entities on specific income statement categories.
The provision for income taxes, as restated, was $795,000 for the third quarter
of fiscal 2004 versus $489,000 in the comparable period in fiscal 2003. The
provision for income taxes, as restated, was $1,654,000 for the first forty
weeks of fiscal 2004 versus $2,282,000 in the comparable period in fiscal 2003.
At the end of the third quarter of fiscal 2004 the Company had a valuation
reserve against its deferred tax asset resulting in a net deferred tax asset of
$8.3 million versus a net deferred tax asset of $9.0 million at the end of
fiscal 2003. Absent a significant and unforeseen change in facts or
circumstances, management re-evaluates the realizability of its tax assets in
connection with its annual budgeting cycle. Management does not believe there
were any significant changes in facts or circumstances through the end of the
third quarter of fiscal 2004.
Page 24
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Discontinued operations includes all disposed of restaurants and the six current
Grady's American Grill restaurants, which at the end of the third quarter the
Company expected to sell or close before the end of fiscal 2004. The decision to
dispose of these locations reflects the Company's ongoing process of evaluating
the performance and cash flows of its various restaurant locations and using the
proceeds from the sale of closed restaurants to reduce outstanding debt. The net
loss from discontinued operations, as restated, for the third quarter of fiscal
2004 was $156,000 versus income of $586,000 in the same period of fiscal 2003.
The net loss from discontinued operations, as restated, for the first forty
weeks of fiscal 2004 was $620,000 versus a loss of $2,290,000 in the same period
in fiscal 2003. The fiscal 2004 results include impairment and facility closing
expenses of $1,555,000 versus $4,575,000 in fiscal 2003.
The total restaurant sales from discontinued operations for the third quarter of
fiscal 2004 were $1,460,000 versus $3,084,000 in fiscal 2003. The total
restaurant sales from discontinued operations for the first forty weeks of
fiscal 2004 were $7,239,000 versus $13,570,000 in the same period in fiscal
2003.
For the third quarter of fiscal 2004, the Company reported net income of
$1,236,000 compared to a net loss of $133,000 for the third quarter of fiscal
2003. For the first forty weeks of fiscal 2004, the Company reported net income
of $1,769,000 compared to a net loss of $233,000 for the same period in fiscal
2003.
Management Outlook
The following section contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995, including statements about
trends in and the impact of certain initiatives upon the Company's operations
and financial results. Forward-looking statements can be identified by the use
of words such as "anticipates," "believes," "plans," "estimates," "expects,"
"intends," "may," and other similar expressions. Forward-looking statements are
made based upon management's current expectations and beliefs concerning future
developments and their potential effects on the Company. There can be no
assurance that the Company will actually achieve the plans, intentions and
expectations discussed in these forward-looking statements. Actual results may
differ materially.
Quick Service
The quick service segment of the restaurant industry is a very mature and
competitive segment, which is dominated by several national chains. Market share
is gained through national media campaigns promoting specific sandwiches,
usually at a discounted price. The national chains extend marketing efforts to
include nationwide premiums and movie tie-ins. To date in fiscal 2004, other
chains in the quick-service restaurant industry, including McDonald's and
Wendy's, have conducted promotional campaigns and introduced new products which
have been successful in taking market share away from Burger King. During the
third quarter of fiscal 2004 Burger King introduced some appealing new products
and improved promotional campaigns. The Company believes these changes were
responsible for the positive same store sales results during the third quarter
of fiscal 2004. The Company does not know if this positive sales momentum will
continue in the fourth quarter of fiscal 2004.
Full Service
The full service segment of the restaurant industry is also mature and
competitive. This segment has a few national companies that utilize national
media efficiently. This segment also has numerous regional and local chains that
provide service and products comparable to the national chains but cannot
support significant marketing campaigns. The Company operates three restaurant
concepts that compete in the full service segment.
Page 25
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
During fiscal 2004, the Company has continued to emphasize the operational and
marketing initiatives that contributed to the success of its Chili's division in
fiscal 2003. While the comparable store sales trends were not as good as the
Company had expected, the Company expects steady financial results for the
remainder of fiscal 2004.
During fiscal 2004, the Company continues to experience a deterioration in its
Italian Dining division's profitability. The Company has experienced significant
competitive intrusion in the markets where it has Italian Dining restaurants.
The Company expects the competitive pressures to continue for the remainder of
fiscal 2004.
