.
.
.
EXHIBIT 99
ITEM 6. SELECTED FINANCIAL DATA
QUALITY DINING, INC.
Fiscal Year Ended (1)
October 26, October 27, October 28, October 29, October 31,
2003 2002 2001 2000 1999
---------------------------------------------------------------
(In thousands, except unit and per share data)
STATEMENT OF OPERATIONS DATA:
Revenues:
Restaurant sales:
Burger King $ 114,983 $ 123,795 $ 80,791 $ 83,228 $ 84,171
Chili's Grill & Bar 80,710 75,760 69,727 60,921 56,837
Italian Dining Division 17,560 17,052 17,126 16,756 16,066
Grady's American Grill 6,078 21,113 32,969 39,288 45,908
--------- --------- --------- --------- ---------
Total revenues 219,331 237,720 200,613 200,193 202,982
--------- --------- --------- --------- ---------
Operating expenses:
Restaurant operating expenses:
Food and beverage 59,271 65,912 55,636 55,562 58,254
Payroll and benefits 63,923 69,571 59,101 58,046 58,229
Depreciation and amortization 9,940 9,893 10,613 10,174 10,023
Other operating expenses 56,638 59,292 49,368 47,345 48,431
--------- --------- --------- --------- ---------
Total restaurant operating expenses: 189,772 204,668 174,718 171,127 174,937
General and administrative (2)(3) 16,068 18,715 15,167 17,112 15,971
Amortization of intangibles 364 431 892 910 1,032
Facility closing costs (90) 355 898 - 1,047
Impairment of assets - - 14,487 - 1,454
--------- --------- --------- --------- ---------
Total operating expenses 206,114 224,169 206,162 189,149 194,441
--------- --------- --------- --------- ---------
Operating income (loss) (4) (5) 13,217 13,551 (5,549) 11,044 8,541
--------- --------- --------- --------- ---------
Other income (expense):
Interest expense (7,143) (7,916) (9,873) (10,589) (10,119)
Minority interest in earnings (2,678) (3,010) (2,886) (2,933) (2,891)
Provision for uncollectible note receivable (6) - - - (10,000) -
Recovery of note receivable 3,459 - - - -
Stock purchase expense (1,294) - - - -
Gain (loss) on sale of property and equipment (42) 1,034 (269) (878) (260)
Other income (expense), net 997 697 1,197 1,030 151
--------- --------- --------- --------- ---------
Total other expense (6,701) (9,195) (11,831) (23,370) (13,119)
--------- --------- --------- --------- ---------
Income (loss) from continuing operations before income
taxes 6,516 4,356 (17,380) (12,326) (4,578)
Income tax provision (benefit) 3,293 522 330 (22) (316)
--------- --------- --------- --------- ---------
Income (loss) from continuing operations 3,223 3,834 (17,710) (12,304) (4,262)
Income (loss) from discontinued operations (7) (2,351) 1,250 2,180 2,593 2,305
--------- --------- --------- --------- ---------
Net income (loss) $ 872 $ 5,084 $ (15,530) $ (9,711) $ (1,957)
--------- --------- --------- --------- ---------
Basic net income (loss) per share:
Continuing operations 0.30 0.34 (1.56) (1.00) (0.33)
Discontinued operations (0.22) 0.11 0.19 0.21 0.18
--------- --------- --------- --------- ---------
Basic net income (loss) per share $ 0.08 $ 0.45 $ (1.37) $ (0.79) $ (0.15)
--------- --------- --------- --------- ---------
Diluted net income (loss) per share:
Continuing operations 0.30 0.34 (1.56) (1.00) (0.33)
Discontinued operations (0.22) 0.11 0.19 0.21 0.18
--------- --------- --------- --------- ---------
Diluted net income (loss) per share $ 0.08 $ 0.45 $ (1.37) $ (0.79) $ (0.15)
--------- --------- --------- --------- ---------
Weighted average shares outstanding:
Basic 10,897 11,248 11,356 12,329 12,668
--------- --------- --------- --------- ---------
Diluted 10,921 11,306 11,356 12,329 12,668
--------- --------- --------- --------- ---------
1
Fiscal Year Ended (1)
October 26, October 27, October 28, October 29, October 31,
2003 2002 2001 2000 1999
---------------------------------------------------------------
RESTAURANT DATA:
Units open at end of period:
Grady's American Grill 12 16 34 35 36
Italian Dining Division 9 9 8 8 8
Burger King (8) 118 115 116 71 70
Chili's Grill & Bar 37 34 33 31 28
-------- -------- -------- --------- ---------
176 174 191 145 142
-------- -------- -------- --------- ---------
BALANCE SHEET DATA:
Working capital (deficiency) $(10,772) $(27,165) $(23,130) $ (22,329) $ (17,917)
Total assets 159,276 170,648 180,971 192,899 203,185
Long-term debt obligations 85,335 96,814 111,736 104,789 110,676
Total stockholders' equity 23,912 25,753 20,380 37,984 49,002
(1) All fiscal years presented consist of 52 weeks except fiscal 1999 which
had 53 weeks.
(2) General and administrative costs in fiscal 2000 include approximately
$1.25 million in unanticipated expenses related to the litigation, proxy
contest and tender offer initiated by NBO, LLC..
(3) General and administrative costs in fiscal 2002 include $1,527,000 of
expense related to the litigation with BFBC, Ltd.
(4) Operating income for the fiscal year ended October 31, 1999 includes
non-cash charges for the impairment of assets and facility closings
totaling $2,501,000. The non-cash charges consist primarily of $650,000
for the disposal of obsolete point of sale equipment that the Company
identified as a result of installing its new point-of-sale system in its
full service dining restaurants, $1,047,000 for the estimated costs and
losses associated with the anticipated closing of two regional offices and
three restaurant locations and $804,000 primarily for a non-cash asset
impairment write down for two under-performing restaurants.
(5) Operating income for the fiscal year ended October 28, 2001 includes
non-cash charges for the impairment of assets and facility closings
totaling $15,385,000. The non-cash charges consist primarily of
$14,487,000 for the impairment of certain long-lived assets of
under-performing Grady's American Grill restaurants and $898,000 for store
closing expenses and lease guarantee obligations.
(6) During fiscal 2000 the Company recorded a $10,000,000 non-cash charge to
fully reserve for the Subordinated Note.
(7) Loss from discontinued operations for the fiscal year ended October 26,
2003 includes non-cash charges for the impairment of assets totaling
$4,411,000. The non-cash charges are primarily for the impairment of
certain long-lived assets of under-performing Grady's American Grill
restaurants.
(8) On October 15, 2001, the Company acquired 42 restaurants from BBD Business
Consultants, Ltd. and its affiliates. The Company's financial statements
include the operating results from the date of acquisition.
2
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD-LOOKING STATEMENTS
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 ability of the Company to sustain sales and margins in the increasingly
competitive environment; 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.
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.
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. 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, four Grady's American Grill
restaurants that met the criteria for `held for sale' treatment in fiscal 2003
and five that met the criteria in fiscal 2004, as discontinued operations in the
accompanying consolidated financial statements.
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.
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.
3
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 claim 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.
4
For an understanding of the significant factors that influenced the Company's
performance during the past three fiscal years, the following discussion should
be read in conjunction with the consolidated financial statements appearing
elsewhere in this Annual Report.
RESULTS OF OPERATIONS
The following table reflects the percentages that certain items of revenue and
expense bear to total revenues.
Fiscal Year Ended
October 26, October 27, October 28,
2003 2002 2001
-------------------------------------
Restaurant sales:
Burger King 52.4% 52.1% 40.3%
Chili's Grill & Bar 36.8 31.8 34.8
Italian Dining Division 8.0 7.2 8.5
Grady's American Grill 2.8 8.9 16.4
----- ----- -----
Total revenues 100.0 100.0 100.0
----- ----- -----
Operating expenses:
Restaurant operating expenses:
Food and beverage 27.0 27.7 27.7
Payroll and benefits 29.1 29.3 29.5
Depreciation and amortization 4.5 4.2 5.3
Other operating expenses 25.9 24.9 24.6
----- ----- -----
Total restaurant operating expenses 86.5 86.1 87.1
----- ----- -----
Income from restaurant operations 13.5 13.9 12.9
----- ----- -----
General and administrative 7.3 7.9 7.6
Amortization of intangibles 0.2 0.2 0.4
Facility closing costs - 0.1 0.5
Impairment of assets - - 7.2
----- ----- -----
Operating income (loss) 6.0 5.7 (2.8)
----- ----- -----
Other income (expense):
Interest expense (3.3) (3.3) (4.9)
Minority interest in earnings (1.2) (1.3) (1.4)
Recovery of note receivable 1.6 - -
Stock purchase expense (0.6) - -
Gain (loss) on sale of property and equipment - 0.4 (0.1)
Other income (expense), net 0.5 0.3 0.5
----- ----- -----
Total other expense, net (3.0) (3.9) (5.9)
----- ----- -----
Income (loss) from continuing operations before income taxes 3.0 1.8 (8.7)
Income tax provision 1.5 0.2 0.1
----- ----- -----
Income (loss) from continuing operations 1.5 1.6 (8.8)
Income (loss) from discontinued operations, net of tax (1.1) 0.5 1.1
----- ----- -----
Net income (loss) 0.4% 2.1% (7.7%)
----- ----- -----
5
FISCAL YEAR 2003 COMPARED TO FISCAL YEAR 2002
Restaurant sales in fiscal 2003 were $219,331,000, a decrease of 7.7%
or $18,389,000, compared to restaurant sales of $237,720,000 in fiscal 2002. The
decrease was due to a $8,812,000 decrease in restaurant sales in the Company's
quick service segment and a $9,577,000 decrease in restaurant sales in the
Company's full service segment. 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, four Grady's American Grill
restaurants that met the criteria for `held for sale' treatment in fiscal 2003
and five that met the criteria in fiscal 2004, as discontinued operations in the
accompanying consolidated financial statements.
The Company's Burger King restaurant sales were $114,983,000 in fiscal
2003 compared to sales of $123,795,000 in fiscal 2002, a decrease of $8,812,000.
The Company had increased revenue of $2,594,000 due to additional sales weeks
from three restaurants opened in fiscal 2003 and two restaurants opened in
fiscal 2002 that were open for their first full year in fiscal 2003. The
Company's Burger King restaurants' average weekly sales decreased to $18,998 in
fiscal 2003 versus $20,668 in fiscal 2002. Sales at restaurants open for more
than one year decreased 8.2% in fiscal 2003 when compared to the same period in
fiscal 2002. The Company believes that the sales decline it experienced in
fiscal 2003 resulted primarily from ineffective marketing and unsuccessful new
product introductions.
The Company's Chili's Grill & Bar restaurant sales increased $4,950,000
to $80,710,000 in fiscal 2003 compared to restaurant sales of $75,760,000 in
fiscal 2002. The Company had increased revenue of $3,716,000 due to additional
sales weeks from three new restaurants opened in fiscal 2003 and one restaurant
opened in fiscal 2002 that was open for its first full year in fiscal 2003. The
Company's Chili's Grill & Bar restaurants average weekly sales increased to
$44,518 in fiscal 2003 versus $43,868 in fiscal 2002. Sales at restaurants open
for more than one year increased 2.1% in fiscal 2003 when compared to the same
period in fiscal 2002. The Company believes that the sales increases it
experienced in fiscal 2003 resulted from the application of the Company's
discipline operating systems and the franchisors successful marketing and menu
strategies.
The Company's Grady's American Grill restaurant sales were $6,078,000
in fiscal 2003 compared to sales of $21,113,000 in fiscal 2002, a decrease of
$15,035,000. The Company sold or closed 18 units in fiscal 2002. The absence of
these units accounted for $14,061,000 of the sales decrease during fiscal 2003.
The Company sold four units in fiscal 2003, had four additional units that met
the criteria for `held for sale' treatment in fiscal 2003 and five that met the
criteria in fiscal 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 $38,235 in fiscal 2003 versus $44,807 in fiscal 2002, a
decrease of 14.7%. 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.
During the second quarter of fiscal 2003 the Company closed three
Grady's American Grill restaurants. The Company sold four Grady's American Grill
restaurants in fiscal 2003 receiving net proceeds of $4.8 million. In light of
these disposals and the continued decline in sales and cash flow in its Grady's
American Grill division, in the second quarter of fiscal 2003, the Company
reviewed the carrying amounts for the balance of its Grady's American Grill
Restaurant assets. The Company estimated the future cash flows expected to
result from the continued operation and the residual value of the remaining
restaurant locations in the division and concluded that, in eight locations, the
undiscounted estimated future cash flows were less than the carrying amount of
the related assets. Accordingly, the Company concluded that these assets had
been impaired. The Company measured the impairment and recorded an impairment
charge related to these assets aggregating $4,411,000 in the second quarter of
fiscal 2003, consisting of a reduction in the net book value of the Grady's
American Grill trademark of $2,882,000 and a reduction in the net book value of
certain fixed assets in the amount of $1,529,000. The impairment charge was
recorded as a component of discontinued operations. In determining the fair
value of the aforementioned restaurants, the Company relied primarily on
discounted cash flow analyses that incorporated an investment horizon of five
years and utilized a risk adjusted discount factor.
