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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

OR

Commission File Number 333-57925

(901) 766-6400
(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:

None

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. [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes  [  ]  No  [X]

State the aggregate market value of the voting and non-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 the last business day of the registrant’s most recently completed second fiscal quarter. Not Applicable.

Number of shares of common stock outstanding: 10,820.

Documents incorporated by reference: None.

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PART I

Item 1. Business

General. The Restaurant Company (the “Company,” “Perkins,” or “TRC”) is a wholly-owned subsidiary of The Restaurant Holding Corporation (“RHC”). TRC conducts business under the name “Perkins Restaurant and Bakery”. TRC is also the sole stockholder of TRC Realty LLC, The Restaurant Company of Minnesota (“TRCM”) and Perkins Finance Corp. RHC is owned principally by Donald N. Smith (“Mr. Smith”), TRC’s Chairman and Chief Executive Officer, and BancBoston Ventures, Inc (“BBV”). Mr. Smith is also the Chairman of Friendly Ice Cream Corporation (“FICC”), which operates and franchises 543 restaurants, located primarily in the northeastern United States. Additional information may be found on our website, www.perkinsrestaurants.com. We make available on our website our Annual Report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K and all exhibits to those reports free of charge as soon as reasonably practicable after they are electronically filed or furnished to the Securities and Exchange Commission.

Operations. We operate and franchise mid-scale full service restaurants, which serve a wide variety of high quality, moderately priced breakfast, lunch and dinner entrees. Our restaurants are open seven days a week except Christmas Day and some are open 24 hours a day. As of December 29, 2002, entrees served in Company-operated restaurants ranged in price from $3.59 to $10.99 for breakfast, $5.29 to $10.99 for lunch and $5.29 to $11.99 for dinner. On December 29, 2002, there were 498 full-service restaurants in our system, of which 155 were Company-operated restaurants and 343 were franchised restaurants. The restaurants operate under the names “Perkins Restaurant and Bakery,” “Perkins Family Restaurant,” “Perkins Family Restaurant and Bakery,” or “Perkins Restaurant” and the mark “Perkins”. The restaurants are located in 35 states with the largest number in Minnesota, Pennsylvania, Florida, Ohio and Wisconsin (see Significant Franchisees). We have fifteen franchised restaurants in Canada.

We offer our customers a “core menu” consisting of certain required menu offerings that each Company-operated and franchised restaurant must offer. Additional items are offered to meet regional and local tastes. We must approve all menu items at franchised restaurants. Menu offerings continually evolve to meet changing consumer tastes. We purchase television, radio, outdoor and print advertisements to encourage trial, to promote product lines and to increase customer traffic. We maintain a computerized labor scheduling and administrative system called PRISM in all Company-operated restaurants to improve our operating efficiency. PRISM is also available to franchisees and is currently utilized in approximately 75% of franchised restaurants.

We also offer cookie doughs, muffin batters, pancake mixes, pies and other food products for sale to our Company-operated and franchised restaurants and bakery and food service distributors through Foxtail Foods (“Foxtail”), our manufacturing division. During 2002, sales of products from this division to Perkins franchisees and outside third parties constituted approximately 10.0% of our total revenues.

Franchised restaurants operate pursuant to license agreements generally having an initial term of 20 years, and pursuant to which a royalty fee (4% of gross sales) and an advertising contribution (3% of gross sales) are paid. Franchisees pay a non-refundable license fee of $40,000 for each of their first two restaurants. Franchisees opening their third and subsequent restaurants pay a license fee of between $25,000 and $50,000 depending on the level of assistance provided by us in opening the restaurant. Typically, franchisees may terminate license agreements upon a minimum of 12 months prior notice and upon payment of specified liquidated damages. Franchisees do not typically have express renewal rights. In 2002, average annual royalties earned per franchised restaurant were approximately $61,000. The following number of license agreements are scheduled to expire in the years indicated: 2003 - fourteen; 2004 - twenty-two; 2005 - nine; 2006 – six; 2007 - twelve. Franchisees typically apply for and receive new license agreements.

