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 June 29, 2003
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
--- ---
Indicate by check mark whether or not the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Exchange Act).
Yes X No
--- ---
As of August 11, 2003, there were 33,123,090 shares of common stock of the
Registrant outstanding.
AVADO BRANDS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 29, 2003
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 Loss..........................................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..................19
Item 3 - Quantitative and Qualitative Disclosures About Market Risk.....25
Item 4 - Controls and Procedures........................................25
Part II - Other Information
Item 4 - Submission of Matters to a Vote of Security Holders............26
Item 6 - Exhibits and Reports on Form 8-K...............................26
Signature....................................................................28
Page 2
Avado Brands, Inc.
Consolidated Statements of Earnings (Loss)
(Unaudited)
(In thousands, except per share data) Quarter Ended Six Months Ended
- --------------------------------------------------------------------------------------- ----------------------
June 29, June 30, June 29, June 30,
2003 2002 2003 2002
- --------------------------------------------------------------------------------------- ----------------------
Restaurant sales:
Canyon Cafe $ 616 7,366 2,190 15,091
Don Pablo's 60,628 62,025 117,551 123,118
Hops 38,548 41,898 76,437 87,447
- --------------------------------------------------------------------------------------- ----------------------
Total restaurant sales 99,792 111,289 196,178 225,656
- --------------------------------------------------------------------------------------- ----------------------
Operating expenses:
Food and beverage 30,485 31,422 58,103 64,013
Payroll and benefits 34,740 36,969 68,058 74,424
Depreciation and amortization 3,601 3,429 7,101 6,920
Other operating expenses 24,561 28,637 48,979 58,996
General and administrative expenses 5,486 6,422 11,520 12,732
Loss (gain) on disposal of assets 47 414 1,678 (110)
Asset revaluation and other charges 469 1,174 2,440 1,824
- --------------------------------------------------------------------------------------- ----------------------
Operating income (loss) 403 2,822 (1,701) 6,857
- --------------------------------------------------------------------------------------- ----------------------
Other income (expense):
Interest expense, net (6,934) (8,084) (19,444) (16,317)
Forgiveness of credit facility amendment and waiver fee - - 6,500 -
Distribution expense on preferred securities (56) (807) (112) (1,922)
Gain on debt extinguishment 5,585 26,783 5,585 26,783
Other, net 692 201 1,081 (211)
- --------------------------------------------------------------------------------------- ----------------------
Total other income (expense) (713) 18,093 (6,390) 8,333
- --------------------------------------------------------------------------------------- ----------------------
Earnings (loss) from continuing operations before income taxes (310) 20,915 (8,091) 15,190
Income tax expense - 1,311 - 375
- --------------------------------------------------------------------------------------- ----------------------
Earnings (loss) from continuing operations (310) 19,604 (8,091) 14,815
- --------------------------------------------------------------------------------------- ----------------------
Discontinued operations:
Earnings (loss) from discontinued operations 37 (5,008) (9,983) (5,937)
- --------------------------------------------------------------------------------------- ----------------------
Net earnings (loss) $ (273) 14,596 (18,074) 8,878
======================================================================================= ======================
Basic earnings (loss) per common share:
Basic earnings (loss) from continuing operations $ (0.01) 0.65 (0.25) 0.50
Basic earnings (loss) from discontinued operations - (0.17) (0.30) (0.20)
- --------------------------------------------------------------------------------------- ----------------------
Basic earnings (loss) per common share $ (0.01) 0.48 (0.55) 0.30
======================================================================================= ======================
Diluted earnings (loss) per common share:
Diluted earnings (loss) from continuing operations $ (0.01) 0.59 (0.25) 0.49
Diluted earnings (loss) from discontinued operations - (0.14) (0.30) (0.20)
- --------------------------------------------------------------------------------------- ----------------------
Diluted earnings (loss) per common share $ (0.01) 0.45 (0.55) 0.29
======================================================================================= ======================
See accompanying notes to consolidated financial statements.
3
Avado Brands, Inc.
Consolidated Balance Sheets
(Unaudited)
(In thousands, except share data)
- ---------------------------------------------------------------------------------------------------------------
June 29, Dec. 29,
2003 2002
- ---------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 288 636
Accounts receivable 4,236 5,087
Inventories 5,217 5,283
Prepaid expenses and other 5,843 2,129
Assets held for sale 524 10,920
- ---------------------------------------------------------------------------------------------------------------
Total current assets 16,108 24,055
Premises and equipment, net 186,108 236,950
Deferred income tax benefit 11,620 11,620
Other assets 31,325 28,670
- ---------------------------------------------------------------------------------------------------------------
$ 245,161 301,295
===============================================================================================================
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 11,377 11,509
Accrued liabilities 36,383 54,292
Current installments of long-term debt and capital lease obligations 17,681 30,838
Income taxes 35,576 35,038
- ---------------------------------------------------------------------------------------------------------------
Total current liabilities 101,017 131,677
Long-term debt 152,869 164,031
Capital lease obligations 3,839 -
Other long-term liabilities 2,062 2,143
- ---------------------------------------------------------------------------------------------------------------
Total liabilities 259,787 297,851
- ---------------------------------------------------------------------------------------------------------------
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 3,179
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 2003 and 2002;
outstanding - 33,123,090 shares in 2003 and 33,101,929 in 2002 405 405
Additional paid-in capital 154,363 154,637
Accumulated deficit (76,192) (58,118)
Treasury stock at cost; 7,355,670 shares in 2003 and 7,376,831 in 2002 (96,381) (96,659)
- ---------------------------------------------------------------------------------------------------------------
Total shareholders' equity (deficit) (17,805) 265
- ---------------------------------------------------------------------------------------------------------------
$ 245,161 301,295
===============================================================================================================
See accompanying notes to consolidated financial statements.
4
Avado Brands, Inc.
Consolidated Statements of Shareholders' Equity (Deficit) and Comprehensive Loss
(Unaudited)
Additional Total
Common Stock Paid-in Accumulated Treasury Shareholders'
(In thousands) Shares Amount Capital Deficit Stock Equity (Deficit)
- ----------------------------------------------------------------------------------------------------------------
Balance at December 29, 2002 40,479 $405 $154,637 ($58,118) ($96,659) $265
- ----------------------------------------------------------------------------------------------------------------
Net and comprehensive loss - - - (17,801) - (17,801)
- ----------------------------------------------------------------------------------------------------------------
Balance at March 30, 2003 40,479 405 154,637 (75,919) (96,659) (17,536)
- ----------------------------------------------------------------------------------------------------------------
Net and comprehensive loss - - - (273) - (273)
Exercise of stock options - - (274) - 278 4
- ----------------------------------------------------------------------------------------------------------------
Balance at June 29, 2003 40,479 $405 $154,363 ($76,192) ($96,381) ($17,805)
================================================================================================================
See accompanying notes to consolidated financial statements.
5
Avado Brands, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands) Six Months Ended
- --------------------------------------------------------------------------------------------------------
June 29, June 30,
2003 2002
- --------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net earnings (loss) $ (18,074) 8,878
Adjustments to reconcile net earnings (loss) to net cash
used in operating activities:
Depreciation of premises and equipment 7,475 7,393
Amortization, write off of deferred costs and prepaid interest 9,776 2,268
Forgiveness of credit facility amendment and waiver fee (6,500) -
Asset revaluation and other charges 2,440 1,824
Gain on debt extinguishment (5,585) (26,783)
Loss (gain) on disposal of assets 1,678 (110)
Loss from discontinued operations 9,983 5,937
Mark-to-market adjustment on interest rate swap - 861
(Increase) decrease in assets:
Accounts receivable 963 99
Inventories (183) 67
Prepaid expenses and other (1,148) 502
Increase (decrease) in liabilities:
Accounts payable (102) (5,926)
Accrued liabilities (18,815) (20,508)
Income taxes 538 248
Other long-term liabilities (134) (192)
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (17,688) (25,442)
- --------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (4,652) (3,109)
Proceeds from disposal of assets and notes receivable, net 3,486 5,639
Proceeds from sale-leaseback 20,000 -
Other, net (685) (912)
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 18,149 1,618
- --------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from revolving credit agreements 5,191 18,127
Proceeds from (repayment of) term credit agreement (12,736) 12,898
Payment of financing costs (4,568) (8,502)
Principal payments on long-term debt (45) (13)
Purchase of long term debt (5,195) (5,584)
Settlement of interest rate swap agreement - (1,704)
Reduction in letter of credit collateral - 9,978
- --------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (17,353) 25,200
- --------------------------------------------------------------------------------------------------------
Cash provided by (used in) discontinued operations 16,544 (1,001)
- --------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (348) 375
Cash and cash equivalents at the beginning of the period 636 559
- --------------------------------------------------------------------------------------------------------
Cash and cash equivalents at the end of the period $ 288 934
========================================================================================================
See accompanying notes to consolidated financial statements.