During fiscal 2004, the Grady's American Grill concept was negatively affected
by competitive intrusion in the Company's markets and limitations in the
Company's ability to efficiently market its restaurants. The Company will
continue to consider opportunities to divest under-performing or non-strategic
restaurants during fiscal 2004. The Company expects the Grady's American Grill
division's operating performance to continue to decline during fiscal 2004.
Income taxes
The Company has recorded a valuation allowance to reduce its deferred tax assets
since it is more likely than not that some portion of the deferred assets will
not be realized. Management has considered all available evidence, both positive
and negative, including the Company's historical operating results, estimates of
future taxable income and ongoing feasible tax strategies in assessing the need
for the valuation allowance. The Company believes the positive evidence includes
the historically consistent profitability of its Chili's, Italian Dining and
Burger King divisions, and the resolution of substantially all of its
bagel-related contingent liabilities. The Company believes the negative evidence
includes the persistent negative trends in its Grady's American Grill division
and the lack of sales momentum in its Burger King division. During the first
forty weeks of fiscal 2004, the Company continued to experience unusual
uncertainty concerning whether, when and to what extent the recent lack of sales
momentum in its Burger King division will be reversed. In estimating its
deferred tax asset, management used its 2004 operating plan as the basis for a
forecast of future taxable earnings. Management did not incorporate growth
assumptions and limited the forecast to five years, the period that management
believes it can project results that are more likely than not achievable. Absent
a significant and unforeseen change in facts or circumstances, management
re-evaluates the realizability of its tax assets in connection with its annual
budgeting cycle.
Page 26
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital principally for building or acquiring new
restaurants, replacing equipment and remodeling existing restaurants. The
Company's restaurants generate cash immediately through sales. As is customary
in the restaurant industry, the Company does not have significant assets in the
form of trade receivables or inventory, and customary payment terms generally
result in several weeks of trade credit from its vendors. Therefore, the
Company's current liabilities have historically exceeded its current assets.
During the first forty weeks of 2004, net cash provided by operating activities
was $14,032,000 compared to $9,681,000 in fiscal 2003. The increase was mainly
due to changes in working capital that provided cash in fiscal 2004 versus
changes in working capital that used cash in fiscal 2003.
During the first forty weeks of fiscal 2004, the Company had $7,359,000 in
capital expenditures in connection with the building of two new full service
restaurants, the purchase of five existing Burger King restaurants and the
refurbishing of existing restaurants.
During the first forty weeks of fiscal 2004, the Company had $8,637,000 in
proceeds from the sales of property and equipment.
The Company had a net repayment of $11,250,000 under its revolving credit
agreement during the first forty weeks of fiscal 2004. As of August 1, 2004, the
Company's revolving credit agreement had an additional $5,670,000 of capacity.
The Company's average borrowing rate on August 1, 2004, was 4.36%.
The Company's primary cash requirements in fiscal 2004 will be capital
expenditures in connection with the building or acquiring of new restaurants,
remodeling of existing restaurants, maintenance expenditures, and the reduction
of debt under the Company's debt agreements. The Company plans to open one
Burger King restaurant during the fourth quarter of fiscal 2004. The actual
amount of the Company's cash requirements for capital expenditures depends in
part on the number of new restaurants opened, whether the Company owns or leases
new units, and the actual expense related to remodeling and maintenance of
existing units. The Company's capital expenditures for the remainder of fiscal
2004 are expected to range from $1,000,000 to $2,000,000. If the Company has
alternative uses or needs for its cash, the Company believes it could reduce
such planned expenditures without affecting its current operations. The Company
has debt service requirements of approximately $1,474,000 in fiscal 2004,
consisting primarily of the principal payments required under its mortgage
facility. The Company expects to reduce its borrowings under its revolving
credit agreement by $2,000,000 within the next year and therefore has classified
$2,000,000 of revolving credit debt as current. The Company had $4,794,000 of
current debt related to the consolidation of its variable interest entities, see
Note 2.
The Company anticipates that its cash flow from operations, together with the
available capacity under its revolving credit agreement as of August 1, 2004,
will provide sufficient funds for its operating, capital expenditure, debt
service and other requirements through the end of fiscal 2004.
As of August 1, 2004, the Company had a financing package totaling $89,066,000,
consisting of a $40,000,000 revolving credit agreement (the "Bank Facility") and
a $49,066,000 mortgage facility (the "Mortgage Facility"), as described below.