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Design Development. Our restaurants are primarily located in freestanding buildings seating between 90 to 250 customers. We employ an on-going system of prototype development, testing and remodeling to maintain operationally efficient, cost-effective and unique interior and exterior facility design and decor. The current prototype packages feature modern, distinctive interior and exterior layouts that enhance operating efficiencies and customer appeal.

System Development. We opened four Company-operated restaurants in 2002 and seven in 2001. In 2001, nine formerly franchised restaurants were converted to Company-operated stores. Five Company-operated restaurants were sold to franchisees during the same period. Seventeen new franchised restaurants opened during 2002 and twelve new franchised restaurants opened in 2001. Two Company-operated restaurants were closed in 2002 and three were closed in 2001. Eighteen franchised restaurants were closed in 2002 and nine were closed in 2001. We also opened two Sage Hen Cafes located in St. Louis Park, MN and Deerfield, IL in 2001. These restaurants were closed during 2002.

Research and Development. Each year, we develop and test a wide variety of products in our 3,000 square foot test kitchen in Memphis, Tennessee. New products undergo extensive operations and consumer testing to determine acceptance. While this effort is an integral part of our overall operations, it was not a material expense in 2002, 2001 or 2000. In addition, no material amounts were spent to conduct consumer research in 2002, 2001 or 2000.

Significant Franchisees. As of December 29, 2002, three franchisees, otherwise unaffiliated with the Company, owned 92 of the 343 franchised restaurants and bakeries. These franchisees operated 41, 29 and 22 restaurants, respectively. 38 of these restaurants were located in Pennsylvania, 26 were located in Ohio and the remaining 28 were located across Wisconsin, Nebraska, Florida, Tennessee, New Jersey, Minnesota, South Dakota, Maryland, Kentucky, New York, Virginia, North Dakota, South Carolina and Michigan. During 2002, we earned net royalties and license fees of $2,435,000, $1,853,000 and $1,592,000, respectively, from these franchisees.

Franchise Guarantees. In the past, we have sponsored financing programs offered by certain lending institutions to assist franchisees in procuring funds for the construction of new franchised restaurants and to purchase and install in-store bakeries. We provided a limited guaranty of funds borrowed. Our obligation under these agreements expired during the first quarter of 2002.

During 2000, we entered into a separate agreement to guarantee fifty percent of borrowings up to a total guarantee of $1,500,000 for use by a franchisee to remodel and upgrade existing restaurants. As of December 29, 2002, $3,000,000 in borrowings were outstanding under this agreement of which $1,500,000 were guaranteed by us.

Service Fee Agreements. Our predecessors entered into arrangements with several different parties which have reserved territorial rights under which specified payments are to be made by us based on a percentage of gross sales from certain restaurants and for new restaurants opened within certain geographic regions. During 2002, we paid an aggregate of $2,694,000 under such arrangements. Three such agreements are currently in effect. Of these, one expires upon the death of the beneficiary, one expires in the year 2075 and the remaining agreement remains in effect as long as we operate Perkins Restaurants and Bakeries in certain states.

Source of Materials. Essential supplies and raw materials are available from several sources, and we are not dependent upon any one source for our supplies and raw materials.

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Patents, Trademarks and Other Intellectual Property. We believe that our trademarks and service marks, especially the mark “Perkins,” are of substantial economic importance to our business. These include signs, logos and marks relating to specific menu offerings in addition to marks relating to the Perkins name. Certain of these marks are registered in the U.S. Patent and Trademark Office and in Canada. Common law rights are claimed with respect to other menu offerings and certain promotions and slogans. We have copyrighted architectural drawings for Perkins restaurants and claim copyright protection for certain manuals, menus, advertising and promotional materials. We do not have any patents.

Seasonality. Our revenues are subject to seasonal fluctuations. Customer counts (and consequently revenues) are generally highest in the summer months and lowest during the winter months because of the high proportion of restaurants located in states where inclement weather adversely affects customer visits.

Working Capital. We ordinarily operate with a working capital deficit since funds generated by cash sales in excess of those needed to service short-term obligations are used by us to reduce debt and acquire capital assets. At December 29, 2002, this working capital deficit was $18.1 million.

Competition. Our business and the restaurant industry in general are highly competitive and are often affected by changes in consumer tastes and eating habits, by local and national economic conditions and by population and traffic patterns. We compete directly or indirectly with all restaurants, from national and regional chains to local establishments. Some of our competitors are corporations that are much larger than us and have substantially greater capital resources at their disposal. In addition, in some markets, primarily in the northeastern United States, Perkins and FICC operate restaurants which compete with each other.

Employees. As of December 29, 2002, we employed approximately 10,700 persons. Approximately 350 of these were administrative and manufacturing personnel and the balance were restaurant personnel. Approximately 41% of the restaurant personnel are part-time employees. We compete in the job market for qualified restaurant management and operational employees. We maintain ongoing restaurant management training programs and have on our staff full-time restaurant training managers and a training director. We believe that our restaurant management compensation and benefits package compares favorably with those offered by our competitors. None of our employees are represented by a union.

Regulation. We are subject to various federal, state and local laws affecting our business. Restaurants generally are required to comply with a variety of regulatory provisions relating to zoning of restaurant sites, sanitation, health and safety. No material amounts have been or are expected to be expensed to comply with environmental protection regulations.

We are subject to a number of state laws regulating franchise operations and sales. Those laws impose registration and disclosure requirements on franchisors in the offer and sale of franchises and, in certain cases, also apply substantive standards to the relationship between franchisor and franchisee. We must also adhere to Federal Trade Commission regulations governing disclosures in the sale of franchises.

Federal and state minimum wage rate laws impact the wage rates of our hourly employees. Future increases in these rates could materially affect our cost of labor.

Segment Information. We have three primary operating segments: restaurants, franchise and manufacturing. See Note 15 of Notes to Financial Statements for financial information regarding each of our segments.

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Item 2. Properties.

The following table lists the location of each of the full-service Company-operated and franchised restaurants in the Perkins system as of December 29, 2002. The table excludes one limited service Perkins Express located in Utah.

Number of Restaurants

Most of the restaurants feature a distinctively styled brick or stucco building. Our restaurants are predominantly single-purpose, one-story, free-standing buildings averaging approximately 5,000 square feet, with a seating capacity of between 90 and 250 customers.

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The following table sets forth certain information regarding Company-operated restaurants and other properties, as of December 29, 2002:

	(1) In addition, we lease eleven properties, ten of which are subleased to others and one of which is vacant. We also own six properties, four of which are leased to others and two of which are vacant.
	(2) Our principal office is located in Memphis, Tennessee, and currently comprises approximately 50,000 square feet under a lease expiring on May 31, 2013, subject to renewal by us for a maximum of 60 months. We also own a 25,149 square-foot manufacturing facility in Cincinnati, Ohio, and lease two other properties in Cincinnati, Ohio, consisting of 36,000 square feet and 120,000 square feet, for use as manufacturing facilities.
	(3) The average term of the remaining leases is seven years, excluding renewal options. The longest lease term will mature in approximately 39 years and the shortest lease term will mature in less than 1 year, assuming the exercise of all renewal options.

Item 3. Legal Proceedings.

We are a party to various legal proceedings in the ordinary course of business. We do not believe that these proceedings, either individually or in the aggregate, are likely to have a material adverse effect on our financial position or results of operations.

Item 4. Submission of Matters to Vote of Shareholders.

Not applicable.

[Intentionally Left Blank]

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PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.

     (a)  Market information.

No established public market exists for our equity securities.

     (b)  Holders.

As of December 29, 2002, there was 1 Stockholder of record.

     (c)  Dividends.

There were no dividends declared or paid during 2002 or 2001.

[Intentionally Left Blank]

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Item 6. Selected Financial Data.