Page 6
AVADO BRANDS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 29, 2003
(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 29, 2002,
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 six
months ended June 29, 2003 are not necessarily indicative of the results that
may be expected for the year ending December 28, 2003.
As a result of the adoption of Statement of Financial Accounting Standards
("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", the Company has classified the revenues, expenses and related assets
and liabilities of 11 Don Pablo's restaurants and one Hops restaurant which were
closed during the first half of 2003, plus 11 additional Don Pablo's restaurants
and eight additional Hops restaurants which were closed in 2002, as discontinued
operations for all periods presented in the accompanying consolidated financial
statements. The revenues, expenses and related assets and liabilities of Canyon
Cafe, which has been divested with the exception of two locations that are held
for sale, have not been classified as discontinued operations in the
accompanying consolidated financial statements. As the decision to divest the
operations of Canyon Cafe was made prior to the implementation of SFAS 144 and
it did not meet the criteria for classification as discontinued operations under
the 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", it is required to
be classified within continuing operations under the provisions of SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of".
NOTE 2 - STOCK BASED COMPENSATION
The Company accounts for its stock based compensation by using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees", and related interpretations ("APB
25"), and has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation". Under APB 25, no stock-based
compensation cost is reflected in net income for grants of stock options to
employees as the Company grants stock options with an exercise price equal to
the market value of the stock on the date of grant.
The following table illustrates the effect on net earnings (loss) and
earnings (loss) per share if the Company had applied the fair value recognition
provisions of SFAS 123 to stock-based employee compensation:
Quarter Ended Six Months Ended
- ------------------------------------------------------ --------------------------- -------------------------
June 29, June 30, June 29, June 30,
(in thousands) 2003 2002 2003 2002
- ------------------------------------------------------ ------------- ------------- ------------- -----------
Net earnings (loss), as reported $ (273) 14,596 (18,074) 8,878
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (156) (235) (366) (318)
- ------------------------------------------------------ ------------- ------------- ------------- -----------
Pro forma net earnings (loss) $ (429) 14,361 (18,440) 8,560
- ------------------------------------------------------ ------------- ------------- ------------- -----------
Earnings (loss) per share:
Basic - as reported $ (0.01) 0.48 (0.55) 0.30
- ------------------------------------------------------ ------------- ------------- ------------- -----------
Basic - pro forma $ (0.01) 0.48 (0.56) 0.29
- ------------------------------------------------------ ------------- ------------- ------------- -----------
Diluted - as reported $ (0.01) 0.45 (0.55) 0.29
- ------------------------------------------------------ ------------- ------------- ------------- -----------
Diluted - pro forma $ (0.01) 0.44 (0.56) 0.28
- ------------------------------------------------------ ------------- ------------- ------------- -----------
Page 7
NOTE 3 - LONG-TERM DEBT
On March 24, 2003, the Company obtained new financing which included a
$39.0 million revolving credit facility (the "Credit Facility") and a $20.0
million sale-leaseback transaction covering 15 Don Pablo's locations (the "Don
Pablo's sale-leaseback"). Proceeds from the new financing were used to pay
amounts outstanding under the Company's previously existing credit agreement
totaling $19.5 million and fees associated with the new financing agreements
totaling $4.6 million.
The Credit Facility limits total borrowing capacity at any given time to an
amount equal to the lesser of $39.0 million or 1.95 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 as
defined in the agreement. A portion of the facility, totaling $17.0 million, was
restricted for the purchase of the Company's 9.75% Senior Notes due 2006
("Senior Notes") and 11.75% Senior Subordinated Notes due June 2009
("Subordinated Notes"). The agreement limited the amount the Company could pay
to acquire Senior Notes and Subordinated Notes to $0.50 and $0.30 per one dollar
outstanding, respectively. In accordance with the agreement, the unused
availability under the restricted portion of the facility terminated on May 31,
2003. The Credit Facility matures on March 24, 2004 but may be extended for one
year at the lender's option and subject to an extension fee equal to five
percent of the total commitment amount. In certain circumstances, borrowings
under the Credit 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 (other than Assets Held for Sale as defined in the agreement),
casualty events and tax refunds, 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 liquidity. The loan is secured by substantially all of the Company's
assets.
During the second quarter of 2003, the Company executed three separate
amendments to the Credit Facility which among other things made certain
technical changes to the agreement and allowed the Company to borrow $2.4
million under the $17.0 million restricted portion of the facility to buy out
the Company's master equipment lease. The remaining unused portion of the
facility was terminated, reducing the maximum commitment under the Credit
Facility from $39.0 million to $30.0 million.
At June 29, 2003, $8.8 million in cash borrowings were outstanding under
the Credit Facility and an additional $12.5 million of the facility was utilized
to secure letters of credit which primarily secure the Company's insurance
programs. Also outstanding at June 29, 2003 was $8.0 million which was borrowed
under the restricted portion of the facility to acquire $11.2 million in face
value of the Company's Senior Notes and buy out the Company's master equipment
lease. The total Credit Facility availability was also reduced by lender
reserves of $0.3 million. At June 29, 2003, $0.4 million of the facility
remained unused and available.
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 $11.2 million in face value of its outstanding Senior Notes during the second
quarter of 2003 and $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
repurchases, the Company's semi-annual interest payments total approximately
$7.9 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. The Company
utilized these provisions with respect to its June 2003 interest payments, June
and December 2002 interest payments and June and December 2001 interest
payments. The Company's ability to make its December 2003 interest payments is
dependent on the outcome of its initiatives to generate cash flow from
operations and sell assets.
NOTE 4 - LIQUIDITY
The Company has suffered from recurring losses from operations, has an
accumulated deficit and its Credit Facility is due March 24, 2004, all of which
raise substantial doubt about the Company's ability to continue as a going
concern. Sufficient liquidity to make required debt service and lease payments
is dependent primarily on the realization of cash flow from operations and
proceeds from the sale of assets. There can be no assurance that such cash flow
and proceeds will be realized.
Page 8
The terms of the Credit Facility, the Company's Senior Notes and
Subordinated Notes, the Don Pablo's sale-leaseback, and the 2000 Hops
sale-leaseback (See Note 11) 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. During the second
quarter of 2003, the Company terminated its previously existing master equipment
lease thereby eliminating any financial covenants or restrictions related to the
lease. At June 29, 2003, the Company was in compliance with the requirements
contained in the Credit Facility, the Don Pablo's sale-leaseback and terms of
the Senior Notes and Subordinated Notes. The Company was not in compliance with
a net worth requirement contained in its 2000 Hops sale-leaseback agreement. The
lessor, however, has waived this requirement until March 31, 2004 at which time
the minimum net worth requirement will be $150.0 million. It is unlikely that
the Company will be in compliance with the $150.0 million net worth requirement
on March 31, 2004. In addition, there is substantial doubt that the Company will
be able to maintain compliance with certain of the financial covenant
requirements contained in its Credit Facility for the twelve-month period ended
September 28, 2003. Although the outcome is uncertain, the Company believes it
will be able to obtain waivers of these defaults or amendments to the
agreements.
In the event the Company is not able to meet its financial covenant targets
under the Credit Facility, an event of default would occur. An event of default
would entitle the lender to, among other things, declare all obligations
immediately due and payable. In the event the amounts due 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 June 29, 2003, the outstanding
balances of the Senior Notes and Subordinated Notes were $105.3 million and
$47.6 million, respectively. An event of default under the Credit Facility would
not result in a cross-default under the Company's two sale-leaseback agreements.
In the event some or all of the obligations under the Company's financing
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.
On July 2, 2003, the Trustee for the Company's Senior Notes received a
Notice of Default and Acceleration Notice, filed by holders representing a
majority of the Company's outstanding Senior Notes. The Company will assert its
position with the Trustee as provided under the terms of the Indenture and
intends to vigorously contest the claims that events of default have occurred
under the Note Indenture. Should it ultimately be determined that an event of
default exists, the Senior Notes could become currently due and payable. In the
event the Senior Notes are accelerated, cross-default provisions would be
triggered in the Company's Credit Facility and Subordinated Notes (See Note 12).
Principal financing sources in the first half of 2003 consisted of (i)
proceeds of $20.0 million from the Don Pablo's sale-leaseback, (ii) cash
provided by discontinued operations, primarily related to the sale of assets, of
$16.5 million, and (iii) other proceeds from the sale of assets of $3.5 million.