6
In light of the continuing negative trends in both sales and cash
flows, the increase in the pervasiveness of these declines amongst individual
stores, and the accelerating rate of decline in both sales and cash flow, the
Company also determined that the useful life of the Grady's American Grill
trademark should be reduced from 15 to five years.
The Company continues to pursue various management actions in response
to the negative trend in its Grady's business, including evaluating strategic
business alternatives for the division both as a whole and at each of its
restaurant locations. While the Company believes that the Grady's American Grill
assets are reported at their estimated fair values as of October 26, 2003, there
can be no assurance thereof.
The Company's Italian Dining Division's restaurant sales increased
$508,000 to $17,560,000 in fiscal 2003 when compared to restaurant sales of
$17,052,000 in fiscal 2002. The Company had increased revenue of $1,730,000 due
to additional sales weeks from one new restaurant opened in fiscal 2002. The
Italian Dining Division's average weekly sales decreased to $37,522 in fiscal
2003 from $40,122 in fiscal 2002. Sales at restaurants open for more than one
year decreased 7.3% in fiscal 2003 when compared to the same period in fiscal
2002. The Company believes that the sales declines it experienced in its Italian
division resulted primarily from competitive intrusion and the Company's
inability to efficiently market this concept.
Total restaurant operating expenses were $189,772,000 in fiscal 2003,
compared to $204,668,000 in fiscal 2002. As a percentage of restaurant sales,
total restaurant operating expenses increased to 86.5% in fiscal 2003 from 86.1%
in fiscal 2002. The following factors influenced the operating margins:
Food and beverage costs were $59,271,000 in fiscal 2003, compared to
$65,912,000 in fiscal 2002. As a percentage of total restaurant sales, food and
beverage costs decreased 0.7% to 27.0% in fiscal 2003 from 27.7% in fiscal 2002.
During fiscal 2003 food and beverage costs, as a percentage of sales, improved
in both the quick service segment and the full service segment. The improvement
in the quick service segment was mainly due to improved margins in the Company's
Grand Rapids, Michigan Burger King market. The Company acquired these
restaurants on October 15, 2001, and has implemented new procedures that have
reduced food costs as a percentage of sales. The decrease in the full service
segment was mainly due to the reduced number of Grady's American Grill
restaurants, which historically have had higher food and beverage costs, as a
percentage of total restaurant sales, than the Company's other full service
concepts.
Payroll and benefits were $63,923,000 in fiscal 2003, compared to
$69,571,000 in fiscal 2002. As a percentage of total restaurant sales, payroll
and benefits decreased to 29.1% in fiscal 2003 from 29.3% in fiscal 2002.
Payroll and benefits, as a percentage of sales, increased in the quick service
segment and decreased in the full service segment. The increase in the quick
service segment was mainly due to a decrease in average weekly sales. The
decrease in the full service segment was mainly due to the reduced number of
Grady's American Grill restaurants, which historically have had higher payroll
and benefit costs, as a percentage of total restaurant sales, than the Company's
other full service concepts.
Depreciation and amortization increased $47,000 to $9,940,000 in fiscal
2003 compared to $9,893,000 in fiscal 2002. As a percentage of total restaurant
sales, depreciation and amortization increased to 4.5% in fiscal 2003 compared
to 4.2% in fiscal 2002. The increase, as a percentage of revenues, was mainly
due to the decrease in average weekly sales at the Company's Burger King,
Italian Dining and Grady's American Grill restaurants.
Other restaurant operating expenses include rent and utilities,
royalties, promotional expense, repairs and maintenance, property taxes and
insurance. Other restaurant operating expenses decreased $2,654,000 to
$56,638,000 in fiscal 2003 compared to $59,292,000 in 2002. The decrease was
mainly due to the reduced number of Grady's American Grill restaurants operating
in fiscal 2003 versus fiscal 2002. Other restaurant operating expenses, as a
percentage of total restaurant sales, increased to 25.9% in fiscal 2003 versus
24.9% in fiscal 2002. The increase, as a percentage of revenues, was mainly due
to the decrease in average weekly sales at the Company's Burger King, Italian
Dining and Grady's American Grill restaurants.
7
Income from restaurant operations decreased $3,493,000 to $29,559,000,
or 13.5% of revenues, in fiscal 2003 compared to $33,052,000, or 13.9% of
revenues, in fiscal 2002. Income from restaurant operations in the Company's
quick service segment decreased $3,359,000 while the Company's full service
segment decreased $129,000 from the prior year.
General and administrative expenses, which include corporate and
district management costs, were $16,068,000 in fiscal 2003, compared to
$18,715,000 in fiscal 2002. As a percentage of total revenues, general and
administrative expenses decreased to 7.3% in fiscal 2003 compared to 7.9% in
fiscal 2002. In fiscal 2002 the Company incurred approximately $1,527,000 in
legal expense for bagel-related litigation (See Note 12 to the Company's
consolidated financial statements) compared to $289,000 in legal expense in
fiscal 2003. The Company also had $1,059,000 less in bonus expense in fiscal
2003 than in fiscal 2002.
Amortization of intangibles was $364,000 in fiscal 2003, compared to
$431,000 in fiscal 2002. The decrease was due to the decreased number of Grady's
American Grill restaurants operated by the Company. As a percentage of total
revenues, amortization of intangibles remained consistent at 0.2% in fiscal 2003
and fiscal 2002.
The Company incurred $220,000 in facility closing costs in fiscal 2003
that have been recorded in discontinued operations and reversed $90,000 in
facility closing costs, which have been recorded in continuing operations,
because actual facility closing costs were lower than the Company's original
estimates.
The Company had operating income of $13,217,000 in fiscal 2003 compared
to operating income of $13,551,000 in fiscal 2002.
Total interest expense decreased to $7,143,000 in fiscal 2003 from
$7,916,000 in fiscal 2002. The decrease was due to lower interest rates and
lower debt levels.
During the third quarter of fiscal 2003, the Chairman and Chief
Executive Officer of the Company, Daniel B. Fitzpatrick, purchased all 1,148,014
shares of the Company's common stock owned by NBO, LLC, for approximately $4.1
million. As a result of this transaction, the Company incurred a one-time,
non-cash charge of $1,294,000, which is equal to the premium to the market price
that Mr. Fitzpatrick paid for the shares. The Company also recorded a
corresponding increase in the Company's additional paid-in capital of
$1,294,000.
During the second 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 (See Note 12 to the Company's consolidated financial statements).
The Company did not have any similar activity in fiscal 2002.
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
$2,678,000 in fiscal 2003 versus $3,010,000 in fiscal 2002. See Note 3 in the
Company's consolidated financial statements for further discussion.
Income tax expense of $3,293,000 was recorded in fiscal 2003 compared
to $522,000 in fiscal 2002. The Company recognized $2,317,000 in federal tax
expense in fiscal 2003 versus a tax benefit of $826,000 in fiscal 2002. At the
end of fiscal 2003, the Company reviewed its valuation reserve against its
deferred tax asset consistent with its historical practice. The Company's
assessment of its ability to realize the net deferred tax asset was based on the
weight of both positive and negative evidence, including the taxable income of
its current operations. The Company believes the positive evidence includes the
Company's profitability in 2002 and 2003, consistent historical 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 recent sales declines in its Burger King
division, and statutory limitations on available carryforward tax benefits. The
Company is currently experiencing unusual uncertainty concerning whether, when
and to what extent the recent sales declines 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
8
and unforeseen change in facts or circumstances, management re-evaluates the
realizability of its tax assets in connection with its annual budgeting cycle.
Based on its assessment and using the methodology described above,
management believes more likely than not the net deferred tax asset will be
realized. The Company is currently profitable, has offset approximately $8.5
million of taxable income with net operating loss carryforward benefits in the
last two years, and management believes the issues that gave rise to historical
losses have been substantially resolved with no impact on its continuing
businesses. Moreover, the Company's Burger King and Chili's businesses have been
historically, and continue to be, profitable. Nonetheless, realization of the
net deferred tax asset will require approximately $26.5 million of future
taxable income. 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.
The Company has net operating loss carryforwards of approximately $57.0
million as well as FICA tip credits and alternative minimum tax credits of $5.1
million. Net operating loss carryforwards of $39.9 million expire in 2012, $3.0
million expire in 2018, $1.6 million expire in 2021 and $12.2 million expire in
2022. FICA tip credits of $1.3 million expire in 2012, $477,000 expire in 2013,
$572,000 expire in 2014, $571,000 expire in 2015, $727,000 expire in 2016,
$702,000 expire in 2017 and $561,000 expire in 2018. The alternative minimum tax
credits of $191,000 carryforward indefinitely. At the end of fiscal 2003 the
Company had a valuation reserve against its deferred tax asset of $24.2 million
resulting in a net deferred tax asset of $9.0 million.
Discontinued operations includes four Grady's American Grill
restaurants sold during fiscal 2003, four restaurants that met the criteria for
`held for sale' treatment in fiscal 2003 and five that met the criteria in
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 for fiscal
2003 was $2,351,000 versus income of $1,250,000 in fiscal 2002. Discontinued
operations for the fiscal year ended October 26, 2003 includes non-cash charges
for the impairment of assets totaling $4,411,000. The total restaurant sales
from discontinued operations for fiscal 2003 were $16,249,000 versus $23,805,000
in fiscal 2002.
The net income in fiscal 2003 was $872,000, or $0.08 per share,
compared to a net income of $5,084,000, or $0.45 per share, in fiscal 2002.
FISCAL YEAR 2002 COMPARED TO FISCAL YEAR 2001
Restaurant sales in fiscal 2002 were $237,720,000, an increase of 18.5%
or $37,107,000, compared to restaurant sales of $200,613,000 in fiscal 2001. The
increase was due to a $43,004,000 increase in restaurant sales in the Company's
quick service segment that was partially offset by a $5,897,000 decrease in
restaurant sales in the Company's full service segment.
The Company's Burger King restaurant sales were $123,795,000 in fiscal
2002 compared to sales of $80,791,000 in fiscal 2001, an increase of
$43,004,000. The Company had increased revenues of $39,568,000 from the Burger
King restaurants in the Grand Rapids, Michigan metropolitan area which were
purchased on October 15, 2001. The Company also had increased revenue of
$2,564,000 due to additional sales weeks from two restaurants opened in fiscal
2002 and three restaurants opened in fiscal 2001 that were open for their first
full year in fiscal 2002. The Company's Burger King restaurants average weekly
sales decreased to $20,668 in fiscal 2002 versus $21,680 in fiscal 2001. The
restaurants in the Grand Rapids acquisition have significantly lower sales than
the Company's other Burger King restaurants, adversely affecting the average
weekly sales for the year ending October 27, 2002. Sales at restaurants open for
more than one year increased 0.5% in fiscal 2002 when compared to the same
period in fiscal 2001.
The Company's Chili's Grill & Bar restaurant sales increased $6,033,000
to $75,760,000 in fiscal 2002 compared to restaurant sales of $69,727,000 in
fiscal 2001. The Company had increased revenue of $3,949,000 due
9
to additional sales weeks from one new restaurant opened in fiscal 2002 and two
restaurants opened in fiscal 2001 that were open for their first full year in
fiscal 2002. The Company's Chili's Grill & Bar restaurants average weekly sales
increased to $43,868 in fiscal 2002 versus $42,650 in fiscal 2001. Sales at
restaurants open for more than one year increased 3.5% in fiscal 2002 when
compared to the same period in fiscal 2001.
The Company's Grady's American Grill restaurant sales were $21,113,000
in fiscal 2002 compared to sales of $32,969,000 in fiscal 2001, a decrease of
$11,856,000. The Company sold or closed 18 units in fiscal 2002. The absence of
these units decreased sales by $11,889,000 during fiscal 2002. The three Grady's
American Grill restaurants remaining in continuing operations had average weekly
sales of $44,807 in fiscal 2002 versus $43,370 in the same period in fiscal 2001
which is a 3.3% increase in comparable store sales.
The Company sold nine of its Grady's American Grill restaurants for
approximately $10.5 million on May 16, 2002. The Company recorded an impairment
charge of $4.1 million related to these nine restaurants during the fourth
quarter of fiscal 2001. As a consequence of this loss and in connection with the
aforementioned evaluation, the Company estimated the future cash flows expected
to result from the continued operation and the residual value of the remaining
restaurant locations in the division and concluded in the fourth quarter of
fiscal 2001 that, in 12 locations, the undiscounted estimated future cash flows
were less than the carrying amount of the related assets. Accordingly, the
Company concluded that these assets had been impaired and recorded an impairment
charge related to these assets aggregating $10.4 million during the fourth
quarter of fiscal 2001.
The Company's Italian Dining Division's restaurant sales decreased
$74,000 to $17,052,000 in fiscal 2002 when compared to restaurant sales of
$17,126,000 in fiscal 2001. The Company had increased revenue of $432,000 due to
additional sales weeks from one new restaurant opened in fiscal 2002. The
Italian Dining Division's average weekly sales decreased to $40,122 in fiscal
2002 from $41,169 in fiscal 2001. Sales at restaurants open for more than one
year decreased 3.0% in fiscal 2002 when compared to the same period in fiscal
2001.
Total restaurant operating expenses were $204,668,000 in fiscal 2002,
compared to $174,718,000 in fiscal 2001. As a percentage of restaurant sales,
total restaurant operating expenses decreased to 86.1% in fiscal 2002 from 87.1%
in fiscal 2001. The following factors influenced the operating margins:
On October 15, 2001, the Company purchased 42 Burger King restaurants
in the Grand Rapids, Michigan metropolitan area (three of which were
subsequently closed). The acquired Burger King restaurants had significantly
lower operating margins than the Company's other Burger King restaurants. The
new Burger King restaurants therefore had a negative effect on operating
margins.