Page 27
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The Mortgage Facility currently includes 34 separate mortgage notes, with
initial terms of either 15 or 20 years. The notes have fixed rates of interest
of either 9.79% or 9.94%. The notes require equal monthly interest and principal
payments. The mortgage notes are collateralized by a first mortgage/deed of
trust and security agreement on the real estate, improvements and equipment on
19 of the Company's Chili's restaurants (nine of which the Company mortgaged its
leasehold interest) and 15 of the Company's Burger King restaurants (three of
which the Company mortgaged its leasehold interest). The mortgage notes contain,
among other provisions, financial covenants that require the Company to maintain
a consolidated fixed charge coverage ratio of at least 1.30 for each of six
subsets of the financed properties.
The Company was not in compliance with the required consolidated fixed charge
coverage ratio for two of the subsets of the financed properties as of October
26, 2003. Both of these subsets are comprised solely of Burger King restaurants
and had fixed charge coverage ratios of 1.11 and 1.26. The Company sought and
obtained waivers of these covenant defaults from the mortgage lenders through
November 28, 2004. If the Company is not in compliance with these covenants as
of November 28, 2004, the Company will most likely seek additional waivers. The
Company believes it would be able to obtain such waivers but there can be no
assurance thereof. If the Company is unable to obtain such waivers it is
contractually entitled to pre-pay the outstanding balances under one or more of
the separate mortgage notes such that the remaining properties in the subsets
would meet the required ratio. However, any such prepayments would be subject to
prepayment premiums and to the Company's ability to maintain its compliance with
the financial covenants in its Bank Facility. Alternatively, the Company is
contractually entitled to substitute one or more better performing restaurants
for under-performing restaurants such that the reconstituted subsets of
properties would meet the required ratio. However, any such substitutions would
require the consent of the lenders in the Bank Facility. For these reasons, the
Company believes that its rights to prepay mortgage notes or substitute
properties may be impractical depending on the circumstances existing at the
time.
On June 10, 2002, the Company refinanced its Bank Facility with a $60,000,000
revolving credit agreement with JP Morgan Chase Bank, as agent, and four other
banks. During the third quarter of fiscal 2004 the Company exercised its right
to unilaterally reduce the capacity under the revolving credit agreement to
$40,000,000. The Bank Facility is collateralized by the stock of certain
subsidiaries of the Company, certain interests in the Company's franchise
agreements with Brinker and Burger King Corporation and substantially all of the
Company's personal property not pledged in the Mortgage Facility.
The Bank Facility contains restrictive covenants including maintenance of
certain prescribed debt and fixed charge coverage ratios, limitations on the
incurrence of additional indebtedness, limitations on consolidated capital
expenditures, cross-default provisions with other material agreements,
restrictions on the payment of dividends (other than stock dividends) and
limitations on the purchase or redemption of shares of the Company's capital
stock.
The Bank Facility provides for borrowings at the adjusted LIBOR rate plus a
contractual spread which is as follows:
RATIO OF FUNDED DEBT
TO CASH FLOW LIBOR MARGIN
- ------------------------------------------------ ------------
Greater than or equal to 3.50 3.00%
Less than 3.5x but greater than or equal to 3.00 2.75%
Less than 3.0x but greater than or equal to 2.5x 2.25%
Less than 2.5x 1.75%
Page 28
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
The Bank Facility also contains covenants requiring maintenance of funded debt
to cash flow and fixed charge coverage ratios for fiscal 2004 and 2005 as
follows:
MAXIMUM FUNDED DEBT
TO CASH FLOW RATIO COVENANT
- -------------------- --------
Fiscal 2003
Q1 through Q3 4.00
Q4 3.75
Fiscal 2004
Q1 through Q3 3.75
Q4 3.50
Fiscal 2005
Q1 through Q2 3.50
Thereafter 3.00
FIXED CHARGE COVERAGE RATIO 1.50
The Company's funded debt to consolidated cash flow ratio may not exceed 3.75
through the third quarter of fiscal 2004 and 3.50 by the end of fiscal 2004. The
Company's funded debt to consolidated cash flow ratio on August 1, 2004 was
3.16.
If the Company does not maintain the required funded debt to consolidated cash
flow ratio that would constitute an event of default under the Bank Facility.
The Company would then need to seek waivers from its lenders or amendments to
the covenants. If the Company was unable to obtain waivers from its lenders or
amendments to the covenants the Company would be in default under the Bank
Facility. During continuance of an event of default, the Company would be
subject to a post-default interest rate under the Bank Facility that increases
the otherwise effective interest rate by 1.50%. In addition to the right to
declare all obligations immediately due and payable, the Bank Facility also has
additional rights including, among other things, the right to sell any of the
collateral securing the Company's obligations under the Bank Facility. In the
event the Company's obligations under the Bank Facility become immediately due
and payable the Company does not have sufficient liquidity to satisfy these
obligations and it is likely that the Company would be forced to seek protection
from its creditors. Such events would also constitute a default under the
Company's franchise agreements with Brinker and Burger King Corporation.
