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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended OCTOBER 27, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to ________
Commission file number 0-23420
QUALITY DINING, INC.
(Exact name of registrant as specified in its charter)
INDIANA 35-1804902
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4220 EDISON LAKES PARKWAY
MISHAWAKA, INDIANA 46545
(Address of principal executive offices) (Zip Code)
(574) 271-4600
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, WITHOUT PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
$24,692,266
Aggregate market value of the voting stock held by nonaffiliates of the
Registrant based on the last sale price for such stock at November 27, 2002
(assuming solely for the purposes of this calculation that all Directors and
executive officers of the Registrant are "affiliates").
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2) of the Act).
Yes [ ] No [X]
$26,592,647
Aggregate market value of the voting common equity held by non-affiliates
computed by reference to the price at which the common equity was last sold, or
the average bid and asked price of such common equity, as of May 10, 2002
(assuming solely for the purposes of this calculation that all Directors and
executive officers of the Registrant are "affiliates").
11,609,099
Number of shares of Common Stock, without par value, outstanding at
January 14, 2003
DOCUMENT INCORPORATED BY REFERENCE
Portions of the following document have been incorporated by reference into this
Annual Report on Form 10-K
IDENTITY OF DOCUMENT PART OF FORM 10-K INTO WHICH
DOCUMENT IS INCORPORATED
Definitive Proxy Statement for the Annual Meeting
of Shareholders to be held March 11, 2003. PART III
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QUALITY DINING, INC.
Mishawaka, Indiana
Annual Report to Securities and Exchange Commission
October 27, 2002
PART I
ITEM 1. BUSINESS.
GENERAL
Quality Dining, Inc. (the "Company") operates four distinct restaurant
concepts. It owns the Grady's American Grill(R) concept and an Italian Dining
concept. The Company operates its Italian Dining restaurants under the
tradenames of Spageddies Italian Kitchen(R) ("Spageddies"(R)) and Papa Vino's
Italian Kitchen(R) ("Papa Vino's"(R)). The Company also operates Burger King(R)
restaurants and Chili's Grill & Bar(TM) ("Chili's"(R)) as a franchisee of Burger
King Corporation and Brinker International, Inc. ("Brinker"), respectively. As
of October 27, 2002, the Company operated 174 restaurants, including 115 Burger
King restaurants, 34 Chili's, 16 Grady's American Grill restaurants, three
Spageddies and six Papa Vino's. Summarized financial information concerning the
Company's reportable segments is included in Note 14 to the Company's financial
statements included elsewhere in this report.
The Company was founded in 1981 and has grown from a two-unit Burger King
franchisee to a multi-concept restaurant operator. The Company has grown by
capitalizing on (i) its significant presence in targeted markets, (ii) the
stable operating performance of its Burger King and Chili's restaurants, (iii)
strategic acquisitions of Burger King restaurants and Chili's restaurants and
(iv) management's extensive experience.
The Company is an Indiana corporation, which is the indirect successor to a
corporation that commenced operations in 1981. Prior to the consummation of the
Company's initial public offering on March 8, 1994 (the "Offering"), the
business of the Company was transacted by the Company and eight affiliated
corporations. As a result of a reorganization effected prior to the Offering,
the Company became a management holding company. The Company, as used herein,
means Quality Dining, Inc. and all of its subsidiaries.
BUSINESS STRATEGY
The Company's fundamental business strategy is to optimize the cash flow of
its operations through proven operating management. The Company plans to use the
majority of its cash flow to refurbish existing restaurants, build or acquire
new restaurants and reduce debt. The Company believes its strategy will
ultimately maximize the long term value of the Company for its shareholders.
Management's operating philosophy, which is shared by all of the Company's
concepts, is comprised of the following key elements:
Value-Based Concepts. Value-based restaurant concepts are important to the
Company's business strategy. Accordingly, in each of its restaurants, the
Company seeks to provide customers with value, which is a product of
high-quality menu selections, reasonably priced food, prompt, courteous service
and a pleasant dining atmosphere.
Focus on Customer Satisfaction. Through its comprehensive management
training programs and experienced management team, the Company seeks to ensure
that its employees provide customers with an enjoyable dining experience on a
consistent basis.
Hands-On Management Style. Members of the Company's senior management are
actively involved in the operations of each of the Company's restaurant
concepts. This active management approach is a key factor in the Company's
efforts to control costs, enhance training and development of employees and
optimize operating income.
Quality Franchise Partners. The Company has historically sought franchisors
with established reputations for leadership in their various segments of the
restaurant industry who have proven integrity and share the Company's focus on
value, customer service and quality.
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Use of Technology. The Company actively tracks the performance of its
business utilizing computer and point-of-sale technology to provide timely and
accurate reporting.
EXPANSION
The Company currently plans to open one or two Burger King restaurants and
two or three full service restaurants in fiscal 2003. The Company also plans to
replace five existing Burger King buildings with new Burger King buildings at
the same locations. The Company's long-term expansion strategy is focused on the
development of restaurants in existing markets in order to optimize market
penetration. In addition, the Company will continue to consider strategic
acquisitions in the Burger King system.
During fiscal 2002, the Company built two new Burger King restaurants, one
new Chili's restaurant and one new Papa Vino's restaurant. The Company sold 15
and closed three Grady's American Grill restaurants in fiscal 2002. (See
"Grady's American Grill" and Note 11 to the Company's financial statements.)
During fiscal 2001, the Company purchased 42 Burger King restaurants in the
Grand Rapids metropolitan area (See Note 13 to the Company's financial
statements). The Company paid $4.2 million in cash and assumed certain
liabilities of approximately $1.8 million. Three of these restaurants were
closed in fiscal 2002.
The amount of the Company's total investment to develop new restaurants
depends upon various factors, including prevailing real estate prices and lease
rates, raw material costs and construction labor costs in each market in which a
new restaurant is to be opened. The Company may own or lease the real estate for
future development.
BURGER KING
General. Prior to December, 2002 Burger King Corporation was an indirect
wholly-owned subsidiary of Diageo, PLC. In July, 2002 Diageo agreed to sell
Burger King Corporation to an investment group led by Texas Pacific Group for
$2.26 billion. In December, 2002, Diageo, PLC announced that it had completed
the sale of Burger King Corporation to Texas Pacific Group although the purchase
price had been reduced to $1.5 billion due in part to the current highly
competitive environment in which Burger King operates. Burger King Corporation
has been franchising Burger King restaurants since 1954 and has since expanded
to locations throughout the world.
Menu. Each Burger King restaurant offers a diverse menu containing a
variety of traditional and innovative food items, featuring the Whopper(R)
sandwich and other flame-broiled hamburgers and sandwiches, which are prepared
to order with the customer's choice of condiments. The menu also typically
includes breakfast entrees, french fries, onion rings, desserts and soft drinks.
The Burger King system philosophy is characterized by its "Have It Your Way"(R)
service, generous portions and competitive prices, resulting in high value to
its customers. Management believes these characteristics distinguish Burger King
restaurants from their competitors and have the potential to provide a
competitive advantage.
Advertising and Marketing. As required by its franchise agreements, the
Company contributes 4.0% of its restaurant sales to an advertising and marketing
fund controlled by Burger King Corporation. Burger King Corporation uses this
fund primarily to develop system-wide advertising, sales promotions and
marketing materials and concepts. In addition to its required contribution to
the advertising and marketing fund, the Company makes local advertising
expenditures intended specifically to benefit its own Burger King restaurants.
Typically, the Company spends its local advertising dollars on television and
radio.
CHILI'S GRILL & BAR
General. The Chili's concept is owned by Brinker, a publicly-held
corporation headquartered in Dallas, Texas. The first Chili's Grill & Bar
restaurant opened in 1975.
Menu. Chili's restaurants are full service, casual dining restaurants
featuring quick and friendly table service designed to minimize customer waiting
and facilitate table turnover. Service personnel are dressed casually to
reinforce the casual environment. Chili's restaurants feature a diverse menu of
broadly appealing food items, including a variety of hamburgers, fajitas, steak,
chicken and seafood entrees and sandwiches, barbecued ribs, salads,
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appetizers and desserts, all of which are prepared fresh daily according to
recipes specified by Chili's. Emphasis is placed on serving substantial portions
of quality food at modest prices. Each Chili's restaurant has a full-service
bar.