THE RESTAURANT COMPANY AND SUBSIDIARIES
SELECTED FINANCIAL AND OPERATING DATA
(In Thousands, Except Number of Restaurants)

(a)	Net of current maturities of $9,489, $1,030, $971, $942 and $1,229.
(b)	Excludes two Company-operated Sage Hen Cafes and one franchised Perkins Express.
(c)	“EBITDA” represents net income (loss) plus (i) net interest, (ii) depreciation and amortization, (iii) provision for (benefit from) disposition of assets, (iv) asset write-down, (v) recapitalization costs, (vi) cumulative effect of change in accounting principle, (vii) loss due to bankruptcy of franchisee, (viii) going private transaction costs, (ix) loss from discontinued operations, (x) provision for minority interest and (xi) provision for (benefit from) income taxes. We have included information concerning EBITDA in this data table because we believe that such information is used as one measure of our historical ability to service debt. EBITDA should not be considered as an alternative to, or more meaningful than, earnings from operations as determined in accordance with generally accepted accounting principles or other traditional indications of our operating performance.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

GENERAL

The following management’s discussion and analysis describes the principal factors affecting the results of operations, liquidity and capital resources, as well as the critical accounting policies of TRC. This discussion should be read in conjunction with the accompanying audited financial statements, which include additional information about our significant accounting policies and practices and the transactions that underlie our financial results.

The key factors that affect our operating results are comparable restaurant sales, which are driven by comparable customer counts and check average, and our ability to manage operating expenses such as food cost, labor and benefits and other costs.

Except as otherwise indicated, references to years mean our fiscal year ended December 29, 2002, December 30, 2001 or December 31, 2000.

[Intentionally Left Blank]

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RESULTS OF OPERATIONS

Overview:

Our 2002 results reflect a solid performance in spite of the continued challenges we face due to the overall soft economic climate and continuing political uncertainty. We are confident that through our continued cost control and restaurant management efforts that we are poised for long-term growth when the economy, particularly the tourism and hospitality sectors, recovers and experiences sustained growth. The following table sets forth all revenues, costs and expenses as a percentage of total revenues for the periods indicated for revenue and expense items included in the consolidated statements of operations.

Net income for 2002 was $2.2 million versus a net loss of $696,000 in 2001 and net income of $4.0 million in 2000. Pre-tax income for 2002 included a loss of $2.2 million related to asset dispositions and write-downs. Pre-tax loss for 2001 included a loss of $374,000 related to asset dispositions and write-downs. Pre-tax income for 2000 included a loss of $1.5 million related to asset dispositions and write-downs.

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Year Ended December 29, 2002 Compared to Year Ended December 30, 2001

Revenues:

Total revenues increased 2.6% over 2001 due primarily to increased restaurant food sales.

Food sales at Company-operated restaurants increased 2.9%. The increase is primarily the result of sales from twenty stores opened or acquired since the beginning of 2001 partially offset by ten stores that were either closed or sold to franchisees since the beginning of 2001. Comparable restaurant sales decreased 2.1% primarily due to a decrease in comparable customer visits of 4.5%, partially offset by a 2.4% increase in check average.

Revenues from Foxtail increased approximately 1.8% over 2001 and constituted 10.0% of our total 2002 revenues. In order to ensure consistency and availability of our proprietary products to each restaurant in the system, Foxtail offers cookie doughs, muffin batters, pancake mixes, pies and other food products to Company-operated and franchised restaurants through food service distributors. Additionally, it produces a variety of non-proprietary products for sale in various retail markets. Sales to Company-operated restaurants are eliminated in the accompanying statements of operations. The increase noted above can be attributed to growth in sales outside of the Perkins system.

Franchise and other revenues, which consist primarily of franchise royalties and initial license fees, decreased 2.9% from the prior year. Royalty revenues decreased due to a decrease in comparable sales and a decline in the number of average franchise restaurants. Initial franchise license fees increased as a result of seventeen franchise restaurants opening in 2002 versus twelve in 2001.

Costs and Expenses:

Food cost:

In terms of total revenues, food cost decreased 0.4 percentage points from 2001. Restaurant division food cost expressed as a percentage of restaurant division sales decreased 0.6 percentage points. The current year decrease was primarily due to menu price increases and a net decrease in commodity costs.

The cost of Foxtail sales, in terms of total Foxtail revenues, increased approximately 0.3 percentage points, as a result of increased raw materials costs. As a manufacturing operation, Foxtail typically has higher food costs as a percent of revenues than the Company’s restaurants.

Labor and benefits:

Labor and benefits expense, as a percentage of total revenues, increased 0.4 percentage points over 2001. Increased workers’ compensation costs, a moderate increase in wage rates and a slight drop in productivity impacted restaurant labor and benefits. Foxtail labor and benefits decreased due to improvements in plant efficiencies.

Federal and state minimum wage laws impact the wage rates of the Company’s hourly employees. Certain states do not allow tip credits for servers which results in higher payroll costs as well as greater exposure to increases in minimum wage rates. In the past, the Company has been able to offset increases in labor costs through selective menu price increases and improvements in labor productivity. However, there is no assurance that future increases can be mitigated through raising menu prices or productivity improvements.

As a percentage of revenues, Foxtail labor and benefit charges are significantly lower than the Company’s restaurants. If Foxtail were to become a more significant component of the Company’s total operations, labor and benefits expense, expressed as a percent of total revenue, would decrease.

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Operating expenses:

Operating expenses, expressed as a percentage of total revenues, decreased 0.4 percentage points from 2001 to 2002.

Restaurant division operating expenses expressed as a percentage of restaurant sales, decreased 0.4 percentage points. The decrease is primarily the result of decreased utility cost due to the drop in natural gas prices. Also, store pre-opening expenses were lower due to the fact that the Company opened fewer stores in 2002 as compared to 2001.

Foxtail expenses, expressed as a percentage of Foxtail revenue, increased 0.3 percentage points. The increase is primarily due to increased transportation and storage costs.

Franchise division operating expenses, expressed as a percentage of franchise revenues decreased 1.4 percentage points compared to the prior year. Expenses under franchise service fee agreements, investment spending for advertising in select franchised markets, and franchise settlements drove the decrease.

General and administrative:

General and administrative expenses declined to 9.1% of total revenues in 2002 from 9.4% of total revenues in 2001. The decrease is primarily attributable to the impact of selected administrative workforce reductions.

Depreciation and amortization:

Depreciation and amortization decreased approximately 9.6% from 2001 due to the cessation of goodwill amortization and the increase in total revenue.

Interest, net:

Net interest expense decreased from 5.5% to 5.3% of revenues. The decrease is the result of reduced average borrowings and lower variable interest rates on the Company’s revolving line of credit.

Provision for/Benefit from disposition of assets:

During 2002, the Company recorded a net gain of $493,000 related to the disposition of assets.

Asset write-down:

The Company recorded charges totaling $2.7 million to write down the carrying value of the two Sage Hen properties and two Company owned restaurants to their estimated fair values.

Other:

Other income decreased approximately $658,000. This decrease is primarily due to the termination of 8 leases and subleases at the end of 2001 on properties leased to a franchisee.

Provision for/Benefit from income taxes:

The benefit from income taxes in 2002 was $179,000. Our effective tax rate was (9.0)% in 2002, 56.6% in 2001 and 31.8% in 2000. The (9.0)% effective tax rate in 2002 was higher than in 2001 due to the fact that we had positive pretax income in 2002 versus a pretax loss in 2001. The 2002 effective tax rate was favorably impacted primarily by credits resulting from excess FICA taxes paid on server tip income that exceeds minimum wage. The effective tax rate is lower than the statutory U.S. federal tax rate and the 2001 effective tax rate primarily due to the utilization of these credits. For 2003, we expect the effective tax rate to be approximately 32.4%. The actual rate, however, will depend on a number of factors, including the amount and source of operating income.

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Year Ended December 30, 2001 Compared to Year Ended December 31, 2000

Revenues:

Total revenues decreased 1.7% over 2000 due primarily to decreased restaurant food sales.

Food sales at Company-operated Perkins Restaurants decreased 2.5%. The decrease can be attributed to a decline in comparable restaurant sales of 2.5% and the fact that fiscal 2001 contained 364 days compared to 366 days in the year ending December 31, 2000. The decline in comparable restaurant sales was due to a decrease in comparable customer visits of 3.0%, which was partially offset by a 0.5% increase in check average. The increase in check average is the result of menu price increases of 1.4% partially offset by increased discounting and sales mix shifts. Sales from two new Sage Hen Cafes opened during 2001 partially offset the decrease.

Revenues from Foxtail increased approximately 2.4% over 2000 and constituted 10.1% of the Company’s total 2001 revenues. The increase in Foxtail revenues is attributable to growth in the number of franchise stores in the Perkins system and increased external sales.

Franchise and other revenues, which consist primarily of franchise royalties and initial license fees, decreased 1.5% from the prior year. Initial franchise license fees decreased as a result of twelve franchise restaurants opening in 2001 versus 25 in 2000. Royalty revenues increased due to a higher number of average franchise restaurants offset by a decrease in comparable sales in franchise restaurants.

Costs and Expenses:

Food cost:

In terms of total revenues, food cost increased 0.3 percentage points from 2000. Restaurant division food cost expressed as a percentage of restaurant division sales also increased 0.3 percentage points. The current year increase was primarily due to a net increase in commodity costs and the promotion of lower margin entrees. The increase was partially offset by certain menu price increases.

The cost of Foxtail sales, in terms of total Foxtail revenues, decreased approximately 1.2 percentage points, as a result of stable commodity costs, an increase in sales of higher margin products and improved manufacturing efficiencies.

Labor and benefits:

Labor and benefits expense, as a percentage of total revenues, was flat compared to 2000. An increase in restaurant labor and benefits was offset by a decrease at Foxtail. A moderate increase in wage rates and a slight drop in productivity impacted restaurant labor and benefits. A decrease in group health program costs partially offset the increase. Foxtail labor and benefits decreased due to improvements in plant efficiencies and a decrease in Foxtail’s worker’s compensation program costs.

Operating expenses:

Operating expenses, expressed as a percentage of total revenues, increased 1.5 percentage points from 2000 to 2001.

Restaurant division operating expenses expressed as a percentage of restaurant sales, increased 1.9 percentage points. The increase related to several factors, the largest of which was the increased cost of natural gas in the first quarter of 2001 combined with severely cold temperatures during the same period. New store opening expenses increased due to the opening of seven new Company-operated restaurants in 2001 compared to four in the prior year. We also increased spending on media advertising in several markets and invested in certain supply and repair expenses as we focused on improving the image of our restaurants.

Foxtail expenses, expressed as a percentage of Foxtail revenue, decreased 0.1 percentage points. The majority of this decrease is due to reduced freight costs.

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Franchise division operating expenses, expressed as a percentage of franchise revenues increased 1.4 percentage points compared to the prior year. Expenses under franchise service fee agreements, investment spending for advertising in select franchised markets, and bad debt expense drove the increase. Franchise opening costs decreased due to the opening of 13 fewer restaurants than in the prior year.

General and administrative:

General and administrative expenses rose to 9.4% of total revenues in 2001 from 9.1% of total revenues in 2000. An effort to improve core training for restaurant management through development of a classroom-based training school, non-recurring charges related to staff reductions, costs associated with the development of Sage Hen Cafe and general increases in the cost of administrative support drove the increase. Reduced levels of incentive compensation costs partially offset these items. The remainder of the rise in costs as a percentage of revenue is due to the decline in revenues.

Depreciation and amortization:

Depreciation and amortization increased approximately 2.9% over 2000 due to the Company’s continuing program to upgrade and maintain existing restaurants and the net addition of eight Company-operated restaurants during the year.

Interest, net:

Net interest expense increased from 5.4% to 5.5% of revenues due to the drop in total revenues. An increase in interest charges on the Senior Discount Notes was offset by a decrease in interest expense associated with capital lease obligations. The impact of higher average borrowings on the Company’s line of credit was offset by the decline in short term borrowing rates. Prior to November 15, 2001, interest accreted on the Senior Discount Notes on a compounding basis. On November 15, 2001 the Company elected to begin accruing cash interest on the Senior Discount Notes.

Provision for/Benefit from disposition of assets:

During 2001, the Company recorded a net gain of $1.1 million related to the disposition of assets. This amount includes a loss of $132,000 related to discontinued development of certain sites and a net gain of $1.2 million related to the sale of seven properties, five of which were Company-operated restaurants sold to a franchisee.

Asset write-down:

The Company recorded charges totaling $1.5 million to write down the carrying value of three properties to their estimated fair values, and to write off the carrying amount of certain intangibles related to the expected future royalty income of franchised restaurants acquired by the Company in December 2001.

Other:

Other income decreased approximately $188,000. This decrease is primarily due to the termination of nine leases and subleases on properties leased to franchisees or third parties. Of the nine properties, six are now Company-operated restaurants formerly leased or subleased by a franchisee, one was disposed of through a lease termination and two are owned and held for sale. The decreases were partially offset by rental income from a vacant property subleased during 2001.

Provision for/Benefit from income taxes:

The benefit from income taxes in 2001 was $907,000. The 2001 benefit reflects the benefit derived from the net loss before income taxes and the utilization of income tax credits, which primarily result from excess FICA taxes paid on server tip income that exceeds the minimum wage.

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CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to adopt accounting policies and make significant judgments and estimates to develop amounts reflected and disclosed in the financial statements. In many cases, there are alternative policies or estimation techniques that could be used. We maintain a thorough process to review the application of our accounting policies and to evaluate the appropriateness of the estimates that are required to prepare the financial statements of a corporation. However, even under optimal circumstances, estimates routinely require adjustment based on changing circumstances and the receipt of new or better information.

Revenue Recognition:

Revenue at Company-operated restaurants is recognized as customers pay for products at the time of sale. The earnings reporting process is covered by our system of internal controls and generally does not require significant management judgments and estimates. However, estimates are inherent in the calculation of franchisee royalty revenue. We calculate an estimate of royalty income each period and adjust royalty income when actual amounts are reported by franchisees. Historically, these adjustments have not been material. We provide for estimated losses for revenues that are not likely to be collected. Although we maintain good relationships with our franchisees, if average sales or the financial health of significant franchisees were to deteriorate, we may have to increase our reserves against collection of franchise revenues.

Insurance Accruals:

We are self-insured up to certain limits for costs associated with workers’ compensation claims, property claims and benefits paid under employee health care programs. At December 29, 2002 and December 30, 2001, we had total self-insurance accruals reflected in our balance sheet of approximately $2.6 million.

The measurement of these costs required the consideration of historical loss experience and judgments about the present and expected levels of cost per claim. We account for these costs primarily through actuarial methods, which develop estimates of the undiscounted liability for claims incurred, including those claims incurred but not reported. These methods provide estimates of future ultimate claim costs based on claims incurred as of the balance sheet date. Other acceptable methods of accounting for these accruals include measurement of claims outstanding and projected payments.

We believe the use of actuarial methods to account for these liabilities provides a consistent and effective way to measure these highly judgmental accruals. However, the use of any estimation technique in this area is inherently sensitive given the magnitude of claims involved and the length of time until the ultimate cost is known. We believe that our recorded obligations for these expenses are consistently measured on a conservative basis. Nevertheless, changes in health care costs, accident frequency and severity and other factors can materially affect the estimate for these liabilities.

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Long-Lived Assets:

The restaurant industry is capital intensive. We have approximately 65% of our total assets invested in property and equipment. We capitalize only those costs that meet the definition of capital assets under generally accepted accounting principles. Accordingly, repairs and maintenance costs that do not extend the useful life of the asset are expensed as incurred.

The depreciation of our capital assets over their estimated useful lives, and the determination of any salvage values, requires management to make judgments about future events. Because we utilize many of our capital assets over relatively long periods (20 – 30 years for our restaurant buildings), we periodically evaluate whether adjustments to our estimated lives or salvage values are necessary. The accuracy of these estimates affects the amount of depreciation expense recognized in a period and, ultimately, the gain or loss on the disposal of the asset. Historically, gains and losses on the disposition of assets have not been significant. However, such amounts may differ materially in the future based on restaurant performance, technological obsolescence, regulatory requirements and other factors beyond our control.

Due to the fact that we invest a significant amount in the construction or acquisition of new restaurants, we have risks that these assets will not provide an acceptable return on our investment and an impairment of these assets may occur. The accounting test for whether an asset held fo