Critical Accounting Policies
Management's Discussion and Analysis of Financial Condition and Results of
Operations are based upon the Company's consolidated financial statements, which
were prepared in accordance with accounting principles generally accepted in the
United States of America. These principles require management to make estimates
and assumptions that affect the reported amounts in the consolidated financial
statements and notes thereto. Actual results may differ from these estimates,
and such differences may be material to the consolidated financial statements.
Management believes that the following significant accounting policies involve a
higher degree of judgment or complexity.
Page 29
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Property and Equipment
Property and equipment are depreciated on a straight-line basis over the
estimated useful lives of the assets. The useful lives of the assets are based
upon management's expectations for the period of time that the asset will be
used for the generation of revenue. Management periodically reviews the assets
for changes in circumstances that may impact their useful lives.
Impairment of Long-Lived Assets
Management periodically reviews property and equipment for impairment using
historical cash flows as well as current estimates of future cash flows. This
assessment process requires the use of estimates and assumptions that are
subject to a high degree of judgment. In addition, at least annually, or as
circumstances dictate, management assesses the recoverability of goodwill and
other intangible assets which requires assumptions regarding the future cash
flows and other factors to determine the fair value of the assets. In
determining fair value, the Company relies primarily on discounted cash flow
analyses that incorporates an investment horizon of five years and utilizes a
risk adjusted discount factor. If these assumptions change in the future,
management may be required to record impairment charges for these assets.
Page 30
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Income taxes
The Company has recorded a valuation allowance to reduce its deferred tax assets
since it is more likely than not that some portion of the deferred assets will
not be realized. Management has considered all available evidence both positive
and negative, including the Company's historical operating results, estimates of
future taxable income and ongoing feasible tax strategies in assessing the need
for the valuation allowance. In estimating its deferred tax asset, management
used its 2004 operating plan as the basis for a forecast of future taxable
earnings. Management did not incorporate growth assumptions and limited the
forecast to five years, the period that management believes it can project
results that are more likely than not achievable. Absent a significant and
unforeseen change in facts or circumstances, management re-evaluates the
realizability of its tax assets in connection with its annual budgeting cycle.
The Company operates in a very competitive industry that can be significantly
affected by changes in local, regional or national economic conditions, changes
in consumer tastes, weather conditions and various other consumer concerns.
Accordingly, the amount of the deferred tax asset considered by management to be
realizable, more likely than not, could change in the near term if estimates of
future taxable income change. This could result in a charge to, or increase in,
income in the period such determination is made.
Other estimates
Management is required to make judgments and or estimates in the determination
of several of the accruals that are reflected in the consolidated financial
statements. Management believes that the following accruals are subject to a
higher degree of judgment.
Management uses estimates in the determination of the required accruals for
general liability, workers' compensation and health insurance. These estimates
are based upon a detailed examination of historical and industry claims
experience. The claims experience may change in the future and may require
management to revise these accruals.
The Company is periodically involved in various legal actions arising in the
normal course of business. Management is required to assess the probability of
any adverse judgments as well as the potential ranges of any losses. Management
determines the required accruals after a careful review of the facts of each
legal action and assistance from outside legal counsel. The accruals may change
in the future due to new developments in these matters.
Management continually reassesses its assumptions and judgments and makes
adjustments when significant facts and circumstances dictate. Historically,
actual results have not been materially different than the estimates that are
described above.
Page 31
ITEM 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
This report contains and incorporates forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, including
statements about the Company's development plans and trends in the Company's
operations and financial results. Forward-looking statements can be identified
by the use of words such as "anticipates," "believes," "plans," "estimates,"
"expects," "intends," "may," and other similar expressions. Forward-looking
statements are made based upon management's current expectations and beliefs
concerning future developments and their potential effects on the Company. There
can be no assurance that the Company will actually achieve the plans, intentions
and expectations discussed in these forward-looking statements. Actual results
may differ materially. Among the risks and uncertainties that could cause actual
results to differ materially are the following: the availability and cost of
suitable locations for new restaurants; the availability and cost of capital to
the Company; the ability of the Company to develop and operate its restaurants;
the hiring, training and retention of skilled corporate and restaurant
management and other restaurant personnel; the integration and assimilation of
acquired concepts; the overall success of the Company's franchisors; the ability
to obtain the necessary government approvals and third-party consents; changes
in governmental regulations, including increases in the minimum wage; the
results of pending litigation; and weather and other acts of God. The Company
undertakes no obligation to update or revise any forward-looking information,
whether as a result of new information, future developments or otherwise.