The primary uses of funds consisted of (i) net cash used in operations of $17.7
million which included interest payments of $19.5 million primarily related to
the Senior and Subordinated Notes and Credit Facility along with operating lease
payments of $10.6 million, (ii) net repayments of credit agreements of $7.5
million, (iii) repurchase of long-term debt of $5.2 million, (iv) capital
expenditures of $4.7 million primarily related to the second quarter buyout of
the Company's master equipment lease, and (v) payment of financing costs related
to the Credit Facility and Don Pablo's sale-leaseback totaling $4.6 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 have any contractual
obligations to open any new restaurants during 2003. Capital expenditures for
existing restaurants are expected to be approximately $2.0 million to $3.0
million during the second half of 2003.
The Company is also exposed to certain contingent payments. In connection
with the Applebee's and Canyon Cafe divestiture transactions, the Company
remains contingently liable for lease obligations relating to 86 Applebee's
restaurants and eleven Canyon Cafe 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 $41.5 million. The Company also remains contingently
liable for lease obligations relating to seven Harrigan's restaurants which were
divested in 1999. Minimum lease payment obligations for those seven restaurants
total $5.3 million and extend through 2012. On March 14, 2003, Harrigan's filed
a bankruptcy petition under Chapter 11 of the Unites States Bankruptcy Code.
Harrigan's is continuing to operate under Chapter 11 and the Company has not
been notified of any intent by the respective landlords to hold the Company
liable for lease obligations pertaining to any of the seven locations. However,
the reorganization of Harrigan's under bankruptcy has not been finalized and
there can be no assurances that the Company will not ultimately be held liable
for some or all of the Harrigan's leases under the plan of reorganization.
Page 9
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. The Company's deductibles
for workers' compensation and general liability are $500,000 per claim. Losses
in excess of these risk retention levels are covered by insurance which
management considers as adequate. Provision for losses expected under these
programs are recorded based upon estimates of the liability for claims incurred.
Such estimates are based on management's evaluation of the nature and severity
of claims and expected losses based on the Company's historical experience,
information provided by the Company's third party administrators and certain
actuarial assumptions used by the insurance industry. In the first half of 2003,
claims paid under the Company's self-insurance programs totaled $2.3 million. In
addition, at June 29, 2003, the Company was contingently liable for letters of
credit aggregating approximately $12.5 million, relating primarily to its
insurance programs. 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's 1998 Federal income tax returns are currently being audited
by the Internal Revenue Service ("IRS"). The Company believes its recorded
liability for income taxes of $35.6 million as of June 29, 2003 is adequate to
cover its exposure that may result from the ultimate resolution of the audit.
During the first quarter of 2003, the Company submitted an Offer in Compromise
to the IRS whereby the Company offered to settle its potential obligations at a
discounted amount. The Offer in Compromise process is a mechanism available to
taxpayers to potentially reduce amounts otherwise payable to the IRS based on
analysis of a taxpayer's ability to pay, the value of its assets versus its
liabilities and other economic factors. Although the ultimate outcome of the
audit or the Offer in Compromise cannot be determined at this time, the Company
does not have sufficient liquidity to pay any significant portion of its
recorded liability if resolution of the audit 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 primarily from the first quarter relocation of its Hops
corporate headquarters 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 and lease agreements and capital
expenditures necessary to maintain its existing restaurants. For the near term,
cash flow from operations will need to be supplemented by asset sales. 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 debt and lease obligations. In addition, there is no
assurance the Company will be able to comply with the financial covenants of its
debt and lease agreements.
NOTE 5 - SUPPLEMENTAL CASH FLOW INFORMATION
For the six months ended June 29, 2003 and June 30, 2002, the following
supplements the consolidated statements of cash flows (amounts in thousands):
2003 2002
---------- ----------
Interest paid $ 19,309 15,285
Distributions paid on preferred securities - 5,372
Income taxes paid (refunded) $ (538) 127
NOTE 6 - ASSET REVALUATION AND OTHER CHARGES
For the six months ended June 29, 2003, asset revaluation and other charges
of $2.4 million include non-cash asset impairment charges of $0.8 million
recorded to reduce the carrying value of the assets of the Company's remaining
Canyon Cafe locations and two Don Pablo's restaurants to estimated fair value
and $1.6 million in other charges primarily related to costs associated with the
relocation of the Hops corporate office to Madison, Georgia.
Asset revaluation and other charges of $1.8 million for the six months
ended June 30, 2002 reflect a non-cash asset impairment charge of $0.7 million
to reduce the carrying value of the assets of the Company's Canyon Cafe
restaurants to estimated fair value and the write-off of $1.1 million in various
capitalized costs associated with sites that are no longer expected to be
developed and related development costs which are not anticipated to be fully
recoverable.
Page 10
NOTE 7 - DISPOSAL OF ASSETS
Loss on disposal of assets of $1.7 million for the six months ended June
29, 2003, primarily reflects losses related to the sale of 15 Don Pablo's
restaurants included in the Company's Don Pablo's sale-leaseback transaction
which occurred during the first quarter.
Gain on disposal of assets of $0.1 million for the six months ended June
30, 2002 reflects an adjustment to amounts receivable from the divestiture of
McCormick & Schmick's which was offset by fees incurred in connection with the
first quarter termination of the Company's interest rate swap agreement and a
loss incurred on the sale of a closed Canyon Cafe location.
NOTE 8 - GAIN ON DEBT EXTINGUISHMENT
Gain on debt extinguishment for the quarter and six months ended June 29,
2003 reflects the retirement of $11.2 million in face value of the Company's
9.75% Senior Notes for $5.2 million plus $0.4 million in accrued interest. After
a $0.4 million write-off primarily of deferred loan costs, the Company recorded
a gain on the extinguishment of $5.6 million.
Gain on debt extinguishment for the quarter and six months ended June 30,
2002 reflects the retirement of $34.2 million in face value of the Company's
11.75% Senior 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 the
extinguishment of $26.8 million.
NOTE 9 - INCOME TAXES
No income tax benefit was recorded related to the loss before income taxes
for the six months ended June 29, 2003. The income tax expense recorded for the
six months ended June 30, 2002 represents the effective rate of expense on
earnings before income taxes for the first six months of 2002. The tax rate was
based on the Company's expected rate for the full fiscal 2002 year.
NOTE 10 - DISCONTINUED OPERATIONS
As discussed in Note 1 - Basis of Presentation, discontinued operations
includes the revenues and expenses of 11 Don Pablo's and one Hops restaurant
which were closed in the first half of 2003, plus 11 additional Don Pablo's
restaurants and eight additional Hops restaurants which were closed during 2002.
The decision to dispose of these 31 locations reflects the Company's ongoing
process of evaluating the performance and cash flows of its various restaurant
locations and using the proceeds from the sale of closed restaurants to reduce
outstanding debt.
Net earnings (loss) and operating income (loss) from discontinued
operations for the quarter and six months ended June 29, 2003, of $0.0 million
and $(10.0) million, respectively, were the same, as no income tax benefit has
been provided. These amounts primarily reflect losses on the disposal of closed
restaurants. Total restaurant sales from discontinued operations were $0.5
million and $3.5 million, respectively, for the quarter and six months ended
June 29, 2003.
Net loss from discontinued operations for the quarter and six months ended
June 30, 2002 of $5.0 million and $5.9 million (for which no tax benefit has
been provided), respectively, primarily reflect asset revaluation and other
charges related to the closure of restaurants. Operating losses were $4.8
million and $5.9 million for the quarter and six months, respectively, on total
restaurant sales from discontinued operations of $10.6 million and $22.0
million, respectively.
NOTE 11 - SALE-LEASEBACK TRANSACTIONS
On March 24, 2003, the Company completed a sale-leaseback transaction
covering 15 Don Pablo's locations (the "Don Pablo's sale-leaseback"). The
transaction included the sale of the land and buildings for total consideration
of $20.0 million. The term of the lease is 20 years with two 10-year renewal
options. Total annual payments due under the lease are $2.4 million at inception
and will escalate by 10% every five years. The portion of the lease attributable
to the buildings has been accounted for as a capital lease while the portion
attributable to the land has been accounted for as an operating lease. As a
result, at March 30, 2003 the Company recorded a capital lease obligation of
$3.9 million. Depreciation on the related assets will be recorded on a
straight-line basis over the 20 year base-term of the lease. In addition, the
Company recorded $10.3 million of prepaid interest, included in other assets in
the accompanying consolidated balance sheet, which will be amortized to interest
expense over the 20 year term of the lease. This prepaid interest represents the
excess of estimated fair value of the 15 locations over the proceeds received
from the transaction. A loss of $1.6 million, representing the excess of
recorded net book value over estimated fair value for the 15 locations was
recorded as a loss on disposal of assets during the first quarter.