Advertising and Marketing. Pursuant to its franchise agreements with
Brinker, the Company contributes 0.5% of sales from each restaurant to Brinker
for advertising and marketing to benefit all restaurants. As part of a
system-wide promotional effort, the Company paid an additional advertising fee
of 0.375% of sales for the period beginning September 1, 1999 and ended August
30, 2000 and paid a similar fee of 1.0% of sales for the period beginning
September 1, 2000 and ended June 27, 2001 and 1.2% of sales for the period
beginning June 28, 2001 through June 26, 2002. From June 27, 2002 through June
25, 2003, the Company has and will pay an additional 2.0% of sales. The Company
is also required to spend 2.0% of sales from each restaurant on local
advertising which is considered to be met by the additional fees of 2.0% of
sales described in the preceding sentence. The Company's advertising
expenditures typically exceed the levels required under its agreements with
Brinker and the Company spends substantially all of its advertising dollars on
television and radio advertising. The Company also conducts promotional
marketing efforts targeted at its various local markets.
The Chili's franchise agreements provide that Brinker may establish
advertising cooperatives ("Cooperatives") for geographic areas where one or more
restaurants are located. Any restaurants located in areas subject to a
Cooperative are required to contribute 3.0% of sales to the Cooperative in lieu
of contributing 0.5% of sales to Brinker. Each such restaurant is also required
to directly spend 0.5% of sales on local advertising. To date, no Cooperatives
have been established in any of the Company's markets.
GRADY'S AMERICAN GRILL
General. Grady's American Grill restaurants feature high-quality food in a
classic American style, served in a warm and inviting setting. The Company sold
15 and closed three Grady's American Grill restaurants during fiscal 2002. These
units did not fit the Company's long-term strategic plan and were not meeting
the Company's performance expectations.
Fiscal 2001 Impairment Charge. 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 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 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 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. During fiscal 2002, the Company continued to experience
declining sales and cash flow in its Grady's American Grill restaurants. While
the Company believes that the Grady's assets are reported at their estimated
fair values as of October 27, 2002, there can be no assurances that future asset
impairments may not occur.
Menu. The Grady's American Grill menu features signature prime rib,
high-quality steaks, seafood, inviting salads, sandwiches, soups and high
quality desserts. Entrees emphasize on-premise scratch preparation in a classic
American style.
Advertising and Marketing. As the owner of the Grady's American Grill
concept, the Company has full responsibility for marketing and advertising. The
Company focuses advertising and marketing efforts in local print media, use of
direct mail programs and radio, with total annual expenditures of approximately
2.0% of the sales for its Grady's American Grill restaurants.
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ITALIAN DINING CONCEPT
General. The Company's Italian Dining concept operates under the tradenames
Papa Vino's Italian Kitchen and Spageddies Italian Kitchen. The first Papa
Vino's restaurant was opened in 1996 and the first Spageddies restaurant was
opened in 1994. The Company had been a franchisee of Spageddies since 1994, and
became the owner of the concept in October 1995. Papa Vino's and Spageddies each
offers a casual dining atmosphere with high-quality food, generous portions and
moderate prices, all enjoyed in a setting featuring the ambiance of a
traditional Italian trattoria with stone archways, large wine casks and wine
racks lining the walls and exhibition cooking in an inviting, comfortable
environment. The Company's Italian Dining concept is proprietary and provides
the Company with flexibility for expansion and development.
Menu. A fundamental component of the Italian Dining concepts is to provide
the customer with a wide variety of high-quality, value-priced Italian food. The
restaurant menu includes an array of entrees, including traditional Italian
pasta, grilled meats and freshly prepared selections of pizzas, soups, salads
and sandwiches. The menu also includes specialty appetizers, fresh baked bread
and desserts, together with a full-service bar.
Advertising and Marketing. As the owner of these concepts, the Company has
full responsibility for marketing and advertising its Italian Dining
restaurants. The Company focuses its advertising and marketing efforts in local
print media, use of direct mail programs and radio, with total annual
expenditures estimated to range between 2% and 3% of the sales for these
restaurants.
TRADEMARKS
The Company owns the following registered trademarks: Grady's American
Grill(R), Spageddies Italian Kitchen(R), Spageddies(R), Papa Vino's(R) and Papa
Vino's Italian Kitchen(R). The Company also owns a number of other trademarks
and service marks which are used in connection with its owned concepts. The
Company believes its marks are valuable and intends to maintain its marks and
any related registrations. Burger King(R) is a registered trademark of Burger
King Corporation. Chili's(R) and Chili's Grill & Bar(TM) are a registered
trademark and trademark, respectively, of Brinker.
ADMINISTRATIVE SERVICES
From its headquarters in Mishawaka, Indiana, the Company provides
accounting, treasury management, information technology, purchasing, human
resources, finance, marketing, advertising, menu development, budgeting,
planning, legal, site selection and development support services for each of its
operating subsidiaries.
Management. The Company is managed by a team of senior managers who are
responsible for the establishment and implementation of a strategic plan. The
Company believes that its management team possesses the ability to manage its
diverse operations.
The Company has an experienced management team in place for each of its
concepts. Each concept's operations are managed by geographic region with a
senior manager responsible for each specific region of operations.
Site Selection. Site selection for new restaurants is made by the Company's
senior management under the direction of the Company's Chief Development
Officer, subject in the case of the Company's franchised restaurants to the
approval of its franchisors. Within a potential market area, the Company
evaluates high-traffic locations to determine profitable trading areas.
Site-specific factors considered by the Company include traffic generators,
points of distinction, visibility, ease of ingress and egress, proximity to
direct competition, access to utilities, local zoning regulations and various
other factors. In addition, in evaluating potential full service dining sites,
the Company considers applicable laws regulating the sale of alcoholic
beverages. The Company regularly reviews potential sites for expansion. Once a
potential site is selected, the Company utilizes demographic and site selection
data to assist in final site selection.
5
Quality Control. The Company's senior management and restaurant management
staff are principally responsible for assuring compliance with the Company's and
its franchisors' operating procedures. The Company and its franchisors have
uniform operating standards and specifications relating to the quality,
preparation and selection of menu items, maintenance and cleanliness of the
premises and employee conduct. Compliance with these standards and
specifications is monitored by frequent on-site visits and inspections by the
Company's senior management. Additionally, the Company employs the use of toll
free customer feedback telephone services and outside "shopper services" to
visit restaurants periodically to ensure that the restaurants meet the Company's
operating standards. The Company's operational structure encourages all
employees to assume a proprietary role ensuring that such standards and
specifications are met.
Burger King. The Company's Burger King operations are focused on
achieving a high level of customer satisfaction with speed, accuracy and
quality of service closely monitored. The Company's senior management and
restaurant management staff are principally responsible for ensuring
compliance with the Company's and Burger King Corporation's operating
procedures. The Company and Burger King Corporation have uniform operating
standards and specifications relating to the quality, preparation and
selection of menu items, maintenance and cleanliness of the premises and
employee conduct. These standards include food preparation rules
regarding, among other things, minimum cooking times and temperatures,
sanitation and cleanliness.
Full Service Dining. The Company has uniform operating standards and
specifications relating to the quality, preparation and selection of menu
items, maintenance and cleanliness of the premises and employee conduct in
its full service dining concepts. At the Company's Chili's restaurants,
compliance with these standards and specifications is monitored by
representatives of Brinker. Each full service dining restaurant typically
has a general manager and three to four assistant managers who together
train and supervise employees and are, in turn, overseen by a multi-unit
manager.
Information Technology Systems. Financial controls are maintained through a
centralized accounting system, which allows the Company to track the operating
performance of each restaurant. The Company has a point-of-sale system in each
of its restaurants which is linked directly to the Company's accounting system,
thereby making information available on a timely basis. During fiscal 1999 and
early fiscal 2000, the Company replaced the point-of-sale equipment in all of
its full service restaurants. During fiscal 2002, the Company replaced its
financial and accounting system with integrated, web-based software operating in
a client/server hardware environment. This information system enables the
Company to analyze customer purchasing habits, operating trends and promotional
results.
Training. The Company maintains comprehensive training programs for all of
its restaurant management personnel. Special emphasis is placed on quality food
preparation, service standards and total customer satisfaction.
Burger King. The training program for the Company's Burger King
restaurant managers features an intensive hands-on training period
followed by classroom instruction and simulated restaurant management
activities. Upon certification, new managers work closely with experienced
managers to solidify their skills and expertise. The Company's existing
restaurant managers regularly participate in the Company's ongoing
training efforts, including classroom programs, off-site training and
other training/development programs, which the Company's senior concept
management designs from time to time. The Company generally seeks to
promote from within to fill Burger King restaurant management positions.
Full Service Dining. The Company requires all general and restaurant
managers of its full service dining concepts to participate in a
system-wide, comprehensive training program. These programs teach
management trainees detailed food preparation standards and procedures for
each concept. These programs are designed and implemented by the Company's
senior concept management teams.
Purchasing. Purchasing and procurement for the Company's Grady's American
Grill and Italian Dining concepts are managed by a dedicated purchasing function
and are generally contracted with full-service distributors. Unit-level
purchasing decisions from an approved list of suppliers are made by each of the
Company's restaurant managers based on their assessment of the provisioning
needs of the particular location. Purchase orders and invoices are reviewed and
approved by restaurant managers.
The Company participates in system-wide purchasing and distribution
programs with respect to its Chili's and Burger King restaurants, which have
been effective in reducing store-level expenditures on food and paper packaging.
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FRANCHISE AND DEVELOPMENT AGREEMENTS
Burger King. On November 3, 2000, the Company entered into a Non-Exclusive
Development Agreement with Burger King Corporation (the "BKC Agreement"). The
BKC Agreement granted the Company the non-exclusive right to develop 12 Burger
King restaurants in three specified counties in Michigan, two specified counties
in Ohio and 20 specified counties in Indiana. The BKC Agreement was scheduled to
expire on June 30, 2004.
The Company paid a $60,000 franchise fee deposit to Burger King
Corporation. With each new restaurant that the Company opened pursuant to the
BKC Agreement, it received a credit of $5,000 against the applicable franchise
fee for such restaurant. Through December 31, 2002, the Company had received a
total of $35,000 in credits against applicable franchise fees for new
restaurants ($25,000) and Target Reservation Agreements ($10,000). In December,
2002 the Company and BKC mutually agreed to terminate the BKC Agreement
principally because many of the target locations reserved in the BKC Agreement
do not meet BKC's new development criteria. Accordingly, the Company will be
entitled to a credit of $5,000 against the applicable franchise fee for each of
the next five new restaurants it opens prior to December 31, 2005.
The Company is responsible for all costs and expenses incurred in locating,
acquiring and developing restaurant sites. The Company must also satisfy Burger
King Corporation's development criteria, which include the specific site, the
related purchase contract or lease agreement and architectural and engineering
plans for each of the Company's new Burger King restaurants. Burger King
Corporation may refuse to grant a franchise for any proposed Burger King
restaurant if the Company is not conducting the operations of each of its Burger
King restaurants in compliance with Burger King Corporation's franchise
requirements. Burger King Corporation periodically monitors the operations of
its franchised restaurants and notifies its franchisees of failures to comply
with franchise or development agreements that come to its attention.
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 fiscal 2001 and $180,000
in fiscal 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 will be from July 1, 2000 to
June 30, 2003. As of July 1, 2003, the royalty rate will become 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
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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 are 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 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 20 years.
The Company invested approximately $6.6 million to remodel the selected
restaurants to Burger King Corporation's current image of which approximately
$3.9 million was expended in fiscal 2002.
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
expects to invest approximately $2.2 million in fiscal 2003 to remodel the
participating restaurants to Burger King Corporation's current image. The
deadline for completing the required improvements is June 30, 2003.
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.
Chili's. The Company has a development agreement with Brinker (the "Chili's
Agreement") to develop up to 41 Chili's restaurants in two regions encompassing
counties in Indiana, Michigan, Ohio, Kentucky ("Midwest Region"), and Delaware,
New Jersey and Pennsylvania ("Philadelphia Region"). 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. As part of a system-wide promotional effort,
the Company paid an additional advertising fee of 0.375% of sales for the period
beginning September 1, 1999 and ended August 30, 2000 and paid a similar fee of
1.0% of sales for the period beginning September 1, 2000 and ended June 27, 2001
and 1.2% for the period beginning June 28, 2001 through June 26, 2002. From June
27, 2002 through June 25, 2003, the Company has and will pay an additional 2.0%
of sales. The Company is also required to spend 2.0% of sales from each
restaurant on local advertising which is considered to be met by the additional
fee of 2% of sales described in the preceding sentence.
8
The Company may develop up to 41 Chili's without specific approval of
Brinker, but is obligated to satisfy the following development schedule:
REQUIRED MINIMUM CUMULATIVE NO. OF
RESTAURANTS ACTUAL CUMULATIVE NO. OF RESTAURANTS
----------- ------------------------------------
MIDWEST PHILADELPHIA MIDWEST PHILADELPHIA
REGION REGION TOTAL REGION REGION TOTAL
------ ------ ----- ------ ------ -----
December 31, 2001 16 15 33(1) 18 15 33
December 31, 2002 15 15 34(1) 19 15 34
June 30, 2003 15 16 35(1)
December 31, 2003 15 16 37(1)
- -------------
(1) The additional restaurants to be opened in these years may be located in
either region at the Company's discretion.
Failure to adhere to this schedule constitutes a default under the Chili's
Agreement and Brinker could terminate the Chili's Agreement. The Chili's
Agreement prohibits Brinker or any other Chili's franchisee from establishing a
Chili's restaurant within a specified geographic radius of the Company's Chili's
restaurants. The Chili's Agreement expires on the earlier of the date upon which
the Company completes the development schedule or December 31, 2003. The Chili's
Agreement and the franchise agreements prohibit the Company, for the term of the
agreements, from owning or operating other restaurants which are similar to a
Chili's restaurant. The Chili's Agreement extends this prohibition, but only
within the Company's development territories, for a period of two years
following the termination of such agreement. In addition, each franchise
agreement prohibits the Company, for the term of the franchise agreement and for
a period of two years following its termination, from owning or operating such
other restaurants within a 10-mile radius of the Chili's restaurant which was
the subject of such agreement.
Under the Chili's Agreement, the Company is responsible for all costs and
expenses incurred in locating, acquiring and developing restaurant sites. Each
proposed restaurant site, the related purchase contract or lease agreement and
the architectural and engineering plans for each of the Company's new Chili's
restaurants are subject to Brinker's approval. Brinker may refuse to grant a
franchise for any proposed Chili's restaurant if the Company is not conducting
the operations of each of its Chili's restaurants in compliance with the Chili's
restaurant franchise requirements. Brinker may terminate the Chili's Agreement
if the Company defaults in its performance thereunder or under any franchise
agreement. Brinker periodically monitors the operations of its franchised
restaurants and notifies the franchisees of any failure to comply with franchise
or development agreements that comes to its attention.
The franchise agreements convey the right to use the franchisor's trade
names, trademarks and service marks with respect to specific restaurant units.
The franchisor 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 and technical assistance and materials. Each franchise
agreement prohibits the Company from transferring a franchise without the prior
approval of the franchisor.
Risks and Requirements of Franchisee Status. Due to the nature of
franchising and the Company's agreements with its franchisors, the success of
the Company's Burger King and Chili's concepts is, in large part, dependent upon
the overall success of its franchisors, including the financial condition,
management and marketing success of its franchisors and the successful operation
of restaurants opened by other franchisees. Certain matters with respect to the
Company's franchised concepts must be coordinated with, and approved by, the
Company's franchisors. In particular, the Company's franchisors must approve the
opening by the Company of any new franchised restaurant, including franchises
opened within the Company's existing franchised territories, and the closing of
any of the Company's existing franchised restaurants. The Company's franchisors
also maintain discretion over the menu items that may be offered in the
Company's franchised restaurants.
9
COMPETITION
The restaurant industry is intensely competitive with respect to price,
service, location and food quality. The industry is mature and competition can
be expected to increase. There are many well-established competitors with
substantially greater financial and other resources than the Company, some of
which have been in existence for a substantially longer period than the Company
and may have substantially more units in the markets where the Company's
restaurants are, or may be, located. McDonald's and Wendy's restaurants are the
principal competitors to the Company's Burger King restaurants. The competitors
to the Company's Chili's and Italian Dining restaurants are other casual dining
concepts such as Applebee's, T.G.I. Friday's, Bennigan's, Olive Garden and Red
Lobster restaurants. The primary competitors to Grady's American Grill are
Houston's, J. Alexander's, Outback Steakhouse, Houlihan's, and O'Charley's
Restaurant & Lounge, as well as a large number of locally-owned, independent
restaurants. The Company believes that competition is likely to become even more
intense in the future.
The Company and the restaurant industry in general are significantly
affected by factors such as changes in local, regional or national economic
conditions, changes in consumer tastes, weather conditions and various other
consumer concerns. In addition, factors such as increases in food, labor and
energy costs, the availability and cost of suitable restaurant sites,
fluctuating insurance rates, state and local regulations and the availability of
an adequate number of hourly-paid employees can also adversely affect the
restaurant industry.
GOVERNMENT REGULATION
Each of the Company's restaurants is subject to licensing and regulation by
a number of governmental authorities, which include alcoholic beverage control
in the case of the Chili's, Italian Dining and Grady's American Grill
restaurants, and health, safety and fire agencies in the state or municipality
in which the restaurant is located. Difficulties or failures in obtaining the
required licenses or approvals could delay or prevent the opening of a new
restaurant in a particular area.
Alcoholic beverage control regulations require each of the Company's
Chili's, Italian Dining and Grady's American Grill restaurants to apply to a
state authority and, in certain locations, county or municipal authorities for a
license or permit to sell alcoholic beverages on the premises and to provide
service for extended hours and on Sundays. Typically, licenses must be renewed
annually and may be revoked or suspended for cause at any time. Alcoholic
beverage control regulations relate to numerous aspects of the daily operations
of the Company's restaurants, including minimum age of patrons and employees,
hours of operation, advertising, wholesale purchasing, inventory control and
handling, storage and dispensing of alcoholic beverages. The loss of a liquor
license for a particular Grady's American Grill, Italian Dining or Chili's
restaurant would most likely result in the closing of the restaurant.
The Company may be subject in certain states to "dramshop" laws, which
generally provide a person injured by an intoxicated patron the right to recover
damages from an establishment that wrongfully served alcoholic beverages to the
intoxicated person. The Company carries liquor liability coverage as part of its
existing comprehensive general liability insurance.
The Company's restaurant operations are also subject to federal and state
minimum wage laws governing such matters as working conditions, overtime and tip
credits. Significant numbers of the Company's food service and preparation
personnel are paid at rates related to the federal minimum wage and,
accordingly, increases in the minimum wage could increase the Company's labor
costs.
The Company is also subject to various local, state and federal laws
regulating the discharge of pollutants into the environment. The Company
believes that it conducts its operations in substantial compliance with
applicable environmental laws and regulations. In an effort to prevent and, if
necessary, to correct environmental problems, the Company conducts environmental
audits of a proposed restaurant site in order to determine whether there is any
evidence of contamination prior to purchasing or entering into a lease with
respect to such site. To date, the Company's operations have not been materially
adversely affected by the cost of compliance with applicable environmental laws.
10
EMPLOYEES
As of October 27, 2002, the Company employed approximately 8,300 persons.
Of those employees, approximately 110 held management or administrative
positions, approximately 670 were involved in restaurant management, and the
remainder were engaged in the operation of the Company's restaurants. None of
the Company's employees is covered by a collective bargaining agreement. The
Company considers its employee relations to be good.
11
ITEM 2. PROPERTIES.
The following table sets forth, as of October 27, 2002, the 15 states in
which the Company operated restaurants and the number of restaurants in each
state. Of the 174 restaurants which the Company operated as of October 27, 2002,
the Company owned 45 and leased 129. Many leases provide for base rent plus an
additional rent based upon sales to the extent the additional rent exceeds the
base rent, while other leases provide for only a base rent.
NUMBER OF COMPANY-OPERATED RESTAURANTS
--------------------------------------
GRADY'S
BURGER AMERICAN ITALIAN
KING CHILI'S GRILL DINING TOTAL
---- ------- ----- ------ -----
Alabama 1 1
Arkansas 1 1
Colorado 3 3
Delaware 2 2
Georgia 1 1
Illinois 1 1
Indiana 43 5 2 50
Michigan 72 10 1 5 88
Mississippi 1 1
New Jersey 5 1 6
North Carolina 2 2
Ohio 4 2 6
Oklahoma 1 1
Pennsylvania 8 8
Tennessee 3 3
------------------------------------------------------
Total 115 34 16 9 174
=== == == = ===
Burger King. As of October 27, 2002, 41 of the Company's Burger King
restaurants were leased from real estate partnerships owned by certain of the
Company's founding shareholders. See ITEM 13, "Certain Relationships and Related
Transactions." The Company also leased six Burger King restaurants directly from
Burger King Corporation and 51 restaurants from unrelated third parties. The
Company owned 17 of its Burger King restaurants as of October 27, 2002.
Chili's Grill & Bar. As of October 27, 2002, the Company owned 12 of its
Chili's restaurants and leased the 22 other restaurants from unrelated parties.
Grady's American Grill. As of October 27, 2002, the Company owned 11 of its
Grady's American Grill restaurants and leased the other five Grady's American
Grill restaurants from unrelated parties.
Italian Dining. As of October 27, 2002, the Company owned five of the
Italian Dining restaurants and leased the four other restaurants from unrelated
parties.
Office Lease. The Company leases approximately 53,000 square feet for its
headquarters facility in an office building located in Mishawaka, Indiana that
was constructed in 1997 and is leased from a limited liability company in which
the Company owns a 50% interest. The remaining term of the lease agreement is 9
years. Approximately 4,500 square feet, 12,400 square feet and 5,200 square feet
of the Company's headquarters building have been subleased to three tenants with
remaining terms of two, three and five years, respectively.
12
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to one remaining legal proceeding relating to the
Company's previously owned bagel-related businesses.
On or about April 15, 1997, Texas Commerce Bank National Association
("Texas Commerce") made a loan of $4,200,000 (the "Loan") to BFBC Ltd., a
Florida limited partnership ("BFBC"). At the time of the Loan, BFBC was a
franchisee under franchise agreements with Bruegger's Franchise Corporation (the
"Franchisor"). The Company at that time was an affiliate of the Franchisor. In
connection with the Loan and as an accommodation of BFBC, the Company executed
to Texas Commerce a "Guaranty". By the terms of the Guaranty the Company agreed
that upon maturity of the Loan by default or otherwise that it would either (1)
pay the Loan obligations or (2) buy the Loan and all of the related loan
documents (the "Loan Documents") from Texas Commerce or its successors. In
addition several principals of BFBC (the "Principal Guarantors") guaranteed
repayment of the Loan by each executing a "Principal Guaranty". On November 10,
1998, Texas Commerce (1) declared that the Loan was in default, (2) notified
BFBC, the Principal Guarantors and the Company that all of the Loan obligations
were due and payable, and (3) demanded payment.
The Company elected to satisfy its obligations under the Guaranty by
purchasing the Loan from Texas Commerce. On November 24, 1998, the Company
bought the Loan for $4,294,000. Thereafter, the Company sold the Loan to its
Texas affiliate Grady's American Grill, L.P. ("Grady's"). On November 30, 1998,
Grady's commenced an action seeking to recover the amount of the Loan from one
of the Principal Guarantors, Michael K. Reilly ("Reilly"). As part of this
action Grady's also sought to enforce a Subordination Agreement that was one of
the Loan Documents against MKR Investments, L.P., a partnership ("MKR"). Reilly
is the general partner of MKR. This action is pending in the United States
District Court for the Southern District of Texas Houston Division as Case No.
H-98-4015. Reilly has denied liability and filed counterclaims against Grady's
alleging that Grady's engaged in unfair trade practices, violated Florida's
"Rico" statute, engaged in a civil conspiracy and violated state and federal
securities laws in connection with the Principal Guaranty (the "Counterclaims").
Reilly also filed a third party complaint ("Third Party Complaint") against
Quality Dining, Inc., Grady's American Grill Restaurant Corporation, David M.
Findlay, Daniel B. Fitzpatrick, Bruegger's Corporation, Bruegger's Franchise
Corporation, Champlain Management Services, Inc., Nordahl L. Brue, Michael J.
Dressell and Ed Davis ("Third Party Defendants") alleging that Reilly invested
in BFBC based upon false representations, that the Third Party Defendants
violated state franchise statutes, committed unfair trade practices, violated
covenants of good faith and fair dealing, violated the state "Rico" statute and
violated state and federal securities laws in connection with the Principal
Guaranty. In addition, BFBC and certain of its affiliates, including the
Principal Guarantors ("Intervenors") have intervened and asserted claims against
Grady's and the Third Party Defendants that are similar to those asserted in the
Counterclaims and the Third Party Complaint. Those Third Party Defendants who
are individuals were present or former officers and directors of the Company and
the Company had advanced defense costs on their behalf until they were dismissed
by the Court.
On December 31, 2002, the District Court dismissed certain claims asserted
by Reilly and the Intervenors and declined to dismiss certain other claims. The
District Court also declined to enforce MKR's Subordination Agreement. The
District Court also determined that BFBC, Reilly and the Principal Guarantors
are obligated for the Loan. Based upon the currently available information, the
Company does not believe that the ultimate resolution of this matter will have a
materially adverse effect on the Company's financial position, however, there
can be no assurance thereof. Neither can there be any assurance that the Company
will be able to realize sufficient value from BFBC, Reilly or the Principal
Guarantors to satisfy the amount of the Loan. The ongoing expense of the BFBC
litigation may be significant to the Company's results of operations.
Pursuant to the Share Exchange Agreement by and among Quality Dining, Inc.,
Bruegger's Corporation, Nordahl L. Brue and Michael J. Dressell ("Share Exchange
Agreement"), the Agreement and Plan of Merger by and among Quality Dining, Inc.,
Bagel Disposition Corporation and Lethe, LLC, and certain other related
agreements entered into as part of the disposition of the Company's
bagel-related businesses in 1997, the Company was responsible for 50% of the
first $14 million of franchise-related litigation expenses, inclusive of
attorney's fees, costs, expenses, settlements and judgments (collectively
"Franchise Damages"). Bruegger's Corporation and certain of its affiliates are
obligated to indemnify the Company from all other Franchise Damages. The Company
was originally obligated to pay the first $3 million of its share of Franchise
Damages in cash. The Company has satisfied this obligation. The remaining $4
million of the Company's share of Franchise Damages was originally payable by
crediting amounts owed to the Company pursuant to the $10 million Subordinated
Note ("Subordinated Note") issued to the Company by Bruegger's Corporation.
However, as a result of the Bruegger's Resolution (described below), the
remainder of the Company's share of Franchise Damages is payable in cash.
13
On or about September 10, 1999, Bruegger's Corporation, Lethe LLC, Nordahl
L. Brue, and Michael J. Dressell commenced an action against the Company in the
United States District Court for the District of Vermont alleging that the
Company breached various provisions of the Share Exchange Agreement which arose
out of a dispute concerning a post-closing net working capital adjustment
contemplated by the Share Exchange Agreement. On February 1, 2000, the Company
filed counter-claims against Bruegger's Corporation for the working capital
adjustment to which it believed it was entitled.
On February 28, 2001, the Company and Bruegger's Corporation reached a
settlement (the "Bruegger's Resolution") of their various disputes that
includes, among other things, the following provisions: (a) the principal amount
of the Subordinated Note was restated to $10.7 million; (b) the Company and
Bruegger's Corporation each released their claim against the other to receive a
net working capital adjustment; (c) the Subordinated Note was modified to, among
other things, provide for an extension of the period through which interest is
to be accrued and added to the principal amount of the Subordinated Note from
October, 2000 through January, 2002. From January, 2002 through June, 2002,
one-half of the interest was to be accrued and added to the principal amount of
the Subordinated Note and one-half of the interest was to be paid in cash.
Commencing in January, 2003, interest was to be paid in cash through the
maturity of the Subordinated Note in October 2004; (d) the Company and
Bruegger's Corporation are each responsible for 50% of the Franchise Damages
with respect to the claims asserted by BFBC Ltd., et al., (e) Bruegger's
Corporation was entitled to 25% of any net recovery made by the Company on the
BFBC, Ltd., Loan; provided, however, that any such entitlement was required to
be applied to the outstanding balance of the Subordinated Note; (f) Bruegger's
Corporation and its affiliates released their claims for breach of
representations and warranties under the Share Exchange Agreement; and (g)
Bruegger's Corporation is entitled to a credit of two dollars against the
Subordinated Note for every one dollar that Bruegger's Corporation prepays
against the Subordinated Note prior to October, 2003 up to a maximum credit of
$4 million.
As of the fourth quarter of fiscal 2001, Bruegger's Corporation advised the
Company that it is unable to continue to pay its 50% share of Franchise Damages.
Since then the Company has and likely will continue to have to incur the full
expense of the BFBC litigation and that Bruegger's Corporation will not have the
ability to perform its indemnity obligations, if any.
It is also likely that the Company may never receive any principal or
interest payments in respect of the Subordinated Note. The Company has never
recognized any interest income from the Subordinated Note and has previously
reserved for the full amount of the Subordinated Note.
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.
14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company did not submit any matters to a vote of security holders during
the fourth quarter of the 2002 fiscal year.
15
EXECUTIVE OFFICERS OF THE COMPANY
Name Age Position
- ---------------------------- ----- --------------------------------------------------------------
Daniel B. Fitzpatrick 45 Chairman of the Board, President and Chief Executive Officer
John C. Firth 45 Executive Vice President, General Counsel and Secretary
James K. Fitzpatrick 47 Senior Vice President, Chief Development Officer and Director
Patrick J. Barry 40 Senior Vice President - Administration and Information
Technology
Lindley E. Burns 48 Senior Vice President - Full Service Dining
Gerald O. Fitzpatrick 42 Senior Vice President - Burger King Division
Christopher L. Collier 41 Vice President - Finance
Robert C. Hudson 46 Vice President - Grady's American Grill Division
Jeanne M. Yoder 36 Vice President and Controller
Daniel B. Fitzpatrick has served as President and Chief Executive Officer
and a Director of the Company since 1982. Prior to founding the Company, Mr.
Fitzpatrick worked for a franchisee of Burger King Corporation, rising to the
level of regional director of operations. He has over 25 years of experience in
the restaurant business. Mr. Fitzpatrick also serves as a director of 1st Source
Corporation, a publicly held diversified bank holding company based in South
Bend, Indiana.
John C. Firth serves as Executive Vice President, General Counsel and
Secretary. Prior to joining the Company in June 1996, he was a partner with the
law firm of Sopko and Firth. Beginning in 1985, he represented the Company as
outside legal counsel with responsibility for the Company's legal affairs.
James K. Fitzpatrick has served as Senior Vice President and Chief
Development Officer of the Company since August 1995. Prior to that, Mr.
Fitzpatrick served as Vice President or Senior Vice President of the Company in
charge of the Company's Fort Wayne, Indiana Burger King restaurant operations
since 1984. Prior to joining the Company, he served as a director of operations
for a franchisee of Burger King Corporation. He has over 25 years of experience
in the restaurant business.
Patrick J. Barry joined the Company in October 1996 and serves as the
Company's Senior Vice President - Administration and Information Technology.
Prior to joining the Company, Mr. Barry was a management consultant with The
Keystone Group and Andersen Consulting.
Lindley E. Burns joined the Company in June of 1995. Prior to joining the
Company he worked for Brinker as a multi-unit manager in its Chili's division
for two years and was a Chili's franchisee for eight years prior to joining
Brinker. He has over 25 years of experience in the restaurant business.
Gerald O. Fitzpatrick serves as a Senior Vice President in the Company's
Burger King Division. Mr. Fitzpatrick has served in various capacities in the
Company's Burger King operations since 1983. Prior to joining the Company, he
served as a district manager for a franchisee of Burger King Corporation. He has
over 20 years of experience in the restaurant business.
Christopher L. Collier joined the Company in July of 1996. Since that time
he has served in various capacities in the Finance Department, most recently as
the Vice President of Financial Reporting. Prior to joining the Company, he
served as the Vice President-Finance at a regional restaurant chain. Mr. Collier
is a certified public accountant.
16
Robert C. Hudson joined the Company in December of 1995 when the Company
acquired Grady's American Grill. From 1992 until joining the Company, Mr. Hudson
held various operational positions at Brinker, most recently as an area director
in its Grady's American Grill division.
Jeanne M. Yoder joined the Company in March of 1996. Since that time she
has served in various capacities in the Accounting Department, most recently as
Assistant Controller. Prior to joining the Company, she served as Controller at
a regional travel agency. Ms. Yoder is a certified public accountant.
The above information includes business experience during the past five
years for each of the Company's executive officers. Executive officers of the
Company serve at the discretion of the Board of Directors. Messrs. Daniel B.
Fitzpatrick, James K. Fitzpatrick and Gerald O. Fitzpatrick are brothers. There
is no family relationship between any other Directors or executive officers of
the Company.
The success of the Company's business is dependent upon the services of
Daniel B. Fitzpatrick, Chairman, President and Chief Executive Officer of the
Company. The Company maintains key man life insurance on the life of Mr.
Fitzpatrick in the principal amount of $3.0 million. The loss of the services of
Mr. Fitzpatrick would have a material adverse effect upon the Company.
(Pursuant to General Instruction G(3) of Form 10-K, the foregoing
information is included as an unnumbered Item in Part I of this Annual Report in
lieu of being included in the Company's Proxy Statement for its 2003 Annual
Meeting of Shareholders.)
17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is traded on the NASDAQ Stock Market's National
Market under the symbol QDIN. The prices set forth below reflect the high and
low sales quotations for the Company's Common Stock as reported by NASDAQ for
the fiscal periods indicated. As of January 14, 2002, there were 426 holders of
record and approximately 3,261 beneficial owners.
Fiscal Year 2002 Fiscal Year 2001
High Low High Low
--------------------- ---------------------
First Quarter $ 2.48 $ 1.80 $ 2.94 $ 1.94
Second Quarter 3.98 2.06 2.75 2.00
Third Quarter 5.00 3.05 3.07 2.05
Fourth Quarter 3.98 2.93 2.64 2.00
The Company does not pay cash dividends on its Common Stock. The Company
does not anticipate paying cash dividends in the foreseeable future. The
Company's revolving credit agreement prohibits the payment of cash dividends and
restricts other distributions. The agreement expires November 1, 2005.
No unregistered equity securities were sold by the Company during fiscal
2002.
Information about the Company's equity compensation plans required by this
Item is set forth in Part III, Item 12 of this report and is incorporated herein
by reference.
18
ITEM 6. SELECTED FINANCIAL DATA
QUALITY DINING, INC.
- -----------------------------------------------------------------------------------------------------------------------------
Fiscal Year Ended (1)
October 27, October 28, October 29, October 31, October 25,
2002 2001 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------
(In thousands, except unit and per share data)
STATEMENT OF OPERATIONS DATA:
Revenues:
Restaurant sales:
Burger King $ 121,526 $ 79,485 $ 81,724 $ 82,650 $ 80,391
Chili's Grill & Bar 75,760 69,727 60,921 56,837 55,572
Grady's American Grill 44,918 60,447 68,615 75,198 81,241
Italian Dining Division 17,052 17,126 16,756 16,066 15,040
- -----------------------------------------------------------------------------------------------------------------------------
Total revenues 259,256 226,785 228,016 230,751 232,244
- -----------------------------------------------------------------------------------------------------------------------------
Operating expenses
Restaurant operating expenses
Food and beverage 73,656 64,196 64,607 67,732 69,102
Payroll and benefits 77,182 67,238 66,782 67,073 66,404
Depreciation and amortization 10,722 11,784 11,312 11,002 11,475
Other operating expenses 65,374 56,811 54,832 55,890 55,644
- -----------------------------------------------------------------------------------------------------------------------------
Total restaurant operating expenses: 226,934 200,029 197,533 201,697 202,625
General and administrative (2)(3) 18,638 15,111 17,073 15,912 15,488
Amortization of intangibles 431 892 910 1,032 1,085
Impairment of assets and facility closing costs 355 15,385 - 2,501 250
- -----------------------------------------------------------------------------------------------------------------------------
Total operating expenses 246,358 231,417 215,516 221,142 219,448
- -----------------------------------------------------------------------------------------------------------------------------
Operating income (loss) (4) (5) 12,898 (4,632) 12,500 9,609 12,796
- -----------------------------------------------------------------------------------------------------------------------------
Other income (expense):
Interest expense (8,429) (10,419) (11,174) (10,709) (11,962)
Provision for uncollectible note receivable (6) - - (10,000) - -
Gain (loss) on sale of property and equipment 1,034 (310) (878) (188) (345)
Interest income 40 22 27 103 190
Other income (expense), net 615 1,163 997 43 541
- -----------------------------------------------------------------------------------------------------------------------------
Total other expense (6,740) (9,544) (21,028) (10,751) (11,576)
- -----------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 6,158 (14,176) (8,528) (1,142) 1,220
Income tax provision (benefit) 1,074 1,354 1,183 815 1,107
- -----------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 5,084 $ (15,530) $ (9,711) $ (1,957) $ 113
- -----------------------------------------------------------------------------------------------------------------------------
Basic net income (loss) per share $ 0.45 $ (1.37) $ (0.79) $ (0.15) $ 0.01
- -----------------------------------------------------------------------------------------------------------------------------
Diluted net income (loss) per share $ 0.45 $ (1.37) $ (0.79) $ (0.15) $ 0.01
- -----------------------------------------------------------------------------------------------------------------------------
Weighted average shares outstanding
- -----------------------------------------------------------------------------------------------------------------------------
Basic 11,248 11,356 12,329 12,668 12,599
- -----------------------------------------------------------------------------------------------------------------------------
Diluted 11,306 11,356 12,329 12,668 12,654
- -----------------------------------------------------------------------------------------------------------------------------
19
- --------------------------------------------------------------------------------------------------------------
Fiscal Year Ended (1)
October 27, October 28, October 29, October 31, October 25,
2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------
RESTAURANT DATA:
Units open at end of period:
Grady's American Grill 16 34 35 36 39
Italian Dining Division 9 8 8 8 8
Burger King (7) 115 116 71 70 70
Chili's Grill & Bar 34 33 31 28 28
----------------------------------------------------------------
174 191 145 142 145
- --------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA:
Working capital (deficiency) $(23,100) $(23,405) $ (22,312) $ (17,962) $ (14,747)
Total assets 156,941 167,238 178,861 189,037 196,275
Long-term debt, capitalized lease
and non-competition obligations 99,031 113,194 106,815 112,815 118,605
Total stockholders' equity 25,753 20,380 37,984 49,002 50,926
(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 ongoing 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 loss 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 $14,525,000 for the
impairment write down for under-performing Grady's American Grill
restaurants and $860,000 for store closing expenses and lease guarantee
obligations.
(6) As of the fourth quarter of fiscal 2000 the Company recorded a $10,000,000
non-cash charge to fully reserve for the Subordinated Note.
(7) 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.
20
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, management periodically 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. If these
assumptions change in the future, management may be required to record
impairment charges for these assets.
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; if these estimates
and assumptions change in the future, the Company may be required to adjust its
valuation allowance. This could result in a charge to, or an 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.
21
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. 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.
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 27, October 28, October 29,
2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------
Revenues:
Restaurant sales:
Burger King 46.9% 35.0% 35.9%
Chili's Grill & Bar 29.2 30.7 26.7
Grady's American Grill 17.3 26.7 30.1
Italian Dining Division 6.6 7.6 7.3
- ---------------------------------------------------------------------------------------------------------------
Total revenues 100.0 100.0 100.0
- ---------------------------------------------------------------------------------------------------------------
Operating expenses:
Restaurant operating expenses:
Food and beverage 28.4 28.3 28.3
Payroll and benefits 29.8 29.6 29.3
Depreciation and amortization 4.1 5.2 5.0
Other operating expenses 25.2 25.1 24.0
- ---------------------------------------------------------------------------------------------------------------
Total restaurant operating expenses: 87.5 88.2 86.6
- ---------------------------------------------------------------------------------------------------------------
Income from restaurant operations 12.5 11.8 13.4
- ---------------------------------------------------------------------------------------------------------------
General and administrative 7.2 6.7 7.5
Amortization of intangibles 0.2 0.4 0.4
Impairment of assets and facility closing costs 0.1 6.8 -
- ---------------------------------------------------------------------------------------------------------------
Operating income (loss) 5.0 (2.1) 5.5
- ---------------------------------------------------------------------------------------------------------------
Other income (expense):
Interest expense (3.3) (4.6) (4.9)
Provision for uncollectible note receivable - - (4.4)
Gain (loss) on sale of property and equipment 0.4 (0.1) (0.4)
Other income and expense, net 0.3 0.5 0.4
- ---------------------------------------------------------------------------------------------------------------
Total other expense, net (2.6) (4.2) (9.3)
- ---------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 2.4 (6.3) (3.8)
Income tax provision 0.4 0.5 0.5
- ----------------------------------------------------------------------------------------------------------------
Net income (loss) 2.0% (6.8)% (4.3)%
- ----------------------------------------------------------------------------------------------------------------
22
FISCAL YEAR 2002 COMPARED TO FISCAL YEAR 2001
Restaurant sales in fiscal 2002 were $259,256,000, an increase of 14.3%
or $32,471,000, compared to restaurant sales of $226,785,000 in fiscal 2001. The
increase was due to a $42,041,000 increase in restaurant sales in the Company's
quick service segment that was partially offset by a $9,570,000 decrease in
restaurant sales in the Company's full service segment.
The Company's Burger King restaurant sales were $121,526,000 in fiscal
2002 compared to sales of $79,485,000 in fiscal 2001, an increase of
$42,041,000. The Company had increased revenues of $38,857,000 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
$2,518,000 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 $20,289 in fiscal 2002 versus $21,329 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 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 $44,918,000
in fiscal 2002 compared to sales of $60,447,000 in fiscal 2001, a decrease of
$15,529,000. The Company sold or closed 18 units in fiscal 2002. The absence of
these units accounted for $11,889,000 of the sales decrease during fiscal 2002.
The Company's Grady's American Grill restaurants had average weekly sales of
$31,922 in fiscal 2002 versus $34,036 in the same period in fiscal 2001. Sales
at restaurants open for more than one year decreased 12.0% in fiscal 2002 when
compared to the same period in fiscal 2001.
The Company continues to experience a significant decrease in sales and
cash flow at its Grady's American Grill division. The Company continues to
pursue 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 restaurant locations.
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.
While the Company believes that the Grady's American Grill assets are
reported at their estimated fair values as of October 27, 2002, there can be no
assurances thereof.
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.
23
Total restaurant operating expenses were $226,934,000 in fiscal 2002,
compared to $200,029,000 in fiscal 2001. As a percentage of restaurant sales,
total restaurant operating expenses decreased to 87.5% in fiscal 2002 from 88.2%
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 have 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 $73,656,000 in fiscal 2002, compared to
$64,196,000 in fiscal 2001. As a percentage of total restaurant sales, food and
beverage costs increased 0.1% to 28.4% in fiscal 2002 from 28.3% in 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 $77,182,000 in fiscal 2002, compared to
$67,238,000 in fiscal 2001. As a percentage of total restaurant sales, payroll
and benefits increased 0.2% to 29.8% in fiscal 2002 from 29.6% in fiscal 2001.
The Company experienced an increase in payroll, as a percentage of sales, in
both the full service and the quick service segments. The increase as a
percentage of sales in the full service segment was mainly due to the decreased
average weekly sales in the Company's Grady's American Grill restaurants. 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.
Depreciation and amortization decreased $1,062,000 to $10,722,000 in
fiscal 2002 compared to $11,784,000 in fiscal 2001. As a percentage of total
restaurant sales, depreciation and amortization decreased to 4.1% in fiscal 2002
compared to 5.2% in fiscal 2001. The decrease was mainly due to a $1,935,000
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 $8,563,000 to
$65,374,000 in fiscal 2002 compared to $56,811,000 in 2001. Other restaurant
operating expenses as a percentage of total restaurant sales remained relatively
consistent at 25.2% in fiscal 2002 versus 25.1% in fiscal 2001. The negative
effect of the addition of Burger King restaurants in Grand Rapids, Michigan was
offset by the positive effect of the disposal of 18 Grady's American Grill
restaurants.
The Company recorded a $355,000 impairment of asset and facility
closing charge in fiscal 2002 consisting primarily of contractual lease costs
for certain closed Grady's American Grill restaurants. The Company recorded a
$15,385,000 impairment of asset and facility closing charge in fiscal 2001. The
charge consisted of a $14,525,000 charge for the impairment of assets in the
Company's Grady's American Grill restaurant division, as discussed above, and
$860,000 in charges for the cost of closing certain restaurant locations and
certain lease guarantee obligations.
24
Income from restaurant operations increased $5,566,000 to $32,322,000,
or 12.5% of revenues, in fiscal 2002 compared to $26,756,000, or 11.8% 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 $878,000 from the prior year.
General and administrative expenses, which include corporate and
district management costs, were $18,638,000 in fiscal 2002, compared to
$15,111,000 in fiscal 2001. As a percentage of total revenues, general and
administrative expenses increased to 7.2% in fiscal 2002 compared to 6.7% in
fiscal 2001. In fiscal 2002 the Company incurred approximately $1,527,000 for
the BFBC, Ltd. litigation (See Note 10 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.
The Company had operating income of $12,898,000 in fiscal 2002 compared
to an operating loss of $4,632,000 in fiscal 2001.
Total other expenses, as a percentage of total revenues, decreased to
2.6% in fiscal 2002 compared to 4.2% 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 $310,000
loss on the sale of fixed assets in fiscal 2001.
Income tax expense of $1,074,000 was recorded in fiscal 2002 compared
to $1,354,000 in fiscal 2001. The decrease in income tax was largely due to a
federal refund of $330,000 related to previous years' alternative minimum tax
payments. The refund was made possible through the Job Creation and Worker
Assistance Act of 2002. The Company utilized $8.5 million of net operating loss
carryforwards to offset current year taxable income.
The Company has net operating loss carryforwards of approximately $44.5
million as well as FICA tip credits and alternative minimum tax credits of $4.6
million. Net operating loss carryforwards of $39.9 million expire in 2012, $3.0
million expire in 2018 and $1.6 million expire in 2021. 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 and 702,000 expire in 2017. The
alternative minimum tax credits of $191,000 carryforward indefinitely. At the
end of fiscal 2002 the Company had a valuation reserve against its deferred tax
asset of $24.0 million resulting in a net deferred tax asset of $10.0 million.
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. Based on this assessment, the Company
believes it is more likely than not that the net deferred tax asset of
$10,000,000 will be realized. Such evidence is reviewed periodically and could
result in the recognition of additional tax benefit or expense related to its
net deferred tax asset position in the future.
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.
FISCAL YEAR 2001 COMPARED TO FISCAL YEAR 2000
Restaurant sales in fiscal 2001 were $226,785,000, a decrease of 0.5%
or $1,231,000, compared to restaurant sales of $228,016,000 in fiscal 2000. The
decrease was due to a $2,239,000 decrease in restaurant sales in the Company's
quick service segment which was partly offset by a $1,008,000 increase in
restaurant sales in the Company's full service segment.
The Company's Burger King restaurant sales were $79,485,000 in fiscal
2001 compared to restaurant sales of $81,724,000 in fiscal 2000, a decrease of
$2,239,000. The Company believes that the reduction in sales was due
25
to less successful promotional programs in fiscal 2001 versus fiscal 2000. The
Company's Burger King restaurants average weekly sales decreased to $21,329 in
fiscal 2001 versus $22,286 in fiscal 2000. The Company had increased revenue of
$1,007,000 due to additional sales weeks from three new restaurants opened
during fiscal 2001 and two restaurants opened in fiscal 2000 which were open for
their first full year in fiscal 2001. The Company also had increased revenue of
$1,651,000 from 42 Burger King restaurants in the Grand Rapids, Michigan
metropolitan area which were purchased on October 15, 2001 (See Note 13).
The Company's Chili's Grill & Bar restaurant sales increased $8,806,000
to $69,727,000 in fiscal 2001 compared to restaurant sales of $60,921,000 in
fiscal 2000. The Company had increased revenue of $5,702,000 due to additional
sales weeks from two new restaurants opened in fiscal 2001 and three restaurants
opened in fiscal 2000 which were open for their first full year in fiscal 2001.
The Company's Chili's Grill & Bar restaurants average weekly sales increased to
$42,650 in fiscal 2001 versus $40,533 in fiscal 2000. The Company believes that
the increase in average weekly sales was due to the continued success of
operational and marketing initiatives by the Company and the franchisor.
The Company's Grady's American Grill restaurant sales were $60,447,000
in fiscal 2001 compared to restaurant sales of $68,615,000 in fiscal 2000, a
decrease of $8,168,000. The Company closed one unit during the first quarter of
fiscal 2001 and one unit during fiscal 2000. These units did not fit the
Company's long-term strategic plan as they were located in geographically remote
markets and were not meeting the Company's performance expectations. These units
contributed $1,807,000 to fiscal 2000 sales. The Company's Grady's American
Grill restaurants had average weekly sales of $34,036 in fiscal 2001 versus
$36,949 in the same period in fiscal 2000.
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 (which were sold
during the second quarter of fiscal 2002). 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 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 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. While the Company believes that the Grady's assets are recorded
at their estimated fair values as of October 27, 2002, there can be no
assurances that future asset impairments may not occur.
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.
The Company's Italian Dining Division's restaurant sales increased
$370,000 to $17,126,000 in fiscal 2001 when compared to restaurant sales of
$16,756,000 in fiscal 2000. The increase was due in part to the continued
success of operational and marketing initiatives which increased average weekly
sales to $41,169 in fiscal 2001 from $40,280 in fiscal 2000.
Total restaurant operating expenses were $200,029,000 in fiscal 2001,
compared to $197,533,000 in fiscal 2000. As a percentage of restaurant sales,
total restaurant operating expenses increased to 88.2% in fiscal 2001 from 86.6%
in fiscal 2000. The following factors influenced the operating margins:
Food and beverage costs were $64,196,000 in fiscal 2001, compared to
$64,607,000 in fiscal 2000. As a percentage of total restaurant sales, food and
beverage costs remained consistent at 28.3% in fiscal 2001 and fiscal
26
2000. The Company was able to offset increased food and beverage costs with
modest menu price increases in both its full service and quick service segments.
Payroll and benefits were $67,238,000 in fiscal 2001, compared to
$66,782,000 in fiscal 2000. As a percentage of total restaurant sales, payroll
and benefits increased 0.3% to 29.6% in fiscal 2001 from 29.3% in fiscal 2000.
Payroll and benefits increased as a percentage of total revenues in the quick
service segment but remained consistent in the full service segment. The
increase in the quick service segment was mainly due to a decrease in average
weekly sales at the Company's Burger King divisions. The Company experienced a
significant increase in the cost of its health insurance program for both its
full service and quick service segments. During fiscal 2001, the Company
incurred approximately $667,000 more expense for health insurance than in fiscal
2000.
Depreciation and amortization increased $472,000 to $11,784,000 in
fiscal 2001 compared to $11,312,000 in fiscal 2000. As a percentage of total
restaurant sales, depreciation and amortization increased to 5.2% in fiscal 2001
compared to 5.0% in fiscal 2000.
Other restaurant operating expenses include rent and utilities,
royalties, promotional expense, repairs and maintenance, property taxes and
insurance. Other restaurant operating expenses increased $1,979,000 to
$56,811,000 in fiscal 2001 compared to $54,832,000 in 2000. Other restaurant
operating expenses as a percentage of total restaurant sales increased in fiscal
2001 to 25.1% from 24.0% in fiscal 2000. The increase was mainly due to an
increase in utility costs of $958,000 in fiscal 2001 compared to fiscal 2000 and
a $607,000 increase in repairs and maintenance expense. The increases were
mainly due to the harsh winter weather in the Company's markets and the spike in
utility rates during fiscal 2001.
The Company recorded a $15,385,000 impairment of asset and facility
closing charge in fiscal 2001. The charge consisted of a $14,525,000 charge for
the impairment of assets in the Company's Grady's American Grill restaurant
division, as discussed above, and $860,000 in charges for the cost of closing
certain restaurant locations and certain lease guarantee obligations. The
Company closed one Grady's American Grill restaurant during fiscal 2001.
General and administrative expenses, which include corporate and
district management costs, were $15,111,000 in fiscal 2001, compared to
$17,073,000 in fiscal 2000. As a percentage of total revenues, general and
administrative expenses decreased to 6.7% in fiscal 2001 compared to 7.5% in
fiscal 2000. In fiscal 2000 the Company incurred approximately $1,250,000 in
expenses related to the litigation, proxy contest and tender offer initiated by
NBO, LLC. The Company did not incur similar expenses during fiscal 2001.
Amortization of intangibles was $892,000 in fiscal 2001, compared to
$910,000 in fiscal 2000. As a percentage of total revenues, amortization of
intangibles remained consistent at 0.4% in fiscal 2001 compared to 0.4% in
fiscal 2000.
The Company had an operating loss of $4,632,000 in fiscal 2001 compared
to operating income of $12,500,000 in fiscal 2000.
Total other expenses, as a percentage of total revenues, decreased to
4.2% in fiscal 2001 compared to 9.3% in fiscal 2000. The decrease is primarily
due to the fiscal 2000 $10.0 million non-cash charge to reserve for the
Subordinated Note. The Company had an increase in other income from
Transformational Payments made by Burger King to the Company. See ITEM 1 -
Franchise and Development Agreements.
Income tax expense of $1,354,000 was recorded in fiscal 2001 compared
to $1,183,000 in fiscal 2000. The increase in income tax was due to increased
state income taxes. The Company has a large portion of state taxes based on
criteria other than income. The Company did not have a tax benefit for fiscal
2001 since an increase in the valuation reserve for its net operating loss
carryforwards offset the benefit created by the fiscal 2001 net loss.
The net loss in fiscal 2001 was $15,530,000, or $1.37 per share,
compared to net loss of $9,711,000, or $0.79 per share, in fiscal 2000.
27
MANAGEMENT OUTLOOK
The following section contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, including
statements about trends in and the impact of certain initiatives upon the
Company's operations and financial results. Forward-looking statements can be
identified by the use of words such as "anticipates," "believes," "plans,"
"estimates," "expects," "intends," "may," and other similar expressions.
Forward-looking statements are made based upon management's current expectations
and beliefs concerning future developments and their potential effects on the
Company. There can be no assurance that the Company will actually achieve the
plans, intentions and expectations discussed in these forward-looking
statements. Actual results may differ materially.
Quick Service. The quick service segment of the restaurant industry is
a very mature and competitive segment, which is dominated by several national
chains. Market share is gained through national media campaigns promoting
specific sandwiches, usually at a discounted price. The national chains extend
marketing efforts to include nationwide premiums and movie tie-ins. During
fiscal 2002, fierce price competition in the quick service segment negatively
affected the Company's Burger King results. To date in fiscal 2003, the price
competition that prevailed in the latter part of fiscal 2002 has continued. If
quick service restaurants continue to rely on price discounting to increase
customer traffic, the Company will either have to continue competing on price or
concede market share. Either circumstance would adversely affect the Company's
results.
The Company should benefit from capital improvements made in fiscal
2001 and fiscal 2002. Specifically, the Transformational Initiatives and the
Early Renewal Program remodeling should enhance the image of the Company's
restaurants and therefore have a positive impact on sales. Additionally, the
Company believes that its acquisition of Burger King restaurants in the Grand
Rapids, Michigan, market should continue to bolster the performance of its
Burger King division in fiscal 2003 through the improvement of the Grand Rapids
profit margins.
Full Service. The full service segment of the restaurant industry is
also mature and competitive. This segment has a few national companies that
utilize national media efficiently. This segment also has numerous regional and
local chains that provide service and products comparable to the national chains
but which cannot support significant marketing campaigns. The Company operates
three restaurant concepts that compete in the full service segment.
During fiscal 2002, the Company experienced strong results in its
Chili's division. These results were achieved by the application of the
Company's disciplined operating systems and successful marketing and menu
strategies. The Company also believes that the results in its Chili's division
were aided by effective product and marketing support from the franchisor.
During fiscal 2003, the Company intends to continue to emphasize the operational
and marketing initiatives that contributed to the success of its Chili's
division in fiscal 2002 and therefore expects steady financial results in fiscal
2003.
During fiscal 2002, the Company experienced a slight deterioration in
its Italian Dining division's profitability. During the fourth quarter of fiscal
2002, the Company opened an additional restaurant that should increase the
profitability of the Italian Dining division during fiscal 2003. The Company
expects sales at restaurants open for a year to be flat or slightly negative in
fiscal 2003 when compared to fiscal 2002.
During fiscal 2002, the results of the Company's Grady's American Grill
division did not meet expectations. The Company believes that the results in
this division were negatively affected by competitive intrusion in the Company's
markets and limitations in the Company's ability to efficiently market its
Grady's American Grill restaurants. During fiscal 2002, the Company sold or
closed 18 restaurants. The Company will continue to consider opportunities to
divest under-performing or non-strategic restaurants in fiscal 2003. The Company
expects the Grady's American Grill division's operating performance to continue
to decline during fiscal 2003.
28
LIQUIDITY AND CAPITAL RESOURCES
The following table summarizes the Company's principal sources and uses of cash:
(Dollars in thousands)
- ---------------------------------------------------------------------------------------------------
Fiscal Year Ended
October 27, October 28, October 29,
2002 2001 2000
- ---------------------------------------------------------------------------------------------------
Net cash provided by operating activities $ 15,425 $ 11,305 $ 20,384
Cash flows from investing activities:
Acquisition of business, net of cash - (4,212) -
Purchase of property and equipment (16,102) (11,821) (11,055)
Purchase of other assets (1,013) (858) (1,501)
Proceeds from the sale of assets 15,517 142 1,105
Other, net - - (57)
Cash flow from financing activities:
Borrowings (repayment) of long-term debt, net (13,523) 6,982 (5,118)
Purchase of common stock (264) (1,925) (1,448)
Loan financing fees (619) - -
Repayment of capitalized lease (470) (455) (417)
The Company requires capital principally for building or acquiring new
restaurants, replacing equipment and remodeling existing restaurants. During the
three year period ended October 27, 2002, the Company financed these activities
principally using cash flows from operations 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 2002, net cash provided by operating activities was
$15,425,000 compared to $11,305,000 in fiscal 2001. The increase in fiscal 2002
compared to fiscal 2001 was mainly due to increased profitability of the
Company.
During fiscal 2002, the Company had $16,102,000 in capital expenditures
in connection with the opening of new restaurants and the refurbishing of
existing restaurants. During fiscal 2002 the Company opened two new full service
restaurants and two quick service restaurants. The Company also replaced three
existing quick service restaurant buildings with new buildings at the same
locations.
The Company purchased and retired 96,064 shares of its common stock
during fiscal 2002 for $264,000. The Company repurchased 736,073 shares of its
common stock in the open market in fiscal 2001 for $1,925,000. The Company does
not presently intend to repurchase shares due to the Company's significant
capital expenditure budget for fiscal 2003.
During fiscal 2002, the Company received $15,517,000 in net proceeds
from the sale of assets, mainly from the sale of 15 Grady's American Grill
restaurants.
The Company had a net repayment of $12,185,000 under its revolving
credit agreement during fiscal 2002. As of October 27, 2002, the Company's
revolving credit agreement had an additional $7,174,000 available for future
borrowings. The Company's average borrowing rate on October 27, 2002 was 5.06%.
The revolving credit agreement is subject to certain restrictive covenants that
require the Company, among other things, to achieve agreed upon levels of cash
flow. Under the revolving credit agreement the Company's funded debt to
consolidated cash flow ratio c