UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the quarterly period ended September 29, 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: 0-19542
AVADO BRANDS, INC.
(Exact name of registrant as specified in its charter)
Georgia 59-2778983
- ---------------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or organization)
Hancock at Washington, Madison, GA 30650
- ---------------------------------------- ------------------------------------
(Address of principal executive offices) (Zip Code)
706-342-4552
---------------------------------------
(Registrant's telephone number, including area code)
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.
X Yes No
--- ---
As of November 15, 2002, there were 33,101,929 shares of common stock of
the Registrant outstanding.
AVADO BRANDS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 29, 2002
INDEX
Part I - Financial Information
Item 1 - Consolidated Financial Statements:
Consolidated Statements of Earnings(Loss).......................3
Consolidated Balance Sheets.....................................4
Consolidated Statements of Shareholders' Equity (Deficit)
and Comprehensive Income........................................5
Consolidated Statements of Cash Flows...........................6
Notes to Consolidated Financial Statements......................7
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations..................18
Item 3 - Quantitative and Qualitative Disclosures About Market Risk.....25
Item 4 - Controls and Procedures........................................25
Part II - Other Information
Item 3 - Defaults Upon Senior Securities................................26
Item 6 - Exhibits and Reports on Form 8-K...............................26
Signature....................................................................27
Certifications...............................................................28
Page 2
Avado Brands, Inc.
Consolidated Statements of Earnings (Loss)
(Unaudited)
(In thousands, except per share data) Quarter Ended Nine Months Ended
- ------------------------------------------------------------------------------------------------- ----------------------------
Sept. 29, Sept. 30, Sept. 29, Sept. 30,
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------- ----------------------------
Restaurant Sales:
Canyon Cafe $ 6,069 7,363 21,161 24,246
Don Pablo's 62,149 68,062 195,979 209,471
Hops 40,194 44,410 134,478 142,092
McCormick & Schmick's - 26,159 - 115,875
- ------------------------------------------------------------------------------------------------- ----------------------------
Total restaurant sales 108,412 145,994 351,618 491,684
- ------------------------------------------------------------------------------------------------- ----------------------------
Restaurant operating expenses:
Food and beverage 30,089 41,836 98,372 139,761
Payroll and benefits 37,488 47,667 118,552 158,631
Depreciation and amortization 3,647 4,732 11,333 15,861
Other operating expenses 29,056 43,203 94,377 131,750
- ------------------------------------------------------------------------------------------------- ----------------------------
Total restaurant operating expenses 100,280 137,438 322,634 446,003
- ------------------------------------------------------------------------------------------------- ----------------------------
General and administrative expenses 6,954 7,547 20,183 23,973
Loss (gain) on disposal of assets 112 (5,271) 3 (5,632)
Asset revaluation and other special charges 1,902 47,130 3,726 48,380
- ------------------------------------------------------------------------------------------------- ----------------------------
Operating income (loss) (836) (40,850) 5,072 (21,040)
- ------------------------------------------------------------------------------------------------- ----------------------------
Other income (expense):
Interest expense, net (7,276) (7,162) (23,593) (26,540)
Distribution expense on preferred securities (55) (1,200) (1,977) (3,646)
Gain on debt extinguishment 14,629 - 41,412 -
Other, net 907 (1,597) 696 (7,316)
- ------------------------------------------------------------------------------------------------- ----------------------------
Total other income (expense) 8,205 (9,959) 16,538 (37,502)
- ------------------------------------------------------------------------------------------------- ----------------------------
Earnings (loss) from continuing operations
before income taxes 7,369 (50,809) 21,610 (58,542)
Income tax expense (benefit) - 13,047 375 10,483
- ------------------------------------------------------------------------------------------------- ----------------------------
Net earnings (loss) from continuing operations 7,369 (63,856) 21,235 (69,025)
- ------------------------------------------------------------------------------------------------- ----------------------------
Discontinued operations:
Earnings (loss) from discontinued operations, net of tax (9,302) (516) (14,290) (1,241)
- ------------------------------------------------------------------------------------------------- ----------------------------
Net earnings (loss) $ (1,933) (64,372) 6,945 (70,266)
================================================================================================= ============================
Basic earnings (loss) per common share:
Basic earnings (loss) from continuing operations $ 0.22 (2.22) 0.69 (2.42)
Basic earnings (loss) from discontinued operations (0.28) (0.02) (0.46) (0.04)
- ------------------------------------------------------------------------------------------------- ----------------------------
Basic earnings (loss) per common share $ (0.06) (2.24) 0.23 (2.46)
================================================================================================= ============================
Diluted earnings (loss) per common share:
Diluted earnings (loss) from continuing operations $ 0.22 (2.22) 0.67 (2.42)
Diluted earnings (loss) from discontinued operations (0.28) (0.02) (0.45) (0.04)
- ------------------------------------------------------------------------------------------------- ----------------------------
Diluted earnings (loss) per common share $ (0.06) (2.24) 0.22 (2.46)
================================================================================================= ============================
See accompanying notes to consolidated financial statements.
Page 3
Avado Brands, Inc.
Consolidated Balance Sheets
(Unaudited)
(In thousands, except share data)
- ------------------------------------------------------------------------------------------------------------------
Sept. 29, Dec. 30,
2002 2001
- ------------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 309 559
Restricted cash - 9,978
Accounts receivable 5,582 10,723
Inventories 5,492 5,870
Prepaid expenses and other 2,575 2,928
Assets held for sale 11,307 9,737
- ------------------------------------------------------------------------------------------------------------------
Total current assets 25,265 39,795
Premises and equipment, net 260,906 285,813
Goodwill, net 34,920 34,920
Deferred income tax benefit 11,620 11,620
Other assets 30,660 26,408
- ------------------------------------------------------------------------------------------------------------------
$ 363,371 398,556
==================================================================================================================
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 7,443 15,766
Accrued liabilities 46,367 64,265
Current installments of long-term debt 35,838 13
Income taxes 33,886 33,773
- ------------------------------------------------------------------------------------------------------------------
Total current liabilities 123,534 113,817
Long-term debt 164,024 215,815
Other long-term liabilities 1,995 3,111
- ------------------------------------------------------------------------------------------------------------------
Total liabilities 289,553 332,743
- ------------------------------------------------------------------------------------------------------------------
Company-obligated mandatorily redeemable preferred securities
of Avado Financing I, a subsidiary holding solely Avado
Brands, Inc. 7% convertible subordinated debentures
due March 1, 2027 3,179 68,559
Shareholders' equity:
Preferred stock, $0.01 par value. Authorized 10,000,000 shares;
none issued - -
Common stock, $0.01 par value. Authorized - 75,000,000 shares;
issued - 40,478,760 shares in 2002 and 2001;
outstanding - 33,101,929 shares in 2002 and 28,682,140 shares in 2001 405 405
Additional paid-in capital 154,637 146,139
Retained earnings 12,256 5,311
Treasury stock at cost; 7,376,831 shares in 2002 and 11,796,620 in 2001 (96,659) (154,601)
- ------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 70,639 (2,746)
- ------------------------------------------------------------------------------------------------------------------
$ 363,371 398,556
==================================================================================================================
See accompanying notes to consolidated financial statements.
Page 4
Avado Brands, Inc.
Consolidated Statements of Shareholders' Equity (Deficit) and Comprehensive Income
(Unaudited)
Additional Total
Common Stock Paid-in Retained Treasury Shareholders'
(In thousands) Shares Amount Capital Earnings Stock Equity (Deficit)
- ---------------------------------------------------------------------------------------------------------------------------
Balance at December 30, 2001 40,479 $405 $146,139 $5,311 ($154,601) ($2,746)
- ---------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) - - - (5,718) - (5,718)
Conversion of convertible preferred securities - - 889 - 4,461 5,350
- ---------------------------------------------------------------------------------------------------------------------------
Balance at March 31, 2002 40,479 405 147,028 (407) (150,140) (3,114)
- ---------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) - - - 14,596 - 14,596
Conversion of convertible preferred securities - - 7,609 - 53,481 61,090
- ---------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2002 40,479 405 154,637 14,189 (96,659) 72,572
- ---------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) - - - (1,933) - (1,933)
- ---------------------------------------------------------------------------------------------------------------------------
Balance at September 29, 2002 40,479 $405 $154,637 $12,256 ($96,659) $70,639
===========================================================================================================================
See accompanying notes to consolidated financial statements.
Page 5
Avado Brands, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands) Nine Months Ended
- -----------------------------------------------------------------------------------------------------------------------
Sept. 29, Sept. 30,
2002 2001
- -----------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net earnings (loss) $ 6,945 (70,266)
Adjustments to reconcile net earnings (loss) to net cash
provided by operating activities:
Depreciation and amortization 15,762 22,139
Deferred income taxes - 10,517
Gain on debt extinguishment (41,412) -
Asset revaluation and other special charges 3,726 48,380
(Gain) loss on disposal of assets 3 (5,632)
Loss from discontinued operations 14,290 1,241
Mark-to-market adjustment on interest rate swap 861 (2,196)
(Increase) decrease in assets:
Accounts receivable 563 (1,736)
Inventories 205 929
Prepaid expenses and other 1,429 (2,810)
Increase (decrease) in liabilities:
Accounts payable (8,323) (3,699)
Accrued liabilities (20,573) 2,221
Income taxes 113 (283)
Other long-term liabilities (273) (2,546)
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (26,684) (3,741)
- -----------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (4,693) (16,333)
Proceeds from disposal of assets and notes receivable, net 6,519 120,725
Additions to noncurrent assets (408) (2,703)
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 1,418 101,689
- -----------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from (repayment of) revolving credit agreements 19,646 (90,831)
Proceeds from (repayment of) term credit agreement 16,165 -
Payment of financing costs (8,502) -
Purchase of long-term debt, net (8,489) -
Principal payments on long-term debt (18) (20)
Settlement of interest rate swap agreement (1,704) -
Payments to collateralize letters of credit - (6,000)
Reduction in letter of credit collateral 9,978 -
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 27,076 (96,851)
- -----------------------------------------------------------------------------------------------------------------------
Cash provided by (used in) discontinued operations (2,060) (1,171)
- -----------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (250) (74)
Cash and cash equivalents at the beginning of the period 559 402
- -----------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at the end of the period $ 309 328
=======================================================================================================================
See accompanying notes to consolidated financial statements.
Page 6
AVADO BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 29, 2002
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X promulgated by the Securities and Exchange Commission.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for annual financial statement
reporting purposes. However, there has been no material change in the
information disclosed in the consolidated financial statements included in the
Company's Annual Report on Form 10-K for the year ended December 30, 2001,
except as disclosed herein. In the opinion of management, all adjustments,
consisting only of normal recurring accruals, considered necessary for a fair
presentation have been included. Operating results for the quarter and nine
months ended September 29, 2002 are not necessarily indicative of the results
that may be expected for the year ending December 29, 2002.