Page 11
In October 2000, the Company completed a sale-leaseback transaction
involving 20 Hops restaurant properties. The transaction included the sale of
the land and buildings for total consideration of $28.4 million. The lease
covers an initial term of 20 years with options to extend the lease for four
periods of five years each. Rent expense related to the sale-leaseback escalates
by 1.2% each year. The transaction, which has been accounted for as an operating
lease, resulted in prepaid rent, which is being amortized over the lease term as
additional rent expense.
NOTE 12 - CONTINGENCIES
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. The Company's deductibles
for workers' compensation and general liability are $500,000 per claim. Losses
in excess of these risk retention levels are covered by insurance which
management considers as adequate. Provisions for losses expected under these
programs are recorded based on estimates of the liability for claims incurred.
Such estimates are based on management's evaluation of the nature and severity
of claims and expected losses based on the Company's historical experience,
information provided by the Company's third party administrators and certain
actuarial assumptions used by the insurance industry. At June 29, 2003, the
Company was contingently liable for letters of credit aggregating approximately
$12.5 million related primarily to its insurance programs.
The Company is also exposed to certain contingent payments. In connection
with the Applebee's and Canyon Cafe divestiture transactions, the Company
remains contingently liable for lease obligations relating to 86 Applebee's
restaurants and 11 Canyon Cafe 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 $41.5 million. The Company also remains contingently
liable for lease obligations relating to seven Harrigan's restaurants which were
divested in 1999. Minimum lease payment obligations for those seven restaurants
total $5.3 million and extend through 2012. On March 14, 2003, Harrigan's filed
a bankruptcy petition under Chapter 11 of the Unites States Bankruptcy Code.
Harrigan's is continuing to operate under Chapter 11 and the Company has not
been notified of any intent by the respective landlords to hold the Company
liable for lease obligations pertaining to any of the seven locations. However,
the reorganization of Harrigan's under bankruptcy has not been finalized and
there can be no assurances that the Company will not ultimately be held liable
for some or all of the Harrigan's leases under the plan of reorganization.
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 brand. The Company believes that the allegations in the complaint are
without merit and is vigorously contesting the complaint. This litigation is
currently at a preliminary stage. 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.
On April 3, 2003, the Company received a communication from counsel
representing an ad hoc committee ("the Committee") of holders of a majority of
the Company's 9.75% Senior Notes ("the Senior Notes"). The communication set
forth concerns of the Committee with respect to certain actions of the Company
and threatened to cause a notice of default under the indenture covering the
Senior Notes to be issued and other legal action to be taken if the Committee's
concerns were not addressed. On May 5, 2003, counsel for the Committee issued a
press release announcing the Committee's intention to cause a notice of default
to be issued, asserting that certain transactions with the Company's Chairman
and CEO constituted violations of covenants in the Indenture governing the
Senior Notes. On July 2, 2003, the Trustee for the Company's Senior Notes
received a Notice of Default and Acceleration Notice, filed by the Committee.
The Company will assert its position with the Trustee as provided under the
terms of the Indenture and intends to vigorously contest the claims that events
of default have occurred under the Note Indenture. Should it ultimately be
determined that an event of default exists, the Senior Notes could become
currently due and payable. While the final outcome of this matter, including any
potential litigation that it might involve, is inherently uncertain, the Company
does not believe that the Committee will prevail in any attempt to accelerate
the Senior Notes. In the event the Senior Notes are accelerated, however,
cross-default provisions would be triggered in the Company's Credit Facility and
Subordinated Notes, which could result in the Company having to seek protection
from its creditors.
Page 12
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 13 - RELATED PARTY TRANSACTIONS
At December 31, 2000, 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, resulting in a net book value 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 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 at December 29, 2002. In conjunction
with the Company's January 9, 2003 and June 24, 2003 payments of semi-annual
interest to holders of its Subordinated Notes, the Chairman made simultaneous
payments of interest totaling $1.6 million. The carrying value of the New
Chairman Note at June 29, 2003, net of the $11.1 million valuation allowance
established in 2001, was $2.6 million.
NOTE 14 - NEW ACCOUNTING PRONOUNCEMENTS
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 adopted SFAS 143 in the first quarter of fiscal 2003. The
adoption of this standard did not have a material impact on its results of
operations or financial position.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS 146 supersedes Emerging
Issues Task Force ("EITF") Issue 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (Including
Certain Costs Incurred in a Restructuring)". SFAS 146 eliminates the provisions
of EITF 94-3 that required a liability to be recognized for certain exit or
disposal activities at the date an entity committed to an exit plan. SFAS 146
requires a liability for costs associated with an exit or disposal activity to
be recognized when the liability is incurred. SFAS 146 is effective for exit or
disposal activities that are initiated after December 31, 2002. The adoption of
this statement did not have a material adverse impact on the Company's results
of operations or financial position during the six months ended June 29, 2003,
however it may impact the timing of expense recognition as the Company continues
to execute its strategy of reducing debt with proceeds from the sale of assets.
Page 13
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure". SFAS 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, the statement amends the
disclosure requirements of SFAS 123 to require prominent disclosure in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results (see Note 2). The provisions of the statement are effective for
financial statements for fiscal years ending after December 15, 2002. As the
Company accounts for stock-based compensation using the intrinsic value method
prescribed in APB No. 25, "Accounting for Stock Issued to Employee's", the
adoption of SFAS 148 had no impact on the Company's financial condition or
results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity". SFAS
150 changes the classification in the statement of financial position of certain
common financial instruments, with characteristics of both liabilities and
equity, from either equity or mezzanine presentation to liabilities (or assets
in some circumstances) and requires an issuer of those financial statements to
recognize changes in fair value or redemption amount, as applicable, in
earnings. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003, and is otherwise effective at the beginning of the
first interim period beginning after June 15, 2003. The effect of adopting SFAS
150 will be recognized as a cumulative effect of an accounting change as of the
beginning of the period of adoption. Restatement of prior periods is not
permitted. Under the provisions of SFAS 150, the Company's convertible preferred
securities will be classified as a long-term liability. The Company will adopt
SFAS 150 in the third quarter of 2003 and is in the process of completing its
assessment of the impact of adoption of the statement on its consolidated
financial position and results of operations.
In November 2001, the EITF reached a consensus on Issue 01-9, "Accounting
for Consideration Given by a Vendor to a Customer". EITF 01-9 addresses the
recognition, measurement and income statement classification for sales
incentives offered to customers. Sales incentives include discounts, coupons,
free products and generally any other offers that entitle a customer to receive
a reduction in the price of a product. Under EITF 01-9, the reduction in the
selling price of the product resulting from any sales incentives should be
classified as a reduction of revenue. The Company adopted EITF 01-9 in fiscal
2002. Prior to adopting this pronouncement, the Company recognized sales
incentives as restaurant operating expenses. As a result of adopting EITF 01-9,
sales incentives have been classified as a reduction of sales for all periods
presented. Sales incentives were $5.7 million and $7.7 million, respectively,
for the quarter and six months ended June 29, 2003 and $1.2 million and $2.5
million, respectively, for the quarter and six months ended June 30, 2002.
In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". FIN 45 expands the disclosure
requirements to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued.
The Interpretation also clarifies that a guarantor is required to recognize, at
the inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. Certain guarantees, including (i) an
original lessee's guarantee of the lease payments when that lessee remains
secondarily liable in conjunction with being relieved from being the primary
obligor and (ii) a parent's guarantee of a subsidiary's debt to a third party,
and a subsidiary's guarantee of debt owed to a third party by either its parent
or another subsidiary of that parent, are excluded from the provisions related
to liability recognition. These guarantees, however, are subject to the
disclosure requirements of the Interpretation. The liability recognition
provisions of FIN 45 are applicable to guarantee's issued after December 31,
2002. The disclosure requirements of the Interpretation are effective for
financial statements of interim and annual periods ending after December 15,
2002. Historically, the only guarantees issued by the Company relate to lease
guarantees where the Company is no longer the primary obligor and guarantees
between Avado Brands, Inc. and its wholly-owned subsidiaries related to debt
owed to third parties. Currently under such guarantees, the Company could be
liable for lease payments extending through 2017 with minimum lease payments
totaling $46.8 million (see Note 12). The Company does not anticipate issuing
any guarantees which would be required to be recognized as a liability under the
provisions of FIN 45 and thus does not expect this Interpretation to have a
material impact on its results of operations or financial position. The Company
adopted the disclosure requirements of FIN 45 effective for fiscal year ended
December 29, 2002.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." The interpretation provides guidance on
consolidating variable interest entities and applies immediately to variable
interests created after January 31, 2003. The interpretation requires variable
interest entities to be consolidated if the equity investment at risk is not
sufficient to permit an entity to finance its activities without support from
other parties, or if the equity investors lack certain specified
characteristics. Adoption of Interpretation No. 46 did not have a material
impact on the Company's consolidated financial statements.
