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 o

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. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes o 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.

Table of Contents

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 537 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. Our internet website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.

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 28, 2003, entrees served in Company-operated restaurants ranged in price from $2.99 to $10.99 for breakfast, $5.49 to $10.99 for lunch and $5.49 to $11.99 for dinner. On December 28, 2003, there were 493 full-service restaurants in our system, of which 156 were Company-operated restaurants and 337 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 thirty-four states with the largest number in Minnesota, Pennsylvania, Florida, Ohio and Wisconsin (see Significant Franchisees). We have sixteen 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 72% 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 2003, sales of products from this division to Perkins franchisees and outside third parties constituted approximately 10.3% 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 2003, 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: 2004 — twenty-four; 2005 — nine; 2006 — six; 2007 — fourteen; 2008 — eleven. Franchisees typically apply for and receive new license agreements.

2

Design Development. Our restaurants are primarily located in freestanding buildings seating between 90 and 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 no Company-operated restaurants in 2003 and four in 2002. Eight new franchised restaurants opened during 2003 and seventeen new franchised restaurants opened in 2002. During 2003, we entered into a lease agreement to operate two franchisee stores for a period of five years. One Company-operated restaurant was closed in 2003 and two were closed in 2002. In addition to the two franchise restaurants operating under Company management, twelve franchised restaurants were closed in 2003 and eighteen were closed in 2002. We also closed two Sage Hen Cafes located in St. Louis Park, MN and Deerfield, IL in 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 2003, 2002 or 2001. In addition, we spent approximately $340,000 conducting consumer research in 2003. No material amounts were spent to conduct consumer research in 2002 or 2001.

Significant Franchisees. As of December 28, 2003, three franchisees, otherwise unaffiliated with the Company, owned 92 of the 337 franchised restaurants. These franchisees operated 41, 29 and 22 restaurants, respectively. 38 of these restaurants are located in Pennsylvania, 26 are located in Ohio and the remaining 28 are located across Wisconsin, Nebraska, Florida, Tennessee, New Jersey, Minnesota, South Dakota, Maryland, Kentucky, New York, Virginia, North Dakota, South Carolina and Michigan. During 2003, we earned net royalties and license fees of $2,473,000, $1,571,000 and $1,592,000, respectively, from these franchisees.

Franchise Guarantees. In the past, we 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 28, 2003, $3,000,000 in borrowings was outstanding under this agreement of which we guaranteed $1,500,000. The franchisee intends to refinance the indebtedness, at which time, our obligation under the current agreement would terminate.

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 2003, we paid an aggregate of $2,670,000 under such arrangements. Three such agreements are currently in effect. Of these, one expires in the year 2075, one is subject to ongoing negotiations 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 spring and 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 28, 2003, this working capital deficit was $6.4 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 that compete with each other.

Employees. As of December 28, 2003, we employed approximately 9,750 persons. Approximately 400 of these were administrative and manufacturing personnel and the balance were restaurant personnel. Approximately 60% 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 28, 2003. 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.

5

The following table sets forth certain information regarding Company-operated restaurants and other properties, as of December 28, 2003:

(1)

In addition, we lease ten properties, all of which are subleased to others. We also own six properties, four of which are leased to others and two of which are vacant land.

(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 38 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]

6

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 28, 2003, there was 1 Stockholder of record.

     (c) Dividends.

There were no dividends declared or paid during 2003 or 2002.

[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 $466, $9,489, $1,030, $971 and $942.

(b)

Excludes two Company-operated Sage Hen Cafes (closed in 2002) and one franchised Perkins Express.

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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 28, 2003, December 29, 2002 or December 30, 2001.

[Intentionally Left Blank]

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RESULTS OF OPERATIONS

Overview:

Our 2003 results reflect a solid performance in spite of the continued challenges we face due to the overall soft economic climate, the war with Iraq and increased competition in certain key markets. We are confident that through our continued cost control and restaurant management efforts that we are poised for long-term growth as the economy, particularly the tourism and hospitality sectors, continues to recover 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 2003 was $3.5 million versus net income of $2.2 million in 2002 and a net loss of $696,000 in 2001. Pre-tax income for 2003 included a loss of $1.6 million related to asset dispositions, write-downs and a lease termination. 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.