Page 32
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to interest rate risk in connection with its $40.0
million revolving credit facility that provides for interest payable at the
LIBOR rate plus a contractual spread. The Company's variable rate borrowings
under this revolving credit facility totaled $32.4 million at August 1, 2004.
The impact on the Company's annual results of operations of a one-point interest
rate change would be approximately $324,000.
ITEM 4. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including
our President and Chief Executive Officer ("CEO") and Principal Financial
Officer ("PFO"), we have evaluated the effectiveness of the design and operation
of our disclosure controls and procedures as of the end of the period covered by
this quarterly report, and, based on their evaluation, our CEO and PFO have
concluded that these controls and procedures are effective.
(b) Changes in Internal Control over Financial Reporting
In the course of the process of closing its accounts for fiscal year 2004, the
Company determined that it had not been properly allocating certain federal tax
attributes between continuing operations and discontinued operations in the
first three fiscal quarters of 2004. After consultation with the Independent
Registered Public Accounting Firm of the Company, the accounting for the
allocation of federal tax attributes has been corrected on this Form 10-Q/A and
the Company has amended its Form 10-Q for the sixteen weeks ended February 15,
2004, and its Form 10-Q for the twelve and twenty-eight weeks ended May 9, 2004.
The Company's previously reported net income and income per share are not
affected by this reclassification.
The Company has instituted enhanced internal controls designed to ensure the
intraperiod allocation of tax expense (benefit) between continuing operations
and discontinued operations conforms to US Generally Accepted Accounting
Principles. Such enhancements will generally conform quarterly procedures to
those utilized by the Company in its year end closing process.
Except as set forth above, there have not been any changes in the Company's
internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) of the Exchange Act) that have materially affected, or are reasonably
likely to materially affect, the Company's internal control over financial
reporting.
Page 33
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Note 4 to the unaudited consolidated financial statements of the Company
included in Part I of this report is incorporated herein by reference.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
On June 15, 2004 a group of five shareholders led by Company CEO Daniel B.
Fitzpatrick ("Fitzpatrick Group") presented the Board with a proposal to
purchase all outstanding shares of common stock owned by the public
shareholders. Under the terms of the proposed transaction, the public holders of
the outstanding shares of the Company would each receive $2.75 in cash in
exchange for each of their shares. The purchase would take the form of a merger
in which the Company would survive as a privately held corporation. The
Fitzpatrick Group advised the Board that it was not interested in selling its
shares to a third party, whether in connection with a sale of the company or
otherwise.
On October 13, 2004, the special committee of independent directors established
by the Company's Board approved in principle, by a vote of three to one, a
transaction by which the Fitzpatrick Group would purchase all outstanding shares
of common stock owned by the public shareholders. Under the terms of the
proposed transaction, the public holders of the outstanding shares of Quality
Dining would receive $3.20 in cash in exchange for each of their shares.
On November 9, 2004, the Company entered into a definitive merger agreement with
a newly-formed entity owned by the Fitzpatrick Group. Under the terms of the
agreement, the public shareholders will receive $3.20 in cash in exchange for
each of their shares. Following the merger, the Company's common stock will no
longer be traded on NASDAQ or registered with the Securities and Exchange
Commission. The Fitzpatrick Group has agreed to vote their shares for and
against approval of the transaction in the same proportion as the votes cast by
all other shareholders voting at the special meeting to be held to vote on the
transaction. The agreement provides that if the shareholders do not approve the
transaction, the Company will reimburse the Fitzpatrick Group for its reasonable
out-of-pocket expenses not to exceed $750,000. The agreement is subject to
customary conditions, including, financing and the approval of the Company's
shareholders and Franchisors.
ITEM 6. EXHIBITS
Exhibits
A list of exhibits required to be filed as part of this report is set
forth in the Index to Exhibits, which immediately precedes such exhibits,
and is incorporated herein by reference.
Page 34
SIGNATURES
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.
Quality Dining, Inc.
(Registrant)
Date: December 23, 2004 By: /s/John C. Firth
------------------------------
Executive Vice President
General Counsel and Secretary
(Principal Financial Officer)
Page 35
INDEX TO EXHIBITS
Exhibit Number Description
- -------------- --------------------------------------------------------------
31.1 Rule 13a-14(a)/15d-14(a) Certification of Principal Executive
Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Principal Financial
Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Executive Vice President and
General Counsel (Principal Financial Officer)
Page 36