Page 14
NOTE 15 - 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 June 29, 2003 and June 30, 2002, these partnerships in the
non-guarantor subsidiaries operated 19 and 20 of the Company's restaurants,
respectively. Accordingly, condensed consolidated balance sheets as of June 29,
2003 and December 29, 2002, and condensed consolidated statements of earnings
(loss) and cash flows for the six months ended June 29, 2003 and June 30, 2002
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, 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)
Six Months Ended June 29, 2003
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Guarantor Non-Guarantor
(In thousands) Subsidiaries Subsidiaries Eliminations Consolidated
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Restaurant sales $ 171,991 24,187 - 196,178
Operating expenses 159,318 22,923 - 182,241
General and administrative expenses 10,416 1,104 - 11,520
(Gain) loss on disposal of assets 1,676 2 - 1,678
Asset revaluation and other charges 2,440 - - 2,440
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Operating income (loss) (1,859) 158 - (1,701)
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Other income (expense) (6,390) - - (6,390)
Earnings (loss) before income taxes
for continuing operations (8,249) 158 - (8,091)
Income taxes - - - -
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Earnings (loss) from continuing operations (8,249) 158 - (8,091)
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Loss from discontinued operations (9,983) - - (9,983)
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Net earnings (loss) $ (18,232) 158 - (18,074)
================================================ ================ ================= =============== ================
Condensed Consolidated Statement of Earnings (Loss)
Six Months Ended June 30, 2002
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Guarantor Non-Guarantor
(In thousands) Subsidiaries Subsidiaries Eliminations Consolidated
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Restaurant sales $ 199,213 26,443 - 225,656
Operating expenses 180,666 23,687 - 204,353
General and administrative expenses 11,535 1,197 - 12,732
(Gain) loss on disposal of assets (110) - - (110)
Asset revaluation and other charges 1,824 - - 1,824
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Operating income 5,298 1,559 - 6,857
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Other income (expense) 8,333 - - 8,333
Earnings before income taxes
for continuing operations 13,631 1,559 - 15,190
Income taxes 336 39 - 375
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Earnings from continuing operations 13,295 1,520 - 14,815
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Loss from discontinued operations (5,817) (120) - (5,937)
- ------------------------------------------------ ---------------- ----------------- --------------- ----------------
Net earnings $ 7,478 1,400 - 8,878
================================================ ================ ================= =============== ================
Page 15
Condensed Consolidated Balance Sheet
June 29, 2003
- ------------------------------------------------ ---------------- ----------------- --------------- ---------------
Guarantor Non-Guarantor
(In thousands) Subsidiaries Subsidiaries Eliminations Consolidated
- ------------------------------------------------ ---------------- ----------------- --------------- ---------------
ASSETS
Current assets $ 15,268 840 - 16,108
Premises and equipment, net 163,060 23,048 - 186,108
Deferred income tax benefit 11,620 - - 11,620
Other assets 31,307 18 - 31,325
Intercompany advances 12,370 - (12,370) -
Intercompany investments 11,415 - (11,415) -
- ------------------------------------------------ ---------------- ----------------- --------------- ---------------
$ 245,040 23,906 (23,785) 245,161
================================================ ================ ================= =============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities $ 100,896 121 - 101,017
Long-term liabilities 158,770 - - 158,770
Intercompany payables - 12,370 (12,370) -
Convertible preferred securities 3,179 - - 3,179
Shareholders' equity (deficit) (17,805) 11,415 (11,415) (17,805)
- ------------------------------------------------ ---------------- ----------------- --------------- ---------------
$ 245,040 23,906 (23,785) 245,161
================================================ ================ ================= =============== ===============
Condensed Consolidated Balance Sheet
December 29, 2002
- ------------------------------------------------ ---------------- ----------------- --------------- ---------------
Guarantor Non-Guarantor
(In thousands) Subsidiaries Subsidiaries Eliminations Consolidated
- ------------------------------------------------ ---------------- ----------------- --------------- ---------------
ASSETS
Current assets $ 23,255 800 - 24,055
Premises and equipment, net 213,130 23,820 - 236,950
Deferred income tax benefit 11,620 - - 11,620
Other assets 28,652 18 - 28,670
Intercompany advances 12,370 - (12,370) -
Intercompany investments 12,131 - (12,131) -
- ------------------------------------------------ ---------------- ----------------- --------------- ---------------
$ 301,158 24,638 (24,501) 301,295
================================================ ================ ================= =============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities $ 131,540 137 - 131,677
Long-term liabilities 166,174 - - 166,174
Intercompany payables - 12,370 (12,370) -
Convertible preferred securities 3,179 - - 3,179
Shareholders' equity (deficit) 265 12,131 (12,131) 265
- ------------------------------------------------ ---------------- ----------------- --------------- ---------------
$ 301,158 24,638 (24,501) 301,295
================================================ ================ ================= =============== ===============
Page 16
Condensed Consolidated Statement of Cash Flows
Six Months Ended June 29, 2003
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Guarantor Non-Guarantor
(In thousands) Subsidiaries Subsidiaries Eliminations Consolidated
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Net cash provided by (used in) operating activities $ (18,681) 993 - (17,688)
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Cash flows from investing activities:
Capital expenditures (4,213) (439) - (4,652)
Proceeds from disposal of assets and notes
receivable, net 3,486 - - 3,486
Proceeds from sale-leaseback 20,000 - - 20,000
Other net (685) - - (685)
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Net cash provided by (used in) investing activities 18,588 (439) - 18,149
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Cash flows from financing activities:
Proceeds from revolving credit agreements 5,191 - - 5,191
Repayment of term credit agreement (12,736) - - (12,736)
Payment of financing costs (4,568) - - (4,568)
Purchase of long-term debt (5,195) - - (5,195)
Principal payments on long-term debt (45) - - (45)
Proceeds from (payment of) intercompany
advances 554 (554) - -
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Net cash provided by (used in) financing activities (16,799) (554) - (17,353)
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Cash provided by (used in) discontinued operations 16,544 - - 16,544
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Net increase (decrease) in cash and cash equivalents (348) - - (348)
Cash and equivalents at the beginning of the period 607 29 - 636
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Cash and equivalents at the end of the period $ 259 29 - 288
==================================================== ================ ================= =============== ==============
Condensed Consolidated Statement of Cash Flows
Six Months Ended June 30, 2002
- ---------------------------------------------------- ---------------- ----------------- --------------- ----------------
Guarantor Non-Guarantor
(In thousands) Subsidiaries Subsidiaries Eliminations Consolidated
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Net cash provided by (used in) operating activities $ (27,692) 2,250 - (25,442)
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Cash flows from investing activities:
Capital expenditures (2,759) (350) - (3,109)
Proceeds from disposal of assets and notes
receivable, net 5,639 - - 5,639
Other net (912) - - (912)
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Net cash provided by (used in) investing activities 1,968 (350) - 1,618
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Cash flows from financing activities:
Proceeds from revolving credit agreements 18,127 - - 18,127
Proceeds from term credit agreements 12,898 - - 12,898
Payment of financing costs (8,502) - - (8,502)
Purchase of long-term debt (5,584) - - (5,584)
Principal payments on long-term debt (13) - - (13)
Settlement of interest rate swap agreement (1,704) - - (1,704)
Reduction in letter of credit collateral 9,978 - - 9,978
Proceeds from (payment of) intercompany
advances 1,780 (1,780) - -
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Net cash provided by (used in) financing activities 26,980 (1,780) - 25,200
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Cash provided by (used in) discontinued operations (881) (120) - (1,001)
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Net increase (decrease) in cash and cash equivalents 375 - - 375
Cash and equivalents at the beginning of the period 530 29 - 559
- ---------------------------------------------------- ---------------- ----------------- --------------- --------------
Cash and equivalents at the end of the period $ 905 29 - 934
==================================================== ================ ================= =============== ==============
Page 17
NOTE 16 - EARNINGS PER SHARE INFORMATION
The following table presents a reconciliation of weighted average shares
and earnings per share amounts (amounts in thousands, except per share data):
(In thousands, except per share data) Quarter Ended Six Months Ended
- -------------------------------------------------------------------------------------------------------------------
June 29, June 30, June 29, June 30,
2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Average number of common shares used in basic calculation 33,104 30,110 33,103 29,560
Effect of dilutive stock options - * 988 - * 895
Shares issuable on assumed conversion of convertible
preferred securities - * 3,207 - * - *
------------------------------------------------------------------------------------------------------------------
Average number of common shares used in diluted calculation 33,104 34,305 33,103 30,455
==================================================================================================================
Earnings (loss) from continuing operations $ (310) 19,604 (8,091) 14,815
Earnings (loss) from discontinued operations 37 (5,008) (9,983) (5,937)
- -------------------------------------------------------------------------------------------------------------------
Net earnings (loss) (273) 14,596 (18,074) 8,878
Distribution savings on assumed conversion of convertible
preferred securities, net of income taxes - * 728 - * - *
- -------------------------------------------------------------------------------------------------------------------
Net earnings (loss) for computation of diluted earnings per
common share $ (273) 15,324 (18,074) 8,878
===================================================================================================================
- -------------------------------------------------------------------------------------------------------------------
Basic earnings (loss) per common share from continuing operations $ (0.01) 0.65 (0.25) 0.50
Basic loss per common share from discontinued operations 0.00 (0.17) (0.30) (0.20)
- -------------------------------------------------------------------------------------------------------------------
Basic earnings (loss) per common share $ (0.01) 0.48 (0.55) 0.30
===================================================================================================================
- -------------------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per common share from continuing opperations $ (0.01) 0.59 (0.25) 0.49
Diluted loss per common share from discontinued operations 0.00 (0.14) (0.30) (0.20)
- -------------------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per common share $ (0.01) 0.45 (0.55) 0.29
===================================================================================================================
* Inclusion of 727,044 and 434,216 shares issuable pursuant to employee
stock option plans would have resulted in a decrease to loss per share for the
quarter and six months ended June 29, 2003, respectively. As those shares are
antidilutive, they are excluded from the computation of diluted loss per share.