10

Year Ended December 28, 2003 Compared to Year Ended December 29, 2002

Revenues:

Total revenues decreased 1.9% over 2002 due primarily to decreased restaurant food sales.

Food sales at Company-operated restaurants decreased 1.6%. The decrease can be attributed to a decline in comparable restaurant sales of 2.9%. Comparable restaurant sales decreased primarily due to a decrease in comparable customer visits of 6.4%, partially offset by a 3.5% increase in check average. Economic weakness prevalent throughout 2003 and increased competition in certain key markets contributed to the decrease in comparable customer visits. The decrease in comparable customer visits was partially offset by an increase in the guest check average due to a menu mix shift and cumulative price increases. The menu mix shift resulted from the introduction of a new menu with a focus on lunch and dinner items, which have a higher menu price than breakfast items.

Revenues from Foxtail increased approximately 0.6% over 2002 and constituted 10.3% of our total 2003 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 revenues and other, which consist primarily of franchise royalties and initial license fees, decreased 1.9% from the prior year. Royalty revenues decreased due to a decrease in comparable sales and a decline in the average number of franchise restaurants by 5.3 restaurants. Initial franchise license fees decreased as a result of eight franchise restaurants opening in 2003 versus seventeen in 2002.

Costs and Expenses:

Food cost:

In terms of total revenues, food cost increased 1.0 percentage points from 2002. Restaurant division food cost expressed as a percentage of restaurant division sales increased 1.1 percentage points. The current year increase was primarily due to increased commodity costs and the introduction of a new menu which resulted in a menu mix shift to higher food cost lunch and dinner items. These increases were partially offset by the impact of selective menu price increases. Commodity costs during 2003 increased 0.9 percentage points over 2002, primarily due to increases in eggs, red meat, oils and pork. The introduction of a new menu during 2003 negatively impacted food costs by 0.4 percentage points as compared to 2002. Overall price increases realized during 2003 were approximately 1.8%, which positively impacted food cost by 0.4 percentage points.

The cost of Foxtail sales, in terms of total Foxtail revenues, increased approximately 0.4 percentage points, as a result of continued increases in 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 0.2 percentage points over 2002. Increased employee insurance and workers’ compensation costs, a moderate increase in wage rates and a drop in productivity impacted restaurant labor and benefits. Foxtail labor and benefits were flat compared to 2002.

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.

11

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.

Operating expenses:

Operating expenses, expressed as a percentage of total revenues, decreased 0.2 percentage points from 2003 to 2002.

Restaurant division operating expenses expressed as a percentage of restaurant sales increased 0.1 percentage points. The increase is primarily the result of increased utility cost due to the rise in natural gas prices. This increase is partially offset by a slight decrease in administrative costs and store marketing expenses.

Foxtail expenses, expressed as a percentage of Foxtail revenue, decreased 1.5 percentage points. The decrease is primarily due to decreased freight, plant maintenance and utility costs.

Franchise division operating expenses, expressed as a percentage of franchise revenues, decreased 2.8 percentage points compared to the prior year. Franchise opening costs decreased due to the opening of nine fewer restaurants than in the prior year. Reduced expenses under franchise service fee agreements, investment spending for advertising in select franchised markets and other franchise related spending also contributed to the decrease.

General and administrative:

General and administrative expenses declined to 8.7% of total revenues in 2003 from 9.1% of total revenues in 2002. The decrease is primarily attributable to reductions in corporate home office expenses and decreased incentive costs.

Depreciation and amortization:

Depreciation and amortization decreased approximately 15.9% from 2002 due to the Company’s continued reduction in capital spending since 2001.

Provision for/Benefit from disposition of assets:

During 2003, the Company recorded a net loss of $336,000 related to the disposition of assets, including $190,000 related to the termination of the lease on the corporate aircraft.

Lease termination:

The Company recorded a net loss of $761,000 on the termination of the lease related to the corporate aircraft.

Asset write-down:

The Company recorded charges totaling $455,000 to write down the carrying value of two Company-operated restaurants to their estimated fair values.

Interest, net:

Net interest expense decreased from 5.3% to 4.9% of revenues. The decrease is the result of reduced average borrowings by the Company during 2003, primarily due to the payment of $8.4 million of accreted interest on the Discount Notes at a redemption price of 105.625% and reduced borrowings on the Revolving Line of Credit.

Other:

Other income decreased approximately $140,000. This decrease is due primarily to a reduction in rental income from properties subleased to others.

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Provision for/Benefit from income taxes:

The provision for income taxes in 2003 was $753,000. Our effective tax rate was 17.5% in 2003 and (9.0)% in 2002. The 17.5% effective tax rate in 2003 was higher than in 2002 due to the fact that 2003 operating income was higher and federal income tax credits were relatively flat as compared to 2002. Also, we experienced a $140,000 reduction in state deferred tax assets due to jurisdiction tax changes. The 2003 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 2002 effective tax rate primarily due to the utilization of these credits. For 2004, we expect the effective tax rate to be approximately 20.0%. The actual rate, however, will depend on a number of factors, including the amount and source of operating income.

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. 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.

13

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 costs 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 operated 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 and 56.6% in 2001. 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.

14

SIGNIFICANT ACCOUNTING POLICIES

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America 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.

Concentration of Credit Risk:

Financial instruments, which potentially expose the Company to concentrations of credit risk, consist principally of franchisee and Foxtail accounts receivable. We perform ongoing credit evaluations of our customers and generally require no collateral to secure accounts receivable. The credit review is based on both financial and non-financial factors. Based on this review, we provide for estimated losses for accounts receivable 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 Reserves:

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 28, 2003 and December 29, 2002, we had total self-insurance accruals reflected in our balance sheet of approximately $4.7 million and $2.6 million, respectively.

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.

15

Long-Lived Assets:

The restaurant industry is capital intensive. We have approximately 60% 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 have invested 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 for use is impaired involves first comparing the carrying value of the asset with its estimated future undiscounted cash flows. If these cash flows do not exceed the carrying value, the asset must be adjusted to its current fair value. We periodically perform this test on each of our restaurants to evaluate whether impairment exists. Factors influencing our judgment include the age of the restaurant (new restaurants have significant start up costs which impede a reliable measure of cash flow), estimation of future restaurant performance and estimation of restaurant fair value. Due to the fact that we can specifically evaluate impairment on a restaurant by restaurant basis, we have historically been able to identify impaired restaurants and record the appropriate adjustment.

During 2003, we determined that impairment existed with respect to two Company-operated restaurants. This determination was made based on our projections that the future cash flows of these restaurants would not exceed the present carrying value of the assets. Accordingly, we recorded an impairment charge of approximately $455,000 to adjust the assets of these restaurants to net realizable value.

We utilize operating leases to finance a significant number of our restaurant properties. Over the years, we have found these leasing arrangements to be favorable from a cash flow and risk management standpoint. Such arrangements typically shift the risk of loss on the residual value of the assets at the end of the lease period to the lessor. As discussed in “Capital Resources and Liquidity” and in Note 5 to the accompanying audited financial statements, at December 28, 2003, we had approximately $85 million (on an undiscounted basis) of future commitments for operating leases.

The future commitments for operating leases are not reflected as a liability in our balance sheet because the leases do not meet the accounting definition of capital leases. The determination of whether a lease is accounted for as a capital lease or an operating lease requires management to make estimates primarily about the fair value of the asset and its estimated economic useful life. We believe that we have a well-defined and controlled process for making this evaluation.

We have approximately $31 million of intangible assets on our balance sheet resulting from the acquisition of businesses. New accounting standards adopted in 2002 require that we review these intangible assets for impairment on an annual basis and cease all goodwill amortization. The adoption of these new rules did not result in an impairment of our recorded intangible assets. The annual evaluation of intangible asset impairment requires the use of estimates about the future cash flows of each of our reporting units to determine their estimated fair values. Changes in forecasted operations and changes in discount rates can materially affect these estimates. However, once an impairment of intangible assets has been recorded, it cannot be reversed.

16

Deferred Income Taxes:

We record income tax liabilities utilizing known obligations and estimates of potential obligations. A deferred tax asset or liability is recognized whenever there are future tax effects from existing temporary differences and operating loss and tax credit carryforwards. We record a valuation allowance to reduce deferred tax assets to the balance that is more likely than not to be realized. In evaluating the need for a valuation allowance, we must make judgments and estimates on future taxable income, feasible tax planning strategies and existing facts and circumstances. When we determine that deferred tax assets could be realized in greater or lesser amounts than recorded, the asset balance and income statement reflect the change in the period such determination is made. We believe that the valuation allowance recorded is adequate for the circumstances. However, changes in facts and circumstances that affect our judgments or estimates in determining the proper deferred tax assets or liabilities could materially affect the recorded amounts.

CAPITAL RESOURCES AND LIQUIDITY

Our primary sources of funding were cash provided by operations and borrowings under our line of credit. The principal use of cash during the year was capital expenditures and principal and interest payments on debt. Capital expenditures consisted primarily of equipment purchases for Foxtail, maintenance capital and costs related to remodels of existing restaurants.

The following table summarizes capital expenditures for each of the past three years (in thousands).

Our capital budget for 2004 is $15.1 million and includes plans to open no new Company-operated restaurants. The primary source of funding for these expenditures is expected to be cash provided by operations. Capital spending could vary significantly from planned amounts as certain of these expenditures are discretionary in nature.

As is typical in the restaurant industry, we operate with a working capital deficit since funds generated by cash sales in excess of those needed to service short-term obligations are used to reduce debt and acquire capital assets. At December 28, 2003, this working capital deficit was $6.4 million.

The Company has a secured $25,000,000 revolving line of credit facility (the “Credit Facility”) with a sub-limit for up to $5,000,000 of letters of credit. All amounts under the Credit Facility bear interest at floating rates based on the agent’s base rate or Eurodollar rates as defined in the agreement. All indebtedness under the Credit Facility is collateralized by a first priority lien on substantially all of the assets of the Company. As of December 28, 2003, there were no borrowings and approximately $4,018,000 of letters of credit outstanding under the Credit Facility. The letters of credit are primarily utilized in conjunction with our workers’ compensation programs.

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At April 20, 2003, we failed to meet the criteria of one of the financial covenants of the Credit Facility. On May 14, 2003, the Company executed an amendment to the Credit Facility that waives the April 20, 2003 covenant violation, reduces the requirements of the financial covenants and lowers the total amount available under the Credit Facility from $40,000,000 to $25,000,000. At December 28, 2003, the Company was in compliance with the requirements of the financial covenants. The Company executed an amendment to the Credit Facility on March 25, 2004 that reduces the requirements of the financial covenants at the end of the first quarter 2004 and thereafter.

We have outstanding $130 million of 10.125% Unsecured Senior Notes (the “Notes”) due December 15, 2007. Interest on the Notes is payable semi-annually on June 15 and December 15. The Notes may be redeemed at any time at a redemption price of 103.375% through December 15, 2004, at which time the redemption price decreases to 101.688%. After December 15, 2005, the Notes may be redeemed at par.

We have outstanding $18 million of 11.25% Senior Discount Notes (the “Discount Notes”) maturing on May 15, 2008. On November 15, 2001, we elected to begin accruing cash interest on the Discount Notes. Cash interest is payable semi-annually on May 15 and November 15. On May 15, 2003, we redeemed $8.4 million in accreted interest of the Discount Notes at a redemption price of 105.625%. The Discount Notes may be redeemed at any time at a redemption price of 105.625% through May 15, 2004, at which time the redemption price decreases to 103.750%. On May 15, 2005, the redemption price decreases to 101.875%, and after May 15, 2006, the Discount Notes may be redeemed at par.

CASH CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

Cash Contractual Obligations:

The following represents the contractual obligations and commercial commitments of the Company as of December 28, 2003 (in thousands):