During fiscal 2002, the Company sold or closed 18 Grady's American
Grill Restaurants. The restaurants disposed of had lower operating margins than
the Company's other restaurants. The sale of the restaurants therefore had a
positive effect on operating margins during fiscal 2002.
Food and beverage costs were $65,912,000 in fiscal 2002, compared to
$55,636,000 in fiscal 2001. As a percentage of total restaurant sales, food and
beverage costs were consistent at 27.7% in both fiscal 2002 and fiscal 2001.
Food and beverage costs in dollars and as a percentage of sales increased in the
quick service segment due to the purchase of Burger King restaurants in Grand
Rapids, Michigan. The Company had an increase in food and beverage costs of
$11,216,000 in fiscal 2002 due to the addition of the Burger King restaurants in
Grand Rapids, Michigan. The full service segment's food and beverage costs, as a
percentage of sales, were lower in fiscal 2002 than fiscal 2001. The decrease
was mainly due to the reduced number of Grady's American Grill restaurants,
which historically have had higher food and beverage costs, as a percentage of
total restaurant sales, than the Company's other full service concepts.
Payroll and benefits were $69,571,000 in fiscal 2002, compared to
$59,101,000 in fiscal 2001. As a percentage of total restaurant sales, payroll
and benefits decreased 0.2% to 29.3% in fiscal 2002 from 29.5% in fiscal 2001.
The Company experienced an increase in payroll, as a percentage of sales, in the
quick service segment. The increase as a percent of sales and in total dollars
in the quick service segment was due to the purchase of the Burger King
restaurants in Grand Rapids, Michigan. The Company experienced an increase in
payroll of $11,950,000 in fiscal 2002 due to the addition of the Burger King
restaurants in Grand Rapids, Michigan. The Company
10
experienced a decrease in payroll as a percentage of sales in the full service
segment mainly due to the decreased number of Grady's American Grill
restaurants.
Depreciation and amortization decreased $720,000 to $9,893,000 in
fiscal 2002 compared to $10,613,000 in fiscal 2001. As a percentage of total
restaurant sales, depreciation and amortization decreased to 4.2% in fiscal 2002
compared to 5.3% in fiscal 2001. The decrease was mainly due to a $1,330,000
decrease at the Company's Grady's division, which was a direct result of the
fiscal 2001 asset impairment charge discussed above. This decrease was partially
offset by a $962,000 increase in depreciation and amortization in the quick
service segment due to the addition of Burger King restaurants in Grand Rapids,
Michigan.
Other restaurant operating expenses include rent and utilities,
royalties, promotional expense, repairs and maintenance, property taxes and
insurance. Other restaurant operating expenses increased $9,924,000 to
$59,292,000 in fiscal 2002 compared to $49,368,000 in 2001. Other restaurant
operating expenses as a percentage of total restaurant sales increased to 24.9%
in fiscal 2002 versus 24.6% in fiscal 2001. The increase in dollars and as a
percent of sales is mainly due to the addition of Burger King restaurants in
Grand Rapids, Michigan.
The Company recorded a $355,000 facility closing charge in fiscal 2002
consisting primarily of contractual lease costs for certain closed Grady's
American Grill restaurants. The Company recorded a $15.4 million impairment of
asset and facility closing charge in fiscal 2001. This amount consisted of a
$4.9 million charge for the reduction in the net book value of the Grady's
American Grill trademark, and a $9.6 million charge for the reduction in the net
book value of certain fixed assets and $860,000 in charges for the cost of
closing certain restaurant locations and certain lease guarantee obligations.
Income from restaurant operations increased $7,157,000 to $33,052,000,
or 13.9% of revenues, in fiscal 2002 compared to $25,895,000, or 12.9% of
revenues, in fiscal 2001. Income from restaurant operations in the Company's
quick service segment increased $4,819,000 while the Company's full service
segment increased $2,280,000 from the prior year.
General and administrative expenses, which include corporate and
district management costs, were $18,715,000 in fiscal 2002, compared to
$15,167,000 in fiscal 2001. As a percentage of total revenues, general and
administrative expenses increased to 7.9% in fiscal 2002 compared to 7.6% in
fiscal 2001. In fiscal 2002 the Company incurred approximately $1,527,000 for
the BFBC, Ltd. litigation (See Note 12 to the Company's consolidated financial
statements). The Company did not incur similar expenses during fiscal 2001. The
Company also incurred an additional $1,163,000 in general and administrative
expenses directly related to the addition of Burger King restaurants in Grand
Rapids, Michigan.
Amortization of intangibles was $431,000 in fiscal 2002, compared to
$892,000 in fiscal 2001. As a percentage of total revenues, amortization of
intangibles decreased to 0.2% in fiscal 2002 compared to 0.4% in fiscal 2001.
The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets" at the
beginning of fiscal 2002. Under SFAS 142, amortization of goodwill was
discontinued.
Total other expenses, as a percentage of total revenues, decreased to
3.9% in fiscal 2002 compared to 5.9% in fiscal 2001. The decrease was mainly due
to lower interest rates and lower debt levels that reduced the Company's
interest expense in fiscal 2002 versus fiscal 2001. The Company also had a
$1,034,000 gain on the sale of fixed assets in fiscal 2002 versus a $269,000
loss on the sale of fixed assets in fiscal 2001.
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
$3,010,000 in fiscal 2002 versus $2,886,000 in fiscal 2001. See Note 3 in the
Company's consolidated financial statements for further discussion.
Income tax expense of $522,000 was recorded in fiscal 2002 compared to
$330,000 in fiscal 2001. The increase was mainly due to the Company recognizing
only a $826,000 tax benefit in fiscal 2002 versus a $946,000 tax benefit in
fiscal 2001. The Company utilized $8.5 million of net operating loss
carryforwards to offset current year taxable income.
11
Discontinued operations includes four Grady's American Grill
restaurants sold during fiscal 2003, four Grady's American Grill restaurants
that met the criteria for `held for sale' treatment in fiscal 2003 and five that
met the criteria in 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 income from
discontinued operations for fiscal 2002 was $1,250,000 versus $2,180,000 in
fiscal 2001. The total restaurant sales from discontinued operations in fiscal
2002 were $23,805,000 versus $27,478,000 in fiscal 2001.
The net income in fiscal 2002 was $5,084,000, or $0.45 per share,
compared to a net loss of $15,530,000, or $1.37 per share, in fiscal 2001.
12
LIQUIDITY AND CAPITAL RESOURCES
The following table summarizes the Company's principal sources and uses of cash:
(Dollars in thousands)
Fiscal Year Ended
October 26, October 27, October 28,
2003 2002 2001
------------------------------------------
Net cash provided by operating activities $ 14,187 $ 16,087 $ 10,886
Cash flows from investing activities:
Acquisition of business, net of cash - - (4,212)
Purchase of property and equipment (9,570) (16,102) (11,821)
Purchase of other assets (892) (1,013) (847)
Proceeds from the sale of assets 4,782 15,517 358
Cash flow from financing activities:
Borrowings (repayment) of long-term debt, net (3,078) (13,268) 6,919
Purchase of common stock (2,806) (264) (1,925)
Loan financing fees - (619) -
Cash distributions to minority interest (4,718) (3,758) (3,626)
Cash provided by discontinued operations 2,366 2,266 3,622
The Company requires capital principally for building or acquiring new
restaurants, replacing equipment and remodeling existing restaurants. During the
three year period ended October 26, 2003, the Company financed these activities
principally using cash flows from operations, proceeds from the sale of assets
and its credit facilities. 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.
In fiscal 2003, net cash provided by operating activities was
$14,187,000 compared to $16,087,000 in fiscal 2002. Lower income from restaurant
operations and changes in operating assets and liabilities that used cash were
partially offset by the gain on the note receivable collection, a reduction in
general and administrative costs and lower interest expense.
During fiscal 2003, the Company had $9,570,000 in capital expenditures
in connection with the opening of new restaurants and the refurbishing of
existing restaurants. During fiscal 2003 the Company opened three new full
service restaurants and one quick service restaurant. The Company also replaced
two existing quick service restaurant buildings with new buildings at the same
locations and acquired two additional quick service restaurants in facilities
leased from a related party.
During fiscal 2003, the Company received $4,782,000 in net proceeds
from the sale of assets, mainly from the sale of four Grady's American Grill
restaurants.
During the third quarter of fiscal 2003, the Chairman and Chief
Executive Officer of the Company, Daniel B. Fitzpatrick, purchased all 1,148,014
shares of the Company's common stock owned by NBO, LLC, for approximately $4.1
million. As a result of this transaction, the Company incurred a one-time,
non-cash charge of $1,294,000, which is equal to the premium to the market price
that Mr. Fitzpatrick paid for the shares. The shares are owned by one of the
Company's Variable Interest Entities (VIE) that has been consolidated into the
Company's financial statements see Note 3. The purchase was substantially
financed by borrowings by the VIE.
The Company had a net repayment of $7,350,000 under its revolving
credit agreement during fiscal 2003. As of October 26, 2003, the Company's
revolving credit agreement had an additional $14,054,000 available for future
borrowings. The Company's average borrowing rate on October 26, 2003 was 4.18%.
The revolving credit agreement is subject to certain restrictive covenants that
require the Company, among other things, to achieve agreed
13
upon levels of cash flow. Under the revolving credit agreement the Company's
funded debt to consolidated cash flow ratio may not exceed 3.75 and its fixed
charge coverage ratio may not be less than 1.50 on October 26, 2003. The Company
was in compliance with these requirements with a funded debt to consolidated
cash flow ratio of 3.68 and a fixed charge coverage ratio of 1.72 as of and for
the period ended October 26, 2003.
The Company's primary cash requirements in fiscal 2004 will be capital
expenditures in connection with the opening of new restaurants, remodeling of
existing restaurants, maintenance expenditures, and the reduction of debt under
the Company's debt agreements. During fiscal 2004, the Company anticipates
opening two or three full service restaurants. The Company does not plan to open
any new quick service restaurants. 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. While the
Company's capital expenditures for fiscal 2004 are expected to range from
$10,000,000 to $12,000,000, 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 2003, consisting primarily of the principal
payments required under its mortgage facility.
The Company anticipates that its cash flow from operations, together
with the $14,054,000 available under its revolving credit agreement as of
October 26, 2003, will provide sufficient funds for its operating, capital
expenditure, debt service and other requirements through the end of fiscal 2004.
As of October 26, 2003, the Company had a financing package totaling
$109,066,000, consisting of a $60,000,000 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 which
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. 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
14
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%
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 2002
Q2 through Q4 4.00
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
October 26, 2003 was 3.68. To maintain the required ratios throughout fiscal
2004, the Company plans to continue to dispose of under-performing restaurants,
using the proceeds to reduce debt and to continue its efforts to optimize cash
flow from its restaurant operations. 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. During continuance of
an event of default, the Company would be subject to a post-default interest
rate under the Bank Facility which 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.
15
The Company has long-term contractual obligations primarily in the form
of lease and debt obligations. The following table summarizes the Company's
contractual obligations and their aggregate maturities as of October 26, 2003:
Payment Due by Fiscal Year
--------------------------------------------------------------------------------------
2009 and
Contractual Obligations 2004 2005 2006 2007 2008 thereafter Total
- ------------------------------- ----------- ------------- ----------- ------------ ----------- ----------- -----------
Mortgage debt-principal $ 1,625 $ 1,792 $ 1,985 $ 2,175 $ 2,316 $ 34,462 $ 44,355
Mortgage debt-interest 4,548 4,383 4,199 3,998 3,527 19,751 40,406
Revolver debt - - 43,600 - - - 43,600
Variable interest entity debt 5,661 234 220 1,320 - - 7,435
Operating leases 8,446 6,641 6,002 5,704 5,050 22,619 54,462
Construction commitments 1,680 - - - - - 1,680
---------- ------------ ---------- ----------- ---------- ---------- ----------
Total contractual cash
Obligations $ 21,960 $ 13,050 $ 56,006 $ 13,197 $ 10,893 $ 76,832 $191,938
---------- ------------ ---------- ----------- ---------- ---------- ----------
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This statement requires that a
liability for a cost associated with an exit or disposal activity be recognized
and measured initially at fair value only when the liability is incurred. It
nullifies the guidance in Emerging Issues Task Force 94-3, which recognized a
liability for an exit cost on the date an entity committed itself to an exit
plan. This statement is effective for exit or disposal activities that are
initiated after December 31, 2002. The Company adopted the provisions of SFAS
146 in the first quarter of fiscal 2003. The adoption of this statement did not
have a material effect on the Company's results.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an amendment of SFAS No.