Inclusion of 214,944 shares for the quarter and six months ended June 29, 2003
and 3,757,224 shares for the six months ended June 30, 2002 related to the
Convertible Preferred Securities would have resulted in a decrease to loss per
share and an increase to earnings per share in each respective period. As those
shares are antidilutive, they are excluded from the computation of diluted
earnings (loss) per share.
Page 18
Item 2.
AVADO BRANDS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the Second Quarter and Six Months Ended June 29, 2003
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, expenses and related assets and liabilities of 11 Don Pablo's
restaurants and one Hops restaurant which were closed during the first half of
2003, plus 11 additional Don Pablo's restaurants and eight additional Hops
restaurants which were closed in 2002, as discontinued operations for all
periods presented in the accompanying consolidated financial statements. The
revenues, expenses and related assets and liabilities of Canyon Cafe, which has
been divested with the exception of two locations that are held for sale, have
not been classified as discontinued operations in the accompanying consolidated
financial statements. As the decision to divest the operations of Canyon Cafe
was made prior to the implementation of SFAS 144 and it did not meet the
criteria for classification as discontinued operations under the 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", it is required to be classified
within continuing operations under the provisions of SFAS 121.
Restaurant Sales
Restaurant sales for the second quarter and six months ended June 29, 2003
were $99.8 million and $196.2 million, respectively, compared to $111.3 million
and $225.7 million for the corresponding periods of 2002. Declining revenues
were primarily due to the divestiture of Canyon Cafe which was substantially
completed in the fourth quarter of 2002 and a decrease in same-store sales at
Don Pablo's and Hops. Sales were adversely impacted during the first half of
2003 by the Company's limited ability to market during the first quarter, as
well as the war in Iraq and a generally sluggish economy. The revenues and
expenses related to 11 Don Pablo's restaurants and one Hops restaurant which
were closed during the first half of 2003, plus 11 additional Don Pablo's
restaurants and eight Hops restaurants which were closed in 2002, have been
included in discontinued operations for all periods presented in the
accompanying consolidated statements of earnings (loss) and consolidated
statements of cash flows. Same-store sales for the second quarter of 2003
decreased by 2.0% at Don Pablo's and 7.9% at Hops as compared to the
corresponding period of the prior year (same-store sales comparisons included
all restaurants classified as continuing operations and open for 18 months as of
the beginning of 2003). On a year-to-date basis, same-store sales decreased by
4.5% at Don Pablo's and 12.5% at Hops.
EITF 01-9, "Accounting for Consideration Given by a Vendor to a Customer",
addresses the recognition, measurement and income statement classification for
sales incentives offered to customers. Sales incentives include discounts,
coupons, free products and generally any other offers that entitle a customer to
receive a reduction in the price of a product. Under EITF 01-9, the reduction in
the selling price of the product resulting from any sales incentives should be
classified as a reduction of revenue. The Company adopted EITF 01-9 in fiscal
2002. Prior to adopting this pronouncement, the Company recognized sales
incentives as restaurant operating expenses. As a result of adopting EITF 01-9,
sales incentives have been classified as a reduction of sales for all periods
presented. Sales incentives were $5.7 million and $7.7 million, respectively,
for the quarter and six months ended June 29, 2003 and $1.2 million and $2.5
million, respectively, for the quarter and six months ended June 30, 2002.
Page 19
Operating Expenses
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 restaurants for the quarter and six month periods ended June 29, 2003
and June 30, 2002.
- ----------------------------------------- ----------------- ---------------- ----------------- ----------------
Quarter Quarter Six Months Six Months
Ended Ended Ended Ended
June 29, 2003 June 30, 2002 June 29, 2003 June 30, 2002
- ----------------------------------------- ----------------- ---------------- ----------------- ----------------
Restaurant sales:
Canyon Cafe 0.6 % 6.6 % 1.1 % 6.7 %
Don Pablo's 60.8 % 55.7 % 59.9 % 54.6 %
Hops 38.6 % 37.6 % 39.0 % 38.8 %
- ----------------------------------------- ----------------- ---------------- ----------------- ----------------
Total restaurant sales 100.0 % 100.0 % 100.0 % 100.0 %
- ----------------------------------------- ----------------- ---------------- ----------------- ----------------
Operating expenses:
Food and beverage 30.5 % 28.2 % 29.6 % 28.4 %
Payroll and benefits 34.8 % 33.2 % 34.7 % 33.0 %
Depreciation and amortization 3.6 % 3.1 % 3.6 % 3.1 %
Other operating expenses 24.6 % 25.7 % 25.0 % 26.1 %
General and administrative expenses 5.5 % 5.8 % 5.9 % 5.6 %
Loss (gain) on disposal of assets 0.0 % 0.4 % 0.9 % 0.0 %
Asset revaluation and other charges 0.5 % 1.1 % 1.2 % 0.8 %
- ----------------------------------------- ----------------- ---------------- ----------------- ----------------
Total operating expenses 99.6 % 97.5 % 100.9 % 97.0 %
- ----------------------------------------- ----------------- ---------------- ----------------- ----------------
Operating income (loss) 0.4 % 2.5 % (0.9)% 3.0 %
- ----------------------------------------- ----------------- ---------------- ----------------- ----------------
Food and beverage costs and payroll and benefits increased, as a percentage
of sales, over the comparable periods of the prior year primarily as a result of
expenses associated with an increase in discounted sales. As a result of
adopting EITF 01-9, sales incentives have been classified as a reduction of
sales for all periods presented. Such sales incentives were $5.7 million and
$7.7 million, respectively, for the quarter and six months ended June 29, 2003
compared to $1.2 million and $2.5 million, respectively, for the quarter and six
months ended June 30, 2002. Additionally, food and beverage costs were
negatively impacted during the second quarter of 2003 by increases in produce
and beef prices.
Other operating expenses for both the quarter and six months ended June 29,
2003 decreased, as a percentage of sales, by 1.1% over the comparable period of
the prior year. The decrease was primarily due to a decrease in marketing
expenses generated by a shift in the Company's marketing strategy from more
expensive broadcast media to focused discount offers which, in accordance with
EITF 01-9 are recorded as a reduction of revenue. Decreased other operating
expenses in the second quarter of 2003 were somewhat offset by increased rent
expense associated with the Don Pablo's sale-leaseback.
General and Administrative Expenses
General and administrative expenses decreased by $0.9 million for the
quarter ended June 29, 2003 compared to the quarter ended June 30, 2002 and
decreased as a percent of sales to 5.5% from 5.8% despite declining sales
volumes and sales reclassifications required by EITF 01-9. The reduction in
general and administrative expenses is largely due to savings realized from the
relocation and consolidation of the Hops office to Madison, Georgia.
Loss (Gain) on Disposal of Assets
Loss on disposal of assets of $1.7 million for the six months ended June
29, 2003, primarily reflects losses related to the sale of 15 Don Pablo's
restaurants included in the Company's Don Pablo's sale-leaseback transaction
which occurred during the first quarter.
Gain on disposal of assets of $0.1 million for the six months ended June
30, 2002 reflects an adjustment to amounts receivable from the divestiture of
McCormick & Schmick's which was offset by fees incurred in connection with the
first quarter termination of the Company's interest rate swap agreement and a
loss incurred on the sale of a closed Canyon Cafe location.
Page 20
Asset Revaluation and Other Charges
For the six months ended June 29, 2003, asset revaluation and other charges
of $2.4 million include non-cash asset impairment charges of $0.8 million
recorded to reduce the carrying value of the assets of the Company's remaining
Canyon Cafe locations and two Don Pablo's restaurants to estimated fair value
and $1.6 million in other charges primarily related to costs associated with the
relocation of the Hops corporate office to Madison, Georgia.
Asset revaluation and other charges of $1.8 million for the six months
ended June 30, 2002 reflect a non-cash asset impairment charge of $0.7 million
to reduce the carrying value of the assets of the Company's Canyon Cafe
restaurants to estimated fair value and the write-off of $1.1 million in various
capitalized costs associated with sites that are no longer expected to be
developed and related development costs which are not anticipated to be fully
recoverable.
Interest and Other Expenses
Net interest expense for the second quarter and six months ended June 29,
2003 was $6.9 million and $19.4 million, respectively, compared to $8.1 million
and $16.3 million for the corresponding periods of the prior year. The reduction
in interest expense for the second quarter ended June 29, 2003 reflected the
elimination of interest expense related to outstanding Senior and Subordinated
Notes repurchased by the Company and a reduction in outstanding borrowings on
the Company's credit facility compared to the prior year. These decreases were
somewhat offset by the write off of $0.9 million of deferred loan costs related
to the $9.0 million commitment reduction of the Company's Credit Facility. The
increase in interest expense for the six months ended June 29, 2003 included
$6.5 million in deferred loan costs which were charged to interest expense as a
result of the Company's March 25, 2003 termination of its previously existing
credit agreement. Interest expense for the six months ended June 30, 2002
included unfavorable mark-to-market adjustments under a fixed-to-floating
interest rate swap agreement, which was terminated on March 25, 2002, and
increased interest charges incurred related to past due sales and use, property
and other taxes.
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 1,307,591 of the securities into 4,419,478 shares of
common stock during 2002, 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 2002, 1,200,391 shares were converted in conjunction with this
distribution payment.
During the second quarter and six months ended June 29, 2003, other income
was recognized primarily as a result of the abatement of previously incurred tax
penalties and the reversal of a liability previously established for unclaimed
gift cards. For the six months ended June 30, 2002, other expenses related
primarily to the incurrence of various tax penalties.
No income tax benefit was recorded related to the loss before income taxes
for the first half of 2003. The tax rate is based on the Company's expected rate
for the full fiscal 2003 year.
Discontinued Operations
As discussed in Note 1 - Basis of Presentation, discontinued operations
includes the revenues and expenses of 11 Don Pablo's and one Hops restaurant
which were closed in the first half of 2003, plus 11 additional Don Pablo's
restaurants and eight additional Hops restaurants which were closed during 2002.
The decision to dispose of these 31 locations reflects the Company's ongoing
process of evaluating the performance and cash flows of its various restaurant
locations and using the proceeds from the sale of closed restaurants to reduce
outstanding debt.
Net earnings (loss) and operating income (loss) from discontinued
operations for the quarter and six months ended June 29, 2003, of $0.0 million
and $(10.0) million, respectively, were the same, as no income tax benefit has
been provided. These amounts primarily reflect losses on the disposal of closed
restaurants. Total restaurant sales from discontinued operations were $0.5
million and $3.5 million, respectively, for the quarter and six months ended
June 29, 2003.
Page 21
Net loss from discontinued operations for the quarter and six months ended
June 30, 2002 of $5.0 and $5.9 million (for which no tax benefit has been
provided), respectively, primarily reflect asset revaluation and other charges
related to the closure of restaurants. Operating losses were $4.8 million and
$5.9 million for the quarter and six months, respectively, on total restaurant
sales from discontinued operations of $10.6 million and $22.0 million,
respectively.
Liquidity and Capital Resources
The Company has suffered from recurring losses from operations, has an
accumulated deficit and its credit facility is due March 24, 2004, all of which
raise substantial doubt about the Company's ability to continue as a going
concern. Sufficient liquidity to make required debt service and lease payments
is dependent primarily on the realization of cash flow from operations and
proceeds from the sale of assets. There can be no assurance that such cash flow
and proceeds will be realized.
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 accrued
liabilities occurred during the first half of 2003 primarily as a result of
interest payments made on the Company's Senior and Subordinated Notes.
On March 24, 2003, the Company obtained new financing which included a
$39.0 million revolving credit facility (the "Credit Facility") and a $20.0
million sale-leaseback transaction covering 15 Don Pablo's locations (the "Don
Pablo's sale-leaseback"). Proceeds from the new financing were used to pay
amounts outstanding under the Company's previously existing credit agreement
totaling $19.5 million and fees associated with the new financing agreements
totaling $4.6 million.
The Credit Facility limits total borrowing capacity at any given time to an
amount equal to the lesser of $39.0 million or 1.95 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 as
defined in the agreement. A portion of the facility, totaling $17.0 million, was
restricted for the purchase of the Company's 9.75% Senior Notes due 2006
("Senior Notes") and 11.75% Senior Subordinated Notes due June 2009
("Subordinated Notes"). The agreement limited the amount the Company could pay
to acquire Senior Notes and Subordinated Notes to $0.50 and $0.30 per one dollar
outstanding, respectively. In accordance with the agreement, the unused
availability under the restricted portion of the facility terminated on May 31,
2003. The Credit Facility matures on March 24, 2004 but may be extended for one
year at the lender's option and subject to an extension fee equal to five
percent of the total commitment amount. In certain circumstances, borrowings
under the Credit 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 (other than Assets Held for Sale as defined in the agreement),
casualty events and tax refunds, 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 liquidity. The loan is secured by substantially all of the Company's
assets.
During the second quarter of 2003, the Company executed three separate
amendments to the Credit Facility which among other things made certain
technical changes to the agreement and allowed the Company to borrow $2.4
million under the $17.0 million restricted portion of the facility to buy out
the Company's master equipment lease. The remaining unused portion of the
facility was terminated, reducing the maximum commitment under the Credit
Facility from $39.0 million to $30.0 million.
At June 29, 2003, $8.8 million in cash borrowings were outstanding under
the Credit Facility and an additional $12.5 million of the facility was utilized
to secure letters of credit which primarily secure the Company's insurance
programs. Also outstanding at June 29, 2003 was $8.0 million which was borrowed
under the restricted portion of the facility to acquire $11.2 million in face
value of the Company's Senior Notes and buy out the Company's master equipment
lease. The total Credit Facility availability was also reduced by lender
reserves of $0.3 million. At June 29, 2003, $0.4 million of the facility
remained unused and available.
Page 22
The terms of the Credit Facility, the Company's Senior Notes and
Subordinated Notes, the Don Pablo's sale-leaseback, and the 2000 Hops
sale-leaseback (See Note 11) 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. During the second
quarter of 2003, the Company terminated its previously existing master equipment
lease thereby eliminating any financial covenants or restrictions related to the
lease. At June 29, 2003, the Company was in compliance with the requirements
contained in the Credit Facility, the Don Pablo's sale-leaseback and terms of
the Senior Notes and Subordinated Notes. The Company was not in compliance with
a net worth requirement contained in its 2000 Hops sale-leaseback agreement. The
lessor, however, has waived this requirement until March 31, 2004 at which time
the minimum net worth requirement will be $150.0 million. It is unlikely that
the Company will be in compliance with the $150.0 million net worth requirement
on March 31, 2004. In addition, there is substantial doubt that the Company will
be able to maintain compliance with certain of the financial covenant
requirements contained in its Credit Facility for the twelve-month period ended
September 28, 2003. Although the outcome is uncertain, the Company believes it
will be able to obtain waivers of these defaults or amendments to the
agreements.
In the event the Company is not able to meet its financial covenant targets
under the Credit Facility, an event of default would occur. An event of default
would entitle the lender to, among other things, declare all obligations
immediately due and payable. In the event the amounts due 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 June 29, 2003, the outstanding
balances of the Senior Notes and Subordinated Notes were $105.3 million and
$47.6 million, respectively. An event of default under the Credit Facility would
not result in a cross-default under the Company's two sale-leaseback agreements.
In the event some or all of the obligations under the Company's financing
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.
On July 2, 2003, the Trustee for the Company's Senior Notes received a
Notice of Default and Acceleration Notice, filed by holders representing a
majority of the Company's outstanding Senior Notes. The Company will assert its
position with the Trustee as provided under the terms of the Indenture and
intends to vigorously contest the claims that events of default have occurred
under the Note Indenture. Should it ultimately be determined that an event of
default exists, the Senior Notes could become currently due and payable. In the
event the Senior Notes are accelerated, cross-default provisions would be
triggered in the Company's Credit Facility and Subordinated Notes (See Note 12).
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 $11.2 million in face value of its outstanding Senior Notes during the second
quarter of 2003 and $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
repurchases, the Company's semi-annual interest payments total approximately
$7.9 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. The Company
utilized these provisions with respect to its June 2003 interest payments, June
and December 2002 interest payments and June and December 2001 interest
payments. The Company's ability to make its December 2003 interest payments is
dependent on the outcome of its initiatives to generate cash flow from
operations and sell assets.
Principal financing sources in the first half of 2003 consisted of (i)
proceeds of $20.0 million from the Don Pablo's sale-leaseback, (ii) cash
provided by discontinued operations, primarily related to the sale of assets, of
$16.5 million, and (iii) other proceeds from the sale of assets of $3.5 million.
The primary uses of funds consisted of (i) net cash used in operations of $17.7
million which included interest payments of $19.5 million primarily related to
the Senior and Subordinated Notes and Credit Facility along with operating lease
payments of $10.6 million, (ii) net repayments of credit agreements of $7.5
million, (iii) repurchase of long-term debt of $5.2 million, (iv) capital
expenditures of $4.7 million primarily related to the second quarter buyout of
the Company's master equipment lease, and (v) payment of financing costs related
to the Credit Facility and Don Pablo's sale-leaseback totaling $4.6 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 have any contractual
obligations to open any new restaurants during 2003. Capital expenditures for
existing restaurants are expected to be approximately $2.0 million to $3.0
million during the second half of 2003.
Page 23
The Company is also exposed to certain contingent payments. In connection
with the Applebee's and Canyon Cafe divestiture transactions, the Company
remains contingently liable for lease obligations relating to 86 Applebee's
restaurants and eleven Canyon Cafe 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 $41.5 million. The Company also remains contingently
liable for lease obligations relating to seven Harrigan's restaurants which were
divested in 1999. Minimum lease payment obligations for those seven restaurants
total $5.3 million and extend through 2012. On March 14, 2003, Harrigan's filed
a bankruptcy petition under Chapter 11 of the Unites States Bankruptcy Code.
Harrigan's is continuing to operate under Chapter 11 and the Company has not
been notified of any intent by the respective landlords to hold the Company
liable for lease obligations pertaining to any of the seven locations. However,
the reorganization of Harrigan's under bankruptcy has not been finalized and
there can be no assurances that the Company will not ultimately be held liable
for some or all of the Harrigan's leases under the plan of reorganization.
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. The Company's deductibles
for workers' compensation and general liability are $500,000 per claim. Losses
in excess of these risk retention levels are covered by insurance which
management considers as adequate. Provision for losses expected under these
programs are recorded based upon estimates of the liability for claims incurred.
Such estimates are based on management's evaluation of the nature and severity
of claims and expected losses based on the Company's historical experience,
information provided by the Company's third party administrators and certain
actuarial assumptions used by the insurance industry. In the first half of 2003,
claims paid under the Company's self-insurance programs totaled $2.3 million. In
addition, at June 29, 2003, the Company was contingently liable for letters of
credit aggregating approximately $12.5 million, relating primarily to its
insurance programs. 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's 1998 Federal income tax returns are currently being audited
by the Internal Revenue Service ("IRS"). The Company believes its recorded
liability for income taxes of $35.6 million as of June 29, 2003 is adequate to
cover its exposure that may result from the ultimate resolution of the audit.
During the first quarter of 2003, the Company submitted an Offer in Compromise
to the IRS whereby the Company offered to settle its potential obligations at a
discounted amount. The Offer in Compromise process is a mechanism available to
taxpayers to potentially reduce amounts otherwise payable to the IRS based on
analysis of a taxpayer's ability to pay, the value of its assets versus its
liabilities and other economic factors. Although the ultimate outcome of the
audit or the Offer in Compromise cannot be determined at this time, the Company
does not have sufficient liquidity to pay any significant portion of its
recorded liability if resolution of the audit 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 primarily from the first quarter relocation of its Hops
corporate headquarters 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 and lease agreements and capital
expenditures necessary to maintain its existing restaurants. For the near term,
cash flow from operations will need to be supplemented by asset sales. 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 debt and lease obligations. In addition, there is no
assurance the Company will be able to comply with the financial covenants of its
debt and lease agreements.
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.
Page 24
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 future compliance
with debt covenants; 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.
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. The Company's exposure to interest rate risk
relates primarily to Libor-based rate obligations on the Company's revolving
credit 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
As of June 29, 2003 and 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 as defined in the federal securities laws.
Based on that evaluation, the Company's Chief Executive Officer and Chief
Financial Officer have concluded that the Company's disclosure controls and
procedures were effective as of the date of that evaluation. However, the design
of any system of controls is based in part upon certain assumptions about the
likelihood of future events, and although the Company's disclosure controls and
procedures have been designed to provide reasonable assurance that the goals of
such control system will be met, there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions,
regardless of how remote.
Page 25
Part II. Other Information
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of shareholders was held on May 7, 2003, at which the
following proposals were voted upon by shareholders: (1) the election of six
members to the Board of Directors, (2) the approval of an amendment to the
Company's 1995 Stock Incentive Plan and (3) the ratification of the selection of
KPMG LLP as the Company's independent auditors.
Each of the six members of the Company's Board of Directors was elected to
serve a term of one year and until his or her successor is elected, and has
qualified by the following votes:
Affirmative Negative
------------- ------------
Tom E. DuPree, Jr. 27,756,021 902,104
Margaret E. Waldrep 27,789,761 868,364
Emilio Alvarez-Recio 27,846,746 811,379
Jerome A. Atkinson 27,847,774 810,351
William V. Lapham 27,895,785 762,340
Robert Sroka 27,850,511 807,614
The remaining proposals, voted on at the May 7, 2003 annual meeting of
shareholders, were approved as follows:
Affirmative Negative Abstaining
----------- -------- ----------
Amendment to the Company's 1995
Stock Incentive Plan 27,849,763 660,933 147,429
Appointment of KPMG LLP 28,559,540 71,174 27,411
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
99.1 Safe Harbor Under the Private Securities Litigation Reform Act of
1995. (1)
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
(1) Incorporated by reference to the corresponding exhibit to the Company's
Quarterly Report on Form 10-Q for the quarter ended April 2, 2000.
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(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K, dated May 5, 2003, which
furnished, pursuant to Item 9, the Company's first quarter earnings press
release, dated May 2, 2003.
The Company filed a Current Report on Form 8-K, dated May 6, 2003, which
disclosed, pursuant to Item 5, certain documents related to a Promissory Note
dated March 6, 2003 by Tom E. DuPree, Jr., the Chairman of the Board and Chief
Executive Officer of the Company, in favor of the Company. Also furnished,
pursuant to Item 9, was a press release issued by the Company with respect to
debt covenant compliance.
The Company filed a Current Report on Form 8-K, dated June 25, 2003, which
disclosed, pursuant to Item 5, a second amendment, dated May 23, 2003, and third
amendment, dated June 12, 2003, to the Company's Third Amended and Restated
Credit Agreement, dated March 21, 2003. Also furnished, pursuant to Item 9, was
a press release, dated June 25, 2003, issued by the Company updating various
business initiatives.
The Company filed a Current Report on Form 8-K, dated July 1, 2003, which
disclosed, pursuant to Item 5, the Company's receipt of a copy of a Notice of
Default and Acceleration Notice, purportedly also delivered to the Trustee of
the Company's 9.75% Senior Notes due June 2006, by certain holders of the Senior
Notes. The Company filed a Current Report on Form 8-K, dated July 1, 2003, which
furnished, pursuant to Item 9, a press release, dated July 1, 2003, issued by
the Company commenting on claims, seeking payment acceleration, made by certain
noteholders of the Company.
Page 27
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: August 12, 2003 /s/Louis J. Profumo
------------------------
Louis J. Profumo
Chief Financial Officer
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