PART I

Item 1.  Business

Overview

Piccadilly Cafeterias, Inc., founded in 1944, is the dominant cafeteria chain in the Southeastern and Mid-Atlantic regions of the United States with 205 cafeterias in 16 states.  We serve a diverse and loyal customer base consisting of families, groups of friends and co-workers, senior citizens, couples, and students.  Our patrons enjoy a wide selection of convenient, healthy, freshly prepared "home cooked" meals at value-oriented prices for lunch and dinner.  Additional information is available on our website at www.piccadilly.com.

Business Strengths

Dominant Market Share in Core Markets.  We are the dominant cafeteria chain in the Southeastern and Mid-Atlantic regions of the United States with 205 cafeterias.  The next largest cafeteria chain in these regions operates approximately 34 cafeterias.  Although the family dining industry is competitive and has grown significantly through the introduction of new restaurant concepts and new restaurant openings, the cafeteria segment has had few new entrants.  In addition, the existing major cafeteria chains have generally focused on their existing regional markets. 

Diverse and Loyal Customer Base.  We have developed substantial brand equity and guest loyalty during our 58-year history.  In addition, we have developed a diverse customer base consisting of families, groups of friends and co-workers, senior citizens, couples, and students.  We believe cafeteria dining meets diverse guest needs by providing convenient, healthy, freshly prepared, and reasonably priced meals.  We attribute our broad market appeal and high level of repeat business to the consistent quality of our meals, our varying menu selection, convenient cafeteria format, value pricing, and well-recognized brand name.

High Quality Food Offering.  We were awarded the 2002 Choice in Chains Gold Award by Restaurants & Institutions (“R&I”) magazine.  The R&I Choice in Chains award is based on a national consumer survey.  Consumers gave us the second highest overall ranking in the cafeteria/buffet segment based on rating attributes such as food quality, service, cleanliness, value, and atmosphere and menu variety.  All of our cafeterias offer a wide variety of quality, reasonably priced meals.  Each of our cafeteria general managers has the ability to vary their menu to include local and seasonal favorites from our extensive proprietary recipe files.  Our typical cafeteria line offers a wide food selection including up to 18 entrees, 2 soups, 20 salads, 18 vegetables, 7 breads, and 22 desserts.  Guests make their meal selections by combining these items according to their individual preferences.

Proven Management.  Our executive officers average over 11 years of experience at Piccadilly.  In addition, our regional and cafeteria managers have an average of 22 and 15 years of experience at Piccadilly, respectively.  As a result, our management team, at both the executive officer and local manager levels, is extremely familiar with our existing markets and customer base.  Mr. Ronald A. LaBorde, our Chief Executive Officer, has served us for over 20 years, and has been our chief executive officer since 1995.

Recent Developments

Fiscal Year-End Reporting Period Change.  Effective April 1, 2002, we adopted a 52-53 week fiscal reporting period effective for fiscal 2002, resulting in a 2002 fiscal year-end date of July 2, 2002, rather than June 30, 2002.  Prospectively, quarterly reporting will include 13-week periods except for a 53-week year in which the fourth quarter of that fiscal year will include 14 weeks.  The change from a June 30 fiscal reporting period to a 52-53 week reporting period is consistent with the reporting cycles of other industry participants.  The next several 53-week years are our fiscal years 2007 and 2012.  We refer to the fiscal year ended July 2, 2002 as fiscal 2002.  We refer to the fiscal years ended June 30, 2001 and 2000 as fiscal 2001 and fiscal 2000, respectively.

Pension Plan Liability.  On August 6, 2002, we announced that we had recorded a net pension liability of $22.5 million as of July 2, 2002, after we determined that the present value of our pension plan liabilities exceeded the fair value of plan assets at that date.  The funded status of the pension plans deteriorated during fiscal 2002 because the fair value of the plans’ assets had declined, reflecting market performance, and the present value of the plans’ liabilities had increased, reflecting a decline in market interest rates.  The recording of the pension plan liability did not affect our earnings, but did reduce total shareholders’ equity at July 2, 2002, by $22.5 million.

New York Stock Exchange Listing.  In September 2001, we submitted a plan to the New York Stock Exchange to demonstrate that we could meet the continued listing requirements of the NYSE by February 8, 2003, a deadline established by the NYSE.  With the minimum pension liability and corresponding reduction in shareholders’ equity recorded as of July 2, 2002, we have determined that we do not expect to meet the shareholders’ equity level targeted by the plan.  Although we continue to have dialogue with representatives of the NYSE on this matter, they have indicated that the NYSE will not waive compliance with its listing conditions.  Accordingly, we are evaluating the eligibility requirements to list our stock on other stock exchanges.  As of August 23, 2002, our per-share stock price was $2.53, which does not meet the initial listing qualifications for either the American Stock Exchange or the NASDAQ. 