123." This statement amends SFAS No. 123, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of Statement 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The Company does not intend to adopt the recognition provisions of SFAS
No. 123, as amended by SFAS No. 148. However, the Company early-adopted the
disclosure provisions in fiscal 2002 and included this information in Note 4 to
the Company's financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities". This Interpretation was
subsequently revised by the FASB in December 2003 (FIN 46R). The objective of
this Interpretation is to provide guidance on how to identify a variable
interest entity (VIE) and determine when the assets, liabilities, noncontrolling
interests, and results of operations of a VIE need to be included in a company's
consolidated financial statements. A company that holds variable interests in an
entity will need to consolidate the entity if the company's interest in the VIE
is such that the company will absorb a majority of the VIE's expected losses
and/or receive a majority of the entity's expected residual returns, if they
occur. FIN 46R also requires additional disclosures by primary beneficiaries and
other significant variable interest holders. FIN 46R is effective for periods
after June 15, 2003 for variable interest entities in which the Company holds a
variable interest it acquired before February 1, 2003. For entities acquired or
created before February 1, 2003, this Interpretation is effective no later than
the end of the first reporting period that ends after March 15, 2004, except for
those variable interest entities that are considered to be special-purpose
entities, for which the effective date is no later than the end of the first
reporting period that ends after December 31, 2003. The Company has applied FIN
46R to the accompanying financial statements (See Note 3).
16
IMPACT OF INFLATION
Management does not believe that inflation has had a material effect on
the Company's operations during the past several years. Increases in labor,
food, and other operating costs could adversely affect the Company's operations.
In the past, however, the Company generally has been able to modify its
operating procedures or increase menu prices to substantially offset increases
in its operating costs.
Many of the Company's employees are paid hourly rates related to
federal and state minimum wage laws and various laws that allow for credits to
that wage. Although the Company has been able to and will continue to attempt to
pass along increases in labor costs through food and beverage price increases,
there can be no assurance that all such increases can be reflected in its prices
or that increased prices will be absorbed by customers without diminishing, to
some degree, customer spending at the Company's restaurants.
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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company is exposed to interest rate risk in connection with its $60.0
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 $43,600,000 at October 26, 2003.
The impact on the Company's annual results of operations of a one-point interest
rate change would be approximately $436,000.
17
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
QUALITY DINING, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
October 26, October 27,
2003 2002
------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,724 $ 1,174
Accounts receivable 1,723 1,923
Inventories 1,670 1,843
Deferred income taxes 2,251 2,356
Assets held for sale 10,737 -
Other current assets 2,192 2,256
--------- ---------
Total current assets 20,297 9,552
--------- ---------
Property and equipment, net 107,910 124,451
--------- ---------
Other assets:
Deferred income taxes 6,749 7,644
Trademarks, net 1,285 5,317
Franchise fees and development fees, net 8,801 9,379
Goodwill, net 7,960 7,960
Liquor licenses, net 2,820 2,653
Other 3,454 3,692
--------- ---------
Total other assets 31,069 36,645
--------- ---------
Total assets $ 159,276 $ 170,648
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 10,055 $ 1,654
Accounts payable 6,182 9,796
Accrued liabilities 19,520 20,319
--------- ---------
Total current liabilities 35,757 31,769
Long-term debt 85,335 96,814
--------- ---------
Total liabilities 121,092 128,583
--------- ---------
Minority interest 14,272 16,312
Commitments and contingencies (Notes 9, 10 and 12)
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 and 12,969,672 shares issued, respectively 28 28
Additional paid-in capital 237,402 237,434
Accumulated deficit (206,514) (207,386)
Unearned compensation (575) (700)
--------- ---------
30,341 29,376
Less treasury stock, at cost, 2,508,587 and 1,360,573 shares, respectively 6,429 3,623
--------- ---------
Total stockholders' equity 23,912 25,753
--------- ---------
Total liabilities and stockholders' equity $ 159,276 $ 170,648
--------- ---------
The accompanying notes are an integral part of the consolidated financial
statements.
18
QUALITY DINING, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Fiscal Year Ended
-------------------------------------
October 26, October 27, October 28,
2003 2002 2001
----------- ----------- -----------
Revenues:
Burger King $ 114,983 $ 123,795 $ 80,791
Chili's Grill & Bar 80,710 75,760 69,727
Italian Dining Division 17,560 17,052 17,126
Grady's American Grill 6,078 21,113 32,969
----------- ----------- -----------
Total revenues 219,331 237,720 200,613
----------- ----------- -----------
Operating expenses:
Restaurant operating expenses:
Food and beverage 59,271 65,912 55,636
Payroll and benefits 63,923 69,571 59,101
Depreciation and amortization 9,940 9,893 10,613
Other operating expenses 56,638 59,292 49,368
----------- ----------- -----------
Total restaurant operating expenses 189,772 204,668 174,718
----------- ----------- -----------
Income from restaurant operations 29,559 33,052 25,895
----------- ----------- -----------
General and administrative 16,068 18,715 15,167
Amortization of intangibles 364 431 892
Facility closing costs (90) 355 898
Impairment of assets - - 14,487
----------- ----------- -----------
Operating income (loss) 13,217 13,551 (5,549)
----------- ----------- -----------
Other income (expense):
Interest expense (7,143) (7,916) (9,873)
Minority interest in earnings (2,678) (3,010) (2,886)
Recovery of note receivable 3,459 - -
Stock purchase expense (1,294) - -
Gain (loss) on sale of property and equipment (42) 1,034 (269)
Other income, net 997 697 1,197
----------- ----------- -----------
Total other expense (6,701) (9,195) (11,831)
----------- ----------- -----------
Income (loss) from continuing operations before income taxes 6,516 4,356 (17,380)
Income tax provision 3,293 522 330
----------- ----------- -----------
Income (loss) from continuing operations 3,223 3,834 (17,710)
Income (loss) from discontinued operations, net of tax (2,351) 1,250 2,180
----------- ----------- -----------
Net income (loss) $ 872 $ 5,084 $ (15,530)
----------- ----------- -----------
Basic net income (loss) per share:
Continuing operations 0.30 0.34 (1.56)
Discontinued operations (0.22) 0.11 0.19
----------- ----------- -----------
Basic net income (loss) per share $ 0.08 $ 0.45 $ (1.37)
----------- ----------- -----------
Diluted net income (loss) per share:
Continuing operations 0.30 0.34 (1.56)
Discontinued operations (0.22) 0.11 0.19
----------- ----------- -----------
Diluted net income (loss) per share $ 0.08 $ 0.45 $ (1.37)
----------- ----------- -----------
Weighted average shares outstanding:
Basic 10,897 11,248 11,356
----------- ----------- -----------
Diluted 10,921 11,306 11,356
----------- ----------- -----------
The accompanying notes are an integral part of the consolidated financial
statements.
19
QUALITY DINING, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars and shares in thousands)
Shares Additional Retained Stock-
Common Common Paid-in Earnings Unearned Treasury holders'
Stock Stock Capital (Deficit) Compensation Stock Equity
---------- --------- ---------- ----------- ------------ ---------- ---------
Balance, October 29, 2000 12,855 $ 28 $ 237,031 $(196,940) $ (437) $ (1,698) $ 37,984
Purchase of treasury stock - - - - - (1,925) (1,925)
Restricted stock grants 103 - 265 - 96 - -
Amortization of unearned
compensation - - - 12,651 - 96
Common stock subject to
redemption - - (245) - - - (245)
Restricted stock forfeited (17) - (49) - 49 - -
Net loss, fiscal 2001 - - - (15,530) - - (15,530)
--------- --------- --------- --------- --------- --------- ---------
Balance, October 28, 2001 12,941 28 237,002 (212,470) (557) (3,623) 20,380
Restricted stock grants 125 - 432 - (432) - -
Retirement of common stock (96) - - - - - -
Amortization of unearned
compensation - - - - 289 - 289
Net income, fiscal 2002 - - - 5,084 - - 5,084
--------- --------- --------- --------- --------- --------- ---------
Balance, October 27, 2002 12,970 28 237,434 (207,386) (700) (3,623) 25,753
Purchase of treasury stock - - - - - (2,806) (2,806)
Restricted stock forfeited (14) - (32) - 32 - -
Stock purchase expense - - - - - - -
Amortization of unearned
compensation - - - - 93 - 93
Net income, fiscal 2003 - - - 872 - - 872
--------- --------- --------- --------- --------- --------- ---------
Balance, October 26, 2003 12,956 $ 28 $ 237,402 $(206,514) $ (575) $ (6,429) $ 23,912
--------- --------- --------- --------- --------- --------- ---------
The accompanying notes are an integral part of the consolidated financial
statements.
20
QUALITY DINING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Fiscal Year Ended
-------------------------------------
October 26, October 27, October 28,
2003 2002 2001
----------- ----------- -----------
Cash flows from operating activities:
Net income (loss) $ 872 $ 5,084 $ (15,530)
Loss (income) from discontinued operations 2,351 (1,250) (2,180)
Minority interest in earnings 2,678 3,010 2,886
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization of property and equipment 9,555 9,631 10,640
Amortization of other assets 1,572 1,617 1,880
Impairment of assets and facility closing costs - 355 15,385
Loss (gain) on sale of property and equipment 42 (1,034) 269
Deferred income taxes 1,000 - -
Amortization of unearned compensation 93 289 96
Changes in operating assets and liabilities, excluding effects
of acquisitions and dispositions:
Accounts receivable 200 (50) 416
Inventories 173 199 391
Other current assets 64 (180) 84
Accounts payable (3,614) (803) (864)
Accrued liabilities (799) (781) (2,587)
----------- ----------- -----------
Net cash provided by operating activities 14,187 16,087 10,886
----------- ----------- -----------
Cash flows from investing activities:
Acquisition of business, net of cash - - (4,212)
Proceeds from sales of property and equipment 4,782 15,517 358
Purchase of property and equipment (9,570) (16,102) (11,821)
Purchase of other assets (892) (1,013) (847)
Other, net 279 - -
----------- ----------- -----------
Net cash used for investing activities (5,401) (1,598) (16,522)
----------- ----------- -----------
Cash flow from financing activities:
Purchase of treasury stock (2,806) - (1,925)
Borrowings of long-term debt 57,259 95,790 70,150
Repayment of long-term debt (60,337) (109,058) (63,231)
Cash distributions to minority interest (4,718) (3,758) (3,626)
Loan financing fees - (619) -
Purchase of common stock subject to redemption - (264) -
----------- ----------- -----------
Net cash (used for) provided by financing activities (10,602) (17,909) 1,368
----------- ----------- -----------
Cash provided by discontinued operations 2,366 2,266 3,622
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 550 (1,154) (646)
Cash and cash equivalents, beginning of year 1,174 2,328 2,974
----------- ----------- -----------
Cash and cash equivalents, end of year $ 1,724 $ 1,174 $ 2,328
----------- ----------- -----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest, net of amounts capitalized $ 7,049 $ 8,084 $ 9,447
Cash paid for income taxes $ 793 $ 1,131 $ 1,284
The accompanying notes are an integral part of the consolidated financial
statements.
21
QUALITY DINING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
{1} NATURE OF BUSINESS
Quality Dining, Inc. and its subsidiaries (the "Company") develop and operate
both quick service and full service restaurants in 13 states. The Company owns
and operates 11 Grady's American Grill restaurants, one Porterhouse Steaks and
Seafood restaurant, three restaurants under the tradename of Spageddies Italian
Kitchen and six restaurants under the tradename Papa Vino's Italian Kitchen. The
Company also operates, as a franchisee, 118 Burger King restaurants and 37
Chili's Grill & Bar restaurants.
{2} DISCONTINUED OPERATIONS
In accordance with 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 2003, four Grady's American Grill that met the criteria for `held
for sale' treatment in fiscal 2003 and five that met the criteria in fiscal 2004
as discontinued operations in the accompanying consolidated financial
statements.
The decision to dispose of these 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. Net income from
discontinued operations for the periods ended October 26, 2003, October 27,
2002, and October 28, 2001 were made up of the following components:
Fiscal Year Ended
October 26, October 27, October 28,
2003 2002 2001
------------ ----------- ------------
Revenue discontinued operations $ 16,219 $ 23,805 $ 27,478
Income discontinued restaurant operations 635 1,802 3,204
Facility closing costs (220) - -
Impairment of assets (4,411) - -
Gain on sale of assets 341 - -
----------- ----------- -----------
Income before taxes (3,655) 1,802 3,204
Income tax provision (benefit) (1,304) 552 1,024
----------- ----------- -----------
Income (loss) from discontinued operations $ (2,351) $ 1,250 $ 2,180
=========== =========== ===========
Basic and diluted net income per share from discontinued
operations $ (0.22) $ 0.11 $ 0.19
============ =========== ===========
Assets held for sale consist principally of property, plant and equipment
totaling $10,737,000 as of October 26, 2003. The cash flows associated with
these restaurants have also been separately identified in the consolidated
statements of cash flows. The accompanying footnotes to the financial statements
have been reclassified as necessary to conform to this presentation.
{3} BASIS OF PRESENTATION
The Company has 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. In accordance with FIN
46R the Company has elected to restate the results of all periods presented 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
22
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 $18,599,000 and $16,065,000 at October 26, 2003 and October 27, 2002,
respectively. The liabilities of the VIE's, which consist primarily of bank
debt, totaled $7,493,000 and $1,713,000 at October 26, 2003 and October 27,
2002, 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 $13,869,000 and $13,707,000 at October 26, 2003 and October 27, 2002,
respectively. The consolidation of the VIE's served to increase total
liabilities by $3,697,000 in fiscal 2003 and decrease total liabilities by
$2,605,000 in fiscal 2002. Additionally, the consolidation of the VIE's
increased treasury stock by $2,806,000 at October 26, 2003 as one of the VIE's
purchased common stock of the Company in fiscal 2003. The change had no impact
on reported net income for the years ended October 26, 2003, October 27, 2002
and October 28, 2001. However, the change did decrease weighted average shares
outstanding, basic and diluted, for the year ending October 26, 2003, because
one of the VIE's purchased 1,148,014 shares of the Company's common stock on
June 27, 2003, although this did not impact reported basic or diluted earnings
per share.
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 fiscal 2003, 2002 and 2001:
Fiscal Year Ended
October 26, October 27, October 28,
2003 2002 2001
------------------------------------------
Depreciation and amortization expense $ 9,805 $ 9,706 $ 10,342
Change in consolidation policy 135 187 271
------- ------- --------
Consolidated depreciation and amortization 9,940 9,893 10,613
------- ------- --------
Other operating expenses 59,217 62,011 51,982
Change in consolidation policy (2,579) (2,719) (2,614)
------- ------- --------
Consolidated other operating expenses 56,638 59,292 49,368
------- ------- --------
General and administrative expenses 15,961 18,638 15,111
Change in consolidation policy 107 77 56
------- ------- --------
Consolidated general and administrative expenses 16,068 18,715 15,167
------- ------- --------
Interest expense 7,479 8,429 10,419
Change in consolidation policy (336) (513) (546)
------- ------- --------
Consolidated interest expense 7,143 7,916 9,873
------- ------- --------
Other income (expense) 992 655 1,185
Change in consolidation policy 5 42 12
------- ------- --------
Consolidated other income (expense) 997 697 1,197
------- ------- --------
Basic net income (loss) per share 0.08 0.45 (1.37)
Change in consolidation policy - - -
------- ------- --------
Consolidated basic net income (loss) per share 0.08 0.45 (1.37)
------- ------- --------
Diluted net income (loss) per share 0.08 0.45 (1.37)
Change in consolidation policy - - -
------- ------- --------
Consolidated diluted net income (loss) per share 0.08 0.45 (1.37)
------- ------- --------
23
Fiscal Year Ended
October 26, October 27, October 28,
2003 2002 2001
------------------------------------------
Weighted average shares outstanding:
Basic 11,311 11,248 11,356
Change in consolidation policy (414) - -
------- ------- --------
Consolidated basic 10,897 11,248 11,356
------- ------- --------
Diluted 11,335 11,306 11,356
Change in consolidation policy (414) - -
------- ------- --------
Consolidated diluted 10,921 11,306 11,356
------- ------- --------
All significant intercompany balances and transactions have been eliminated.
{4} SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
FISCAL YEAR - The Company maintains its accounts on a 52/53 week fiscal year
ending the last Sunday in October. The fiscal year ended October 26, 2003
(fiscal 2003) contained 52 weeks. The fiscal years ended October 27, 2002
(fiscal 2002) and October 28, 2001 (fiscal 2001) also contained 52 weeks.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS - The preparation of
financial statements in conformity with generally accepted accounting principles
in the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
REVENUE RECOGNITION - The Company recognizes revenue upon delivery of products
to its customers.
INVENTORIES - Inventories consist primarily of restaurant food and supplies and
are stated at the lower of cost or market. Cost is determined using the
first-in, first-out method.
INSURANCE/SELF-INSURANCE - The Company uses a combination of insurance,
self-insurance retention and self-insurance for a number of risks including
workers' compensation, general liability, employment practices, directors and
officers liability, vehicle liability and employee related health care benefits.
Liabilities associated with these risks are estimated in part by considering
historical claims experience, demographic factors, severity factors and other
actuarial assumptions.
PROPERTY AND EQUIPMENT - Property and equipment, including capitalized leased
properties, are stated at cost. Depreciation and amortization are being recorded
on the straight-line method over the estimated useful lives of the related
assets. Leasehold improvements are amortized over the shorter of the estimated
useful life or the lease term of the related asset. The general ranges of
original depreciable lives are as follows:
Years
-----
Capitalized Lease Property 17-20
Buildings and Leasehold Improvements 10-31-1/2
Furniture and Equipment 3-7
Computer Equipment and Software 5-7
Upon the sale or disposition of property and equipment, the asset cost and
related accumulated depreciation are removed from the accounts and any resulting
gain or loss is included in Other Expense. Normal repairs and maintenance costs
are expensed as incurred.
LONG-LIVED ASSETS - Long-lived assets and intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of a
restaurant's long-lived asset group to be held and used is measured by a
comparison of the carrying amount of the assets to the future net cash flows
expected to be generated by the asset or asset group. If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceeds the fair value of the
assets. Considerable management judgment is necessary to estimate the fair value
of the assets, including a discounted value of estimated future cash flows and
fundamental analyses. Accordingly, actual results could vary from such
estimates. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less the cost to sell.
ADOPTION OF STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 141 AND NO. 142. In
July 2001, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 141,
24
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS 141 requires that the purchase method of accounting be used for
business combinations initiated after June 30, 2001. SFAS 141 also establishes
criteria that must be used to determine whether acquired intangible assets
should be recognized separately from goodwill in the Company's financial
statements. Under SFAS 142, amortization of goodwill, including goodwill
recorded in past business combinations, will discontinue upon adoption of this
standard. In addition, goodwill and indefinite-lived intangible assets will be
tested for impairment in accordance with the provisions of SFAS 142. SFAS 142 is
effective for fiscal years beginning after December 15, 2001. The Company early
adopted the provisions of SFAS 142, in the first quarter of fiscal 2002. SFAS
142 allows up to six months from the date of adoption to complete the
transitional goodwill impairment test which requires the comparison of the fair
value of a reporting unit to its carrying value (using amounts measured as of
the beginning of the year of adoption) to determine whether there is an
indicated transitional goodwill impairment. The quantification of an impairment
requires the calculation of an "implied" fair value for a reporting unit's
goodwill. If the implied fair value of the reporting unit's goodwill is less
than its recorded goodwill, a transitional goodwill impairment charge is
recognized and reported as a cumulative effect of a change in accounting
principle. The Company completed the impairment testing of goodwill during the
second quarter of fiscal 2002 and determined that there is no transitional
goodwill impairment.
Amortized intangible assets consist of the following:
(Dollars in thousands) As of October 26, 2003
- ------------------------------------ -------------------------------------------------
Gross Carrying Accumulated Net
Amortized intangible assets Amount Amortization Book Value
------------- ------------ ----------
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 fiscal 2003 was
$1,113,000. The estimated intangible amortization expense for each of the next
five years is $1,359,000.
In the second quarter of fiscal 2003, the Company recorded an impairment charge
related to certain Grady's American Grill restaurants that resulted in a
reduction of the net book value of the Grady's American Grill trademark by
$2,882,000. In conjunction with the Company's impairment assessment, the Company
revised its estimate of the remaining useful life of the trademark from 15 to 5
years. As a result of these changes, net income for fiscal 2003 increased by
$87,000, which is approximately $0.01 per diluted share.
In the fourth quarter of fiscal 2001, the Company recorded an impairment charge
related to certain Grady's American Grill restaurants that resulted in a
reduction of the net book value of the Grady's American Grill trademark by
$4,920,000. In conjunction with the Company's impairment assessment, the Company
revised its estimate of the remaining useful life of the trademark to 15 years.
The original estimated life of the trademark was 40 years. As a result of these
changes, net income for fiscal 2002 was decreased by $89,000, which is
approximately $0.01 per diluted share.
The Company operates four distinct restaurant concepts in the food-service
industry. It owns the Grady's American Grill concept, an Italian Dining concept
and it 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 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.
25
ADOPTION OF STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 142. The following
table reports the comparative impact the adoption of Statement 142 has on the
Company's reported results of operations.
Fiscal Year Ended
October 26, October 27, October 28,
2003 2002 2001
---------- ---------- ----------
(Dollars in thousands, except for earnings-per-share amounts)
Reported net income (loss) $ 872 $ 5,084 $ (15,530)
Add back: Goodwill amortization - - 541
---------- ---------- -----------
Adjusted net income (loss) $ 872 $ 5,084 $ (14,989)
========== ========== ===========
Basic earnings (loss) per share:
Reported net income (loss) $ 0.08 $ 0.45 $ (1.37)
Goodwill amortization - - 0.05
---------- ---------- -----------
Adjusted net income (loss) $ 0.08 $ 0.45 $ (1.32)
========== ========== ===========
Diluted earnings (loss) per share:
Reported net income (loss) $ 0.08 $ 0.45 $ (1.37)
Goodwill amortization - - 0.05
---------- ---------- -----------
Adjusted net income (loss) $ 0.08 $ 0.45 $ (1.32)
========== ========== ===========
Fiscal Year Ended
October 26, October 27, October 28,
2003 2002 2001
---------- ---------- ----------
(Dollars in thousands, except for earnings-per-share amounts)
Reported net income (loss) from continuing operations $ 3,223 $ 3,834 $ (17,710)
Add back: Goodwill amortization - - 541
---------- ---------- -----------
Adjusted net income (loss) from continuing operations $ 3,223 $ 3,834 $ (17,169)
========== ========== ===========
Basic earnings (loss) per share:
Reported net income (loss) from continuing operations $ 0.30 $ 0.34 $ (1.56)
Goodwill amortization - - 0.05
---------- ---------- -----------
Adjusted net income (loss) from continuing operations $ 0.30 $ 0.34 $ (1.51)
========== ========== ===========
Diluted earnings (loss) per share:
Reported net income (loss) from continuing operations $ 0.30 $ 0.34 $ (1.56)
Goodwill amortization - - 0.05
---------- ---------- -----------
Adjusted net income (loss) from continuing operations $ 0.30 $ 0.34 $ (1.51)
========== ========== ===========
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
the respective franchisors are deferred and expensed in the period the related
restaurants are opened. Franchise fees are being amortized on a straight-line
basis, generally over 20 years. Accumulated amortization of franchise fees as of
October 26, 2003 and October 27, 2002 was $5,981,000 and $5,239,000,
respectively.
ADVERTISING - The Company incurs advertising expense related to its concepts
under franchise agreements (See Note 5) or through local advertising.
Advertising costs are expensed at the time the related advertising first takes
place. Advertising costs were $8,011,000, $8,523,000 and $7,630,000 for fiscal
years 2003, 2002 and 2001, respectively.
LIQUOR LICENSES - Costs incurred in securing liquor licenses for the Company's
restaurants and the fair value of liquor licenses acquired in acquisitions are
capitalized and amortized on a straight-line basis, principally over 20 years.
Accumulated amortization of liquor licenses as of October 26, 2003 and October
27, 2002 was $1,514,000 and $1,316,000, respectively.
26
DEFERRED FINANCING COSTS - Deferred costs of debt financing included in other
non-current assets are amortized over the life of the related loan agreements,
which range from three to 20 years.
COMPUTER SOFTWARE COSTS - Costs of purchased and internally developed computer
software are capitalized in accordance with SOP 98-1 and amortized over a five
to seven year period using the straight-line method. As of October 26, 2003 and
October 27, 2002, capitalized computer software costs, net of related
accumulated amortization, aggregated $890,000 and $1,188,000, respectively.
Amortization of computer software costs was $265,000, $259,000 and $391,000 for
fiscal years 2003, 2002 and 2001 respectively.
CAPITALIZED INTEREST - Interest costs capitalized during the construction period
of new restaurants and major capital projects were $18,000, $28,000 and $18,000
for fiscal years 2003, 2002 and 2001 respectively.
STOCK-BASED COMPENSATION - The Company has adopted the disclosure provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation", as amended by SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an
amendment of SFAS No. 123." These statements encourage rather than require
companies to adopt a new method that accounts for stock-based compensation
awards based on their estimated fair value at the date they are granted.
Companies are permitted, however, to continue accounting for stock compensation
awards under 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 the 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. The Company has elected to continue to apply APB Opinion No. 25.
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:
October 26, October 27, October 28,
(in thousands, except per share amounts) 2003 2002 2001
---------------------------------------- ---- ---- ----
Net income (loss), as reported $ 872 $ 5,084 $ (15,530)
Deduct: Total stock option based employee compensation expense
determined by using the Black-Scholes option pricing model, net of
related tax effects (38) (48) (61)
------- -------- ---------
Net income (loss), pro forma $ 834 $ 5,036 $ (15,591)
------- -------- ---------
Basic net income (loss) per common share, as reported $ 0.08 $ 0.45 $ (1.37)
Basic net income (loss) per common share, pro forma $ 0.08 $ 0.45 $ (1.37)
The weighted average fair value at the date of grant for options granted during
fiscal 2003, 2002 and 2001 was $1.05, $1.76 and $1.12 per share, respectively.
The fair value of each option grant is estimated on the date of the grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in fiscal 2003, 2002 and 2001: dividend yield of 0%
for all years; expected volatility of 53.5%, 55.0% and 54.1%, respectively;
risk-free interest rate of 3.6%, 3.5% and 4.6%, respectively; and expected lives
of 5 years for all fiscal years.
STOCK PURCHASE EXPENSE - During the third quarter of fiscal 2003, the Chairman
and Chief Executive Officer of the Company, Daniel B. Fitzpatrick, purchased all
1,148,014 shares of the Company's common stock, owned by NBO, LLC ("NBO"), for
approximately $4.1 million. The Company was required to take a one-time non-cash
charge of $1,294,000, which is equal to the premium to the market price that Mr.