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" in the second quarter of 2002. The
Company also adopted SFAS No. 142, "Goodwill and Other Intangible Assets", and
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
in the first quarter of 2002. SFAS 144 supersedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of", and the accounting and reporting provisions of APB Opinion No. 30,
"Reporting the Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions", for the disposal of a "Segment" of a business as
defined in that Opinion. As a result of the adoption of SFAS 144, the Company
has classified the revenues and expenses of nine Don Pablo's restaurants and two
Hops restaurants which were closed in the first nine months of 2002, plus one
additional Hops restaurant which was held for sale at September 29, 2002, as
discontinued operations for all periods presented in the accompanying
consolidated financial statements. The revenues and expenses of Canyon Cafe
which is also held for sale (including two restaurants closed in 2002 and three
restaurants closed in 2001), the McCormick & Schmick's brand, which was divested
in August 2001, and eight Don Pablo's and two Hops restaurants which were closed
in 2001, have not been classified as discontinued operations in the accompanying
consolidated financial statements. As the decision to divest these operations
was made prior to the implementation of SFAS 144 and they did not meet the
criteria for classification as discontinued operations under the provisions of
APB Opinion No. 30, they will continue to be classified within continuing
operations under the provisions of SFAS 121. As a result, the Company will
restate its quarterly reports on Form 10-Q for the quarters ended March 31, 2002
and June 30, 2002. The restated 10-Q's will present the operations of Canyon
Cafe and McCormick & Schmick's as continuing operations in 2002 and 2001.
Earnings of $0.1 million for the quarter ended March 31, 2002 and a loss of $0.4
million for the quarter ended June 30, 2002 and earnings of $2.6 million and
$3.9 million for the quarters ended April 1, 2001 and July 1, 2001,
respectively, which were previously presented as discontinued operations, will
be reclassified to continuing operations in the restated 10-Q's along with
corresponding information from 2001 which will also be reclassified to
continuing operations.
NOTE 2 - LONG-TERM DEBT AND LIQUIDITY
On March 25, 2002, the Company completed a $75.0 million credit facility
(the "Credit Facility") to replace its existing credit agreement. The Credit
Facility, which matures on March 25, 2005, limits total borrowing capacity at
any given time to an amount equal to two and one quarter times the Company's
trailing 12 months earnings before interest, income taxes and depreciation and
amortization as determined for the most recently completed four quarters
("Borrowing Base EBITDA"). The calculation of Borrowing Base EBITDA excludes the
2001 operations of McCormick & Schmick's, gains and losses on the disposal of
assets, asset revaluation and other special charges, non-cash rent expense and
preopening costs. The agreement provides a $35.0 million revolving credit
facility, which may be used for working capital and general corporate purposes,
and a $40.0 million term loan facility, which is limited to certain defined
purposes, excluding working capital and capital expenditures. In certain
circumstances, borrowings under the term loan facility are required to be repaid
to the lender and any such repayments are not available to be re-borrowed by the
Company. Events generating a required repayment include, among other things,
proceeds from asset dispositions, casualty events, tax refunds and excess cash
flow, each as defined in the Credit Facility. In addition, the lender has the
right to impose certain reserves against the Company's total borrowing
availability under the facility, which may limit the Company's availability on
both the revolving and term loans. Lender imposed reserves against the Company's
total borrowing availability, as of September 29, 2002, were $2.0 million.
Irrespective of future borrowings, certain obligations will exist with respect
to the agreement, including annual anniversary fees of $1.1 million and an
additional fee payable at maturity of $5.1 million. The loan is secured by
substantially all of the Company's assets.
Page 7
The terms of the Credit Facility, the Company's 9.75% Senior Notes due 2006
("Senior Notes") and 11.75% Senior Subordinated Notes due 2009 ("Subordinated
Notes"), $30.0 million master equipment lease and $28.4 million Hops
sale-leaseback transaction collectively include various provisions which, among
other things, require the Company to (i) achieve certain EBITDA targets, (ii)
maintain defined net worth and coverage ratios, (iii) maintain defined leverage
ratios, (iv) limit the incurrence of certain liens or encumbrances in excess of
defined amounts and (v) limit certain payments. In conjunction with the closing
of the Credit Facility, the Company terminated its interest rate swap agreement
thereby eliminating any aforementioned restrictions contained in that agreement.
In addition, in March 2002 the master equipment lease agreement was amended to
substantially conform the covenants to the Credit Facility and certain
provisions contained in the sale-leaseback agreement were also amended. In June
2002, the Company obtained an amendment to the Credit Facility which allowed the
use of proceeds from the term loan facility to make the one-time payment of
accrued interest related to the Company's $3.50 term convertible securities, due
2027. The amendment also increased the interest rate on revolving loans by 1.5%
and increased the fees related to letter of credit accommodations by 1.0%. In
the third quarter, the Company completed a second amendment to the Credit
Facility which amended certain definitions relating to the payment of delinquent
taxes and made other technical corrections to the agreement. Subsequent to the
end of the quarter, the Company completed a third amendment to the Credit
Facility which made additional technical corrections to the agreement.
At September 29, 2002, the Company was not in compliance with certain
EBITDA requirements contained in the Credit Facility and master equipment lease.
The Company's failure to comply with these EBITDA requirements is a result of a
decline in sales and corresponding decrease in cash flow, which has fallen below
the Company's expectations. Under both of these agreements, the failure to meet
the prescribed EBITDA targets represents an event of default whereby the
respective creditors have the right to declare all obligations under the
agreements immediately due and payable. Although neither creditor has notified
the Company of its intent to do so, acceleration of the obligations would have a
material adverse effect on the Company. At September 29, 2002, outstanding cash
borrowings under the Credit Facility totaled $35.8 million and these obligations
have been classified as current liabilities in the accompanying consolidated
balance sheet. In addition, outstanding letters of credit, which are secured by
the Credit Facility, totaled $15.3 million at quarter end. Remaining obligations
under the master equipment lease totaled $9.2 million at September 29, 2002. In
the event the obligations under the Credit Facility are accelerated,
cross-default provisions contained in the indentures to the Senior Notes and
Subordinated Notes would be triggered, creating an event of default under those
agreements as well. At September 29, 2002, the outstanding balances of the
Senior and Subordinated notes were $116.5 million and $47.6 million
respectively. In the event some or all of the obligations under the Company's
credit agreements become immediately due and payable, the Company does not
currently have sufficient liquidity to satisfy these obligations and it is
likely that the Company would be forced to seek protection from its creditors.
The Company is currently involved in discussions with its Credit Facility
lenders as well as the lessor under the master equipment lease and is seeking to
obtain amendments to these agreements or waivers of the covenant violations.
Although these creditors have verbally indicated their intent to consider
favorably the Company's requests, there can be no assurance that such waivers or
amendments will be formally granted. During the continuance of an event of
default, the Company is subject to a post-default interest rate under the Credit
Facility, which increases the otherwise effective interest rates by three
percentage points effective September 30, 2002. As a result, the Company's per
annum interest rate on revolving and term loans will be 14.75% and the rate on
letter of credit accommodations will be 6.50%. The Credit Facility lender also
has additional rights during the continuance of an event of default including,
among other things, the right to (i) make and collect certain payments on the
Company's behalf, (ii) require cash collateral to secure letters of credit,
(iii) make certain investigations into the Company's activities, (iv) receive
reimbursement for certain expenses incurred and (v) sell any of the collateral
securing the obligations or settle, on the Company's behalf, any legal
proceedings related to the collateral. Under the master equipment lease, in
addition to the right to declare all future scheduled rent payments immediately
due and payable, the lessor has the right, among other things, to repossess the
leased equipment, which is located primarily in the Company's restaurants.
Interest payments on the Company's Senior Notes and Subordinated Notes are
due semi-annually in each June and December. Prior to the Company's repurchase
of $52.4 million in face value of its outstanding Subordinated Notes in the
second and third quarters of 2002, the Company's semi-annual interest payments
totaled approximately $11.6 million. Subsequent to the repurchase, the Company's
semi-annual interest payments will total approximately $8.5 million. Under the
terms of the related note indentures, the Company has an additional 30-day
period from the scheduled interest payment dates before an event of default is
incurred, due to late payment of interest, and the Company utilized these
provisions with respect to its June 2002 interest payments as well as its June
and December 2001 interest payments. The Company's ability to make its December
2002 interest payments is dependent on the outcome of its discussions with the
Credit Facility lenders. If the Company is unable to obtain an amendment to the
Credit Facility or a waiver of the covenant violations, the Credit Facility
lender can prevent the Company from making its interest payments. In addition,
Page 8
currently, the Company does not have sufficient liquidity or availability under
its borrowing arrangements to make the December interest payments. Sufficient
liquidity to make these payments is dependent on several management initiatives,
including the realization of proceeds from the sale of assets. There can be no
assurance that these initiatives will be successful.
The Company's maximum borrowing capacity will be adjusted from $55.7
million to $53.3 million in conjunction with the Company's filing of its
required reports with the lender on or before November 13, 2002. At September
29, 2002, $19.6 million of cash borrowings were outstanding under the revolving
portion of the Credit Facility and $16.2 million was outstanding under the term
portion of the facility. At September 29, 2002, in addition to the $19.6 million
of cash borrowings outstanding under the revolving facility, an additional $15.3
million of the facility was utilized to secure letters of credit, fully
utilizing the maximum $35.0 million available on the revolving facility. At
September 29, 2002, $2.6 million remained unused and available under the term
loan facility. As a result of the upcoming reduction in the Company's borrowing
base, availability on the term facility will be reduced by $2.4 million on or
about November 13, 2002, while availability on the revolving facility will
remain unchanged.
Borrowings under the term loan facility during the third quarter included
$3.2 million (including approximately $0.3 million in accrued interest) to
repurchase $18.2 million in face value of the Company's outstanding Subordinated
Notes. After a $0.7 million write-off primarily of deferred loan costs and
unamortized initial issue discount on the Subordinated Notes, the Company
recorded a gain on the extinguishment of $14.6 million. During the second
quarter of 2002, term loan advances of $7.5 million were used to repurchase
$34.2 million in face value of Subordinated Notes and the Company recorded a
gain of $26.8 million. Also in the second quarter, an additional $5.4 million of
term loan proceeds were used to make a one-time payment of accrued interest,
equal to $4.25 per share, to holders of the Company's $3.50 term convertible
securities, due 2027 (the "TECONS"). The payment was conditional upon the
holders of at least 90% of the outstanding TECONS agreeing to convert their
securities into shares of common stock of the Company pursuant to the terms of
the TECONS. According to the terms of the securities, each TECON can be
converted, at the holders' option, into 3.3801 shares of common stock. During
the second quarter, holders representing approximately 95% of the outstanding
securities agreed to the terms of the offer and, in connection with the $5.4
million payment, 1,200,391 TECONS were converted into 4,057,442 shares of the
Company's common stock. As a result of this transaction, the outstanding balance
of the TECONS was reduced by $60.0 million.
Principal financing sources in the first nine months of 2002 consisted of
(i) term loan proceeds of $16.2 million, (ii) revolving loan proceeds of $11.1
million, net of financing costs of $8.5 million, (iii) a $10.0 million refund of
payments to collateralize letters of credit for the Company's self-insurance
programs and (iv) proceeds of $6.5 million from disposition of assets related
primarily to the McCormick & Schmick's divestiture and the sale of the real
estate of a Canyon Cafe restaurant. The primary uses of funds consisted of (i)
net cash used in operations of $26.7 million which included interest payments of
$28.0 million primarily related to the Senior Notes, Subordinated Notes and the
one-time TECON payment, in addition to operating lease payments of $18.1
million, (ii) $8.5 million, net of accrued interest of $2.2 million, for the
repurchase of $52.4 million in face value of the Company's outstanding
Subordinated Notes, (iii) capital expenditures of $4.7 million, and (iv)
settlement of the Company's interest rate swap agreement for $1.7 million.
The Company incurs various capital expenditures related to existing
restaurants and restaurant equipment in addition to capital requirements for
developing new restaurants. The Company does not anticipate opening any new
restaurants during the remainder of 2002. Capital expenditures for existing
restaurants are expected to be approximately $1 million for the remainder of
2002. Capital expenditures of $4.7 million for the first nine months of 2002
relate primarily to capital spending for existing restaurants. Capital
expenditures for continuing operations during the first nine months of 2001 were
$16.3 million and provided for the opening of three new restaurants, as well as
capital for existing restaurants.
The Company is also exposed to certain contingent payments. Under the
Company's insurance programs, coverage is obtained for significant exposures as
well as those risks required to be insured by law or contract. It is the
Company's preference to retain a significant portion of certain expected losses
related primarily to workers' compensation, physical loss to property, and
comprehensive general liability. Provisions for losses estimated under these
programs are recorded based on estimates of the aggregate liability for claims
incurred. For the nine months ended September 29, 2002, claims paid under the
Company's self-insurance programs totaled $3.7 million. In addition, at
September 29, 2002, the Company was contingently liable for letters of credit
aggregating approximately $15.3 million, relating to its insurance programs.
Page 9
The Company's 1998 Federal income tax returns are currently in the early
stages of an audit by the Internal Revenue Service (IRS). The Company believes
its recorded liability for income taxes is adequate to cover its exposure that
may result from the ultimate resolution of the audit. Although the ultimate
outcome of the audit cannot be determined at this time, the Company does not
have sufficient liquidity to pay any significant portion of its recorded
liability if resolution results in such amount being currently due and payable.
Management does not currently expect that this will be the result, or that any
resolution with respect to audit issues will be reached in the near future.
Management has taken steps to improve cash flow from operations, including
changing the Company's marketing strategy to be less reliant on expensive
broadcast media, reducing overhead through consolidation of functions and
personnel reductions and adjusting supervisory management level personnel in its
restaurant operations. There is no assurance these efforts will be successful in
improving cash flow from operations sufficiently to enable the Company to
continue to meet its obligations, including scheduled interest and other
required payments under its debt agreements and capital expenditures necessary
to maintain its existing restaurants. During the past twelve months, the Company
realized $14.5 million from the sale of assets, which has supplemented its cash
flow from operations and enabled the Company to meet its obligations. For the
near term, it is probable that cash flow from operations will need to be
supplemented by asset sales and other liquidity improvement initiatives. There
is no assurance the Company will be able to generate proceeds from these efforts
in sufficient amounts to supplement cash flow from operations, thereby enabling
the Company to meet its obligations.
NOTE 3 - SUPPLEMENTAL CASH FLOW INFORMATION
For the nine months ended September 29, 2002 and September 30, 2001, the
following supplements the consolidated statements of cash flows (amounts in
thousands):
2002 2001
---------- ----------
Interest paid (net of amounts capitalized) $ 22,621 20,056
Distributions paid on preferred securities $ 5,372 -
Income taxes paid (refunded) $ 262 249
NOTE 4 - ASSET REVALUATION AND OTHER SPECIAL CHARGES
Third quarter 2002 asset revaluation and other special charges of $1.9
million, which were predominately non-cash, primarily reflect asset impairment
charges taken to reduce the carrying value of the assets of the Canyon Cafe
brand to estimated fair value. Asset revaluation and other special charges for
the nine months ended September 29, 2002 include an additional $1.8 million,
which reflects a $0.6 million asset impairment charge at Canyon Cafe as well as
the decision to write-off $1.2 million in various capitalized costs related to
future restaurant development.
Third quarter 2001 asset revaluation and other special charges of $47.1
million related primarily to a $44.6 million non-cash asset impairment charge at
Canyon Cafe. A continued deterioration of sales and corresponding lack of
operating performance improvement resulted in a carrying amount of assets which
exceeded the sum of expected future cash flows associated with such assets. As a
result, an impairment loss was recorded based on the difference between the
estimated fair value and the carrying amount of the Canyon Cafe assets. The
impairment charge included a $38.1 million reduction of goodwill with the
remaining charge recorded primarily as a reduction of premises and equipment in
the accompanying consolidated balance sheet.
NOTE 5 - DISPOSAL OF ASSETS
Loss on disposal of assets of $0.1 million for the quarter ended September
29, 2002 reflects a $0.2 million loss related to the lease termination on a
closed Canyon Cafe location which was partially offset by a $0.1 million gain on
the sale of a closed Hops location, both of which were classified as held for
sale at December 30, 2001.
Gain on disposal of assets of $5.3 million for the quarter ended September
30, 2001 reflects an $8.0 million gain on the sale of McCormick & Schmick's
which was somewhat offset by the write off of deferred loan costs associated
with the Company's revolving credit facility which was repaid with proceeds from
the sale transaction. Gain on disposal for the nine months ended September 30,
2001 includes the net result of the sale of an office facility in Bedford, Texas
and the sale of various closed restaurant properties and miscellaneous assets.
NOTE 6 - GAIN ON DEBT EXTINGUISHMENT
Gain on debt extinguishment for the quarter ended September 29, 2002
reflects the retirement of $18.2 million in face value of Subordinated Notes for
$2.9 million plus $0.3 million in accrued interest. After a $0.7 million
Page 10
write-off primarily of deferred loan costs and unamortized initial issue
discount, the Company recorded a third quarter gain on the extinguishment of
$14.6 million. For the nine months ended September 29, 2002, gain on debt
extinguishment includes the second quarter retirement of $34.2 million in face
value of Subordinated Notes for $5.6 million plus $1.9 million in accrued
interest. After a $1.8 million write-off primarily of deferred loan costs and
unamortized initial issue discount, the Company recorded a gain on
extinguishment, during the second quarter, of $26.8 million.
NOTE 7 - INCOME TAXES
Income tax expense represents the effective rate of expense on earnings
before income taxes for the first nine months of 2002. The tax rate is based on
the Company's expected rate for the full fiscal 2002 year.
NOTE 8 - DISCONTINUED OPERATIONS
As discussed in Note 1 - Basis of Presentation, discontinued operations
includes the revenues and expenses of nine Don Pablo's and two Hops restaurants
which were closed in the first nine months of 2002, plus one additional Hops
restaurant which was held for sale at September 29, 2002 and subsequently closed
in November 2002. The decision to dispose of these 12 locations reflects the
Company's ongoing process of evaluating the performance and cash flows of its
various restaurant locations. The Company expects to complete the divestiture of
these locations in the next three to nine months. Subsequent to September 29,
2002, the Company closed seven additional restaurants including two Don Pablo's
and five Hops restaurants. As the decision to dispose of these locations was
made during the fourth quarter, they have not been classified as discontinued
operations. The Company will record any appropriate asset impairment charges
related to these locations, during the fourth quarter.
Net loss from discontinued operations for the quarter and nine months ended
September 29, 2002, for which no taxes have been allocated, of $9.3 million and
$14.3 million, respectively, primarily reflects non-cash asset impairment
charges of $8.5 million and $11.8 million, respectively, primarily to reduce the
carrying value of the restaurant assets, which are held for sale, to estimated
fair value. Losses from restaurant operations (before asset revaluation and
other special charges and (gain) loss on disposal of assets) for the quarterly
and year-to-date periods were $0.8 million and $2.5 million, respectively, on
total restaurant sales from discontinued operations of $1.9 million and $9.2
million, respectively, for the 12 restaurants classified as held for sale in the
quarter ended September 29, 2002.
Net loss from discontinued operations for the quarter and nine months ended
September 30, 2001 of $0.5 million (net of income tax benefit of $0.3 million)
and $1.2 million (net of income tax benefit of $0.7 million) respectively,
reflects losses from restaurant operations (before asset revaluation and other
special charges and (gain) loss on disposal of assets) on total restaurant sales
from discontinued operations of $3.7 million and $11.9 million, respectively.
NOTE 9 - CONTINGENCIES
In 1997, two lawsuits were filed by persons seeking to represent a class of
shareholders of the Company who purchased shares of the Company's common stock
between May 26, 1995 and September 24, 1996. Each plaintiff named the Company
and certain of its officers and directors as defendants. The complaints alleged
acts of fraudulent misrepresentation by the defendants which induced the
plaintiffs to purchase the Company's common stock and alleged illegal insider
trading by certain of the defendants, each of which allegedly resulted in losses
to the plaintiffs and similarly situated shareholders of the Company. The
complaints each sought damages and other relief. In 1998, one of these suits
(Artel Foam Corporation Pension Trust, et al. v. Apple South, Inc., et al.,
Civil Action No. CV-97-6189) was dismissed. An amended complaint, styled John
Bryant, et al. vs. Apple South, Inc., et al. consolidating previous actions was
filed in January 1998. During 1999, the Company received a favorable ruling from
the 11th Circuit Court of Appeals relating to the remaining suit. As a result of
the ruling, the District Court again considered the motion to dismiss the case,
and the defendants renewed their motion to dismiss in December 1999. In June
2000, the District Court dismissed with prejudice the remaining suit. The
plaintiffs appealed the court's final decision. Upon hearing the appeal, a
three-judge panel reversed the motion to dismiss and gave the plaintiffs the
opportunity to amend their suit and state with more particularity their
allegations. The plaintiffs have made a settlement demand, which is under
consideration by the Company's insurer. Although the ultimate outcome of the
suit cannot be determined at this time, the Company believes that the
allegations in the complaint are without merit.
In September 2002, the Company was named as the Defendant in an action
filed in the U.S. District Court for the Middle District of Georgia. The
Plaintiff, Bank of America Securities, LLC, alleges that it is owed a fee of
approximately $1.0 million, relating to the Company's sale of the McCormick &
Schmick's Restaurant brand. The Company believes that the allegations in the
complaint are without merit and plans to vigorously contest the complaint. This
litigation is currently at a preliminary stage and no discovery has occurred.
Thus, it is not possible for the Company to evaluate the likelihood of the
plaintiff prevailing on its claims. Because this claim is a suit on a contract,
the Company's existing insurance policies do not provide coverage. There can be
no assurance that an adverse determination in this litigation would not have a
material adverse effect on the Company's financial condition or results of
operations.