Long-term Notes Repurchased.  During the past two years we have successfully completed two sale-leaseback transactions involving 18 of our cafeteria properties that we previously owned in fee.  We used the proceeds from these transactions to repurchase $29.8 million of our long-term debt.  Due to these transactions, our overall cost of capital has declined and we will realize a reduction in expense of $2.5 million annually.  We have recorded extraordinary charges of $4.1 million primarily to write-off the pro-rata portion of unamortized financing costs related to the repurchased debt, including $1.6 million of extraordinary charges recorded in fiscal 2002.

On December 11, 2001, we used available cash balances to repurchase approximately $3.7 million of our long-term debt.  Approximately $0.3 million of extraordinary charges were recorded to write-off unamortized financing costs related to the repurchased debt.

Non-performing Cafeterias Closed.  During the fourth quarter of fiscal 2001, we completed an evaluation of non-performing cafeterias and determined that 14 cafeterias should be closed.  Our evaluation determined that future operating cash flows from these cafeterias would be insufficient to cover their lease–related payments and operating costs.  These cafeterias were closed on July 31, 2001.  We recorded charges of $3.5 million relating to the decision to close these cafeterias, principally for future lease-related costs.  Closing these cafeterias had a positive impact on future results since these cafeterias, in the aggregate, posted operating losses of approximately $2.0 million during fiscal 2001.  In addition to the 14 cafeterias closed in July 2001, we closed nine additional cafeterias during fiscal 2002.  For the most part, the underlying leases for these cafeterias had reached the end of their respective terms and we either elected not to pursue renewal opportunities or were unsuccessful in achieving sufficient occupancy cost reductions to warrant renewing the lease.  Overall, these cafeterias had break-even results for fiscal 2002.

Projected Downturn in First Quarter Fiscal 2003 Financial Performance.  In our “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we disclose that in March 2002 we implemented a four-month advertising campaign, including media advertising, in markets comprising approximately 50% of the markets where our cafeterias operate.  We further reported that we believe this advertising campaign was partially responsible for improving year-to-year sales comparisons for the last two months of our fiscal 2002 fourth quarter.  The improvement in year-to-year sales comparisons has not continued into the first two four-week periods of fiscal 2003.  For the four-week period ended July 30, 2002, our sales were down 2.9% and for the three-week period ended August 20, 2002, our sales were down 4.0%.  We believe that the weakened economy and the uncertainty created by the extremely volatile and declining stock market during that period had an impact on the spending habits of our guest base. 

Cafeteria Operations

Store Design and Layout.  Our traditional cafeterias average approximately 10,000 square feet in size and seat, on average, approximately 350 guests.  During 1997, we completed the design of a more compact cafeteria model, which has approximately 7,500 square feet and seats approximately 200 guests.  This smaller cafeteria allows us to access a broader range of markets at a lower investment cost.  As of July 2, 2002, we have 10 cafeterias utilizing this new design and format.  We did not open any new cafeterias in fiscal 2002, and we do not currently plan to open any new cafeterias during fiscal 2003.

Menu.  All of our cafeterias offer a wide variety of quality, reasonably priced meals.  Each of our cafeteria general managers has the ability to vary their menu to include local and seasonal favorites from our extensive proprietary recipe files.  Our typical cafeteria line offers a wide food selection including up to 18 entrees, 2 soups, 20 salads, 18 vegetables, 7 breads, and 22 desserts.  Guests make their meal selections by combining these items according to their individual preferences.  

Pricing.  We sell most meals as "bundled" meals that include an entrée, side items, and bread.  Guests are also able to purchase meals on an a la carte basis.  Approximately 65% of meals served in fiscal 2002 were sold as “bundled” meals.  We continuously evaluate our pricing structure to assure that we deliver value-oriented meals to our guests.

Meal Preparation.  Cafeteria team members cook and prepare most of our food served from scratch using standardized recipes.  Menus are varied at the discretion of cafeteria management in response to local and seasonal guest preferences. 

Purchasing and Distribution.  Currently, the general managers at each of our cafeterias have purchasing responsibility for approximately one-third of the food ingredients used in our recipes, with each general manager negotiating with local or regional suppliers for that particular cafeteria, subject to meeting quality specifications.  The remaining two-thirds of the food ingredients used in our recipes is purchased centrally and distributed through a single regional distributor.  We expect to increase the percentage of items centrally purchased.  By expanding central purchasing, we believe we will benefit from higher volume purchase discounts, as well as greater consistency in food quality across all of our cafeterias.

Currently, our single regional distributor is located in Baton Rouge, Louisiana.  The food items that are not obtained through this distributor are primarily fresh red meat, poultry, produce, and dairy products.  Other than fresh poultry, these items are purchased from local suppliers and delivered directly to our cafeterias.  During the first quarter of fiscal 2003, we will add a second regional distributor with distribution centers in Orlando, Florida and Atlanta, Georgia.  Each of our two regional distributors will distribute products to approximately one-half of our cafeterias.  We believe that there are numerous other distributors available to process our shipments should these distributors be unable to meet our distribution needs.