Fitzpatrick paid for the shares.
NET INCOME (LOSS) 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 dilutive
shares represents options on common stock. Excluded from the diluted earnings
per share calculations for fiscal 2003, 2002 and 2001 were 580,683, 457,020 and
608,454, respectively, because to include them would have been anti-dilutive.
27
CONCENTRATIONS OF CREDIT RISK - Financial instruments, which potentially subject
the Company to credit risk, consist primarily of cash and cash equivalents and
notes receivable. Substantially all of the Company's cash and cash equivalents
at October 26, 2003 were concentrated with a bank located in Chicago, Illinois.
CASH AND CASH EQUIVALENTS - The Company considers all highly liquid investments
with original maturities of three months or less to be cash equivalents.
INCOME TAXES - The Company utilizes SFAS No. 109, "Accounting for Income Taxes,"
which requires recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been included in the
financial statements or tax returns. Under this method, deferred tax assets and
liabilities are determined based on the differences between the financial
statement and tax basis of assets and liabilities using enacted tax rates in
effect for the years in which the differences are expected to reverse. SFAS 109
requires the establishment of a valuation reserve against any deferred tax
assets if the realization of such assets is not deemed more likely than not.
RECLASSIFICATIONS - To enhance comparative data, management concluded during
fiscal 2003 that sales of promotional items, consisting primarily of toys
accompanying kids meals in the quick service segment, should be reported as
revenues. Previously, these items were immaterial in amount and the value
attributable to them was recorded as an offset to other restaurant operating
expense. Amounts reported in prior periods have been reclassified to conform to
the current quarter's presentation. For all periods presented, the
reclassifications result in an increase of approximately 1% in consolidated
revenue and restaurant operating expenses as compared to amounts previously
reported. Such reclassifications had no impact on previously reported income
from restaurant operations, operating income, net income, or stockholders'
equity.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This statement requires that a
liability for a cost associated with an exit or disposal activity be recognized
and measured initially at fair value only when the liability is incurred. It
nullifies the guidance in Emerging Issues Task Force 94-3, which recognized a
liability for an exit cost on the date an entity committed itself to an exit
plan. This statement is effective for exit or disposal activities that are
initiated after December 31, 2002. The Company adopted the provisions of SFAS
146 in the first quarter of fiscal 2003. The adoption of this statement did not
have a material affect on the Company's results.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an amendment of SFAS No.
123." This statement amends SFAS No. 123, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of Statement 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The Company does not intend to adopt the recognition provisions of SFAS
No. 123, as amended by SFAS No. 148. The Company has adopted the disclosure
provisions.
28
{5} OTHER CURRENT ASSETS AND ACCRUED LIABILITIES
Other current assets and accrued liabilities consist of the following:
October 26, October 27,
(Dollars in thousands) 2003 2002
- ---------------------- ---- ----
Other current assets:
Prepaid real estate taxes $ 689 $ 652
Prepaid insurance 589 611
Deposits 406 428
Prepaid expenses and other current assets 508 565
------- -------
$ 2,192 $ 2,256
------- -------
Accrued liabilities:
Accrued salaries, wages and severance $ 3,711 $ 4,601
Accrued insurance costs 3,688 3,286
Unearned income 2,214 2,269
Accrued advertising and royalties 1,324 1,214
Accrued property taxes 1,344 1,106
Accrued sales taxes 738 908
Other accrued liabilities 6,501 6,935
------- -------
$19,520 $20,319
------- -------
{6} PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
October 26, October 27,
(Dollars in thousands) 2003 2002
- ---------------------- ---- ----
Land and land improvements $ 31,746 $ 42,548
Buildings and leasehold improvements 95,263 96,273
Furniture and equipment 57,221 63,718
Construction in progress 571 2,060
--------- ---------
184,801 204,599
--------- ---------
Less, accumulated depreciation and capitalized lease amortization 76,891 80,148
--------- ---------
Property and equipment, net $ 107,910 $ 124,451
--------- ---------
{7} FRANCHISE AND DEVELOPMENT RIGHTS
The Company has entered into franchise agreements with two franchisors for
the operation of two of its restaurant concepts, Burger King and Chili's. The
existing franchise agreements provide the franchisors with significant rights
regarding the business and operations of the Company's franchised restaurants.
The franchise agreements with Burger King Corporation require the Company to pay
royalties ranging from 2.75% to 4.5% of sales and advertising fees of 4.0% of
sales. The franchise agreements with Brinker International, Inc. ("Brinker")
covering the Company's Chili's restaurant concept require the Company to pay
royalty and advertising fees equal to 4.0% and 0.5% of Chili's restaurant sales,
respectively. In addition, the Company is required to spend 2.0% of sales from
each of its Chili's restaurants on local advertising which is considered to be
met by the additional contributions described below. As part of a system-wide
promotional effort, the Company paid an additional advertising fee as follows:
29
Period % of Sales
- ------ ----------
September 1, 1999 through August 30, 2000 0.375%
September 1, 2000 through June 27, 2001 1.0%
June 28, 2001 through June 26, 2002 1.2%
June 27, 2002 through June 25, 2003 2.0%
June 26, 2003 through June 30, 2004 2.25%
The Company's development agreement with Brinker expired on December 31,
2003. The development agreement entitled the Company to develop up to 41 Chili's
restaurants in two regions encompassing counties in Indiana, Michigan, Ohio,
Kentucky, Delaware, New Jersey and Pennsylvania. The Company paid development
fees totaling $260,000 for the right to develop the restaurants in the regions.
Each Chili's franchise agreement requires the Company to pay an initial
franchise fee of $40,000, a monthly royalty fee of 4.0% of sales and advertising
fees of 0.5% of sales. The Company completed all of its obligations under its
development agreement prior to its expiration.
On January 27, 2000 the Company executed a "Franchisee Commitment"
pursuant to which it agreed to undertake certain "Transformational Initiatives"
including capital improvements and other routine maintenance in all of its
Burger King restaurants. The capital improvements include the installation of
signage bearing the new Burger King logo and the installation of a new
drive-through ordering system. The initial deadline for completing these capital
improvements - December 31, 2001 - was extended to December 31, 2002, although
the Company met the initial deadline with respect to 66 of the 70 Burger King
restaurants subject to the Franchisee Commitment. The Company completed the
capital improvements to the remaining four restaurants prior to December 31,
2002. In addition, the Company agreed to perform, as necessary, certain routine
maintenance such as exterior painting, sealing and striping of parking lots and
upgraded landscaping. The Company completed this maintenance prior to September
30, 2000, as required. In consideration for executing the Franchisee Commitment,
the Company received "Transformational Payments" totaling approximately $3.9
million during fiscal 2000. In addition, the Company received supplemental
Transformational Payments of approximately $135,000 in October of 2001 and
$180,000 in 2002. The portion of the Transformational Payments that corresponds
to the amount required for the capital improvements will be recognized as income
over the useful life of the capital improvements. The portion of the
Transformational Payments that corresponds to the required routine maintenance
was recognized as a reduction in maintenance expense over the period during
which maintenance was performed. The remaining balance of the Transformational
Payments was recognized as other income ratably through December 31, 2001, the
term of the initial Franchisee Commitment, except that the supplemental
Transformational Payments were recognized as other income when received.
During fiscal 2000, Burger King Corporation increased its royalty and
franchise fees for most new restaurants. The franchise fee for new restaurants
increased from $40,000 to $50,000 for a 20 year agreement and the royalty rate
increased from 3.5% of sales to 4.5% of sales, after a transitional period. For
franchise agreements entered into during the transitional period, the royalty
rate will be 4.0% of sales for the first 10 years and 4.5% of sales for the
balance of the term.
For new restaurants, the transitional period was from July 1, 2000 to June
30, 2003. Since July 1, 2003, the royalty rate is 4.5% of sales for the full
term of new restaurant franchise agreements. For renewals of existing franchise
agreements, the transitional period was from July 1, 2000 through June 30, 2001.
As of July 1, 2001, existing restaurants that renew their franchise agreements
will pay a royalty of 4.5% of sales for the full term of the renewed agreement.
The advertising contribution remains at 4.0% of sales. Royalties payable under
existing franchise agreements are not affected by these changes until the time
of renewal, at which time the then prevailing rate structure will apply.
Burger King Corporation offered a voluntary program as an incentive for
franchisees to renew their franchise agreements prior to the scheduled
expiration date ("2000 Early Renewal Program"). Franchisees that elected to
participate in the 2000 Early Renewal Program were required to make capital
investments in their restaurants by, among other things, bringing them up to
Burger King Corporation's current image, and to extend occupancy leases.
Franchise agreements entered into under the 2000 Early Renewal Program have
special provisions regarding the royalty payable during the term, including a
reduction in the royalty to 2.75% over five years generally beginning April,
2002 and concluding in April, 2007.
The Company included 36 restaurants in the 2000 Early Renewal Program. The
Company paid franchise fees of $877,000 in the third quarter of fiscal 2000 to
extend the franchise agreements of the selected restaurants for 16 to
30
20 years. In fiscal 2001 and 2002, the Company invested approximately $6.6
million to remodel the selected restaurants to Burger King Corporation's current
image.
Burger King Corporation offered an additional voluntary program as an
incentive to franchisees to renew their franchise agreements prior to the
scheduled expiration date ("2001 Early Renewal Program"). Franchisees that
elected to participate in the 2001 Early Renewal Program are required to make
capital investments in their restaurants by, among other things, bringing them
up to Burger King Corporation's current image (Image 99), and to extend
occupancy leases. Franchise agreements entered into under the 2001 Early Renewal
Program have special provisions regarding the royalty payable during the term,
including a reduction in the royalty to 2.75% over five years commencing 90 days
after the semi-annual period in which the required capital improvements are
made.
The Company included three restaurants in the 2001 Early Renewal Program.
The Company paid franchise fees of $144,925 in fiscal 2001 to extend the
franchise agreements of the selected restaurants for 17 to 20 years. The Company
invested approximately $1.7 million in fiscal 2003 to remodel two participating
restaurants to Burger King Corporation's current image. The Company withdrew one
restaurant from the 2001 Early Renewal Program in fiscal 2004.
Through participation in the various early renewal plans the Company has
been able to reduce it royalty expense by $421,000, $301,000 and $146,000 in
fiscal 2004, 2003 and 2002, respectively.
Burger King Corporation also provides general specifications for designs,
color schemes, signs and equipment, formulas for preparation of food and
beverage products, marketing concepts, inventory, operations and financial
control methods, management training, technical assistance and materials. Each
franchise agreement prohibits the Company from transferring a franchise without
the prior approval of Burger King Corporation.
Burger King Corporation's franchise agreements prohibit the Company,
during the term of the agreements, from owning or operating any other hamburger
restaurant. For a period of one year following the termination of a franchise
agreement, the Company remains subject to such restriction within a two mile
radius of the Burger King restaurant which was the subject of the franchise
agreement.
31
{8} INCOME TAXES
The provision for income taxes for the fiscal years ended October 26, 2003,
October 27, 2002 and, October 28, 2001 is summarized as follows:
Fiscal Year Ended
October 26, October 27, October 28,
(Dollars in thousands) 2003 2002 2001
- ---------------------- ---- ---- ----
Current:
Federal $ - $ (330) -
State 976 1,348 1,276
-------- --------- ---------
976 1,018 1,276
-------- --------- ---------
Deferred:
Provision (benefit) for the period 2,317 (496) (946)
-------- --------- ---------
Total $ 3,293 $ 522 $ 330
-------- --------- ---------
The components of the deferred tax assets and liabilities are as follows:
October 26, October 27,
(Dollars in thousands) 2003 2002
- ---------------------- ---- ----
Deferred tax assets:
Net operating loss carryforwards $ 19,852 $ 15,589
Note receivable allowance - 6,991
FICA tip credit and minimum tax credit 5,141 4,580
Accrued liabilities 2,531 2,290
Property and equipment 2,888 2,401
Capitalized lease obligations 637 686
Trademarks 1,767 666
Franchise Fees 803 737
Other 616 790
-------- --------
Deferred tax assets 34,235 34,730
Less: Valuation allowance (24,169) (23,958)
-------- --------
10,066 10,772
-------- --------
Deferred tax liabilities:
Goodwill (958) (686)
Other (108) (86)
-------- --------
Deferred tax liabilities (1,066) (772)
-------- --------
Net deferred tax assets $ 9,000 $ 10,000
-------- --------
The Company has net operating loss carryforwards of approximately $56.7
million as well as FICA tip credits and alternative minimum tax credits of $5.1
million.
Net operating loss carryforwards expire as follows:
Net operating loss
carryforwards
-------------
Net operating loss carryforwards expiring 2012 $ 39,921,000
Net operating loss carryforwards expiring 2018 3,000,000
Net operating loss carryforwards expiring 2021 1,619,000
Net operating loss carryforwards expiring 2022 12,181,000
------------
Total net operating loss carryforwards $ 56,721,000
------------
32
FICA tip credits expire as follows:
FICA Tip Credits
----------------
FICA tip credit expiring in 2012 $ 1,340,000
FICA tip credit expiring in 2013 477,000
FICA tip credit expiring in 2014 572,000
FICA tip credit expiring in 2015 571,000
FICA tip credit expiring in 2016 727,000
FICA tip credit expiring in 2017 702,000
FICA tip credit expiring in 2018 561,000
-----------
Total FICA tip credits $ 4,950,000
-----------
The alternative minimum tax credits of $191,000 carryforward indefinitely.
At October 26, 2003, the Company has deferred tax assets consisting
principally of carryforward tax losses and credits aggregating $34,235,000.
After considering the weight of available positive and negative evidence
regarding the realizability of these assets, the Company has recorded a
valuation allowance aggregating $24,169,000, to reduce its net deferred tax
asset to $9,000,000, the amount management believes more likely than not will be
realized. The significant positive evidence considered by management in making
this judgment included the Company's profitability in 2002 and 2003, the
consistent historical profitability of the Company's Burger King, Chili's and
Italian Dining divisions, and the resolution during 2003 of substantially all
contingent liabilities related to its sold bagel businesses. The negative
evidence considered by management includes persistent negative operating trends
in its Grady's American Grill division, recent same store sales declines in the
Burger King division (the largest operating unit) and statutory limitations on
available carryforward tax benefits.
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.
Based on its assessment and using the methodology described above,
management believes more likely than not the net deferred tax asset will be
realized. The Company is currently profitable, has offset approximately $8.5
million of taxable income with net operating loss carryforward benefits in the
last two years, and management believes the issues that gave rise to historical
losses have been substantially resolved with no impact on its continuing
businesses. Moreover, these core businesses have been historically, and continue
to be, profitable. Nonetheless, realization of the net deferred tax asset will
require approximately $26.5 million of future taxable income. 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.
Differences between the effective income tax rate and the U.S. statutory tax
rate are as follows:
Fiscal Year Ended
October 26, October 27, October 28,
(Percent of pretax income) 2003 2002 2001
- -------------------------- ---- ---- ----
Statutory tax rate 34.0% 34.0% (34.0)%
State income taxes, net of federal income tax benefit 9.9 20.4 4.8
FICA tax credit (4.6) (8.3) (2.1)
Change in valuation allowance 3.2 (38.1) 33.1
Stock purchase expense 6.8 - -
Other, net 1.3 3.9 0.1
---- ----- ----
Effective tax rate 50.6% 11.9% 1.9%
---- ----- ----
33
{9} LONG-TERM DEBT AND CREDIT AGREEMENTS
The Company has a financing package totaling $109,066,000, consisting of a
$60,000,000 revolving credit agreement and a $49,066,000 mortgage facility, as
described below. The revolving credit agreement executed with JP Morgan Chase
Bank, as agent for a group of five banks, provides for borrowings of up to
$60,000,000 with interest payable at the adjusted LIBOR rate plus a contractual
spread. The weighted average borrowing rate under the revolving credit agreement
on October 26, 2003 was 4.18%. The revolving credit agreement will mature on
November 1, 2005, at which time all amounts outstanding thereunder are due. The
Company had $14,054,000 available under its revolving credit agreement as of
October 26, 2003. The revolving credit agreement 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 real and personal property not pledged in the mortgage
financing.
The revolving credit agreement contains, among other provisions,
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. Under the revolving credit
agreement the Company's funded debt to consolidated cash flow ratio could not
exceed 3.75 and its fixed charge coverage ratio could not be less than 1.50 on
October 26, 2003. The Company was in compliance with these requirements with a
funded debt to consolidated cash flow ratio of 3.68 and a fixed charge coverage
ratio of 1.72.
Letters of credit reduce the Company's borrowing capacity under its
revolving credit facility and represent purchased guarantees that ensure the
Company's performance or payment to third parties in accordance with specified
terms and conditions which amounted to $2,346,000 and $1,876,000 as of October
26, 2003 and October 27, 2002, respectively.
The $49,066,000 mortgage facility currently includes 34 separate mortgage
notes, with 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 and 15 of the Company's
Burger King restaurants. The mortgage notes contain, among other provisions,
financial covenants which 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 revolving credit agreement. 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 revolving credit agreement. 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.
The Company has adopted FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities", as revised by the FASB in December 2003 (FIN 46R),
(See Note 3). 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 (VIE). 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 VIE's bank debt
totaled $7,434,000 at October 26, 2003 and $5,661,000 of that debt was
classified as current debt.
The aggregate maturities of long-term debt subsequent to October 26, 2003
are as follows:
34
(Dollars in thousands)
FISCAL YEAR
- -----------
2004 $ 10,286
2005 2,026
2006 42,805
2007 3,495
2008 2,316
2009 and thereafter 34,462
--------
Total $ 95,390
--------
{10} EMPLOYEE BENEFIT PLANS
STOCK OPTIONS
The Company has four stock option plans: the 1993 Stock Option and
Incentive Plan, the 1997 Stock Option and Incentive Plan, the 1993 Outside
Directors Stock Option Plan and the 1999 Outside Directors Stock Option Plan .
On March 26, 1997 the Company's shareholders approved the 1997 Stock
Option and Incentive Plan and therefore no awards for additional shares of the
Company's common stock will be made under the 1993 Stock Option and Incentive
Plan. Under the 1997 Stock Option and Incentive Plan, shares of restricted stock
and options to purchase shares of the Company's common stock may be granted to
officers and other employees. An aggregate of 1,100,000 shares of common stock
has been reserved for issuance under the 1997 Stock Option and Incentive Plan.
As of October 26, 2003, there were 105,935 and 545,083 options outstanding under
the 1993 Stock Option and Incentive Plan and the 1997 Stock Option and Incentive
Plan, respectively. Typically, options granted under these plans have a term of
10 years and become exercisable incrementally over 3 years.
In December of 2000 the Company's Board of Directors approved the 1999
Outside Directors Stock Option Plan. Under the 1999 Outside Directors Stock
Option Plan, 80,000 shares of common stock have been reserved for the issuance
of nonqualified stock options to be granted to non-employee directors of the
Company. On May 1, 2001, and on each May 1 thereafter, each then non-employee
director of the Company will receive an option to purchase 2,000 shares of
common stock at an exercise price equal to the fair market value of the
Company's common stock on the date of grant. Each option has a term of 10 years
and becomes exercisable six months after the date of grant. During fiscal 2003
the Company issued 10,000 shares under the 1999 Outside Directors Stock Option
Plan. As of October 26, 2003, there were 38,000 and 46,000 options outstanding
under the 1993 Outside Directors Stock Option Plan and the 1999 Outside
Directors Stock Option Plan, respectively.
On June 1, 1999, the Company implemented a Long Term Incentive
Compensation Plan (the "Long Term Plan") for seven of its executive officers and
certain other senior executives (the "Participants"). The Long Term Plan is
designed to incent and retain those individuals who are critical to achieving
the Company's long term business objectives. The Long Term Plan consists of (a)
options granted with an exercise price equal to the closing price of the
Company's common stock on the grant date, which vest over three years; (b)
restricted stock awards of common shares which vest over seven years, subject to
accelerated vesting in the event the price of the Company's common stock
achieves certain targets; and, for certain Participants, (c) a cash bonus
payable at the conclusion of fiscal year 2000. Under the Long Term Plan, the
Company issued 102,557 restricted shares in fiscal 2001 and 104,360 restricted
shares in fiscal 2000. There were 14,318 of restricted stock forfeited in fiscal
2003, no shares of restricted stock were forfeited in fiscal 2002 and 17,415
shares of restricted stock forfeited in fiscal 2001.
During fiscal 2002, the Company issued 125,000 restricted shares and
75,000 options on similar terms as those which were issued under the Long Term
Plan. During fiscal 2003, the Company did not issue any restricted shares or
stock options to employees.
As a result of the restricted stock grants, the Company recorded an
increase to additional paid in capital and an offsetting deferred charge for
unearned compensation. The deferred charge is equal to the number of shares
granted multiplied by the Company's closing share price on the day of the grant.
The deferred charge is classified in the equity section of the Company's
consolidated balance sheet as unearned compensation and is being amortized to
35
compensation expense on a straight-line basis over the vesting period, subject
to accelerated vesting if the Company's common stock reaches certain benchmarks.
Activity with respect to the Company's stock option plans for fiscal years
2003, 2002 and 2001 was as follows:
Weighted Average
Exercise
Number of Shares Price
---------------- -----------------
Outstanding, October 29, 2000 634,825 $ 5.78
Granted 19,000 2.17
Canceled (45,371) 5.07
Exercised - -
------- ------
Outstanding, October 28, 2001 608,454 5.72
Granted 75,000 3.46
Canceled (11,955) 9.11
Exercised - -
------- ------
Outstanding, October 27, 2002 671,499 5.41
Granted 10,000 2.11
Canceled (30,481) 3.41
Exercised - -
------- ------
Outstanding, October 26, 2003 651,018 $5.45
------- ------
Exercisable, October 26, 2003 606,518
-------
Available for future grants at October 26, 2003 240,943
-------
The following table summarizes information relating to fixed-priced stock
options outstanding for all plans as of October 26, 2003.
Options Outstanding Options Exercisable
------------------- -------------------
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Range of Exercise Price Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- ----------------------- ----------- ---------------- -------------- ----------- --------------
$.10 - $3.50 436,698 5.20 years $ 3.06 422,198 $ 3.09
$3.51 - $12.00 133,200 5.29 years $ 6.70 103,200 $ 7.63
$12.01 - $32.875 81,120 1.78 years $ 16.28 81,120 $ 16.28
RETIREMENT PLANS
On October 27, 1986, the Company implemented the Quality Dining, Inc.
Retirement Plan and Trust ("Plan I"). Plan I is designed to provide all of the
Company's employees with a tax-deferred long-term savings vehicle. The Company
provides a matching cash contribution equal to 50% of a participant's
contribution, up to a maximum of 5% of such participant's compensation. Plan I
is a qualified 401(k) plan. Participants in Plan I elect the percentage of pay
they wish to contribute as well as the investment alternatives in which their
contributions are to be invested. Participant's contributions vest immediately
while Company contributions vest 25% annually beginning in the participant's
second year of eligibility since Plan I inception.
On May 18, 1998, the Company implemented the Quality Dining, Inc.
Supplemental Deferred Compensation Plan ("Plan II"). Plan II is a non-qualified
deferred compensation plan. Plan II participants are considered a select group
of management and highly compensated employees according to Department of Labor
guidelines. Since the implementation of Plan II, Plan II participants are no
longer eligible to contribute to Plan I. Plan II participants elect the
percentage of their pay they wish to defer into their Plan II account. They also
elect the percentage of their account to be allocated among various investment
options. The Company makes matching allocations to the Plan II participants'
deferral accounts equal to 50% of a participant's contribution, up to a maximum
of 5% of such participant's compensation, subject to the same limitations as are
applicable to Plan I participants. Company allocations vest 25% annually,
beginning in the participant's second year of eligibility since Plan I
inception.
The Company's contributions under Plan I and Plan II aggregated $246,000,
$197,000 and $184,000 for fiscal years 2003, 2002 and 2001, respectively.
36
OTHER PLANS
The Company also entered into agreements with five of its executive
officers and two other senior executives pursuant to which the employees have
agreed not to compete with the Company for a period of time after the
termination of their employment and are entitled to receive certain payments in
the event of a change of control of the Company.
{11} LEASES
The Company leases its office facilities and a substantial portion of the
land and buildings used in the operation of its restaurants. The restaurant
leases generally provide for a noncancelable term of five to 20 years and
provide for additional renewal terms at the Company's option. Most restaurant
leases contain provisions for percentage rentals on sales above specified
minimums. Rental expense incurred under these percentage rental provisions
aggregated $296,000, $401,000 and $304,000 for fiscal years 2003, 2002 and 2001,
respectively.
As of October 26, 2003, future minimum lease payments related to these leases
were as follows:
(Dollars in thousands)
Fiscal Year
- -----------
2004 $ 8,446
2005 6,641
2006 6,002
2007 5,704
2008 5,050
2009 and thereafter 22,619
---------
Total $ 54,462
---------
Rent expense, including percentage rentals based on sales, was $8,822,000,
$9,806,000 and $6,180,000 for fiscal years 2003, 2002 and 2001, respectively.
The Company has ten subleases at restaurants and four subleases at its
corporate headquarters building. As of October 26, 2003, future minimum lease
payments related to these subleases were $4,770,000. Sublease payments were
$848,000, $656,000 and $460,000 for fiscal years 2003, 2002 and 2001
respectively.
{12} COMMITMENTS AND CONTINGENCIES
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.
37
The Company has accrued $3,688,000 (see Note 4) 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 October 26, 2003, the Company had commitments aggregating $1,680,000
for the construction of restaurants.
During fiscal 2003, the Company was party to a lawsuit with BFBC Ltd
("BFBC"), a former franchisee of Bruegger's Bagels, and certain principals of
BFBC (the "Franchisee Parties"). During the second quarter of fiscal 2003, the
Company entered into a settlement agreement with the Franchisee Parties that
provided for a cash payment by the Franchisee Parties to the Company in the
amount of $3.75 million and the dismissal of all remaining claims in the
lawsuit. The Company recorded a gain of $3,459,000 in the second quarter of
fiscal 2003 as a result of this settlement. Subsequent to the end of the second
quarter of fiscal 2003, and ancillary to the BFBC settlement, the Company
transferred to Bruegger's Corporation's senior secured lender the Company's
interest in the $10.7 million Subordinated Note issued by Bruegger's Corporation
to the Company in connection with the divestiture of the Company's bagel-related
businesses in 1997. The Company received payment of $55,000 for the Subordinated
Note. The Company had previously reserved for the full amount of the
Subordinated Note. Accordingly, the Company recorded a $55,000 gain in respect
of this payment in the third quarter of fiscal 2003.
The Company is involved in various other 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.
{13} IMPAIRMENT OF LONG-LIVED ASSETS
During fiscal 2003 the Company closed four Grady's American Grill
restaurants. In light of these disposals and the continued decline in sales and
cash flow in its Grady's American Grill division the Company reviewed the
carrying amounts for the balance of its Grady's American Grill Restaurant
assets. The Company estimated the future cash flows expected to result from the
continued operation and the residual value of the remaining restaurant locations
in the division and concluded that, for the division as a whole, and in
particular with respect to eight locations, the undiscounted estimated future
cash flows were less than the carrying amount of the related assets.
Accordingly, the Company concluded that these assets had been impaired. The
Company measured the impairment and recorded an impairment charge related to
these assets aggregating $4,411,000 in the second quarter of fiscal 2003,
consisting of a reduction in the net book value of the Grady's American Grill
trademark of $2,882,000 and a reduction in the net book value of certain fixed
assets in the amount of $1,529,000. In accordance with SFAS 144, this amount has
been classified in discontinued operations in the Consolidated Statement of
Operations for fiscal 2003.
In determining the fair value of the aforementioned restaurants, the
Company relied primarily on discounted cash flow analyses that incorporated an
investment horizon of five years and utilized a risk adjusted discount factor.
In light of the continuing negative trends in both sales and cash flows,
the increase in the pervasiveness of these declines amongst individual stores,
and the accelerating rate of decline in both sales and cash flow, the Company
also determined that the useful life of the Grady's American Grill trademark
should be reduced from 15 to five years.
During the second half of fiscal 2001, the Company experienced a
significant decrease in sales and cash flow in its Grady's American Grill
division. The Company initiated various management actions in response to this
declining trend, including evaluating strategic business alternatives for the
division both as a whole and at each of its 34 restaurant locations.
Subsequently, the Company entered into an agreement to sell nine of its Grady's
American Grill restaurants for approximately $10.4 million. Because the carrying
amount of the related assets as of October 28, 2001 exceeded the estimated net
sale proceeds, the Company recorded an impairment charge of $4.1 million related
to these nine restaurants. As a consequence of this loss and in connection with
the aforementioned evaluation, the Company estimated the future cash flows
expected to result from the continued operation and the residual value of the
remaining restaurant locations in the division and concluded that, in 12
locations, the undiscounted estimated future cash flows were less than the
carrying amount of the related assets. Accordingly, the
38
Company concluded that these assets had been impaired. The Company measured the
impairment and recorded an impairment charge related to these assets aggregating
$10.4 million in fiscal 2001, consisting of a reduction in the net book value of
the Grady's American Grill trademark of $4.9 million and a reduction in the net
book value of certain fixed assets in the amount of $5.5 million.
In determining the fair value of the aforementioned 12 restaurants, the
Company relied primarily on discounted cash flow analyses that incorporated
investment horizons ranging from three to 15 years and utilized a risk adjusted
discount factor.
Also, in the fourth quarter of fiscal 2001, the Company committed to plans
to close two Grady's American Grill restaurants during the first quarter of
2002. The Company accrued exit costs aggregating approximately $0.2 million,
principally for on-going rental costs.
While the Company believes that the Grady's assets are reported at their
estimated fair values as of October 26, 2003, there can be no assurances that
future asset impairments may not occur.
{14} RELATED PARTY TRANSACTIONS
The Company leases 43 of its Burger King restaurants from entities that are
substantially owned by certain directors, officers and stockholders of the
Company. 42 of these restaurants are owned by the real estate entities that have
been consolidated in accordance with FIN 46R (See Note 3). Amounts paid for
leases with these related entities are as follows:
Fiscal Year Ended
October 26, October 27, October 28,
(Dollars in thousands) 2003 2002 2001
- ---------------------- ---------- ---------- -----------
Base rentals $ 3,331 $ 3,213 $ 3,418
Percentage rentals 289 526 506
------- ------- -------
3,620 3,739 3,924
------- ------- -------
Affiliated real estate partnerships and two other entities related through
common ownership pay management fees to the Company as reimbursement for
administrative services provided. Total management fees for fiscal 2003 were
$12,000 and $14,000 in each of fiscal 2002 and 2001.
During the fiscal years 2003, 2002 and 2001, the Company made payments to
companies owned by certain directors, stockholders and officers of the Company
of $231,000, $301,000 and $339,000, respectively, for air transportation
services. These amounts exclude salary and related expenses paid to the pilots
during fiscal years 2003 and 2002 in the amounts of $104,000 and $16,000,
respectively. Prior to fiscal 2002, the pilots' salaries and related expenses
were borne by the Airplane Companies.
{15} ACQUISITIONS AND DISPOSITIONS
On October 15, 2001, the Company purchased certain assets from BBD
Business Consultants, LTD. and its affiliates. BBD Business Consultants, LTD.
operated 42 Burger King restaurants in the Grand Rapids, Michigan metropolitan
area. The Company also purchased leasehold improvements and entered into lease
agreements with the landlords of 41 of the 42 Burger King restaurants. During
fiscal 2002, the Company closed three of these restaurants. In conjunction with
this transaction the Company obtained franchise agreements for the acquired
restaurants from Burger King Corporation. The purchase price for the restaurants
aggregated $6,067,000 and consisted of $4,212,000 in cash and $1,855,000 in
assumed liabilities. The acquisition was accounted for as a purchase. Goodwill
of approximately $1,096,000 was recorded in connection with the acquisition, and
subsequently was adjusted to $988,000 for the finalization of various
liabilities. The operating results of the restaurants have been included in the
Company's consolidated financial statements since the date of the acquisition.
The following table summarizes the fair values of the assets acquired and
liabilities assumed at the date of the acquisition.
39
At October 15, 2001
-------------------
Current assets $ 657,000
Property and equipment 3,276,000
Franchise fees 1,038,000
Goodwill 988,000
-----------
Total assets acquired $ 5,959,000
Cash paid 4,212,000
-----------
Liabilities assumed $ 1,747,000
-----------
The franchise fees will be amortized over the remaining life of each
restaurant's franchise agreement which is between one and 18 years. The $988,000
of goodwill was allocated within the quick service segment and has not been
amortized in accordance with FASB 142.
The following unaudited pro forma results for the fiscal year ended
October 28, 2001 were developed assuming the Grand Rapids Burger Kings had been
acquired as of the beginning of the period presented. Prior to the acquisition,
BBD Business Consultant's fiscal year ended December 31. BBD Business
Consultants' prior period financial statements have been conformed with the
Company's year end for the fiscal 2001 unaudited pro forma results. The
unaudited pro forma results reflect certain adjustments, including interest
expense (including capitalized interest on occupancy leases), depreciation of
property and equipment and amortization of intangible assets.
Fiscal Year
-----------
October 28,
2001
-----------
(Unaudited)
Total revenues $ 268,144
Pro forma net loss (14,538)
Pro forma net loss per share (1.28)
The unaudited pro forma results shown above are not necessarily indicative
of the consolidated results that would have occurred had the acquisitions taken
place at the beginning of the respective period, nor are they necessarily
indicative of results that may occur in the future.
During fiscal 2003, the Company sold four of its Grady's American Grill
restaurants for net proceeds of $4,779,000. The Company recorded a $341,000 gain
related to these sales.
During fiscal 2002, the Company sold 15 of its Grady's American Grill
restaurants for net proceeds of $15,512,000. The Company recorded a $1,360,000
gain related to these sales.
{16} 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
40
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.
{17} SEGMENT REPORTING
The segment information has been prepared in accordance with SFAS 131,
"Disclosure about Segments of an Enterprise and Related Information" (SFAS 131).
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 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. For purposes of applying SFAS 131,
the Company considers the Grady's American Grill, the two Italian Dining
concepts and Chili's Grill & Bar to be similar and has aggregated them into a
single reportable 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 3).
The "other reconciling items" column includes corporate related items,
intercompany eliminations and income and expense not allocated to reportable
segments.
41
OTHER
FULL QUICK ALL RECONCILING
(Dollars in thousands) SERVICE SERVICE OTHER ITEMS TOTAL
---------------------- ------- ------- ----- ----- -----
FISCAL 2003
Revenues $ 104,348 $ 114,983 $ 3,586 $ (3,586) $ 219,331
Income from restaurant operations (1) 14,351 12,677 2,942 (411) 29,559
Operating income 8,683 3,173 2,835 (1,474) $ 13,217
Interest expense 7,143
Other income 442
---------
Income from continuing operations before
income taxes $ 6,516
=========
Total assets 68,417 51,296 18,599 20,964 $ 159,276
Depreciation and amortization 4,842 5,011 500 992 11,345
FISCAL 2002
Revenues $ 113,925 $ 123,795 $ 3,890 $ (3,890) $ 237,720
Income from restaurant operations (1) 14,480 16,036 3,196 (660) 33,052
Operating income 7,219 5,314 3,119 (2,101) $ 13,551
Interest expense 7,916
Other income (expense) (1,279)
---------
Income from continuing operations before
income taxes $ 4,356
=========
Total assets 91,630 51,210 16,065 11,743 $ 170,648
Depreciation and amortization 5,138 4,672 552 1,286 11,648
FISCAL 2001
Revenues $ 119,822 $ 80,791 $ 3,918 $ (3,918) $ 200,613
Income from restaurant operations (1) 12,200 11,217 3,139 (661) 25,895
Operating income (loss) (10,404)(2) 4,538 3,083 (2,766) $ (5,549)
Interest expense 9,873
Other income (expense) (1,958)
---------
Loss from continuing operations before
income taxes $ (17,380)
=========
Total assets 104,425 45,268 16,505 14,773 $ 180,971
Depreciation and amortization 7,593 3,312 636 1,513 13,054
(1) Income from operations is restaurant sales minus total operating expenses.
(2) Includes charges for the impairment of assets and facility closing costs
totaling $15,385,000.
42
{18} SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
(in thousands, except per share amounts)
Year ended October 26, 2003
---------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Total revenues $ 65,144 $ 49,690 $ 52,031 $ 52,466
Operating income (loss) 2,882 2,846 3,128 4,361
Income (loss) from continuing operations before income taxes 278 4,284 (230)(2) 2,184
Net income $ 179 $ (280)(1) $ (133) $ 1,106
======== ========= ========= =========
Basic net income (loss) per share $ 0.02 $ (0.02) $ (0.01) $ 0.11
======== ========= ========= =========
Diluted net income (loss) per share $ 0.02 $ (0.02) $ (0.01) $ 0.11
======== ========= ========= =========
Weighted average shares:
Basic 11,311 11,311 10,805 10,163
Diluted 11,358 11,316 10,805 10,208
Year ended October 27, 2002
---------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Total revenues $ 73,271 $ 56,895 $ 54,833 $ 52,721
Operating income 3,712 2,912 4,050 2,877
Income (loss) from continuing operations before income taxes 540 942 1,809 1,065
Net income $ 942 $ 1,223 $ 1,718 $ 1,201
======== ========= ========= =========
Basic net income per share $ 0.08 $ 0.11 $ 0.15 $ 0.11
======== ========= ========= =========
Diluted net income per share $ 0.08 $ 0.11 $ 0.15 $ 0.11
======== ========= ========= =========
Weighted average shares:
Basic 11,206 11,206 11,270 11,311
Diluted 11,298 11,422 11,617 11,417
(1) Includes charges for the impairment of assets and facility closing costs
totaling $14,411,000 and a recovery of note receivable in the amount of
$3,459,000.
(2) Includes stock purchase expense of $1,294,000.
43
QUALITY DINING, INC.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors
of Quality Dining, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of Quality
Dining, Inc. and its subsidiaries at October 26, 2003 and October 27, 2002, and
the results of their operations and their cash flows for each of the three years
in the period ended October 26, 2003 in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedule appearing on the immediately following page
presents fairly, in all material aspects, the information set forth therein when
read in conjunction with the related consolidated financial statements and
financial statement schedules. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States),
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As discussed in Note 3 to the consolidated financial statements, the Company
adopted the provisions of FASB Interpretation No. 46-R, "Consolidation of
Variable Interest Entities", on October 27, 2003.
As discussed in Note 4 to the consolidated financial statements, the Company
changed the manner in which it accounts for goodwill and other intangible assets
as of October 29, 2001 and the manner in which it accounts for long-lived
assets to be disposed of as of October 28, 2002.
PricewaterhouseCoopers LLP
Chicago, Illinois
December 23, 2003, except for Notes 2, 3 and 16,
as to which the date is December 21, 2004
44
II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(IN THOUSANDS)
Additions
---------
Balance at Charged to Charged Balance at
Beginning of Costs and to Other End of
Period Expenses Accounts Deductions Period
------ -------- -------- ---------- ------
Year ended October 28, 2001
Income tax valuation allowance $ 20,362 5,343 - - $ 25,705
Year ended October 27, 2002
Income tax valuation allowance $ 25,705 - - (1,747)(1) $ 23,958
Year ended October 26, 2003
Income tax valuation allowance $ 23,958 211 - - $ 24,169
(1) During fiscal 2002 the Company utilized NOL carryforwards to offset
current-year taxable income.
45