Page 11
In connection with the Applebee's and Harrigan's divestiture transactions
completed during 1999 and 1998, the Company remains contingently liable for
lease obligations relating to 86 Applebee's restaurants and nine Harrigan's
restaurants. Assuming that each respective purchaser became insolvent, an event
management believes to be remote, the Company could be liable for lease payments
extending through 2017 with minimum lease payments totaling approximately $37.0
million. Management believes that the ultimate disposition of these contingent
liabilities will not have a material adverse effect on the Company's
consolidated financial position or results of operations.
The Company is involved in various other claims and legal actions arising
in the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position or results of operations.
NOTE 10 - INTEREST RATE SWAP
During the first quarter of 2002, the Company terminated its only interest
rate swap agreement. The settlement or fair market value of the interest rate
swap on the date of termination was $1.7 million. Prior to termination,
mark-to-market adjustments of $0.9 million were recorded as an increase to
interest expense, which increased the settlement or fair market value of the
interest rate swap to $1.7 million from $0.8 million at December 30, 2001.
At September 30, 2001, the settlement or fair market value of the interest
rate swap was $6.7 million and is included in other long-term liabilities in the
accompanying consolidated balance sheet. For the nine months ended September 30,
2001, mark-to-market adjustments of $2.2 million were recorded as a reduction of
interest expense.
NOTE 11 - RELATED PARTY TRANSACTIONS
At December 30, 2001, the Company held several notes receivable, one of
which was secured by real estate, from Tom E. DuPree, Jr., Chairman of the Board
and Chief Executive Officer of the Company (the "Chairman Notes" and the
"Chairman"). At December 30, 2001, the due date of the Chairman Notes was June
30, 2002 with an interest rate of 11.5% payable at maturity. At December 30,
2001, total amounts owed to the Company under the Chairman Notes were $10.9
million in principal and $3.0 million in accrued interest. At that time, the
Company recorded an allowance against the ultimate realization of amounts due
totaling $11.1 million, yielding a net balance of $2.8 million, the fair value
of the real estate collateral held by the Company.
In March 2002, the Board of Directors approved a series of transactions
whereby the Chairman sold the real estate collateral securing one of the
Chairman Notes and, with the $2.8 million in proceeds, purchased $14.0 million
in face value of the Company's 11.75% Senior Subordinated Notes, due June 2009
(the "Subordinated Notes"). The Subordinated Notes were pledged as collateral by
the Chairman to secure amounts owed by him to the Company under the Chairman
Notes. On March 6, 2002 the principal and interest due on the several Chairman
Notes were consolidated into one note with a principal balance of $14.1 million
(the "New Chairman Note"), and the interest payment terms, interest rate and due
date of the note were changed to match the terms and due date of the
Subordinated Notes. All amounts of interest and principal paid by the Company on
the Subordinated Notes owned by the Chairman and pledged as collateral to the
Company, will be used to make simultaneous payments to the Company on amounts
due to the Company under the New Chairman Note.
In conjunction with the Company's July 10, 2002 payment of the semi-annual
interest due to holders of its Subordinated Notes, the Chairman made a
simultaneous payment of principal and interest under the New Chairman Note in
the amount of $0.8 million. As a result, the principal balance of the New
Chairman Note was reduced to $13.7 million.
NOTE 12 - NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets", which requires nonamortization of goodwill and intangible assets that
have indefinite useful lives and annual tests of impairments of those assets.
The statement also provides specific guidance about how to determine and measure
goodwill and intangible asset impairments, and requires additional disclosure of
information about goodwill and other intangible assets. The provisions of the
statement are required to be applied starting with fiscal years beginning after
December 15, 2001 and applied to all goodwill and other intangible assets
recognized in financial statements at that date. The Company adopted SFAS 142
effective at the beginning of its fiscal 2002 year. The following table
discloses the Company's consolidated earnings, assuming it excluded goodwill
amortization for the periods ended:
Page 12
Quarter Ended Nine Months Ended
- ----------------------------------------------------------------------------------- ------------------------------
Sept. 29, Sept. 30, Sept. 29, Sept.30,
2002 2001 2002 2001
- ----------------------------------------------------------------------------------- ------------------------------
Net earnings (loss) $ (1,933) (64,372) 6,945 (70,266)
Add back:
Goodwill amortization, net of income taxes - 647 - 2,731
Trademark amortization, net of income taxes - 6 - 14
- ------------------------------------------------------------------------------------ -----------------------------
Adjusted net earnings (loss) $ (1,933) (63,719) 6,945 (67,521)
==================================================================================== =============================
Basic earnings (loss) per share: $ (0.06) (2.24) 0.23 (2.46)
Add back:
Goodwill amortization, net of income taxes - 0.02 - 0.10
Trademark amortization, net of income taxes - 0.00 - 0.00
- ------------------------------------------------------------------------------------ -----------------------------
Adjusted basic earnings (loss) per share $ (0.06) (2.22) 0.23 (2.36)
==================================================================================== =============================
Diluted earnings per share: $ (0.06) (2.24) 0.22 (2.46)
Add back:
Goodwill amortization, net of income taxes - 0.02 - 0.10
Trademark amortization, net of income taxes - 0.00 - 0.00
- ------------------------------------------------------------------------------------- ----------------------------
Adjusted diluted earnings (loss) per share $ (0.06) (2.22) 0.22 (2.36)
===================================================================================== ============================
In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations", which requires entities to recognize the fair value of
a liability for an asset retirement obligation in the period in which it is
incurred. The statement is effective for fiscal years beginning after June 15,
2002. The Company is assessing the impact of adoption of the statement on its
consolidated financial position and results of operations.
In October 2001, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets". SFAS 144, which was adopted by the Company in the first
quarter of 2002, supersedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", for the disposal of a "Segment" of a business as defined in that
Opinion. As a result of the adoption of SFAS 144, the Company has classified the
revenues and expenses of nine Don Pablo's restaurants and two Hops restaurants
which were closed in 2002, plus one additional Hops restaurant which was held
for sale at September 29, 2002, as discontinued operations for all periods
presented in the accompanying consolidated financial statements. The revenues
and expenses of Canyon Cafe which is also held for sale (including two
restaurants closed in 2002 and three restaurants closed in 2001), the McCormick
& Schmick's brand, which was divested in August 2001, and eight Don Pablo's and
two Hops restaurants which were closed in 2001, have not been classified as
discontinued operations in the accompanying consolidated financial statements.
As the decision to divest these operations was made prior to the implementation
of SFAS 144 and they did not meet the criteria for classification as
discontinued operations under the provisions of APB Opinion No. 30, they will
continue to be classified within continuing operations under the provisions of
SFAS 121.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections", which eliminates the requirement to report gains and losses
related to extinguishments of debt as extraordinary items. The statement also
included other amendments and technical corrections, which will not have a
material impact on the Company. The provisions of the statement related to the
treatment of debt extinguishments are required to be applied in fiscal years
beginning after May 15, 2002. The Company elected to adopt SFAS 145 in the
second quarter of 2002. As a result of the application of the statement, for the
nine months ended September 29, 2002, the Company's $41.4 million gain, related
to the repurchase of $52.4 million of its Subordinated Notes is not presented as
an extraordinary item in the accompanying Consolidated Statements of Earnings
(Loss). The Company has not reported any extraordinary items in prior periods
and, accordingly, no prior period reclassifications were required.
Page 13
NOTE 13 - GUARANTOR SUBSIDIARIES
The Company's Senior Notes and Credit Facility are fully and
unconditionally guaranteed on a joint and several basis by substantially all of
its wholly owned subsidiaries. Such indebtedness is not guaranteed by the
Company's non-wholly owned subsidiaries. These non-guarantor subsidiaries
primarily include certain partnerships of which the Company is typically a 90%
owner. At September 29, 2002 and December 30, 2001, these partnerships in the
non-guarantor subsidiaries operated 19 and 20 of the Company's restaurants,
respectively. At September 30, 2001, these partnerships in the non-guarantor
subsidiaries operated 60 of the Company's restaurants. Accordingly, condensed
consolidated balance sheets as of September 29, 2002 and December 30, 2001, and
condensed consolidated statements of earnings and cash flows for the nine months
ended September 29, 2002 and September 30, 2001 are provided for such guarantor
and non-guarantor subsidiaries. Corporate costs associated with the maintenance
of a centralized administrative function for the benefit of all Avado
restaurants, as well as goodwill, have not been allocated to the non-guarantor
subsidiaries. In addition, interest expense has not been allocated to the
non-guarantor subsidiaries. Separate financial statements and other disclosures
concerning the guarantor and non-guarantor subsidiaries are not presented
because management has determined that they are not material to investors. There
are no contractual restrictions on the ability of the guarantor subsidiaries to
make distributions to the Company.
Condensed Consolidated Statement of Earnings (Loss)
Nine Months Ended September 29, 2002
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Guarantor Non-Guarantor
(In thousands) Subsidiaries Subsidiaries Eliminations Consolidated
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Restaurant sales $ 313,319 38,299 - 351,618
Restaurant operating expenses 288,294 34,340 - 322,634
General and administrative expenses 18,454 1,729 - 20,183
(Gain) loss on disposal of assets 3 - - 3
Asset revaluation and other special charges 3,726 - - 3,726
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Operating income 2,842 2,230 - 5,072
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Other income (expense) 16,538 - - 16,538
Earnings (loss) before income taxes
for continuing operations 19,380 2,230 - 21,610
Income taxes 292 83 - 375
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Net earnings (loss) from continuing operations 19,088 2,147 - 21,235
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Net earnings (loss) from discontinued
operations (14,131) (159) - (14,290)
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Net earnings (loss) $ 4,957 1,988 - 6,945
================================================ ================ ================= =============== ================
Condensed Consolidated Statement of Earnings (Loss)
Nine Months Ended September 30, 2001
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Guarantor Non-Guarantor
(In thousands) Subsidiaries Subsidiaries Eliminations Consolidated
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Restaurant sales $ 371,103 120,581 - 491,684
Restaurant operating expenses 333,532 112,471 - 446,003
General and administrative expenses 18,542 5,431 - 23,973
(Gain) loss on disposal of assets (5,632) - - (5,632)
Asset revaluation and other special charges 48,380 - - 48,380
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Operating income (23,719) 2,679 - (21,040)
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Other income (expense) (37,324) (178) - (37,502)
Earnings (loss) before income taxes
for continuing operations (61,043) 2,501 - (58,542)
Income taxes 9,664 819 - 10,483
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Net earnings (loss) from continuing operations (70,707) 1,682 - (69,025)
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Net earnings (loss) from discontinued
operations (1,081) (160) - (1,241)
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Net earnings (loss) $ (71,788) 1,522 - (70,266)
================================================ ================ ================= =============== ================
Page 14
Condensed Consolidated Balance Sheet
September 29, 2002
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Guarantor Non-Guarantor
(In thousands) Subsidiaries Subsidiaries Eliminations Consolidated
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
ASSETS
Current assets $ 24,456 809 - 25,265
Premises and equipment, net 236,824 24,082 - 260,906
Goodwill, net 34,920 - - 34,920
Deferred income tax benefit 11,620 - - 11,620
Other assets 30,642 18 - 30,660
Intercompany investments 12,370 - (12,370) -
Intercompany advances 10,082 - (10,082) -
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
$ 360,914 24,909 (22,452) 363,371
================================================ ================ ================= =============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities $ 121,077 2,457 - 123,534
Long-term liabilities 166,019 - - 166,019
Intercompany payables - 12,370 (12,370) -
Convertible preferred securities 3,179 - - 3,179
Shareholders' equity 70,639 10,082 (10,082) 70,639
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
$ 360,914 24,909 (22,452) 363,371
================================================ ================ ================= =============== ================
Condensed Consolidated Balance Sheet
December 30, 2001
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Guarantor Non-Guarantor
(In thousands) Subsidiaries Subsidiaries Eliminations Consolidated
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
ASSETS
Current assets $ 38,927 868 - 39,795
Premises and equipment, net 260,957 24,856 - 285,813
Goodwill, net 34,920 - - 34,920
Deferred income tax benefit 11,620 - - 11,620
Other assets 26,390 18 - 26,408
Intercompany investments 12,370 - (12,370) -
Intercompany advances 12,647 - (12,647) -
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
$ 397,831 25,742 (25,017) 398,556
================================================ ================ ================= =============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities $ 113,092 725 - 113,817
Long-term liabilities 218,926 - - 218,926
Intercompany payables - 12,370 (12,370) -
Convertible preferred securities 68,559 - - 68,559
Shareholders' equity (2,746) 12,647 (12,647) (2,746)
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
$ 397,831 25,742 (25,017) 398,556
================================================ ================ ================= =============== ================
Page 15
Condensed Consolidated Statement of Cash Flows
Nine Months Ended September 29, 2002
- ----------------------------------------------------- ---------------- ----------------- --------------- ----------------
Guarantor Non-Guarantor
(In thousands) Subsidiaries Subsidiaries Eliminations Consolidated
- ----------------------------------------------------- ---------------- ----------------- --------------- ----------------
Net cash provided by (used in) operating activities $ (29,954) 3,270 - (26,684)
- ----------------------------------------------------- ---------------- ----------------- --------------- ----------------
Cash flows from investing activities:
Capital expenditures (4,149) (544) - (4,693)
Proceeds from disposal of assets, net 6,519 - - 6,519
Other investing activities (408) - - (408)
- ----------------------------------------------------- ---------------- ----------------- --------------- ----------------
Net cash provided by (used in) investing activities 1,962 (544) - 1,418
- ----------------------------------------------------- ---------------- ----------------- --------------- ----------------
Cash flows from financing activities:
Proceeds from revolving credit agreements 19,646 - - 19,646
Proceeds from term credit agreement 16,165 - - 16,165
Payment of financing costs (8,502) - - (8,502)
Payment of long-term debt (8,489) - - (8,489)
Principal payments on long-term debt (18) - - (18)
Reduction in letter of credit collateral 9,978 - - 9,978
Proceeds from (payment of) intercompany
advances 2,565 (2,565) - -
Settlement of interest rate swap agreement (1,704) - - (1,704)
- ----------------------------------------------------- ---------------- ----------------- --------------- ----------------
Net cash provided by (used in) financing activities 29,641 (2,565) - 27,076
- ----------------------------------------------------- ---------------- ----------------- --------------- ----------------
Cash provided by (used in) discontinued operations (1,901) (159) - (2,060)
- ----------------------------------------------------- ---------------- ----------------- --------------- ----------------
Net increase (decrease) in cash and cash equivalents (252) 2 - (250)
Cash and equivalents at the beginning of the period 532 27 - 559
- ----------------------------------------------------- ---------------- ----------------- --------------- ----------------
Cash and equivalents at the end of the period $ 280 29 - 309
===================================================== ================ ================= =============== ================
Condensed Consolidated Statement of Cash Flows
Nine Months Ended September 30, 2001
- ------------------------------------------------------ ---------------- ----------------- --------------- ----------------
Guarantor Non-Guarantor
(In thousands) Subsidiaries Subsidiaries Eliminations Consolidated
- ------------------------------------------------------ ---------------- ----------------- --------------- ----------------
Net cash provided by operating activities $ (8,818) 5,077 - (3,741)
- ------------------------------------------------------ ---------------- ----------------- --------------- ----------------
Cash flows from investing activities:
Capital expenditures (15,487) (846) - (16,333)
Proceeds from disposal of assets, net 120,725 - - 120,725
Other investing activities (2,703) - - (2,703)
- ------------------------------------------------------ ---------------- ----------------- --------------- ----------------
Net cash provided by (used in) investing activities 102,535 (846) - 101,689
- ------------------------------------------------------ ---------------- ----------------- --------------- ----------------
Cash flows from financing activities:
Proceeds from revolving credit agreements (90,831) - - (90,831)
Principal payments on long-term debt (20) - - (20)
Payments to collateralize letters of credit (6,000) - - (6,000)
Proceeds from (payment of) intercompany
advances 4,168 (4,168) - -
- ------------------------------------------------------ ---------------- ----------------- --------------- ----------------
Net cash provided by (used in) financing activities (92,683) (4,168) - (96,851)
- ------------------------------------------------------ ---------------- ----------------- --------------- ----------------
Cash provided by (used in) discontinued operations (1,106) (65) - (1,171)
- ------------------------------------------------------ ---------------- ----------------- --------------- ----------------
Net increase (decrease) in cash and cash equivalents (72) (2) - (74)
Cash and equivalents at the beginning of the period 310 92 - 402
- ------------------------------------------------------ ---------------- ----------------- --------------- ----------------
Cash and equivalents at the end of the period $ 238 90 - 328
====================================================== ================ ================= =============== ================
Page 16
NOTE 14 - SHAREHOLDER RIGHTS PLAN
On August 6, 2002, the Company's Board of Directors adopted a Shareholder
Rights Plan. Under the plan, Rights will be distributed as a dividend at the
rate of one Right for each share of Avado common stock, par value $0.01 per
share, held by shareholders of record as of the close of business on September
4, 2002. The Rights Plan was not adopted in response to any effort to acquire
control of Avado Brands.
The Rights Plan is designed to deter coercive takeover tactics, including
the accumulation of shares in the open market or through private transactions
and to prevent an acquirer from gaining control of Avado without offering a fair
and adequate price and terms to all of Avado's shareholders. The Rights will
expire on September 4, 2007.
Each Right initially will entitle stockholders to buy one unit of a share
of a series of preferred stock for $9.50. The Rights generally will be
exercisable only if a person or group acquires beneficial ownership of 15% or
more of Avado's common stock or commences a tender or exchange offer upon
consummation of which such person or group would beneficially own 15% or more of
Avado's common stock.
NOTE 15 - EARNINGS PER SHARE INFORMATION
The following table presents a reconciliation of weighted averages shares
and earnings per share amounts.
Computation of Earnings (Loss) Per Common Share
(In thousands, except per share data) Quarter Ended Nine Months Ended
- -------------------------------------------------------------------------------------------------------------------------------
Sept. 29, Sept. 30, Sept. 29, Sept. 30,
2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------------------------
Average number of common shares used in basic calculation 33,102 28,680 30,740 28,530
Net additional shares issuable pursuant to employee stock
option plans at period-end market price 475 - * 787 - *
Shares issuable on assumed conversion of convertible
preferred securities - * - * - * - *
- -------------------------------------------------------------------------------------------------------------------------------
Average number of common shares used in diluted calculation 33,577 28,680 31,527 28,530
===============================================================================================================================
Net earnings (loss) from continuing operations $ 7,369 (63,856) 21,235 (69,025)
Net earnings (loss) from discontinued operations (9,302) (516) (14,290) (1,241)
- -------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) (1,933) (64,372) 6,945 (70,266)
Distribution savings on assumed conversion of convertible
preferred securities, net of income taxes - * - * - * - *
- -------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) for computation of diluted earnings per common share $ (1,933) (64,372) 6,945 (70,266)
===============================================================================================================================
Basic earnings (loss) per common share from continuing operations $ 0.22 (2.22) 0.69 (2.42)
Basic earnings (loss) per common share from discontinued operations (0.28) (0.02) (0.46) (0.04)
- -------------------------------------------------------------------------------------------------------------------------------
Basic earnings (loss) per common share $ (0.06) (2.24) 0.23 (2.46)
===============================================================================================================================
Diluted earnings (loss) per common share from continuing operations $ 0.22 * (2.22)* 0.67 * (2.42)*
Diluted earnings (loss per common share from discontinued operations (0.28) (0.02) (0.45) (0.04)
- -------------------------------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per common share $ (0.06) (2.24) 0.22 (2.46)
===============================================================================================================================
* Inclusion of shares issuable pursuant to employee stock option plans and
the shares related to the convertible preferred securities results in an
increase to earnings (loss) per share ("EPS") in both the quarter and nine
months ended September 30, 2001. For the quarter and nine months ended September
29, 2002, inclusion of shares issuable related to the convertible preferred
securities results in an increase to EPS. As such shares are antidilutive, they
have been excluded from the computation of diluted EPS.
Page 17
Item 2.
AVADO BRANDS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the Third Quarter and Nine Months Ended September 29, 2002
Presentation
In October 2001, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets". SFAS 144, which was adopted by the Company in the first
quarter of 2002, supersedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", for the disposal of a "Segment" of a business as defined in that
Opinion. As a result of the adoption of SFAS 144, the Company has classified the
revenues and expenses of nine Don Pablo's restaurants and two Hops restaurants
which were closed in the first nine months of 2002, plus one additional Hops
restaurant which was held for sale at September 29, 2002, as discontinued
operations for all periods presented in the accompanying consolidated financial
statements. The revenues and expenses of Canyon Cafe which is also held for sale
(including two restaurants closed in 2002 and three restaurants closed in 2001),
the McCormick & Schmick's brand, which was divested in August 2001, and eight
Don Pablo's and two Hops restaurants which were closed in 2001, have not been
classified as discontinued operations in the accompanying consolidated financial
statements. As the decision to divest these operations was made prior to the
implementation of SFAS 144 and they did not meet the criteria for classification
as discontinued operations under the provisions of APB Opinion No. 30, they will
continue to be classified within continuing operations under the provisions of
SFAS 121.As a result, the Company will restate its quarterly reports on Form
10-Q for the quarters ended March 31, 2002 and June 30, 2002. The restated
10-Q's will present the operations of Canyon Cafe and McCormick & Schmick's as
continuing operations in 2002 and 2001. Earnings of $0.1 million for the quarter
ended March 31, 2002 and a loss of $0.4 million for the quarter ended June 30,
2002 and earnings of $2.6 million and $3.9 million for the quarters ended April
1, 2001 and July 1, 2001, respectively, which were previously presented as
discontinued operations, will be reclassified to continuing operations in the
restated 10-Q's along with the corresponding information from 2001 which will
also be reclassified to continuing operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections", which eliminates the requirement to report gains and losses
related to extinguishments of debt as extraordinary items. The statement also
included other amendments and technical corrections, which will not have a
material impact on the Company. The provisions of the statement related to the
treatment of debt extinguishments are required to be applied in fiscal years
beginning after May 15, 2002. The Company elected to adopt SFAS 145 in the
second quarter of 2002. As a result of the application of the statement, for the
nine months ended September 29, 2002, the Company's $41.4 million gain, related
to the repurchase of $52.4 million of its 11.75% Senior Subordinated Notes was
not presented as an extraordinary item in the accompanying Consolidated
Statements of Earnings (Loss). The Company has not reported any extraordinary
items in prior periods and, accordingly, no prior period reclassifications were
required.
Restaurant Sales
Restaurant sales included in continuing operations for the third quarter
and nine months ended September 29, 2002 were $108.4 million and $351.6 million,
respectively, compared to $146.0 million and $491.7 million for the same
respective periods of 2001. Declining revenues were primarily due to the August
2001 divestiture of McCormick & Schmick's. For continuing operations related to
the Company's Don Pablo's and Hops brands, restaurant sales for the third
quarter and nine months ended September 29, 2002 were $102.3 million and $330.5
million, respectively, compared to $112.5 million and $351.6 million for the
same respective periods of 2001. Declining revenues were primarily a result of a
decrease in same-store sales at Don Pablo's and Hops and a decrease in operating
capacity from the closure of eight Don Pablo's and two Hops in 2001. The
revenues and expenses related to nine Don Pablo's restaurants and two Hops
restaurants which were closed during 2002, plus one additional Hops restaurant
which is held for sale at September 29, 2002, have been included in discontinued
operations in the accompanying consolidated statements of earnings.
Same-store-sales for the third quarter of 2002 decreased by 8.7% at Don Pablo's
and 9.4% at Hops as compared to the corresponding period of the prior year
(same-store-sales comparisons include all restaurants open for 18 months as of
the beginning of the quarter). On a year-to-date basis, same-store sales
decreased by 6.0% at Don Pablo's and 4.8% at Hops. Declining revenues for the
nine months ended September 29, 2002 were slightly offset by increased operating
capacity from one new Hops restaurant opened in 2001.
Page 18
Restaurant Operating Expenses
Restaurant operating expenses included in continuing operations for the
nine months ended September 29,2002 increased to 91.8% of sales compared to
90.7% of sales in the comparable period of 2001. The resulting decrease in
restaurant operating margins was due primarily to the divestiture of McCormick &
Schmick's which contributed to higher restaurant margins in 2001. For the
quarterly period ended September 29, 2002, restaurant operating expenses
decreased to 92.5% of sales compared to 94.1% in the comparable prior-year
period. The absence in 2002 of higher operating margins from McCormick &
Schmick's was more that offset by decreases in other operating expenses at Don
Pablo's and Hops. The following table sets forth the percentages which certain
items of income and expense bear to total restaurant sales for the operations of
the Company's Don Pablo's and Hop's brands (excluding the nine Don Pablo's and
three Hops restaurants which are classified as discontinued operations) for the
quarter and nine month periods ended September 29, 2002 and September 30, 2001.
- --------------------------------------------- ---------------- ----------------- ---------------- -----------------
Quarter Quarter Nine Months Nine Months
Ended Ended Ended Ended
Sept. 29, 2002 Sept. 30, 2001 Sept. 29, 2002 Sept. 30, 2001
- --------------------------------------------- ---------------- ----------------- ---------------- -----------------
Restaurant sales:
Don Pablo's 60.7% 60.5% 59.3% 59.6%
Hops 39.3% 39.5% 40.7% 40.4%
- --------------------------------------------- ---------------- ----------------- ---------------- -----------------
Total restaurant sales 100.0% 100.0% 100.0% 100.0%
- --------------------------------------------- ---------------- ----------------- ---------------- -----------------
Restaurant operating expenses:
Food and beverage 27.9% 28.4% 28.1% 28.1%
Payroll and benefits 34.3% 32.5% 33.4% 32.2%
Depreciation and amortization 3.6% 3.9% 3.4% 3.8%
Other operating expenses 26.2% 30.7% 26.5% 27.7%
- --------------------------------------------- ----------------- ----------------- ---------------- -----------------
Total restaurant operating expenses 92.0% 95.5% 91.4% 91.8%
- --------------------------------------------- ----------------- ----------------- ---------------- -----------------
Pro forma income from restaurant operations 8.0% 4.5% 8.6% 8.2%
General and administrative expenses 6.6% 5.6% 5.9% 5.5%
- --------------------------------------------- ---------------- ----------------- ---------------- -----------------
Pro forma operating income before special
charges and (gain) loss on disposals 1.4% (1.1)% 2.7% 2.7%
============================================= ================ ================= ================ =================
Pro forma operating income from the continuing operations of Don Pablo's
and Hops (before asset revaluation and other special charges and gain/loss on
the disposal of assets) for the quarter and nine months ended September 29, 2002
was 1.4% of sales and 2.7% of sales, respectively, compared to an operating loss
of 1.1% of sales and operating income of 2.7% of sales for the corresponding
periods of 2001. The resulting increase in pro forma operating income for the
quarter ended September 29, 2002 compared to the quarter ended September 30,
2001 was predominately due to decreases in marketing expenditures as a result of
the Company's decision to revise its overall marketing strategy to encompass a
more regional focus which significantly reduced its marketing expense. Increases
in operating income were somewhat offset by declining sales volumes which
generated an increase in the fixed component of payroll and benefits, general
and administrative expenses and other fixed operating expenses as a percentage
of sales.
For the nine months ended September 29, 2002, increased operating expenses
as a percent of sales, which resulted from declining sales volumes, were offset
by (i) decreases in utility costs as a result of unseasonably warm weather
during the first quarter of 2002 and (ii) decreases in costs associated with new
manager training at Don Pablo's and Hops due to improved management retention.
While the Company's change in marketing strategy dramatically reduced marketing
expenditures during the third quarter of 2002, for the nine months ended
September 29, 2002 marketing expense, as a percent of sales, was comparable to
the corresponding period of 2001. Marketing expense for the continuing
operations of Don Pablo's and Hops, as a percent of sales, for the quarter and
nine months ended September 29, 2002 was 3.8% and 5.6%, respectively, compared
to 6.5% and 5.8% for the corresponding periods of 2001.
General and Administrative Expenses
General and administrative expenses included in continuing operations of
6.4% and 5.7% of sales for the quarter and nine months ended September 29, 2002,
respectively, increased over the comparable periods of the prior year due
primarily to a decline in sales volumes.
Page 19
Asset Revaluation and Other Special Charges
Third quarter 2002 asset revaluation and other special charges of $1.9
million, which were predominately non-cash, primarily reflect asset impairment
charges taken to reduce the carrying value of the assets of the Canyon Cafe
brand to estimated fair value. Asset revaluation and other special charges for
the nine months ended September 29, 2002 include an additional $1.8 million,
which reflects a $0.6 million asset impairment charge at Canyon Cafe as well as
the decision to write-off $1.2 million in various capitalized costs related to
future restaurant development.
Third quarter 2001 asset revaluation and other special charges of $47.1
million related primarily to a $44.6 million non-cash asset impairment charge at
Canyon Cafe. A continued deterioration of sales and corresponding lack of
operating performance improvement resulted in a carrying amount of assets which
exceeded the sum of expected future cash flows associated with such assets. As a
result, an impairment loss was recorded based on the difference between the
estimated fair value and the carrying amount of the Canyon Cafe assets. The
impairment charge included a $38.1 million reduction of goodwill with the
remaining charge recorded primarily as a reduction of premises and equipment in
the accompanying consolidated balance sheet.
Interest and Other Expenses
Net interest expense for the third quarter and nine months ended September
29, 2002 was $7.3 million and $23.6 million, respectively, compared to $7.2
million and $26.5 million for the corresponding periods of the prior year.
Decreased interest expense, for the nine months ended September 29, 2002, was
primarily due to the divestiture of McCormick & Schmick's, the proceeds of which
were used to repay $95.8 million outstanding under the Company's revolving
credit facility during the third quarter of 2001. Decreases in interest expense
were somewhat offset by unfavorable mark-to-market adjustments recorded during
the first quarter of 2002 under a fixed-to-floating interest rate swap
agreement, which was terminated on March 25, 2002, and by increased interest
charges incurred primarily during the first quarter of 2002 related to past due
sales and use, property and other taxes. For the quarter ended September 29,
2002, interest expense was comparable to the corresponding period of the prior
year. The Company's $52.4 million repurchase of its 11.75% Senior Subordinated
Notes due 2009, resulted in a $1.3 million reduction in interest expense during
the third quarter of 2002. Interest expense for the corresponding period of 2001
was reduced by favorable mark-to-market adjustments related to the Company's
interest rate swap agreement.
Distribution expense on preferred securities relates to the Company's $3.50
term convertible securities with a liquidation preference of $50 per security
and convertible into 3.3801 shares of Avado Brands common stock for each
security (the "TECONS"). Expenses related to these securities decreased as a
result of the conversion of 86,128 of the securities into 291,115 shares of
common stock during 2001, coupled with 1,307,591 additional conversions in the
first half of 2002 into 4,419,789 shares of common stock all of which were
issued from treasury stock. The Company has the right to defer quarterly
distribution payments on the Convertible Preferred Securities for up to 20
consecutive quarters and has deferred all such payments beginning with the
December 1, 2000 payment until December 1, 2005. The Company may pay all or any
part of the interest accrued during the extension period at any time.
In June 2002, the Company made a one-time distribution payment of accrued
interest, totaling $5.4 million or $4.25 per share, to holders of its TECONS. Of
the 1,307,591 shares converted during the first half of 2002, 1,200,391 were
converted in conjunction with this distribution payment. As a result of these
conversions, annual distribution expense on the remaining TECONS outstanding
will be approximately $0.2 million.
Loss on disposal of assets of $0.1 million for the quarter ended September
29, 2002 reflects a $0.2 million loss related to the lease termination on a
closed Canyon Cafe location which was partially offset by a $0.1 million gain on
the sale of a closed Hops location.
During the nine months ended September 29, 2002, other income related
primarily to the abatement of previously incurred tax penalties. For the nine
months ended September 30, 2001, other expense was primarily related to the
incurrance of various tax penalties and the amortization of goodwill. For the
nine months ended September 30, 2001, the Company recorded goodwill amortization
of $1.6 million. As a result of the Company's first quarter 2002 adoption of
SFAS 142, "Goodwill and Other Intangible Assets", goodwill is no longer being
amortized.
Income tax expense represents the effective rate of expense on earnings
before income taxes for the first nine months of 2002. The tax rate is based on
the Company's expected rate for the full fiscal 2002 year.
Page 20
Discontinued Operations
As discussed in Note 1 - Basis of Presentation, discontinued operations
includes the revenues and expenses of nine Don Pablo's and two Hops restaurants
which were closed in the first nine months of 2002, plus one additional Hops
restaurant which was held for sale at September 29, 2002 and subsequently closed
in November 2002. The decision to dispose of these 12 locations reflects the
Company's ongoing process of evaluating the performance and cash flows of its
various restaurant locations. The Company expects to complete the divestiture of
these locations in the next three to nine months. Subsequent to September 29,
2002, the Company closed seven additional restaurants including two Don Pablo's
and five Hops restaurants. As the decision to dispose of these locations was
made during the fourth quarter, they have not been classified as discontinued
operations. The Company will record any appropriate asset impairment charges
related to these locations, during the fourth quarter.
Net loss from discontinued operations for the quarter and nine months ended
September 29, 2002, for which no taxes have been allocated, of $9.3 million and
$14.3 million, respectively, primarily reflects non-cash asset impairment
charges of $8.5 million and $11.8 million, respectively, primarily to reduce the
carrying value of the restaurant assets, which are held for sale, to estimated
fair value. Losses from restaurant operations (before asset revaluation and
other special charges and (gain) loss on disposal of assets) for the quarterly
and year-to-date periods were $0.8 million and $2.5 million, respectively, on
total restaurant sales from discontinued operations of $1.9 million and $9.2
million, respectively, for the 12 restaurants classified as held for sale in the
quarter ended September 29, 2002.
Net loss from discontinued operations for the quarter and nine months ended
September 30, 2001 of $0.5 million (net of income tax benefit of $0.3 million)
and $1.2 million (net of income tax benefit of $0.7 million) respectively,
reflects losses from restaurant operations (before asset revaluation and other
special charges and (gain) loss on disposal of assets) on total restaurant sales
from discontinued operations of $3.7 million and $11.9 million, respectively.
Liquidity and Capital Resources
Generally, the Company operates with negative working capital since
substantially all restaurant sales are for cash while payment terms on accounts
payable typically range from 0 to 45 days. Fluctuations in accounts receivable,
inventories, prepaid expenses and other current assets, accounts payable and
accrued liabilities typically occur as a result of restaurant openings and
closings and the timing of settlement of liabilities. Decreases in accounts
payable during the first nine months of 2002 occurred as a result of a planned
reduction in various outstanding obligations with borrowings from the Company's
$75.0 million refinanced credit facility. Decreases in accrued liabilities
during the first nine months of 2002 occurred as a result of (i) a reduction in
accrued interest due to the retirement of $52.4 million in outstanding debt
related to the Company's 11.75% Senior Subordinated Notes, (ii) a reduction in
accrued interest due to the payment of accrued interest and conversion of
1,307,591 shares, or $65.4 million, of the Company's Convertible Preferred
Securities and (iii) the payment of previously deferred payments related to
sales, use, property and other taxes.
On March 25, 2002, the Company completed a $75.0 million credit facility
(the "Credit Facility") to replace its existing credit agreement. The Credit
Facility, which matures on March 25, 2005, limits total borrowing capacity at
any given time to an amount equal to two and one quarter times the Company's
trailing 12 months earnings before interest, income taxes and depreciation and
amortization as determined for the most recently completed four quarters
("Borrowing Base EBITDA"). The calculation of Borrowing Base EBITDA excludes the
2001 operations of McCormick & Schmick's, gains and losses on the disposal of
assets, asset revaluation and other special charges, non-cash rent expense and
preopening costs. The agreement provides a $35.0 million revolving credit
facility, which may be used for working capital and general corporate purposes,
and a $40.0 million term loan facility, which is limited to certain defined
purposes, excluding working capital and capital expenditures. In certain
circumstances, borrowings under the term loan facility are required to be repaid
to the lender and any such repayments are not available to be re-borrowed by the
Company. Events generating a required repayment include, among other things,
proceeds from asset dispositions, casualty events, tax refunds and excess cash
flow, each as defined in the Credit Facility. In addition, the lender has the
right to impose certain reserves against the Company's total borrowing
availability under the facility, which may limit the Company's availability on
both the revolving and term loans. Lender imposed reserves against the Company's
total borrowing availability, as of September 29, 2002, were $2.0 million.
Irrespective of future borrowings, certain obligations will exist with respect
to the agreement, including annual anniversary fees of $1.1 million and an
additional fee payable at maturity of $5.1 million. The loan is secured by
substantially all of the Company's assets.
The terms of the Credit Facility, the Company's 9.75% Senior Notes due 2006
("Senior Notes") and 11.75% Senior Subordinated Notes due 2009 ("Subordinated
Notes"), $30.0 million master equipment lease and $28.4 million Hops
sale-leaseback transaction collectively include various provisions which, among
other things, require the Company to (i) achieve certain EBITDA targets, (ii)
maintain defined net worth and coverage ratios, (iii) maintain defined leverage
ratios, (iv) limit the incurrence of certain liens or encumbrances in excess of
defined amounts and (v) limit certain payments. In conjunction with the closing
of the Credit Facility, the Company terminated its interest rate swap agreement
thereby eliminating any aforementioned restrictions contained in that agreement.
In addition, in March 2002 the master equipment lease agreement was amended to
substantially conform the covenants to the Credit Facility and certain
Page 21
provisions contained in the sale-leaseback agreement were also amended. In June
2002, the Company obtained an amendment to the Credit Facility which allowed the
use of proceeds from the term loan facility to make the one-time payment of
accrued interest related to the Company's $3.50 term convertible securities, due
2027. The amendment also increased the interest rate on revolving loans by 1.5%
and increased the fees related to letter of credit accommodations by 1.0%. In
the third quarter, the Company completed a second amendment to the Credit
Facility which amended certain definitions relating to the payment of delinquent
taxes and made other technical corrections to the agreement. Subsequent to the
end of the quarter, the Company completed a third amendment to the Credit
Facility which made additional technical corrections to the agreement.
At September 29, 2002, the Company was not in compliance with certain
EBITDA requirements contained in the Credit Facility and master equipment lease.
The Company's failure to comply with these EBITDA requirements is a result of a
decline in sales and corresponding decrease in cash flow, which has fallen below
the Company's expectations. Under both of these agreements, the failure to meet
the prescribed EBITDA targets represents an event of default whereby the
respective creditors have the right to declare all obligations under the
agreements immediately due and payable. Although neither creditor has notified
the Company of its intent to do so, acceleration of the obligations would have a
material adverse effect on the Company. At September 29, 2002, outstanding cash
borrowings under the Credit Facility totaled $35.8 million and these obligations
have been classified as current liabilities in the accompanying consolidated
balance sheet. In addition, outstanding letters of credit, which are secured by
the Credit Facility, totaled $15.3 million at quarter end. Remaining obligations
under the master equipment lease totaled $9.2 million at September 29, 2002. In
the event the obligations under the Credit Facility are accelerated,
cross-default provisions contained in the indentures to the Senior Notes and
Subordinated Notes would be triggered, creating an event of default under those
agreements as well. At September 29, 2002, the outstanding balances of the
Senior and Subordinated notes were $116.5 million and $47.6 million
respectively. In the event some or all of the obligations under the Company's
credit agreements become immediately due and payable, the Company does not
currently have sufficient liquidity to satisfy these obligations and it is
likely that the Company would be forced to seek protection from its creditors.
The Company is currently involved in discussions with its Credit Facility
lenders as well as the lessor under the master equipment lease and is seeking to
obtain amendments to these agreements or waivers of the covenant violations.
Although these creditors have verbally indicated their intent to consider
favorably the Company's requests, there can be no assurance that such waivers or
amendments will be formally granted. During the continuance of an event of
default, the Company is subject to a post-default interest rate under the Credit
Facility, which increases the otherwise effective interest rates by three
percentage points effective September 30, 2002. As a result, the Company's per
annum interest rate on revolving and term loans will be 14.75% and the rate on
letter of credit accommodations will be 6.50%. The Credit Facility lender also
has additional rights during the continuance of an event of default including,
among other things, the right to (i) make and collect certain payments on the
Company's behalf, (ii) require cash collateral to secure letters of credit,
(iii) make certain investigations into the Company's activities, (iv) receive
reimbursement for certain expenses incurred and (v) sell any of the collateral
securing the obligations or settle, on the Company's behalf, any legal
proceedings related to the collateral. Under the master equipment lease, in
addition to the right to declare all future scheduled rent payments immediately
due and payable, the lessor has the right, among other things, to repossess the
leased equipment, which is located primarily in the Company's restaurants.
Interest payments on the Company's Senior Notes and Subordinated Notes are
due semi-annually in each June and December. Prior to the Company's repurchase
of $52.4 million in face value of its outstanding Subordinated Notes in the
second and third quarters of 2002, the Company's semi-annual interest payments
totaled approximately $11.6 million. Subsequent to the repurchase, the Company's
semi-annual interest payments will total approximately $8.5 million. Under the
terms of the related note indentures, the Company has an additional 30-day
period from the scheduled interest payment dates before an event of default is
incurred, due to late payment of interest, and the Company utilized these
provisions with respect to its June 2002 interest payments as well as its June
and December 2001 interest payments. The Company's ability to make its December
2002 interest payments is dependent on the outcome of its discussions with the
Credit Facility lenders. If the Company is unable to obtain an amendment to the
Credit Facility or a waiver of the covenant violations, the Credit Facility
lender can prevent the Company from making its interest payments. In addition,
currently, the Company does not have sufficient liquidity or availability under
its borrowing arrangements to make the December interest payments. Sufficient
liquidity to make these payments is dependent on several management initiatives,
including the realization of proceeds from the sale of assets. There can be no
assurance that these initiatives will be successful.
During the third quarter of 2002, Borrowing Base EBITDA was $24.7 million,
resulting in a maximum borrowing capacity of $55.7 million. At September 29,
Page 22
2002, the Company's trailing 12 months EBITDA totaled $23.7 million.
Accordingly, the Company's maximum borrowing capacity will be adjusted from
$55.7 million to $53.3 million in conjunction with the Company's filing of its
required reports with the lender on or before November 13, 2002. At September
29, 2002, $19.6 million of cash borrowings were outstanding under the revolving
portion of the Credit Facility and $16.2 million was outstanding under the term
portion of the facility. At September 29, 2002, in addition to the $19.6 million
of cash borrowings outstanding under the revolving facility, an additional $15.3
million of the facility was utilized to secure letters of credit, fully
utilizing the maximum $35.0 million available on the revolving facility. At
September 29, 2002, $2.6 million remained unused and available under the term
loan facility. As a result of the upcoming reduction in the Company's borrowing
base, availability on the term facility will be reduced by $2.4 million on or
about November 13, 2002, while availability on the revolving facility will
remain unchanged.
Borrowings under the term loan facility during the third quarter included
$3.2 million (including approximately $0.3 million in accrued interest) to
repurchase $18.2 million in face value of the Company's outstanding Subordinated
Notes. After a $0.7 million write-off primarily of deferred loan costs and
unamortized initial issue discount on the Subordinated Notes, the Company
recorded a gain on the extinguishment of $14.6 million. During the second
quarter of 2002, term loan advances of $7.5 million were used to repurchase
$34.2 million in face value of Subordinated Notes and the Company recorded a
gain of $26.8 million. Also in the second quarter, an additional $5.4 million of
term loan proceeds were used to make a one-time payment of accrued interest,
equal to $4.25 per share, to holders of the Company's $3.50 term convertible
securities, due 2027 (the "TECONS"). The payment was conditional upon the
holders of at least 90% of the outstanding TECONS agreeing to convert their
securities into shares of common stock of the Company pursuant to the terms of
the TECONS. According to the terms of the securities, each TECON can be
converted, at the holders' option, into 3.3801 shares of common stock. During
the second quarter, holders representing approximately 95% of the outstanding
securities agreed to the terms of the offer and, in connection with the $5.4
million payment, 1,200,391 TECONS were converted into 4,057,442 shares of the
Company's common stock. As a result of this transaction, the outstanding balance
of the TECONS was reduced by $60.0 million.
Principal financing sources in the first nine months of 2002 consisted of
(i) term loan proceeds of $16.2 million, (ii) revolving loan proceeds of $11.1
million, net of financing costs of $8.5 million, (iii) a $10.0 million refund of
payments to collateralize letters of credit for the Company's self-insurance
programs and (iv) proceeds of $6.5 million from disposition of assets related
primarily to the McCormick & Schmick's divestiture and the sale of the real
estate of a Canyon Cafe restaurant. The primary uses of funds consisted of (i)
net cash used in operations of $26.7 million which included interest payments of
$28.0 million primarily related to the Senior Notes, Subordinated Notes and the
one-time TECON payment, in addition to operating lease payments of $18.1
million, (ii) $8.5 million, net of accrued interest of $2.2 million, for the
repurchase of $52.4 million in face value of the Company's outstanding
Subordinated Notes, (iii) capital expenditures of $4.7 million, and (iv)
settlement of the Company's interest rate swap agreement for $1.7 million.
The Company incurs various capital expenditures related to existing
restaurants and restaurant equipment in addition to capital requirements for
developing new restaurants. The Company does not anticipate opening any new
restaurants during the remainder of 2002. Capital expenditures for existing
restaurants are expected to be approximately $1 million for the remainder of
2002. Capital expenditures of $4.7 million for the first nine months of 2002
relate primarily to capital spending for existing restaurants. Capital
expenditures for continuing operations during the first nine months of 2001 were
$16.3 million and provided for the opening of three new restaurants, as well as
capital for existing restaurants.
The Company is also exposed to certain contingent payments. Under the
Company's insurance programs, coverage is obtained for significant exposures as
well as those risks required to be insured by law or contract. It is the
Company's preference to retain a significant portion of certain expected losses
related primarily to workers' compensation, physical loss to property, and
comprehensive general liability. Provisions for losses estimated under these
programs are recorded based on estimates of the aggregate liability for claims
incurred. For the nine months ended September 29, 2002, claims paid under the
Company's self-insurance programs totaled $3.7 million. In addition, at
September 29, 2002, the Company was contingently liable for letters of credit
aggregating approximately $15.3 million, relating to its insurance programs.
The Company's 1998 Federal income tax returns are currently in the early
stages of an audit by the Internal Revenue Service (IRS). The Company believes
its recorded liability for income taxes is adequate to cover its exposure that
may result from the ultimate resolution of the audit. Although the ultimate
outcome of the audit cannot be determined at this time, the Company does not
have sufficient liquidity to pay any significant portion of its recorded
liability if resolution results in such amount being currently due and payable.
Management does not currently expect that this will be the result, or that any
resolution with respect to audit issues will be reached in the near future.
Page 23
Management has taken steps to improve cash flow from operations, including
changing the Company's marketing strategy to be less reliant on expensive
broadcast media, reducing overhead through consolidation of functions and
personnel reductions and adjusting supervisory management level personnel in its
restaurant operations. There is no assurance these efforts will be successful in
improving cash flow from operations sufficiently to enable the Company to
continue to meet its obligations, including scheduled interest and other
required payments under its debt agreements and capital expenditures necessary
to maintain its existing restaurants. During the past twelve months, the Company
realized $14.5 million from the sale of assets, which has supplemented its cash
flow from operations and enabled the Company to meet its obligations. For the
near term, it is probable that cash flow from operations will need to be
supplemented by asset sales and other liquidity improvement initiatives. There
is no assurance the Company will be able to generate proceeds from these efforts
in sufficient amounts to supplement cash flow from operations, thereby enabling
the Company to meet its obligations.
Effect of Inflation
Management believes that inflation has not had a material effect on
earnings during the past several years. Future inflationary increases in the
cost of labor, food and other operating costs could adversely affect the
Company's restaurant operating margins. In the past, however, the Company
generally has been able to modify its operations to offset increases in its
operating costs.
Various federal and state laws increasing minimum wage rates have been
enacted over the past several years. Such legislation, however, has typically
frozen the wages of tipped employees at $2.13 per hour if the difference is
earned in tip income. Although the Company has experienced slight increases in
hourly labor costs in recent years, the effect of increases in minimum wage have
been significantly diluted due to the fact that the majority of the Company's
hourly employees are tipped and the Company's non-tipped employees have
historically earned wages greater than federal and state minimums. As such, the
Company's increases in hourly labor costs have not been proportionate to
increases in minimum wage rates.
Forward-Looking Information
Certain information contained in this quarterly report, particularly
information regarding the future economic performance and finances, restaurant
development plans, capital requirements and objectives of management, is forward
looking. In some cases, information regarding certain important factors that
could cause actual results to differ materially from any such forward-looking
statement appear together with such statement. In addition, the following
factors, in addition to other possible factors not listed, could affect the
Company's actual results and cause such results to differ materially from those
expressed in forward-looking statements. These factors include the outcome of
the Company's discussion with its creditors concerning certain events of
default, the outcome of the audit of the Company's 1998 Federal income tax
returns, competition within the casual dining restaurant industry, which remains
intense; changes in economic conditions such as inflation or a recession;
consumer perceptions of food safety; weather conditions; changes in consumer
tastes; labor and benefit costs; legal claims; the continued ability of the
Company to obtain suitable locations and financing for new restaurant
development; government monetary and fiscal policies; laws and regulations; and
governmental initiatives such as minimum wage rates and taxes. Other factors
that may cause actual results to differ from the forward-looking statements
contained in this release and that may affect the Company's prospects in general
are described in Exhibit 99.1 to the Company's Form 10-Q for the fiscal quarter
ended April 2, 2000, and the Company's other filings with the Securities and
Exchange Commission.
Page 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risk from changes in interest rates and
changes in commodity prices. Historically the Company's exposure to interest
rate risk has related primarily to variable U.S.-based rates and foreign-based
rate obligations on the Company's revolving credit agreement and a fixed to
floating interest rate swap agreement. Interest swap agreements have
historically been utilized to manage overall borrowing costs and balance fixed
and floating interest rate obligations. As of March 25, 2002 the Company
terminated the one such swap agreement it had in place and no further obligation
remains after that date.
The Company purchases certain commodities such as beef, chicken, flour and
cooking oil. Purchases of these commodities are generally based on vendor
agreements, which often contain contractual features that limit the price paid
by establishing price floors or caps. As commodity price aberrations are
generally short-term in nature and have not historically had a significant
impact on operating performance, financial instruments are not used to hedge
commodity price risk.
Item 4. Controls and Procedures
Within the 90-day period prior to the filing of this report, an evaluation
was carried out under the supervision and with the participation of the
Company's management, including the Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures. Based on that evaluation, the Company's
Chief Executive Officer and Chief Financial Officer have concluded that the
Company's disclosure controls and procedures are effective in ensuring that
information required to be disclosed in Company reports filed or submitted under
the Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
However, the design of any system of controls is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions, regardless of how remote.
There have been no significant changes in the Company's internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of the evaluation.
Page 25
Part II. Other Information
Item 3. Defaults Upon Senior Securities
At September 29, 2002, the Company was not in compliance with certain
earnings before interest, income taxes and depreciation and amortization
("EBITDA") requirements contained in the Company's $75.0 million credit facility
(the "Credit Facility") and $30.0 million master equipment lease. Under both of
these agreements, the failure to meet the prescribed EBITDA targets represents
an event of default whereby the respective creditors have the right to declare
all obligations under the agreements immediately due and payable. Although
neither creditor has notified the Company of its intent to do so, acceleration
of the obligations could have a material adverse effect on the Company. At
September 29, 2002, outstanding cash borrowings under the Credit Facility
totaled $35.8 million and these obligations have been classified as current
liabilities in the accompanying consolidated balance sheet. In addition,
outstanding letters of credit, which are secured by the Credit Facility, totaled
$15.3 million at quarter end. Remaining obligations under the master equipment
lease totaled $9.2 million at September 29, 2002. In the event the obligations
under the Credit Facility are accelerated, cross-default provisions contained in
the indentures to the Company's 9.75% Senior Notes due 2006 ("Senior Notes") and
11.75% Senior Subordinated Notes due 2009 ("Subordinated Notes") would be
triggered, creating an event of default under those agreements as well. At
September 29, 2002, the outstanding balances of the Senior Notes and
Subordinated Notes were $116.5 million and $47.6 million respectively. In the
event some or all of the obligations under the Company's credit agreements
become immediately due and payable, the Company does not currently have
sufficient liquidity to satisfy these obligations and it is likely that the
Company would be forced to seek protection from its creditors.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
10.1 Amendment Number Two, dated as of September 23, 2002, to Second
Amended and Restated Credit Agreement dated as of March 20, 2002 by and among
Avado Brands, Inc., as Borrower, the lenders signatory thereto, Foothill Capital
Corporation, as Administrative Agent, and Ableco Finance LLC, as Collateral
Agent.
10.2 Amendment Number Three, dated as of November 11, 2002, to Second
Amended and Restated Credit Agreement dated as of March 20, 2002 by and among
Avado Brands, Inc., as Borrower, the lenders signatory thereto, Foothill Capital
Corporation, as Administrative Agent, and Ableco Finance LLC, as Collateral
Agent.
11.1 Computation of earnings per common share
99.1 Safe Harbor Under the Private Securities Litigation Reform Act of
1995*
99.2 Certification of Corporate Officers pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
* Incorporated by reference to the corresponding exhibit to the Company's
Quarterly Report on Form 10-Q for the quarter ended April 2, 2000.
(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K, dated August 6, 2002, which
disclosed, pursuant to Item 5, the Company's adoption of a shareholders rights
plan pursuant to a Rights Agreement.
Page 26
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Avado Brands, Inc.
(Registrant)
Date: November 19, 2002 By: /s/ Louis J. Profumo
------------------------
Louis J. Profumo
Chief Financial Officer
Page 27
CERTIFICATIONS
I, Tom E. DuPree, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Avado Brands,
Inc.,
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being covered.
b. evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors:
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 19, 2002 By: /s/ Tom E. DuPree, Jr.
--------------------------
Tom E. DuPree, Jr.
Chairman and Chief Executive Officer
Page 28
CERTIFICATIONS
I, Louis J. Profumo, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Avado Brands,
Inc.,
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being covered.
b. evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors:
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 19, 2002 By: /s/ Louis J. Profumo
------------------------
Louis J. Profumo
Chief Financial Officer
Page 29