Employees.  We refer to our employees as team members.  As of July 2, 2002, we had approximately 8,400 team members, of whom all but 95 corporate headquarters team members worked at Piccadilly's 205 cafeterias.  On average, each cafeteria operates with two to four managers and assistant managers and employs 40 to 60 team members.  Most team members are paid on an hourly basis, except cafeteria managers.  Our team members are not unionized.  We have experienced no significant work stoppages and believe that our team member relations are good.

Trademarks and Trade Names.  Our cafeterias operate principally under the Piccadilly Cafeterias name and service mark, which is registered with the United States Patent and Trademark Office for a term presently expiring in January 2009.  Registered service marks may continually be renewed for 10-year periods.  We regard our service marks and trademarks as having significant value and being an important factor in the development of the Piccadilly concept.  Our policy is to pursue and maintain registration of our service marks and trademarks whenever possible and to oppose vigorously any infringement or dilution of our service marks and trademarks.

Risks Factors Relating to Our Business

Our sales initiatives may not be successful.  We have experienced a long-term, relatively consistent decline in guest traffic and net sales from our cafeteria operations.  We have been able to offset some of the effects of this decline by various cost-saving initiatives that we discuss elsewhere in this Item 1.  However, our ability to sustain a consistent and improving level of profitability in the future will largely depend upon our ability to successfully implement sales initiatives that increase guest traffic at our cafeterias without sacrificing profitability.

We are vulnerable to increasing labor costs.  We are dependent upon an available labor pool of unskilled and semi-skilled employees, many of whom are hourly employees whose minimum wages are government proscribed.  Numerous proposals have been made on federal, state, and municipal levels to increase minimum wage levels.  Because a significant number of our employees are paid at rates tied to the federal minimum wage, an increase in the minimum wage would increase our labor costs.  A shortage in the labor pool or other general inflationary pressures or changes could also increase labor costs.  An increase in labor costs could have a material adverse effect on our financial results and no assurance can be given that we will be able to pass through any cost increases to our guests.

We are vulnerable to fluctuations in the cost, availability, and quality of our ingredients.  The cost, availability, and quality of the ingredients we use to prepare our food are subject to a range of factors, many of which are beyond our control.  Fluctuations in economic conditions, weather, and demand could adversely affect the cost of our ingredients.  We require fresh produce, dairy products, and meat, and are therefore subject to the risk that shortages or interruptions in supply of these food products could develop.  All of these factors could have a material adverse effect on our financial results.  Although we believe that we could find alternative suppliers for these ingredients, we have no control over fluctuations in the price of commodities, and no assurance can be given that we will be able to pass through any cost increases to our guests.

We face intense competition.  All aspects of the restaurant business are highly competitive.  Price, restaurant locations, food quality, service and attractiveness of facilities are important aspects of competition, and the competitive environment is often affected by factors beyond a particular restaurant management’s control, including changes in the public’s eating habits, population and traffic patterns, and economic conditions.  Our cafeterias compete with a large number of other restaurants, including national and regional restaurant chains and franchised restaurant operations, as well as locally owned, independent restaurants.  Many of our competitors have greater financial resources than we have.  There can be no assurance that we will be able to compete successfully against our competitors in the future or that competition will not have a material adverse effect on our financial results.

We are vulnerable to changes in consumer preferences and economic conditions.  Food service businesses are often affected by changes in consumer tastes, national, regional, and local economic conditions, and demographic trends.  Factors such as traffic patterns, demographics, and the type, number and location of competing restaurants may adversely affect the performance of individual cafeterias.  In addition, inflation, increased food, labor, energy, employee benefit costs, and insurance rates, national, regional and local regulations, regional weather conditions, and the availability of experienced management and hourly employees may harm the restaurant industry in general and our cafeterias in particular.  Adverse changes in any of these factors could reduce guest traffic or impose practical limits on pricing, which could have a material adverse effect on our financial results.  Our continued success will depend in part on our ability to anticipate, identify, and respond to changing consumer preferences and economic conditions.

We face risks because of the number of cafeterias that we lease.  Our success depends in part on our ability to renew leases in existing locations at rental rates we believe to be reasonable.  We currently lease all of our cafeterias located in strip shopping centers and malls and we lease the land for all but 12 of our freestanding cafeterias.  Many of our leases have terms expiring during the next five years.  Each lease agreement also provides that the lessor may terminate the lease for a number of reasons, including if we default in any payment of rent or taxes or if we breach any covenants or agreements in the lease.  Although we believe that we are in compliance with all lease covenants and agreements and that we will be able to renew our existing leases, we can offer no assurances that we will always comply with all lease covenants and agreements nor that we will succeed in renewing such leases in the future at rental rates that we believe to be reasonable or at all.  Moreover, if certain locations should prove to be unprofitable, we would remain obligated for lease payments if we decided to withdraw from such locations.  Termination of any of our leases could harm our financial results. 

We may be required to make additional contributions to our previously frozen benefit pension plans.  We sponsor two qualified defined benefit pension plans.  Both of these plans are frozen so covered employees are not currently accruing benefits under these plans.  These plans are subject to the minimum funding levels of the Employee Retirement Income Security Act of 1974.  Several market-driven factors, over which we have no control, influence the funding level of these plans and thus the timing and extent to which we are required to fund contributions to these plans.  The net present value of obligations of the plans is subject to fluctuations in interest rates and the fair value of plan assets is subject to market volatility.  In the future, we may be required to use a substantial portion of our available liquidity to fund minimum required contributions to the plans.  There can be no assurance that we will have sufficient liquidity to fund the minimum required contributions when they become due.  Moreover, there can be no assurance that after such contributions are made, the remaining liquidity will be sufficient for operating purposes.

We are subject to restrictions under the terms of our debt agreements.  Our Senior Credit Facility includes covenants that require us to maintain specified financial ratios, including fixed charge coverage and leverage ratios and a minimum level of earnings before interest, income tax, depreciation, and amortization expenses.  In addition, our Senior Credit Facility, Senior Note Indenture, and Term Loan Credit Facility (collectively, our “Debt Agreements”) contain covenants that restrict, among other things, our ability to incur additional indebtedness and dispose of assets, incur or guarantee obligations, repay indebtedness or amend debt instruments, pay dividends, create liens on assets, make investments, make acquisitions, engage in mergers or consolidations, make capital expenditures and engage in certain transactions with subsidiaries or affiliates.  Although we are currently in compliance with all of these ratios and covenants, our ability to continue to comply with these covenants in the future may be affected by events beyond our control and we cannot give any assurances that we will satisfy those requirements.  We may be prevented from taking advantage of available business opportunities if we fail to meet certain financial ratios or because of the limitations imposed on us by the restrictive covenants under our Debt Agreements.  Moreover, a failure to comply with any of these provisions contained in our Debt Agreements could lead to an event of default, which, under the terms of those Debt Agreements, could result in all amounts outstanding under any of them to be declared immediately due and payable.  In that event, we may be unable to secure alternative sources of capital at terms satisfactory to us.

We face the risk of adverse publicity and litigation.  We may from time to time be the subject of complaints or litigation from guests alleging illness, injury, or other food quality, health, or operational concerns.  Negative publicity resulting from these allegations could have a material adverse effect on our financial results, regardless of whether the allegations are valid or whether we are liable.  In addition, employee claims against us based on, among other things, discrimination, harassment, or wrongful termination may divert our financial and management resources that would otherwise be used to benefit the performance of our operations.  We have been subject to such employee claims from time to time, and although these claims have not historically had a material impact on our operations, a significant increase in the number of these claims or an increase in the number of successful claims could have a material adverse effect on our financial results.

We face risks associated with government regulation.  Each of our cafeterias is subject to licensing and regulation by the health, sanitation, safety, building, and fire agencies of the respective states and municipalities in which the cafeteria is located.  A failure to comply with one or more regulations could result in the imposition of sanctions, including the closing of facilities for an indeterminate period of time or third-party litigation, either of which could have a material adverse effect on our financial results.  Under various federal, state and local laws, an owner or operator of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances on or in such property.  Such liability may be imposed without regard to whether the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances.  Although we are not aware of any material environmental conditions that require remediation by us under federal, state, or local law at our properties, we have not conducted a comprehensive environmental review of our properties or operations and no assurance can be given that we have identified all of the potential environmental liabilities at our properties or that such liabilities would not have a material adverse effect on our financial condition.

Item 2.  Properties

All of our cafeterias are located in urban and suburban areas, in a variety of strip shopping centers, malls, and freestanding buildings.  We lease all of the cafeterias located in strip shopping centers and malls.  Of the 75 cafeterias located in freestanding buildings, we own the building and land for 12 of the cafeterias, and the remaining freestanding cafeterias are operated in Company-owned buildings located on leased land under long-term leases.  We rent most of our cafeteria facilities under long-term leases with varying provisions and with original lease terms generally of 20 to 30 years and in most cases, with options to renew for several successive five-year periods.  Leases provide for monthly rentals, typically computed on the basis of a fixed amount plus a percent of sales.  We evaluate the sales trends and the forecasted operating results for cafeterias with expiring lease terms to determine whether to exercise renewal options or negotiate lease extensions.

Our cafeteria locations by state as of July 2, 2002, are as follows: